The Ontario Municipal Employees Retirement System has posted a 10-per-cent return for 2012, slightly above its benchmark, with private equity and real estate investments more than making up for losses in the oil and gas sector.

But, as with many pension funds, OMERS is still feeling the impact of the investment losses it racked up when the financial crisis hit. The estimate of all of the payments that its members will be entitled to is $10-billion higher than the actuarial measure of OMERS’ net assets.

“This deficit is based on a long-term projection going out several decades and in no way reflects our ability to pay pensions in the short term,” OMERS chief financial officer Patrick Crowley stated in a press release.

“Solid investment returns which have averaged 8.9 per cent per year in the four years since the financial crisis, and 8.24 per cent over the past 10 years, combined with contribution increases, are already having a positive impact on reducing the deficit,” he added. “Sustained returns at this level could bring the plan back to fully funded status earlier than anticipated.”

The fund collected $3.2-billion in contributions during 2012 and paid out $2.7-billion in benefits. Its net assets rose by $5.7-billion to $60.8-billion.

Its capital markets arm, which manages its publicly-traded investments such as stocks and bonds, posted a return of 7.5 per cent.

Its private market portfolio posted a 13.8 per cent return. Within that portfolio private equity investments returned 19.2 per cent, real estate (managed by its real estate business Oxford Properties) 16.9 per cent, and infrastructure 12.7 per cent. But its “strategic investments,” which are largely in the oil and gas sector, posted a return of negative 10.1 per cent because of falling oil and gas prices in 2012.

During a press conference OMERS CEO Michael Nobrega said the pension fund is now seeing a flood of opportunities to acquire oil and gas properties in Saskatchewan and Alberta, with junior oil and gas firms unable to finance.

“We’ve had more opportunities in the last two weeks than we’ve had in three years,” he said.

OMERS is in the midst of rebalancing its portfolio away from stocks and bonds towards more private market investments. Its goal is to ultimately have about 53 per cent of its assets in the public markets, and 47 per cent private. At the end of the year it had 60 per cent in public markets and 40 per cent in private, compared to 82 and 18 per cent, respectively, nine years ago.

About 88 per cent of the fund is now managed by OMERS employees, as opposed to external fund managers, up from 74 per cent five years ago, and OMERS is trying to take that figure to 95 per cent.

Canadian pension fund OMERS said on Friday it wants to diversify beyond its traditional strongholds in North America, Britain and Western Europe, but will remain focused on property, healthcare, infrastructure and energy assets as it seeks deals around the world.

OMERS, which manages the pension plan for Ontario's public-sector municipal workers and has become a global dealmaker by virtue of its deep pockets, said it is just looking for the right opportunities based on risk and reward.

"We'll be highly focused in terms of the sectors we're looking at. We have investments in energy, large infrastructure projects on a world-wide basis, in healthcare and in pipelines, and we'll continue to look for those kinds of opportunities around the world for the right risk-return," OMERS chief financial officer Patrick Crowley said in an interview.

"I don't think we want to restrict ourselves to any one particular jurisdiction -- we have a large fund and we're very active and we want to get the best return for our members."

OMERS has been a major buyer of private market assets for more than a decade, accelerating the pace of acquisitions after the onset of the global economic crisis of 2008-09.

It said Friday it notched a 10 percent return on investments in 2012 as its private equity, property and infrastructure portfolios made strong gains, offsetting losses on its investment in Alberta's oil and gas sector.

Net assets at the fund grew to C$60.8 billion last year from C$55.1 billion at the end of 2011.

"The C$5.7 billion increase in our net assets demonstrates the strength and robustness of OMERS business model with the capacity to generate growing investment cash yields and more than ample liquidity to withstand market shocks under stressed financial conditions," Michael Nobrega, OMERS president and chief executive, said in a statement.

The Toronto-based pension plan also said it rang up returns of 19.2 percent in OMERS Private Equity, 16.9 percent in Oxford Properties, 12.7 percent in Borealis Infrastructure and 7.5 percent in capital markets.

A negative 10.1 percent return in OMERS Strategic Investments, which represents less than 3 percent of OMERS net investments, was due to year-end valuations of its principal assets in Alberta's energy sector as oil and gas prices fell to their lowest levels in five years.

Crowley said he expects that investment to pay off down the road, as OMERS benefits from the patience and long investment horizon that competitors may not enjoy.

"This is an investment where the gas and the oil is still in the ground, we have the properties, we valued those properties based on forecasts of prices for next three to four years, but we believe longer-term this remains a very good investment, and it is something we're still committed to," Crowley said.

"Not only Alberta but also this sector, and we think this could be a big opportunity for us to take advantage of people who may not have liquidity to stay in the business."

The 2012 total investment return of 10 percent far outpaced the 3.2 percent return in 2011 and edged out the plan's benchmark return of 9.75 percent, the fund said.

OMERS said it was still working to overcome investment losses in 2008 stemming from the global financial crisis. Its five-year annualized rate of return is 3.56 percent, while its 10-year rate of return is 8.24 percent. In the last four years since the financial crisis, the plan has notched an 8.9 percent investment return.

Crowley said OMERS, which competes with sovereign wealth funds as well as other big pension funds for acquisitions and investment deals globally, would continue to rely on partnerships to minimize investment risks in equity deals that require "quite large" checks to be written.

"We've looked at bringing in people to co-invest along side with us, and that has worked out reasonably well," said Crowley, pointing to its move last year to team up with Japan's pension funds and some major conglomerates to form the world's largest infrastructure fund to invest in assets such as roads and airports with greater agility.

"If you have that in place you can take advantage of opportunities faster, more efficiently, and there is not as much negotiation among yourselves as to what you are going to bid, because all of that is settled up front. That is the advantage of this type of arrangement," said Crowley.

The partnership has been seen as an unprecedented effort to cut out asset managers as middle men in infrastructure investment and compete head-to-head with the handful of the world's biggest funds that have the capacity to lead their own investments in infrastructure assets.

OMERS Strategic Investments, which represents less than two and a half per cent of OMERS net investments, has its principal assets in Alberta’s oil and gas sector. The year-end valuation of these assets was negatively impacted as oil and gas prices fell to their lowest levels in five years. 

The numbers on the performance of the country’s balanced funds are preliminary, but clients of two firms — Connor Clark & Lunn and HughesLittle — have reason to be well pleased with their investment manager in 2012.

Based on data compiled by API Asset Performance Inc., the two managers posted returns of 16.6% and 16% respectively last year, making them the only two to post one year gains of at least 16%. (The Signature Enhanced Yield Fund, managed by CI was close: it was up by 15.7%.)

That performance by CC&L’s High Income Fund and by HughesLittle’s Balanced Fund – gave them a top quartile ranking in the 90-plus institutional balanced funds surveyed by API. To be ranked in the first quartile a return of at least 10.7% was required.

The two-star performing firms are no stranger to generating impressive results: over the past one, two and four years the two funds have been in the top quartile. Over two and four years, on an annual basis, CC&L is up by 11.5% and 19.0% respectively; over the same two time periods HughesLittle was up by 14.1% and 15.8% respectively.

For 2012, the preliminary results for the institutional balanced funds indicate that the median manager generated a return of 8.8% gross of management fees. In a note, API said that “the 8.8% median return generated for the year is welcome news for pension funds with typical liability discount rates between 4.5% and 6.5%”.

At 8.8%, the return for the media manager was 110 basis points higher than the 7.7% generated by the API Balanced Passive Index. According to API, its balanced passive index “weights asset class market indexes on the average asset mix of institutional managers, and can be viewed as a low cost alternative to active management.” The result is also an argument for active manager, API argues given that “the average fee for a $100-million balanced fund is below 0.5%.”

API’s numbers show that over the past one, two and four years, its balanced passive index generated a performance good enough for a fourth, third and third quartile ranking, which is presumably an argument for active management.

Over four years the five best performing balanced funds were: CC&L (19.0%); HughesLittle (15.8%); Barometer High Income Pool (15.7%); CI Signature Income & Growth Fund (13.2%) and Bissett Dividend Income Fund (13.2%.)

While CC&L and HughesLittle were the top performers last year, the balanced fund managed by Acuity, the Acuity Pooled Canadian balanced fund, was the worst performer: it was up by a mere 1.9%.

The Ontario Teachers’ Pension Plan is aiming to be more aggressive in its portfolio, its CEO says, after the provincial government and teachers’ union struck an unusual deal to tackle the plan’s deficit.

“It lowers our risk profile quite substantially, from the board’s perspective, such that we can absorb a little more risk in our investment strategy,” Teachers’ chief executive officer Jim Leech said in an interview Monday. That might mean, for example, new flexibility to bolster investments in emerging markets, do more private equity deals, or put more of its money into stocks.

Mr. Leech has been frustrated because, just as the pension plan needs to boost investment returns, chronic deficits over the past decade have forced it to maintain a highly conservative investment profile. That has meant restricting equities to 45 per cent of its portfolio, a lower weighting than most pension funds.

But the fund’s co-sponsors, the Ontario government and the Ontario Teachers’ Federation, have agreed to eliminate the guaranteed inflation protection that is paid on benefits to plan members, a move that will wipe out the plan’s $9.6-billion deficit (as of Jan. 1, 2012).

The province and union have also agreed to study ways to put a permanent stop to the fund’s deficits, research that will likely look at the balance between the number of years that teachers work and the number of years that they receive benefits. In 1990, teachers worked, on average, for 29 years and received retirement benefits for 25 years; by 2011, they worked for 26 years and drew pensions for 30 years. The profession skews toward women and tends to be healthy, resulting in long life expectancy.

The province and union reached the agreement to eliminate the deficit more than two weeks ago but it has remained under the public radar as Queen’s Park settles back in after a leadership change. One of the main issues the province has been contending with is contract negotiations with the teachers, in the wake of a bitter dispute that erupted when former premier Dalton McGuinty prohibited teachers from striking last fall and then imposed new contracts on them early last month.

“It is difficult; teachers did take a reduction in benefits, but I think that ensures the sustainability of the pension plan and weathers the storm created by low interest rates and changing demographics,” Terry Hamilton, president of the Ontario Teachers’ Federation, said in an interview. “The times didn’t help the situation but it shows how we continue to work effectively with the government.”

Mr. Leech says the agreement is one of the most significant of its kind in the industry. “Pension plans have to evolve,” he said. “Plans have to show that they can evolve to the new reality, and I think what these two sponsors have done – the government and the teachers – is shown that they can make that evolution.”

Former finance minister Dwight Duncan made it clear last spring that Teachers’ pension deficit would have to be tackled through benefit reductions, rather than contribution increases, since the province matches what teachers pay into the plan.

The government and union have agreed to numerous measures over the years to eliminate deficits, and the guaranteed inflation protection had already been cut from 100 per cent to 50 per cent.

But Mr. Leech says the changes should have a more permanent impact this time, characterizing this agreement as “a dramatic move.” While the goal will still be to pay inflation protection, the need to do so is removed entirely.

“It provides us with a tool to absorb some hiccups, if there are any, because you can float the inflation protection up and down,” Mr. Leech said, adding that the sponsors have “invoked it such that, going forward, 45 per cent will be paid until further notice.” That will take effect at the start of 2015, Mr. Hamilton said.

While Teachers has not yet disclosed its 2012 annual results, Mr. Leech said it has informed the co-sponsors that, since interest rates fell further during the year, the fund is likely to report a small deficit as of the start of this year – in the neighborhood of 97-per-cent or 98-per-cent funded, he said. “But it will be much smaller … and it is easily handled,” he said.

We use bond repurchase agreements to fund investments in all asset classes because it is cost effective and allows us to retain our economic exposure to government bonds. For efficiency reasons, we also use derivatives to gain passive exposure to global equity and commodity indices in lieu of buying the actual securities. Derivative contracts and bond repurchase agreements have played a large part in our investment program since the early 1990s.

In addition, absolute return strategies enable us to earn positive returns that are uncorrelated to other asset groups. We employ these strategies internally to capitalize on market inefficiencies and we complement our own activity by using external hedge fund managers. The use of external hedge funds provides us with access to unique approaches that augment performance and diversify risk.

HOOPP does almost everything internally while Teachers' will often use external managers for investment activities they can't replicate internally. Both funds use repos extensively, leveraging up their stock and bond portfolios, saving millions in the process (instead of having some custodian do it off balance sheet, charging them insane fees).

The big difference, however, is Ontario Teachers' takes directional leverage whereas HOOPP doesn't (repos are matched by money market instruments, not invested in hedge funds, private equity and real estate). I have heard figures that Teachers' is leveraged up to 50%, which works well in good years, but goes against them in bad years like 2008, when they crashed and burned.

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

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

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

The Caisse du dépôt et placement du Québec tallied a 9.6% return for its depositors last year as the global economy slowed, building more credibility for Caisse chief executive Michael Sabia in his effort to put the institution on solid footing and beat back critics.

Riding a strong performance in its stock holdings, which generated $8.8-billion in net earnings including roughly one quarter from its private equity portfolio, Canada’s second largest pension fund manager slightly beat the median 9.4% return for the country’s defined benefit pensions as estimated by RBC Investor & Treasury Services.

Net assets grew to $176.2-billion as both returns and deposits increased.

“[Equity markets] were buoyed by the actions of central banks everywhere” last year, Caisse chief investment officer Roland Lescure told reporters during a lockup to discuss the results. “It was like an oxygen ball,” for foreign-based banks in particular, he said.

Mr. Sabia, who was brought in by the former provincial Liberals to help reverse a crushing $40-billion loss for the Caisse in 2008, has managed to build $56.1-billion worth of new wealth since his arrival by simplifying investments, reducing leverage and maintaining a high level of cash. The pension fund plans to increase private equity investments, notably real estate, by $10-billion to $12-billion by the end of 2014.

Mr. Sabia has also managed to keep the new Parti Québécois government on side, largely by ramping up investments in Quebec-based companies.

Premier Pauline Marois has vowed to tighten the Caisse’s legally-instituted mandate in order to heighten its nation-building role, but the pension fund seems to be doing that on its own.

Mr. Sabia has spent $8.3-billion in new money on Quebec-based investments since 2009, and $2.9-billion last year alone, highlighted by a $1-billion investment in CGI Group. Plans for future Quebec investments include a new railway to serve the Labrador iron ore mining trough, together with Canadian National Railway Co (correction: the CNR project was abandoned).

Roughly 27% of the Caisse total assets are Quebec-based, representing $47.1-billion (correction: 22% of Caisse's total assets are in Quebec; reporter used net assets).

“We don’t have a quota for our Quebec investments,” Caisse executive vice-president Bernard Morency told reporters Wednesday. “We approach it as the opportunities present themselves.”

Mr. Lescure noted that global growth ran out of steam in 2012 as emerging markets slowed, Europe sustained continued recession and the United States staged a timid recovery. Canada and Quebec also slowed while the private sector recovered in the United States and an upturn began in China and certain emerging markets. Positive movement in those two areas, combined with stronger action by European policy makers to shore up the euro, allowed equity markets to finish the year on a stronger footing, he said.

The Caisse’s Canadian equity portfolio returned 6.6%, hampered by weakness in materials and pressure on Canada’s energy producers. The Caisse is heavily weighted in energy and materials investments, with stakes in companies such as Enbridge and Suncor.

There was a big gap in investment results between the Caisse’s different asset classes, Mr. Morency noted, which means different depositors also saw different returns as their portfolio mixes are different. At the low end, fixed income returned only 3.9% as interest income from bonds remain weak by historical standards. Towards the higher end, real estate returned 11.1% (correction: inflation-sensitive assets returned 11.1% and real estate 12.4%).

The pension fund controls real estate company Ivanhoe Cambridge, which has been rejigging its portfolio of assets over the past five years to focus on shopping centres, office buildings and residential complexes. Ivanhoe has sold 40% of its hotel assets so far. Plans to sell the entire portfolio of hotels are being delayed by weak market values at the moment, Ivanhoe president Daniel Fournier said.

“It will take a few more years” to sell them all, Mr. Fournier said. “We’ll be very patient.”

• First, Fixed Income outperformed its benchmark (3.9% vs 3.2%) 
• Inflation-sensitive investments gained 11.1% led by Real Estate (12.4%) and then Infrastructure (8.7%). I spoke to a reporter yesterday and told him the Caisse has the best real estate team in Canada, which says a lot because there are other excellent teams.
• Nonetheless, Real Estate underperformed its benchmark by 80 basis points and Infrastructure underperformed its benchmark by a whopping 6.3%. This tells me their benchmarks in these portfolios are extremely tough to beat (go back to read an older comment, It's All About Benchmarks, Stupid!)
• Equities returned 12.2% led by gains in Private Equity (13.6%). But Private Equity also underperformed its benchmark by 50 basis points. Again, no free lunch in the Caisse's private market benchmarks.
• In public markets, Global Equity slightly outperformed its benchmark (14% vs 13.6%) but Canadian Equity underperformed its benchmark (6.6% vs 7.7%) due to its overweight position in materials and energy.
• Hedge Funds outperformed by 70 basis points (4.7% vs 4%)
• The ABTN portfolio (old asset-backed commercial paper where they lost billions) was revalued up, adding $1.7B to overall results. Stéphane Rolland of  Les Affaires noted that without the gains in ABTN, the Caisse would have underperformed its overall benchmark. He also noted that the Caisse underperformed the median 9.9% return for the country’s defined benefit pensions managing over $1 billion as estimated by RBC Investor & Treasury Services.

In the first half of 2009, the Caisse reorganized its operations. In particular, it completed an extensive overhaul of its portfolio offering and risk management and it also repositioned the portfolios in the real estate sector. Since making these major changes, the Caisse has achieved an annualized return of 10.7%, equivalent to net investment results of $50.7 billion.

In 2012, the Caisse continued to improve its efficiency and pay close attention to its operating expenses. Operating expenses, including external management fees, totalled $295 million in 2012. The ratio of expenses to average net assets was 17.9 basis points (18.0 basis points in 2011) and continues to place the Caisse among the leaders in its management category. 

Il a enseigné la finance pendant 33 ans, formé 4000 étudiants et géré des fonds de retraite pendant 17 ans. L'argent, il connaît ça. Mais aujourd'hui, Jacques Bourgeois s'inquiète avant tout d'une chose: le déclin de la finance à Montréal.

Au fil des ans, l'homme maintenant âgé de 72 ans a observé la lente érosion de la finance montréalaise au profit de Toronto, de New York ou de Londres. «Si on ne se réveille pas bientôt, c'est fini», dit le vieux prof, que nous avons rencontré à son bureau de HEC Montréal.

Il y a trois ans, Jacques Bourgeois a fait le tour des caisses de retraite du Québec pour savoir qui gère l'argent des Québécois. Résultat de son sondage: la part des fonds gérés par des gestionnaires québécois a fondu entre 2005 et 2009, passant de 63% à 53%.

Comme le total des fonds québécois était d'environ 400 milliards de dollars, il estime que ce sont 40 milliards de dollars de fonds qui ont échappé aux gestionnaires québécois sur cette période. Et depuis 2009, la saignée se poursuit, croit-il.

«Aujourd'hui, certains régimes de retraite d'université ont 0% de leurs avoirs placé entre les mains de gestionnaires québécois. Zéro pour cent! Tout est géré par Toronto, Boston, New York ou Londres. Ce sont pourtant des régimes cotisés à même les salaires des profs, payés avec l'impôt des Québécois», dit-il.

Selon lui, le déclin est généralisé. Il touche aussi les services de recherche des maisons de courtage du Québec, qui ont réduit le nombre de leurs analystes au Québec au profit de Toronto et Calgary. «Ce sont des jobs payants. Pas des jobs à 75 000$», dit-il.

Il n'y a pas de doute, les scandales des dernières années, Norbourg et Norshield en tête, ont ravagé les petites boîtes de gestion au Québec. Plusieurs particuliers et fonds institutionnels se sont dit: plus jamais je ne confierai mon argent à de petites boîtes. Vive les grandes firmes! Vive les banques! Vive les Fidelity, Trimark et autres fonds étrangers!

Ces scandales ont marqué l'inconscient collectif et ont nui à la finance montréalaise. Mais il faudra tôt ou tard tourner la page.

Pour tourner cette page, Jacques Bourgeois travaille dans l'ombre. «Dernièrement, j'ai finalement réussi à faire bouger un gros fonds de retraite pour l'inciter à donner des mandats de gestion au Québec. Une affaire de 200-300 millions. Mais ça m'a pris cinq ans», dit-il.

Les gestionnaires québécois sont-ils moins bons? Est-ce la raison du déclin? «Moins bons? Pas du tout. Aux HEC, notre fonds de retraite a obtenu le meilleur rendement des fonds universitaires au Canada sur 10 ans entre 2001 et 2011. Premier au Canada. Et 90% des fonds y sont gérés par des Québécois.»

Bien sûr, il y a une question de taille. Au Québec, les firmes capables d'accepter un mandat de 10 à 100 millions de dollars d'une caisse de retraite ne sont pas légion. Il y a Fiera Capital, Jarislowsky Fraser, Letko Brosseau et Hexavest, entre autres, mais après, la taille diminue rapidement.

Jacques Bourgeois croit que les grands investisseurs institutionnels devraient encourager la relève, comme aux États-Unis. Dans certains états au sud de la frontière, dit-il, les caisses de retraite sont encouragées à confier 1% de leur actif sous gestion à des gestionnaires émergents.

Ce n'est pas nécessairement le cas au Québec. À la Caisse de dépôt et placement, par exemple, environ 91% des fonds sont gérés à l'interne et le reste est géré par des gestionnaires externes établis au Québec (environ 0,8%) ou hors Québec (environ 8,2%), nous indique l'institution.

La Caisse a recours aux services de firmes externes du Québec pour gérer des investissements boursiers, des placements privés et des fonds de couverture, essentiellement. Il ne s'agit pas nécessairement de gestionnaires émergents, cependant.

Selon le porte-parole Maxime Chagnon, la Caisse connaît très bien le marché du Québec et du Canada, qu'elle gère donc à l'interne. C'est ce qui explique qu'elle a davantage recours à des gestionnaires hors Québec pour ses besoins, dit-il. «Notre choix est fonction de l'expertise, des besoins et des marchés qu'on couvre.»

Mais Jacques Bourgeois n'en démord pas. «Toutes les semaines, je reçois l'appel d'une jeune firme de gestion de fonds qui tente d'avoir des mandats institutionnels. Mais il n'y a rien à faire», raconte l'ex-professeur.

C'est clair, il y a des risques. Il y aura toujours des risques. Les fonds institutionnels devront faire leurs devoirs et enquêter avant de décaisser les fonds. Toutefois, favoriser des gestionnaires d'ici forme la relève et crée des emplois payants sans qu'il n'en coûte un sou de subvention au gouvernement. Et il met des PME locales sur le radar, explique M. Bourgeois.

En effet, le financier de Toronto à qui l'on confie la gestion des petites capitalisations a nécessairement une meilleure connaissance des entreprises locales. «L'univers du gestionnaire, c'est davantage son patelin. On connait mieux ce qui est proche. En faisant gérer les petites capitalisations à Toronto, nos PME retiennent moins l'attention et leur valeur boursière finit par être moindre», dit-il.

Bref, Jacques Bourgeois lance un cri du coeur. L'objectif n'est pas de faire gérer 100% de nos fonds par des Québécois, mais chaque pourcentage additionnel représente 4 milliards. Convaincu?

Japan's public pension fund will be reviewing its portfolio when its new fiscal year starts in April, an official said Friday, helping stoke market interest in how the country's pension funds respond to rising share prices and a weakening yen.

The Government Pension Investment Fund, the world's largest, is responsible for Japan's employee pension insurance and national pension plans, which together cover more than 60 million people. In dollar terms, its assets under management exceed Mexico's gross domestic product, World Bank statistics show.

Coming during a share rally fueled by mostly foreign investors, asset managers and strategists say, a change in the portfolios of Japan's notoriously conservative funds—heavy in domestic bonds—could be the start of a significant positive turn for Japanese markets.

"Periodically we must inspect" our portfolio, Masahiro Ooe, director general of the fund's planning department, told reporters in Tokyo. "Once we get into the next fiscal year, I want to proceed with this work as soon as possible."

While Mr. Ooe declined to give any details, his remarks suggest the giant fund may have taken notice of the recent stock rally, even as Japanese government bond yields sink yet lower.

Rising share prices and a weaker yen—which boosted returns from foreign-currency denominated assets when expressed in in yen—helped improve the fund's October-December investment profit to ¥5.14 trillion ($55.5 billion), or 4.8% on its ¥111.93 trillion total asset holdings. That compares with a profit of ¥528.7 billion in the previous quarter.

Domestic shares returned 16.7%, good for a ¥2.07 trillion profit, while domestic bonds—60% of the portfolio—logged a negative return of 0.06%, the only asset class that did not contribute to the gain. Foreign stocks marked a 13.8% gain and foreign bonds 13.6%.

Amid signs of a pickup in global growth and an easing of concern about Europe's sovereign-debt crisis, the Nikkei Stock Average gained 17% in the October-December quarter. The Dow Jones Industrial Average declined 2.5%.

Stocks currently account for a far smaller portion of the portfolios of Japanese pension funds than of their peers in the U.S. or U.K.—35%, according to a January report by consultancy Towers Watson, versus 52% and 45%, respectively. Only about 26% of the GPIF portfolio is domestic and foreign shares.

Japan's public pension fund, the world's largest, recorded investment gains of $56 billion in October-December, its second best quarter on record, on the back of strong domestic equities, while the yen's fall helped boost the performance of foreign assets.

The fund's performance was helped largely by Prime Minister Shinzo Abe's aggressive reflationary fiscal and monetary policies, which triggered the yen's fall and lifted the broad Topix stock index .TOPX by almost 17 percent over the three month period.

Global asset managers and market dealers closely watch the performance of the Government Pension Investment Fund (GPIF) due to the size of its portfolio - which is larger than the economy of Mexico, the world's 14th biggest.

The GPIF recorded an investment gain of 5.14 trillion yen ($55.71 billion) in October-December, significantly higher than the previous quarter's 484 billion yen gain. That translates into a positive return of 4.83 percent, versus 0.49 percent in July-September.

The fund, which started operations in 2001, had its best quarter a year ago, in January-March 2012, posting an investment gain of 5.48 trillion yen and a positive return of 5.11 percent.

The fund's total asset size rose 4 percent to 111.9 trillion yen ($1.21 trillion) as of end-December from 107.7 trillion yen in September.

The biggest investment gains were in domestic stocks - up 2.07 trillion yen for the fund's best quarter since January-March last year. The performance in Japanese stocks translates into a positive return of 16.71 percent. The benchmark Topix index, including dividends, rose 16.73 percent.

The GPIF had a positive return of 13.62 percent from foreign bonds and 13.78 percent from foreign equities.

However, returns on domestic bonds slipped 0.06 percent - an investment loss of 35.4 billion yen - for the first quarter since January-March 2011.

JAPAN BOND ALLOCATION

The sharp recovery in domestic shares and the weaker yen may give the GPIF a headache as it may need to reallocate its huge portfolio - its weighting of foreign equities is near the allowed ceiling, while its weighting of domestic bonds has slipped to near its minimum limit.

By end-December, the fund was about 60 percent invested in domestic bonds, approaching the minimum 59 percent limit. It had about 13 percent in foreign equities, close to its allocation ceiling of 14 percent.

The GPIF allocates its investments based on its model core portfolio with a 67 percent allocation to domestic bonds, 11 percent to domestic stocks, 9 percent to foreign stocks and 8 percent to foreign bonds. The allocation range for domestic bonds is 59-75 percent, and 4-14 percent for foreign equities.

Chairman Takahiro Mitani told Reuters last month the fund will review its long-term investment target and portfolio allocation model around April, adding that review should include a discussion on the investment strategy towards Japanese government bonds.

Yields on 10-year JGBs were around decade lows of 0.640 percent on Friday.

Last year, a report by Japan's Board of Audit, requested by the upper house of the national assembly, called for the GPIF to consider reviewing its target and allocations.

Long-dated Japanese government prices inched higher on Friday, with the 30-year yield hitting a seven-month low, as pension funds looked to extend the duration of their portfolios.

Expectations that the Bank of Japan will adopt bold monetary easing also supported the market, although gains were capped after Tokyo's Nikkei share average reversed earlier losses and traded higher.

The 30-year yield slipped 4.5 basis points to 1.765 percent after dropping at one point to 1.750 percent, a seven-month low. The 30-year yield has shed 14.5 basis points this week, its biggest weekly decline since December 2008.

The 20-year yield eased 3 basis points to 1.575 percent, falling for an eight straight session and after touching a seven-month trough of 1.555 percent.

"It's more related to the extension trade by pension funds who need to extend the asset side duration by buying long-end of the curve to match the underlying index," said Naomi Muguruma, senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities.

"Another factor pushing the yields down is expectations of aggressive easing by the new BOJ chief," she said.

Prime Minister Shinzo Abe on Thursday nominated Asian Development Bank President Haruhiko Kuroda to be BOJ governor after current chief Masaaki Shirakawa steps down on March 19, and tapped academic Kikuo Iwata and BOJ official Hiroshi Nakaso as deputy governors.

The 10-year yield inched down 0.5 basis point to 0.655 percent by mid-afternoon after falling to 0.640 percent, a fresh nearly 10-year low.

With the super-long sectors outperforming, the spread between 10- and 30-year bonds narrowed to 111 basis points to its lowest level since late September.

Ten-year JGB futures added 3 ticks to 144.05 after hitting a two-month peak of 145.21 to within striking distance of a record high of 145.26.

Muguruma said the 10-year yield was likely to trade between 0.600 and 0.700 percent in the near-term as investors were likely to want to see what policy the new BOJ chief would adopt in whipping deflation.

Jiji news reported on Thursday that Kuroda's confirmation hearing would be on March 4, with the two nominees for the deputy positions to appear before lawmakers the following day.

During the six decades of generally positive macroeconomic conditions that followed the post WW2 Marshal Plan and Treaty of Paris, the European Union created an integrated legal-commercial bloc that eventually rivaled the United States in terms of economic dynamism while seemingly simultaneously preserving the progressive social model inherited from Germany’s Bismarckian tradition and Britain’s Liberal “welfare reforms”.

And Germany and the UK were very much the twin engines of European economic growth throughout that period, with the highly innovative and lightly regulated City of London becoming progressively more important than Wall Street for the origination and trading of key asset classes, including fixed income instruments, currencies, derivatives and asset-backed securities.

But things changed abruptly after 2008: European and British policymakers must now confront a series of crises unfolding inauspiciously at the same time.

The unending Euro ‘debt crisis’, the social unrest resulting from the harsh austerity measures imposed by the EU Commission and/or national governments, the newfound (and sometimes not thought out) regulatory zeal of EU lawmakers, with their sudden passion for “financial regulation” and “banking supervision” which comes after years of complacent laissez-faire.

But the most serious crisis is the least visible: Europe’s growing pension predicament means that millions of European retirees now live in poverty, and, more dramatically, tens of millions of European workers are likely to retire in the next ten years with inadequate pension benefits that will leave them far below the poverty line, even in relatively rich member states such as the UK and Germany.

We have to remember that the European Union was established precisely to put an end to an ‘age of austerity’ that lasted for more than five years after the Second World War.

The renewed social contract underwriting that European experiment was founded precisely on the dual promise of generous pension plans and modern infrastructures for all citizens. Tellingly, these basic promises are being broken across most of the European Union today.

Two weeks ago, HSBC Holdings plc, Europe’s leading financial services company and the UK’s largest private sector employer, announced abruptly its unilateral decision to terminate the bank’s generous defined benefit (DB) pension fund from next year for all existing members, an unprecedented move for a firm of that size and likely to inspire other plan sponsors across the EU.

By a cruel irony, a team of HSBC economists and actuarial experts published a special report the same week, showing that most UK workers are not preparing adequately for retirement, with 19% saving nothing at all!

The first age of austerity (1945-1949), often cited by David Cameron and George Osborne as a metaphor for Europe’s current economic circumstances, was a short hiatus: the Marshall Plan and the Treaty of Paris (from which the EU was derived) rapidly restarted the European growth engine.

This is unlikely to happen this time around as the United States is unable (“Fiscal Cliff”, “Debt Ceiling”) and unwilling to ‘bankroll’ the rest of the world, the European Union is divided against itself and exposed to severe demographic, macroeconomic and fiscal pressures and, more importantly, the energy and commodity producing nations of Latin America and the Arab world are no longer ruled by pliable “comprador” technocrats eager to please the West by adjusting supply to the economic cycle of Europe and America.

All this is happening at a time when the European Central Bank and the Bank of England are pursuing a particularly hazardous monetary policy (the “quantitative easing” series), in essence keeping interest rates at artificially low levels for an extended period of time.

This has a doubly negative impact for pension funds and pension beneficiaries: several consecutive years of lower returns for the fixed income asset class as a whole will further widen the pension funding gap in the medium-term, and, in parallel, rampant inflation will erode salaries in real terms (a fact recently recognized by the Office for National Statistics in the UK), forcing workers and pensioners alike to dip into their savings to pay for food and fuel.

The $86 billion system that funds pensions for public workers, state troopers, local police and firefighters, and teachers lost ground in the first year public workers were required to pay more toward their retirements, according to reports released Monday.

Actuarial reports show the funds had significantly lower-than-expected investment returns, and lost additional ground because the state paid one-seventh of its contribution to the system for the fiscal year that ended June 30, 2012. As a result, the gap between the system's assets and eventual liabilities grew by $5.5 billion, or 3 percent.

Gov. Chris Christie said he wasn't surprised by the reports, but public employee unions said they were disappointed.

"We're falling behind by a heck of a lot less than we were in the years before I got here when they were making no pension payments," Christie said after an event in Jersey City. "The unfunded liabilities will continue to increase somewhat, but significantly less than they did under previous administrations, so we're making progress. But you can't expect that I'm going to come in here to a $60-plus billion dollar under-funded pension and fix it overnight."

Christie championed pension changes enacted in 2011 that required public workers to contribute at least 1 percent more of their pay toward retirement benefits and raised the retirement age from 62 to 65 for new hires. Public employee unions fought the changes, which they said passed the burden onto workers after years of missed payments by the state. The 2011 law allowed the state to phase in its pension contribution over seven years in one-seventh increments. Christie has proposed a $1.67 billion contribution for the fiscal year that begins July 1, which represents three-sevenths of the state's share for the year.

"Today's announcement by the actuary for the Police and Firemen's Retirement System (PFRS) that the value of the pension fund had dropped in 2012 is a cause for serious frustration by the members of the New Jersey State PBA," said its president, Anthony Wieners. "Police officers, both active and retired, made a commitment to ensure our pensions were secure under the guise of shared sacrifice, but politicians have again shortchanged the retirement system."

Janet Cranna of Buck Consultants, one of two actuaries to present their review of pension funds Monday, said the PFRS' funding ratio fell below the target rate of 76.4 percent because of a drag by the state. Local employers are funding PFRS at a rate of 78 percent, while the state's funding level is at 53 percent.

The retirement fund for state police also saw an increase in its unfunded liability, which Cranna attributed to the state falling shy of its funding obligation, low investment returns and more retirees.

"The state made a commitment to fund their part of the pension, and we're going to hold them to it," said Christopher Burgos, president of the state trooper union.

Pension changes enacted in 2011 required workers to pay more to shore up the system, which was in danger of becoming insolvent without significant changes. Automatic cost-of-living increases, or COLAs, were suspended until the funds rebound. Administrators cannot consider reinstating the COLAs until funds hit their targets and can show sustainability at that level.

Treasury Department spokesman Bill Quinn said the pension system shortfall would be worse if reforms had not been enacted. For example, the unfunded actuarial accrued liability for state and local pension funds was a combined $53.8 billion before the reforms were enacted and $36.3 billion after, an improvement of $17.5 billion, he said.

Pension fund investments saw a 2.52 rate of return for the fiscal year, far below the 7.95 percent return rate that was assumed.

But Quinn said other large state pension systems fared worse: The return rate for California's system was 1 percent and Florida's was .29 percent for the same period.

The summit, organized by a coalition of unions that represents public workers, drew Democrat and Republican state lawmakers to an AFL-CIO office in Burr Ridge, Illinois, but ended after three hours without a statement of consensus or a commitment to meet again.

Daniel Biss, a Democratic state senator from Chicago's northern suburbs who as a state representative co-authored a plan to address the state's pension mess, said "no substantive breakthrough" was made during the meeting.

In Illinois, five state pensions are in the red by a staggering $97 billion - or more than $20,000 for every household in the state. Inaction by lawmakers has prompted rating agencies to downgrade the state's credit rating and raised fears of service cuts, tax increases and other hardships for the residents.

"I'm glad that everyone was in the same room," Biss said. "But at some point, you have to stop talking about talking and start crafting a solution. That didn't happen."

Ontario is closing in on a deal with teachers to overhaul their pension plan, in what would be a landmark agreement for governments struggling to contain the costs of public-sector pensions.

The agreement would freeze pension contributions for five years, sources told The Globe and Mail – meaning a greater proportion of pension-fund shortfalls would come out of teachers’ future benefits instead of provincial coffers.

If finalized, the agreement with one of Canada’s largest funds would be a significant development in the battle to limit government exposure as the country confronts a looming pension crisis, which is being accelerated by an aging population and sluggish investment returns.

Governments at all levels are trying to reduce the cost of public-sector retirement plans that are ultimately paid for by taxpayers – many of whom have less generous employer-backed pensions or none at all.

Sources on both sides of the table said a deal has not been signed, but they confirmed that negotiators have been in advanced discussions, having recently returned to the table. Talks had fallen apart at the height of labour unrest between Ontario and its teachers’ unions.

For Ontario, in particular, limiting how much it spends on pensions is especially urgent in light of its $12-billion deficit. Similar deals to freeze contributions were reached in late 2012 with Ontario unions representing health-care workers, civil servants and community-college employees, but the $117-billion Ontario Teachers’ Pension Plan – which covers about 300,000 current and former teachers – represents much greater cost pressures.

Last year’s Ontario budget allocated $1.46-billion to match teachers’ contributions to their plan in 2012-13 – a number that has risen steadily in recent years because of funding shortfalls. Since 2006, both government and employee contributions have gone from 8.9 per cent of teachers’ annual income (above maximum pensionable earnings under the Canada Pension Plan) to 12.75 per cent; that percentage will rise to 13.1 per cent by next year, under an agreement reached prior to the current negotiations.

The province and the unions said a recent agreement to stop guaranteeing that benefits will receive some inflation protection has eliminated the $9.6-billion unfunded liability as of Jan. 1, 2012.

But Ontario Teachers’ Pension Plan CEO Jim Leech has said he expects the plan to show a deficit, albeit a much smaller and more manageable one, when it next reports its results for the latest year – and bigger shortfalls could arise again in the future.

If so, the effect of the deal in the works would likely be to further reduce benefits, rather than asking either the province or teachers to pay more.

If the deal mirrored the agreements with smaller unions last fall, future benefits that plan members would receive could be cut by as much as 20 per cent before contributions were put back on the table.

Such an arrangement would more or less follow the recommendations of last year’s government-commissioned report by economist Don Drummond, who singled out the teachers’ pension as unsustainable.

“Further increases in contribution rates would affect both parties’ ability to pay,” Mr. Drummond cautioned. “For the province, it would mean fewer financial resources to fund other programs. For individual teachers, it would mean lower disposable income and more personal financial resources to fund current benefits.”

Some teachers would welcome restrictions to further contribution increases, because the amounts coming off their paycheques are already unusually high. But the fact that benefits already earned would not be affected could contribute to worries among younger teachers that they are paying for generous pensions they themselves won’t be able to enjoy.

As a result, there is no guarantee that union members will ratify the deal likely to be sent to them soon. But their leadership appears to be counting on an awareness that too much push-back could lead to future governments taking a harder line.

Seeking to capitalize on the perception that the public sector has been shielded from economic realities facing other Ontarians, Progressive Conservative Leader Tim Hudak has proposed that employees be moved from defined benefit to defined contribution plans, and that the retirement age be raised.

While Kathleen Wynne’s governing Liberals have stopped well short of those sorts of changes, sources familiar with the negotiations suggested that the prospect of Mr. Hudak’s party winning office may have helped bring the teachers back to the table to strike a deal now. And even the Liberals hinted in last year’s budget that they might legislate pension-spending restraint if unions did not co-operate – another prospect that might have weighed on negotiators’ minds.

Governments in Canada have adopted various measures aimed at limiting public-sector pension costs. New Brunswick has perhaps gone the furthest, moving toward a hybrid system in which base benefits are protected but additional ones are subject to market forces; others have settled for pooling plans in hopes of finding efficiencies. All concerned will likely be monitoring the impact of deals struck in Ontario.

The world’s top hedge funds did far less well than usual last year, as smaller rivals made more money for investors and the average return of the top 20 lagged behind those with a simple balanced portfolio.

Calculations by LCH Investments, the fund of hedge funds run by the Edmond de Rothschild group, found the 20 top hedge funds made $32.4bn for their investors last year, less than a fifth of the $172bn made by the industry as a whole. Over their history, the top 20 funds have generated almost half the total profits made by the industry, helping explain the stellar reputations of top names such as Ray Dalio, Seth Klarman and David Tepper.

The tough year for the hedge fund elite came as two top managers stepped down. Billionaire philanthropist George Soros retired from running other people’s money at the start of 2012, while John Arnold, a fellow billionaire, told investors in May he would be closing his Houston-based Centaurus Energy.
But the relatively poor year for the elite appears to be driven by the continued underperformance of “macro” hedge funds, which bet on interest rates, currencies and big market moves. Many of the world’s best-known investors are macro managers, led by Mr Soros and including Paul Tudor Jones, Louis Bacon, Ray Dalio and Alan Howard.

Rick Sopher, chairman of LCH, said the big winners in the past year had been stock pickers, with the biggest profits made by Lone Pine, Steve Mandel’s Connecticut-based fund.

Lone Pine’s returns were boosted by its long-only funds, which produced about two-thirds of last year’s $4.6bn of gains. They are counted by LCH as part of its hedge funds because they are run without the index benchmarks standard in long-only funds .

After Mr Mandel, the most money was made by Dallas-based Maverick Capital, another equity manager, who made $3.7bn. Like Mr Mandel, founder Lee Ainslie is a “Tiger cub”, a former protégé of hedge fund legend Julian Robertson at Tiger Capital.

Equity managers generally had a good performance last year, helped by rising markets and falling correlations between stocks, which helped those good at picking winners and losers. Their success follows what had been an awful 2011 for many, with Mr Ainslie recording his worst year and cutting back Maverick’s risk-taking as a result.

But Mr Sopher said the top 20 table showed the key to longer-term success was avoiding becoming too big. “When you look at the one thing that virtually all the managers on this list have in common, it’s that they have all either at some point or all the way through restricted capacity [how much money they will accept].”

Five of the funds on the list still run by their founders have made more money for clients than they currently run in assets, mostly because they chose to return money to customers.

Last summer, macro fund Moore Capital decided to shrink by a quarter, with Louis Bacon, its founder, saying it was trickier to make money in politically driven markets. Brevan Howard, a macro fund run from Geneva, has also begun returning capital after a couple of years of weak performance, while managers including Lone Pine, Viking and Eddie Lampert’s ESL Investments are known for being hard for investors to access.

The LCH table is closely watched by fund managers, as it tracks the amount of money actually made for customers rather than simple percentage returns. Percentage returns can be misleading because funds tend to do well early in their lives, then produce weaker returns as they grow bigger – meaning they do not make nearly so much in dollars as the long-run percentage figures suggest. The weakness of the dollar measure is that it is also influenced by customer behaviour, with flighty private clients tending to pull their money after a period of bad performance.

A pair of funds run by Mr Dalio’s Bridgewater Associates topped the LCH table for a second year, but the funds – the biggest in the world, with $76bn between them – had a poor year, making customers $1bn. Mr Soros’s closed Quantum fund retained the number two spot. John Paulson’s Paulson & Co, in third, had another poor year in its flagship fund but its other funds and the denomination of much of its assets in gold allowed it to scrape a profit for customers.

On average investors in the top hedge funds still run by their founders would have been slightly better off last year buying 10-year US Treasuries and a US tracker fund to create a balanced 60 per cent equity, 40 per cent bond portfolio at the start of the year. That would have generated 11 per cent, a little more than the average of the top funds.

...there are good reasons to chop hedge fund fees in half, especially for these large quantitative CTAs and global macro funds. Why should Ray Dalio or anyone else managing over $100 billion get $2 billion in management fees? It's ridiculous and I think institutional investors should get together at their next ILPA meeting and have a serious discussion on fees for large hedge funds and private equity shops.

In my opinion, these large funds should charge no management fee (or negligible one of 25 basis points) and focus exclusively on performance. The "2 & 20" fee structure is fine for small, niche funds that have capacity constraints or funds just starting off and ramping up, but it's indefensible for funds managing billions as it transforms them into large, lazy asset gatherers, destroying alignment of interests with investors.

Now, one can argue that Bridgewater is becoming the next Pimco, a mega asset manager which successfully manages a lot more in assets. That's fine but then why charge 2 & 20?

In an environment of extreme volatility, most hedge funds are going to get killed. Only the very best will survive but institutional investors better be careful, because even top funds can experience a serious drawdown in this market.

None of this surprises me. I agree with Simon Lack, who I interviewed on my blog last month, most hedge funds are terrible and after fees, there is little left for investors to justify allocating to this space.

But even Simon Lack agrees there are excellent absolute return managers out there who earn their performance fees. And while many smaller funds are struggling to survive, others are thriving and beating their larger rivals.

The problem is that large institutional investors have all succumbed to the placebo effect of large hedge funds and in an environment of cover-your-ass politics, the herd all invests in brand names, finding refuge in doing what everyone else is doing.

To be fair, there are excellent large funds, some of which I mentioned in my tracking top funds Q1 activity, and more importantly, scale is an issue for large investors. If you're CPPIB or someone managing hundreds of billions, you're not going to waste your time investing in or seeding some small hedge fund or private equity fund.

There are ways to seed hedge funds and I've already mentioned that some of the world's best pension funds are seeding alpha managers, but they're doing it intelligently. My best advice to those who want to gain the economic incentives of seeding a hedge fund is to give some funds of funds another go, with a specific seeding mandate.

A number of institutional investors intend to carve out an allocation in their asset mix for volatility strategies, despite consultants' views that volatility is not yet a formal asset class.

Stanford Management Co., Palo Alto, Calif., which runs Stanford University's $20 billion endowment, for example, is “trying to fine-tune our asset allocation,” said Vera Kotlik, director, absolute return and fixed income, during a panel discussion of large institutional investors at the Global Volatility Summit held in New York on Feb. 25.

SMC's investment staff is in “the nascent stage” of research with respect to how long volatility strategies may fit in, Ms. Kotlik said, noting “it's clear that there's real value in volatility strategies.” She said the staff is looking at both relative value hedge funds and long volatility strategies and is researching whether there is a place for a separate allocation to volatility managers.

“We're looking for key relationships,” Ms. Kotlik said.

China Investment Corp., Beijing, on the other hand, is more likely to work with one of the existing relative value managers within the sovereign wealth fund's $15 billion hedge fund portfolio to add tail-risk hedging, said Roslyn Zhang, managing director, fixed income and absolute return.

CIC, which has $200 billion invested outside of China, conducted “extensive research” on dedicated tail-risk hedging strategies after the 2008-2009 financial crisis but found the approaches costly and difficult to size appropriately, as well as hard to execute with regard to timing, Ms. Zhang said.

The sovereign fund also would consider treating volatility management investments as an asset class allocation and prefer using separate accounts to permit flexible customization, Ms. Zhang said. Other speakers on the panel have been managing pension portfolio volatility internally using derivatives for some years, including Marc-Andre Soubliere, vice president fixed income and derivatives for Montreal-based Air Canada's C$10.9 billion (U.S.$10.6 billion) pension fund.

Sanjay Chawla, senior director, global asset allocation and absolute return for The Dow Chemical Co., described how he and his team are tactically trading volatility in the company's U.S. defined benefit pension plans, which total more than $12 billion.

The strong institutional investor interest notwithstanding, “volatility is not an asset class — yet,” said Samuel E. “Q.” Belk IV, director of diversifying assets at Cambridge Associates LLC, during a lively panel of investment consultants.

While controlling the volatility of institutional portfolios is an “enormously important area” for clients of the Boston-based institutional investment consulting firm, Mr. Belk added that volatility management strategies today are like “venture capital companies in the '70s.”

“Volatility is a statistical measure of dispersal of returns,” stressed Claire Smith, partner and research analyst based in the Geneva office of alternative investment consultant Albourne Partners Ltd., London.

'Isn't an asset class'

“Volatility isn't an asset class. It's a derivative of other asset classes,” said Ms. Smith, a specialist in quantitative and volatility hedge fund strategies.

The widely varying experiences and approaches described by institutional investors at the volatility conference demonstrated that “there is something for everyone in volatility management” when it comes to portfolio construction and management issues, said Paul Britton, whose idea it was to bring investors and managers together to focus just on volatility issues.

Mr. Britton is founder and CEO of Capstone Investment Advisors LLC, London, which manages $2 billion in a relative value volatility hedge fund and $200 million in a tail-risk fund.

Mr. Britton acknowledged that tail-risk approaches to managing volatility were down on average between 12% and 20% in 2012 and investors are finding it “very hard to put money into anything producing negative returns.”

However, he is bullish that volatility will rise as financial institutions continue to reduce leverage in their balance sheets ahead of next year's regulatory milestones such as the Volcker Rule, which is due to be implemented by July 2014. He sees this period as a pivotal transition that could bring very interesting opportunities for hedge funds to enhance their balance sheets to replace the capital that the banks were once able to provide to the capital markets.

Mr. Britton said he expects that the Chicago Board Options Exchange Market Volatility index, the most widely used measure of the implied volatility of the S&P 500, will experience extremes both on the downside and the upside as the buffers that the bank balance sheet once provided continue to shrink.

Those extremes are exactly what Mr. Britton and his cohorts in volatility management are waiting for.

“It's a moral dilemma for volatility managers. We're happiest when things blow up,” he quipped.

The market hasn't "priced in" a eurozone break-up for the simple reason that it won't happen. All these hedgies waiting for a "Lehman-style event" so they can score big are collecting 2 & 20, selling fear to their institutional clients.

The biggest and most powerful hedge funds in the world stand ready to pump up the jam. The black swan of 2012 remains a mild eurozone recession. When fears of a eurozone break-up dissipate, greed and massive liquidity will drive all risk assets much, much higher. That remains my prediction, and if I am wrong, God help us all!!

In our view, one of the keys to a successful low-volatility strategy is the decision to invest only in dividend-paying companies. The regular payment of dividends is often an indicator of disciplined corporate decision-making and sound financial health, and research suggests that dividend-paying companies have better-quality earnings.

Dividend-paying funds have been gaining interest among risk-weary investors. However, unlike low-volatility products, these vehicles are designed primarily to produce yield and are not structured to reduce absolute volatility. From a volatility-management perspective, the fact that a company pays dividends—or that its dividend yields are high—is not enough to accurately assess the expected stability of its stock performance. For example, the highest-yielding stocks tend to be distressed companies with artificially high yields and greater volatility. Therefore, we believe that a meaningful analysis must combine dividend yield with both dividend growth potential and dividend sustainability measures, including cash flow indicators.

An investment manager’s methodology for assessing risk is another critical element in constructing lower-volatility portfolios. The danger for many managers is an over-reliance on historical correlations and other backward-looking measures to predict volatility, essentially assuming that history will repeat itself. A more effective approach, based on our research, is to take a diverse outlook that includes both statistical and fundamental insights—in other words, pairing quantitative measures of risk with a fundamental view toward companies that are likely to deliver more stable returns over time.

If you can raise the portfolio Sharpe ratio to 4 (good luck), who cares if it's defined as an asset class or just  a low beta strategy? It does not matter how it is defined, what matters is how it helps the portfolio. This is a silly argument. The real question is does tail hedging work and is it worth the cost? Sure it is hard to time, but if you can buy a long vol strategy or a short stock strategy that makes money with a good Sharpe ratio then it would it should be included in the portfolio....Look at Goldman, they take intelligent risks which is why they rarely have a losing day trading.

Steven Daniels, chief investment officer at Tesco Pension Investment – the principal investment manager for the supermarket giant’s £7bn UK staff pension scheme – told delegates at the National Association of Pension Funds conference yesterday: “Pension funds are the new banks. Everyone sees us as long-term lenders, and that is great. I’m happy to participate. We are the new banks, good banks potentially. But we are not mugs.”

His comments echo those of Martin Mannion, chairman of the NAPF’s investment council and director of finance and risk for GlaxoSmithKline’s £11bn UK pension funds, who warned on Wednesday that governments should not treat pension schemes as “a kind of slush fund that can be dipped into when the going gets tough”.

As long-term investors, pension funds are increasingly being seen as an alternative financing option as banks, under balance sheet pressure, continue to deleverage and decrease lending. The UK government has been urging pension schemes to step in to fund initiatives, such as infrastructure projects, where public investment has dried up.

But pension funds point out that the lack of suitable investment and financing vehicles is limiting their activity.

James Duberly, director of pensions investments at the BBC Pensions Trust, said: “It’s a brilliant idea. It works to the advantage of pension schemes with a long-term horizons.” But he told delegates that there was a shortage of sufficiently simple structures. The BBC has yet to make a big move.

Michelle McGregor Smith, chief executive of British Airways Pension Investment Management, is also interested in the idea, and said consultants had been pushing the concept. “The opportunity is there, but it is difficult to find the right vehicle,” she said.

Pension schemes are looking to diversify their holdings. According to an NAPF conference poll, 78% of defined-benefit scheme delegates confirmed they were moving away from equities.

Mike O’Brien, global head of JP Morgan Asset Management’s institutional client group, said: “There is a structural move away from equities within institutional portfolios worldwide. The next great rotation will be into bricks and mortar.”

He added that sovereign wealth funds were making a big move into direct investment in real estate and infrastructure.

The British government has made it easier for local authority pension schemes to invest in infrastructure by doubling the amount they can invest to up to 30 percent of their assets, paving the way potentially for billions of pounds of investment to be made in projects such as new roads and railways.

The National Association of Pension Funds (NAPF) said on Wednesday that from April local government pension funds will be able to raise the amount they can invest in key infrastructure projects from 15 percent to 30 percent of their assets under new rules set by the government's Department for Communities and Local Government.

Britain's local authority pension schemes had been lobbying the government for more leeway to invest in infrastructure, arguing that current rules were hampering their investment in the sector.

"Many local authority pension funds have told us that they are prevented from making the best decision on investments because of outdated rules which place limits on the amount that can be invested in infrastructure," Darren Philp, policy director at the NAPF, said in a statement.

A new Pensions Infrastructure Platform (PIP) has been launched as a way for pension funds to invest in capital projects with the backing of six large pension schemes, including the London Pension Fund Authority (LPFA), West Midlands Pension Fund and Strathclyde Pension Fund.

Volatile equity markets and rock-bottom interest rates have already caused a surge in new pension fund money going into transport and other major facility projects.

Asset manager APG, which runs the giant ABP pension fund and construction sector fund bfpBouw, is planning to increase its investment in infrastructure by some 50% over the ‘coming years’, the Financieele Dagblad reports on Tuesday.

The increase will take APG’s investment in building projects up to some €9bn, the FD quotes portfolio manager Jan-Willem Ruisbroek as saying.

‘Our clients want to invest up to 3% of their assets in this investment category. At the moment it is around 2%,’ he said.

This may seem like a small shift, but in absolute terms it means billions of euros extra to be spent on toll roads, wind farms, bridges and utilities, the FD said.

Nevertheless, the Netherlands will not profit enormously from this change in strategy. APG has a minimum investment of €100m and this means Dutch projects will be too small or will not meet other demands, the FD said.

Income seekers are flooding into the space vacated by deleveraging banks to replace traditional funding sources for infrastructure debt issuance.

The hunt for yield is tempting many institutional and fund investors to consider the asset class, while project managers are casting around for a replacement to reduced bank finance.

In the first six weeks of 2013 alone, around $900 million was raised for new fund issues, a third of the $2.7 billion raised during the whole of 2012, reports research house Prequin.

Funds being marketed are targeting a total raise of more than $8 billion, it said.

That has tempted new entrants to the market, such as JP Morgan and BlackRock, which both poached management teams and announced plans to launch funds in the second half of 2012, while more traditional mixed debt/equity infrastructure funds have flourished.

‘In the past, the infrastructure debt fund market has been a fairly niche part of the asset class, but it is growing in prominence,’ said Prequin.

‘This shift is partially being driven by incoming capital adequacy requirements for banks [Basel III], which are making new debt investments in illiquid infrastructure assets a more difficult prospect and are forcing banks out of the space.

‘This is creating a gap in the infrastructure debt market for non-traditional lenders that are attracted to the stable revenue streams and the long-term liability matching characteristics of infrastructure debt.’

Boe Pahari of AMP Capital Investors added: ‘Banks have a changed appetite in terms of leveraged ratios and tenders after the credit crunch. As a result, there is a space where pension funds can participate on the debt side, particularly in mezzanine [lending].’

The long-term fixed capital structures of infrastructure contracts make them particularly suitable for matching liabilities over potential multi-decade periods and a potential substitute for managers who might be wary of sovereign duration risk.

Infrastructure credit typically offers a premium of around 2.5% to 3% above Treasuries. Apart from credit risk, that prices in some fairly unusual contract risks that investors need to understand, however.

‘In an infrastructure loan, the issuer agrees to pay a floating rate coupon plus spread, based on a fixed principal repayment schedule,’ warned JP Morgan’s sector specialist team. ‘This amortisation schedule cannot be altered without the agreement of the lenders, nor can coupon payments be altered. However, the borrower has the option to repay the loan partially, or in its entirety, at par and would not have to pay any further coupons or compensate the lender for the loss of future spread payments.’

‘Although borrowers have this option, prepayment rates have historically been extremely low. Full prepayment rates for infrastructure, as defined by Standard & Poor’s and maintained on a bank consortia database, have been 1.6% in total in western Europe and virtually 0% in the UK since the database’s inception in the 1980s.’

The relative illiquidity of the market has also been one of the major factors deterring wider take-up of the asset class until now. Harder to quantify are political risks. For instance, in the UK, the government last year pledged to underwrite up to £40 billion in infrastructure credit.

While generating favourable headlines, Capital Economics said it would be prudent to take the commitments with a large pinch of salt.

‘Some of these measures are not quite as generous as they look,’ said the company’s chief UK economist Vicky Redwood. ‘For example, the money for the temporary lending programme will come out of departments’ existing budgets. And the investment in the railways will be funded by fare rises and efficiency savings rather than extra public sector money.

‘Meanwhile, take-up of the guarantees scheme may be limited due to the long list of conditions that companies have to fulfill. To qualify, projects have to be nationally significant, ready to start construction within a year, have equity finance already committed, be good value to the taxpayer and have acceptable credit quality.

‘Accordingly, it is questionable whether there are many projects that meet these criteria but cannot find full funding from the markets anyway.’

Major asset managers, cowed by the cost, the risk and the controversy involved in investing in farmland, are joining forces to increase investment in the historically under-capitalised sector.

In one example, Swiss fund of funds Adveq is in talks with three European pension funds, a private family and a Korean asset manager to buy farmland, in which it will act as the originator and lead investor.

Last year one of the world's largest institutional investors, TIAA-CREF, partnered with pension funds including British Colombia Investment Management Corporation and AP2 to create a $2 billion investment vehicle to buy farmland.

The new approach is likely to attract significant amounts of money from pension funds and other institutional investors into farmland, a sector in which they are reluctant to go it alone.

"We see agriculture and farmland as an asset class that's still being shaped," said Biff Ourso, director and portfolio manager of farmland investments at U.S. asset manager TIAA-CREF.

"It (working together) creates alignment for investors, economies of scale, cost-sharing and the transparency that a lot of investors want today," he added.

Adveq expects three institutional investor club deals to close in the next 12 months, each between $200 million and $400 million in size.

Investors are attracted into farmland by the rising global demand for food and a low correlation of agricultural land prices with traditional asset classes.

Pension funds have been cautious in how they approach the sector, however, because charities worldwide have voiced concern that large-scale land grabs by foreign investors could push up food prices, push farmers off the land and increase hunger.

"Agriculture is a very sensitive subject for two reasons, one is the fundamental human right for food in a food-insecure world, and secondly land is sacred to every country. To sell land in some societies is not acceptable," said independent consultant Mahendra Shah, member of a panel advising Adveq on agricultural investment strategy.

"My personal view is these pension funds are afraid to go into the field alone, and they want to spread their bet or their risk by having partners join them."

FLEDGLING ASSET CLASS

By working together, pension funds aim to create bespoke investment vehicles in a fledgling asset class that meet requirements for responsible investment in a sensitive area.

Research by Macquarie in 2012 showed institutional investment at a meagre $30 billion to $40 billion out of a total global value for farmland of $8.4 trillion.

Most farmland is owned by family farmers, giving institutional investors huge scope for buying up individual properties to form larger operations.

Institutional investors say that by working together they have a much better chance of being successful in terms of social responsibility as well as economic returns.

But some agricultural experts questioned the benefits.

"It's not absolutely clear to me that the simple fact that just a few of them come together is going to produce a better overall result," said David Hallam, director of trade and markets at the United Nations food agency (FAO).

"Unless the nature of the actual investments changes substantially, then I don't see the fact that a few companies get together would necessarily improve things," he added.

RICH SEAM

Institutional investors have generally focused on regions that are net exporters of food including North America, Australia, South America and Central and Eastern Europe.

"We like to be a in a situation where we're not taking food from the local market, where we are not taking food away from its natural value chain for speculation purposes, (where) on the contrary we contribute to increasing food production," said Berry Polmann, executive director at Adveq.

"While doing so, we don't want to undercut local farmers by producing more at lower costs, eroding their competitive power and wiping them out. That's one of the reasons why Africa for us is very difficult."

Adveq's group is looking for farmland assets in North America, Central and Eastern Europe, Latin America and Oceania.

Through partnering, institutional investors aim to become more efficient and share knowledge.

"We prefer to go with other institutional investors," said Ibrahim Abdulkhaliq, portfolio manager, alternative investments at MASIC, a Saudi Arabian institutional family office.

Abdulkhaliq cited two reasons for the trend - more difficult governance and due diligence in farmland and the ability to reduce costs, making investments more viable.

“As long as the music is playing, you’ve got to get up and dance.” With those immortal words, then-Citigroup (NYSE:C) Chief Executive Charles Prince explained in July 2007 what had motivated his managers to steer their bank into insolvency.

The multi-trillion dollar question that regulators and investors ought to be asking is whether bankers are again succumbing to the urge to shimmy while the shimmying is good.

There are a number of reasons to think they’re doing just that. Tops is the fact that with interest rates so low, there’s been a breakdown in the traditional “3-5-3” banking model—pay 3% on deposits, lend the money out at 5% and be on the golf course by 3 p.m.

Compressed net interest margins mean bankers face pressure to under-price risk to win loan business and to look to other questionable tactics to turn a buck.

Regulators’ ever-tightening grip on how bankers run their businesses is taking a bite out of fee revenue, too. Until recently, banks propagated the fiction that they offered “free” services like checking accounts, which in fact cost them around $350 a year to maintain. They recouped their costs and earned a profit by charging fees on the back-end. Some were of the “gotcha” variety, like those for over-drawing accounts, paying card balances late or for credit card payment protection plans of marginal value to buyers. The newly empowered Consumer Financial Protection Bureau has put a plug in many such revenue streams.

In addition to narrow lending margins and increased regulation, bankers are living in a world where animal spirits have returned to financial markets. Stocks and other “risk” assets are back in vogue. Greed is again trumping fear.

In what imprudent ways are bankers likely to respond to these various pressures? Take your pick.

Comptroller of the Currency Thomas Curry warned back in October that regulators were "ready to take action" against banks that boost earnings by releasing reserves with excessive haste. Comptrollers do not tend to talk in such hypotheticals unless there’s a genuine cause for concern behind them.

Federal Reserve Governor Sarah Bloom Raskin warned last month that “The pressure to generate enhanced profits through high fees is palpable, and banks may choose to move aggressively down these paths.”

One banking insider also pointed out to me this week that the owners of many small banks are looking to sell. With a high price tag as their beacon, the temptation to pretty the financials is strong. That may help explain the fevered competition to write commercial and industrial loans, he added.

“There are more people in the marketplace and they’re not acting entirely rational, so we all have to end up being more competitive and that means we have to sacrifice margin,” US Bank (USB) Chief Executive Richard Davis said earlier this week of the loan market.

Froth is bubbling up in bank M&A too. Three recent deals involved premiums of 32% to 83% above tangible book value, implying that buyers are willing to bet on the prospect that the targets will be worth more in the future than they are today. "We are seeing in-market [banks buying banks] deals with big expectations around cost savings,” Phil Weaver, a partner at PricewaterhouseCoopers toldAmerican Banker recently.

Cost-savings is another term for “synergy,” the buzz-word that over the years has impoverished shareholders and enriched investment bankers in roughly equal measure.

Think this time regulators will remove the punch bowl in time? Don’t fool yourself. Consider how blind they were to JPMorgan Chase’s (JPM) multi-billion dollar London Whale until they read about him in the press. Their early warning systems appear to be no better today than they were when Chuck Prince was leading the dance at Citi.

It is a difficult time to be a pension fund manager. Few asset classes are generating strong performance, complicating asset allocation decisions to the point of paralysing investors.

Paul Jayasingha, senior investment consultant at Towers Watson, said: “Volatile markets and heightened risk awareness continue to make asset allocation very challenging as companies and trustees balance such priorities as long- term de-risking, short-term market opportunities, rebalancing and maintaining a strategic asset-allocation mix.”

Equity allocations for UK pension schemes fell from 61% in 2002 to 56% in 2007, and to 45% in 2012, according to data from Towers Watson. However, UK pension funds have increased their exposure to alternative assets from 3% to an average of 17% over the past decade and allocations to bonds have also increased over the past five years – from 30% in 2007 to 37% in 2012.

Risk-averse schemes have sought the relative safety of bonds. James Montier, member of the asset-allocation committee at fund manager GMO, said: “Governments, in their process of financial repression, are forcing everyone to try to buy bonds. Pension funds are told that they need to liability match, so they need bonds. They are forcing everyone into these incredibly low-yielding assets and dragging down the returns of other assets as well.”

Equities provide better value than bonds, according to Jayasingha, but convincing pension schemes to invest in stocks is far from easy. He said: “It is challenging to know what to do about it when the goal for many funds is to reduce risk overall and diversify from existing equity holdings.”

Poor investment returns also continue to be a problem for trustees. The FTSE 100 is down 9% since 2000, which equates to a cumulative loss of about 0.7% annually. Antti Ilmanen, managing director of AQR Capital Management, said: “Investors have figured out that in the last 10 years or so their portfolios have been driven by one source of risk, which is market direction. All portfolios move with market direction, even when they are supposed to be diversified. It was embarrassing – no matter what they had in their portfolios their returns were driven by the markets.”

DC silver lining

In spite of this increased correlation between asset classes and the investor paralysis that has followed, fund managers remain confident that equities will return to favour, particularly as defined-contribution assets grow.

Projections from market research firm Spence Johnson show growth in the DC market is expected to continue from £286bn in December last year to £800bn by 2022, overtaking defined-benefit plans.

Neil Walton, head of strategic solutions at Schroders, said: “Participants in defined-contribution schemes will need good solid long-term returns to grow into anything sensible, so equity investing is definitely here to stay, probably within diversified portfolios.”

Diversified growth or multi-asset style portfolios have proved popular with investors attracted by access to a wide range of asset classes within a single product. Assets managed by diversified growth funds in the UK and Ireland rose from £30bn to £50bn in the 12 months to the end of June, according to investment consultancy Aon Hewitt.

Cerulli Associates estimates that the number of European diversified growth funds range from 40 to 100, depending on their definition, and there are an estimated 50 managers offering multi-asset funds in the UK.

But investors should be wary of going back to the old days of balanced management, where a single fund manager was appointed to invest across an often pre-determined and limited range of asset classes, warned Deb Clarke, investment partner at investment consultancy Mercer, which recently launched its own diversified fund.

Clarke said: “The flexible funds are interesting. Some of them have attracted a lot of assets. There is some merit to them, but we wouldn’t like to see them become just like the old balanced funds. It has to be someone with a skill set that can move in and out quickly and be holistic, not the old fashioned case of 60% equities and 40% bonds.”

Low-risk returns

Exchange-traded funds, smart beta products and traditional passive investments have also attracted investors keen to reduce their active exposure in search of low-risk, cheaper sources of returns. ETF assets under management have risen from $800bn at the end of 2007 to $1.3 trillion four years later despite the crisis, a compound annual growth rate of 14%, according to Boston Consulting Group. If passive mandates are grouped with ETF assets, the penetration of passive products within the total asset management market grew from 7% in 2003 to 12% in 2011.

ETF assets exceeded the $2 trillion mark in January. For Jeff Molitor, chief investment officer at Vanguard, whose lower fees helped spark a price war among ETF providers last year, the rationale is clear: “One of the few things that investors can control is the costs, the prices they pay.”

The lacklustre performance of some active managers compared with their passive counterparts has also made it harder to convince nervous investors to return to active investing. Passive fund managers outperformed active managers in 30% of fund sectors in the three years to August 2011, according to data from Cerulli Associates. When active strategies did outperform, the differences in returns ranged from as little as 0.4 percentage points for Japanese equities to 11.9 for hedge funds.

Consultants say that with active managers charging higher fees, investors are opting for a larger passive allocation with a smaller core of active. Clarke said: “I think the issue is that there are fewer assets to go around and perhaps what needs to change is the fee structure.”

But active managers point out that the cyclical nature of the markets means they can add value. Charlie Crole, institutional client director at Jupiter, said: “If you look at the oil sector and banks, together they account for 25% to 30% of the index. The oil and gas sector fell in aggregate by 7.5% last year and the bank sector was up 40%, so you had a performance differential of nearly 50%. Are you going to slavishly follow an index where one of the largest sectors can fall by 7% and another rises by 40%?”

High conviction

As a result, many active managers are hoping to attract investors by pursuing high conviction strategies, which are typically based on a narrowly focused portfolio of stocks or bonds, or are based on a particular investment thesis or macro overlay.

Scottish Widows Investment Partnership, for example, is creating high conviction active share portfolios, picking what it believes are outperforming companies, such as TripAdvisor, carpet manufacturer Mohawk Industries or Treasury Wine Estates, according to Will Low, director of equities at SWIP.

Others, such as Berenberg Bank, are pitching the use of more overlay strategies to their institutional clients. Matthew Stemp, head of investment management UK, said: “One of the ways we are engaging with clients is to talk about using more market overlays on existing asset classes in order to protect funds from market falls but allow them to maintain existing asset classes. Three or four years ago building an equity overlay would not have been talked about. Now we are discussing this.”

• Top tips for beating inertia

1. Invite pension funds to pre-commit to begin investing at a specific time in the future and ask them to set the date for that action
2. Work with pension funds to agree on the size and frequency of periodic investments
3. Decide in advance the nature of the assets that need to be purchased.

Source: Allianz Global Investors Center for Behavioral Finance

•  Investment paralysis : it’s all in the mind

Investors, reluctant to re-enter the market and saving record amounts of cash since the start of the financial crisis nearly five years ago, have become paralysed by what behavioural scientists call “loss aversion”.

But although loss aversion is the most important psychological factor in investment paralysis, it can be overcome by “fuzzy accounting”, according to Allianz Global Investors’ Center for Behavioral Finance, which was founded in 2010 with the goal of turning academic insights into actionable ideas.

The research, Invest More Tomorrow, argues that if an investor puts all his or her cash into the market in one large transaction, then any increase or decrease in the value of the investment as the market moves up or down is easy to see.

However, if an investor commits a specific portion of his or her portfolio – say, 25% – at regular intervals such as every three months, then he or she doesn’t have a single reference point or sum of money to focus on. So if the investments from the first entry into the market were to lose value, the investor would feel that he or she had only committed a small portion of cash, and would see an opportunity to buy cheap with his or her next purchase. This strategy is known as dollar – or pound – cost averaging.

Procrastination by investors is another issue facing fund managers and advisers. The Center’s research suggests investors should be asked if they are willing to commit to entering the markets at some point in the future. This puts the timing of the strategy into the hands of the investor, rather than having it imposed on them, and the investor feels more in control and more committed to following the agreed-upon action.

The ECB expects inflation to fall to 1.3pc next year but the underlying rate is significantly lower given the distorting effects of austerity taxes. Any error would raise the risk of slow slide into a Japanese-style trap.

“Europe is heading into a deflationary scenario if they don’t do anything to boost the money supply,” said Lars Christensen from Danske Bank. “This already looks very similar to what happened in Japan in 1996 and 1997.”

The Japanese discovered that they were acutely vulnerable to an external shock once inflation had fallen below 1pc for a protracted period.In their case the East Asian crash of 1998 tipped them over the edge into a serious crisis.

Eurozone lending to companies has fallen by €100bn over the last six months, and small firms are struggling with a severe credit crunch across the Club Med bloc. Mr Draghi said there were no plans to introduce a variant of the Bank of England's Funding for Lending to channel money where it is most needed.

Critics say the ECB has persistently under-estimated the severity of the downturn, and has failed to offset drastic budget cuts with monetary stimulus. Both levers of policy are set on contraction, with bank deleveraging compounding the effect.

There is a risk that the bank may be caught out again this year. German industrial orders fell 1.9pc in January, dashing hopes of German-led rebound.

Christine Lagarde, head of the International Monetary Fund, said it is too early to assume that the worst is over. “Clearly the world economy avoided collapse last year. I am very concerned that, by moving into a semi-complacent mood, people risk a relapse,” she told the Irish Times.

The Catholic charity Caritas called for radical change in the eurozone’s whole crisis strategy, saying the current course was self-defeating and “putting the very legitimacy of the EU at risk”.

It said child poverty had reached dramatic levels in Ireland, Spain, Italy, Portugal and Greece, while deep cuts to welfare have left the most vulnerable stripped of a safety net. It said the chief victims bore no responsibility for the crisis, a breach of natural justice.

The crisis has engulfed France where a key gauge of the money supply -- six-month real M1 -- is contracting at an annual rate of 6.6pc and flashing graver warning signs than in Italy or Spain.

Figures out today showed that French unemployment rose to a euro-era high of 10.6pc in the fourth quarter, with the total looking for work near 3.7m.

France’s BVA confidence index plunged 12 points last month. Some 75pc of households fear that the economy will deteriorate over the next year. It is the worst reading since President Francois Hollande took power in May with a pledge to kick start growth and break the back of unemployment.

The Figaro said the French jobless rate is now higher than at any time in the 1930s, when farm ties and the empire acted as a safety valve.

“France is on the brink economic implosion,” said economist Christian Saint Etienne, warning that a state sector nearing 57pc of GDP rendered the country unfit for of EMU.

The bottom line is that we have a lot of evidence suggesting that the failure of deflation to materialize reflects wage rigidity, not absence of economic slack. And it is therefore frustrating to see supposedly well-informed people talk about this issue as if none of that work had been done.

Illinois, which has the worst-funded state pension system in the United States, agreed on Monday to settle federal civil securities fraud charges alleging it repeatedly misled municipal bond investors about the underfunding of its pensions, the U.S. Securities and Exchange Commission said on Monday.

Illinois neither admitted or denied the charges and was not ordered to pay a penalty. It agreed to change its practices to more fully disclose risks to bond investors.

The settlement of charges that Illinois failed from 2005 to early 2009 to fully tell investors the risks of buying $2.2 billion worth of its municipal bonds is the latest blow to the state's reputation as fiscally troubled and crippled by a pension shortfall of $98.6 billion (figure above from WSJ is short a couple of billion dollars).

In official statements accompanying bond offerings Illinois explained that factors such as market performance had contributed to the increase in its unfunded pension liability, but it "misleadingly omitted to disclose the primary driver of the increase - the insufficient contributions," the SEC said.

In order to keep its contributions low, Illinois had developed a complicated system that included "ramp-ups" and "pension holidays," the SEC said.

Instead of paying to pension funds what actuaries had determined to be the annual contributions, Illinois followed a funding plan approved by the legislature that deferred the payment of pension obligations, compounding its pension burden.

The legislature phased in the state's contribution over a fifteen-year "ramp" period, where the amount Illinois put in gradually grew until in 2011 it made the full amount. It then had to put in a level amount so the pension system was funded by 2045.

The state went further, amortizing pension costs over 50 years, instead of the typical 30, which gave it a longer window to pay off the liability. Then, it lowered the contributions in 2006 by 56 percent and in 2007 by 45 percent in "pension holidays."

Illinois "failed to disclose the effect of its unfunded pension systems on the state's ability to manage other obligations, the SEC said. "The state also did not inform investors that rising pension costs could continue to affect its ability to satisfy its commitments in the future."

It also did not explain to investors that its "inability to make its contributions increased the investment risk to bondholders," the SEC said, adding it "did not identify or discuss how this underfunding compromised the state's creditworthiness or increased its financing costs."

The state of Illinois has $19.67 billion pension obligation bonds outstanding, out of a total of about $50.2 billion in outstanding municipal bonds, according to Thomson Reuters data.

INSTITUTIONAL FAILURES

There were also institutional failures, according to the regulator. The Illinois government relied on bond underwriters, consultants and lawyers to advise them what to disclose but those same groups were relying on the state for the advice, SEC said.

"The result was a process in which no one person fully accepted responsibility for identifying and analyzing potential pension disclosures," the settlement document said.

Beginning in 2009, the state took steps to address the commission's concerns, the SEC said. Over the last four years, Illinois has improved disclosures in the pension section of its bond offering documents, retained disclosure counsel, and instituted written policies on disclosure.

In 2010, the state also enacted a law that employees hired after Jan. 1, 2011 would have a higher retirement age and lower pension.

Governor Pat Quinn said the commission had acknowledged the "proactive steps" Illinois took improve its pension disclosures, and that "the state began these enhancements prior to being contacted by the SEC."

Quinn and the state legislature are currently locked in a political battle as to how best to fix the funding gap, which is so large that it has led Illinois to have the worst credit rating among U.S. states. All three rating agencies have raised alarms that the swelling pension obligations and problems could eat away at the state's credit quality.

Investors' concerns over credit quality has driven up the amounts the state must pay to borrow - on Friday the spread of yields on Illinois debt to Municipal Market Data's benchmark scale was 140 basis points for a 10-year bond. For the last year, the spread has averaged 149.8 basis points, the second highest after financially troubled Puerto Rico.

Many states had long short-changed their pension funds, and when their revenues collapsed during the 2007-09 recession, they pulled even further back on contributions. At the same time the leading source of revenues for pensions, investments, plummeted in the financial crisis. According to Pew Center on the States, the pension gap for all states is currently $757 billion.

Illinois Comptroller Judy Baar Topinka, a Republican who was not in office when the alleged abuses took place, said the state has done "the right thing."

"Unfortunately we will all be paying for the mishandling of the pension funds for many years to come. At the time I warned that raiding our pension funds and borrowing to make our payments was a 'ticking financial time bomb' and sadly, that has come to pass," Topinka said.

The case marks the second time the SEC has charged a state in connection with public pension disclosure failures. The SEC had previously charged New Jersey in 2010, for not adequately informing investors of the costs of its pensions, saying at the time the charges were a warning to all other issuers in the $3.7 trillion municipal bond market.

Elaine Greenberg, chief of the SEC's Municipal Securities and Public Pensions Unit said in a statement on the settlement, pension disclosure "continues to be a top priority."

Ottawa has granted Air Canada more time to meet its pension funding obligations, but with tough conditions that include the airline’s executives taking a hit to the wallet.

Ottawa needed to act to ensure the carrier’s fiscal health, Finance Minister Jim Flaherty said in a statement Tuesday. “Air Canada is the country’s largest airline and contributes significantly to the Canadian economy,” he said.

In what appeared to be a message to other organizations that might want financial aid, Mr. Flaherty made it clear that this is an extraordinary case that required imposing strict conditions in exchange for the pension funding extension. The Finance Minister is slated to present the 2013-14 federal budget within weeks.

The Montreal-based carrier will freeze executives’ compensation at the rate of inflation, ban special bonuses and limit management incentive programs.

The airline’s chief executive officer, Calin Rovinescu, had a total payout of nearly $4-million in 2011, including $1.4-million in salary and $1.2-million in share-based awards.

The federal government also said the airline won’t be able to declare any dividends and embark on share repurchases.

Faced with a $4.2-billion pension solvency deficit at the start of 2012, Air Canada had originally sought permission to limit its payments to $150-million annually over 10 years. In Tuesday’s deal, the company must pay at least $150-million a year, with an annual average of $200-million spread over seven years.

“During lengthy discussions with the company, the government demanded that Air Canada strengthen its initial proposal with tough new conditions such as greater solvency payments, a shortened term and measures that will ensure that employees and executives of Air Canada are part of the solution,” the Finance Department said.

The conditions suggest Ottawa wants to ensure that, after giving Air Canada an extension, it won’t be faced with the poor optics of big executive bonuses. And one Finance Department official said the government believes the tough conditions will be an incentive for Air Canada to pay off its pension deficit faster and return to business as usual.

The Air Transport Association of Canada, whose members include smaller carriers such Porter Airlines Inc., complained last month about the prospect of Ottawa helping the former Crown corporation. “The cap requested by Air Canada would barely cover the deficit’s annual interest and would do absolutely nothing to tackle this crippling deficit,” the association wrote on Feb. 12 to Mr. Flaherty, Prime Minister Stephen Harper and Transport Minister Denis Lebel.

Mr. Flaherty defended the decision. “It’s important to note that Air Canada’s unions and retirees have been supportive of the company’s request for further solvency funding relief for its pension plans,” he said. “This regulatory change is not costing Canadian taxpayers a single dollar, but it is providing Air Canada time to pay off the sizable pension deficit.”

Air Canada obtained pension funding relief in 2009, but that arrangement was set to expire on Jan. 30, 2014.

The new agreement means that for the period from 2014 through 2020, “Air Canada will contribute an aggregate minimum of $1.4-billion in solvency deficit payments, in addition to its pension current service payments,” the airline said, adding that for 2009-2013, it will have contributed nearly $1.48-billion in past service contributions and current service costs.

Air Canada doesn’t currently pay any dividends, but rival WestJet Airlines Ltd. does. Calgary-based WestJet has complained in the past about Air Canada gaining an unfair competitive advantage through pension relief.

“In the current extremely low-interest-rate environment, Air Canada’s pension solvency deficit funding payments would be unsustainable without this extension in place,” the company said late Tuesday. “Air Canada will submit to the Office of the Superintendent of Financial Institutions all communications materials it intends to send to pension plan beneficiaries prior to funding the plans in accordance with the new regulations.”

The federal government announced Tuesday that it would give Air Canada more time to eliminate the $4.2-billion deficit in its pension plan, but imposed strict rules on the airline that limit executive pay and prevent it from paying dividends.

"By taking this action, we are ensuring that Air Canada remains viable, that thousands of jobs are protected and the service is there when Canadians need it," Finance Minister Jim Flaherty said in a statement.

"Air Canada is the country's largest airline and contributes significantly to the Canadian economy."

The deal requires the airline to make contributions to the plan of at least $150 million a year totalling at least $1.4 billion over seven years, on top of the regular contributions required by the plan.

Executive pay frozen

The agreement also freezes increases in executive pay at the rate of inflation, prohibits special bonuses and puts limits on executives' incentive plans. The airline will also be prevented from paying dividends and buying back stock as well as making any pension plan benefit improvements without regulatory approval.

Air Canada's pension deficit has been a chronic problem for the airline due to low interest rates which have driven up liabilities.

The airline had wanted Ottawa to put a $150-million cap on its annual solvency deficit payments for the next decade, starting in 2014.

Flaherty noted that Air Canada's unions and retirees have been supportive of the company's request for help with its pension deficit.

"This regulatory change is not costing Canadian taxpayers a single dollar, but it is providing Air Canada time to pay off the sizeable pension deficit," the minister said.

Pension holiday extended

In 2009, Air Canada signed a deal with the federal government that granted the airline a moratorium on special pension contributions to reduce its deficit for that year and 2010. Under that deal, which expires next year, Air Canada was required to make $150 million in special payments in 2011, $175 million in 2012 and $225 million in 2013.

The Air Transport Association of Canada had argued against Ottawa granting Air Canada pension relief, saying it would create an uneven playing field.

The group, which represents small regional carriers and training centres, argued that Ottawa should provide broad pension assistance to all Canadian companies, instead of giving a competitive advantage to the former Crown corporation.

"We don't really have anything to add, but that we respect the government's decision," said John McKenna, president and CEO of ATAC.

McKenna said the group has decided to be more "cautious" after it was falsely accused of being overly critical of the airline.

Last week, it posted a public apology on the front page of its website for the open letter it had written to the federal government to voice its concerns.

Air Canada has said that cost savings from its recent labour agreements, the startup of low-cost carrier Rouge and pension relief will help to lead the airline to sustainable profits.

Shares in Air Canada closed down six cents to $2.57 Tuesday on the Toronto Stock Exchange.

Save your tears, but it’s not easy being a middle market private equity firm these days. Due to significant structural hurdles and headwinds facing U.S. private equity funds—not to mention an increasingly challenging political and economic environment—a growing number of savvy private equity managers are responding by becoming more entrepreneurial and thinking outside of the proverbial box. The current problems and structural issues are not going away anytime soon. As a result, private equity managers are left with little choice but to adapt to these evolving conditions.

There are a number of reasons why the standard private equity fund is losing its luster. The biggest issue the industry faces is liquidity where a 10-year lockup with two 1-year extensions is the norm. That is a long time to keep precious capital locked up, especially in a bad economic cycle during which a fund can’t exit its investment. Most investors don’t like the 10-year lockup and would rather opt for a more liquid structure. LP’s seem to be moving away from blind pool investing, and opting for more flexible vehicles and structures. The industry’s investor base is changing: Institutional investors like banks and insurers are withdrawing from fund investing. To attract different sources of money, the industry may need to offer different structures. The latter is particularly true with family offices: as they get more sophisticated, they also want to go direct into deals and not into funds. Looking forward private equity firms needs to be more agnostic about how their vehicles are structured. Their job should be not to preserve the existing fund model, but to make sure that investors’ capital is delivered to companies in need of investment in the most efficient way possible.

Then there is the actual cost of raising a fund, as well as the overall fund structure—this includes paying investment professionals, analysts, marketing and investor relations professionals, fundraising people—it’s a very costly infrastructure. When you factor in some of the other common expenses like expensive commercial office space, perhaps sky-high midtown Manhattan office space, along with expensive travel, and the costs quickly add up. In addition, it can easily take up to two years to raise a new fund. Time is money and many investors simply do not have the time nor patience to wait this long. And then as funds have be registered with SEC, there are growing legal and regulatory costs to consider. At the same time “fee compression” is revealing itself more and more frequently.

Right now, it’s the bigger funds that are getting bigger, while the smaller, emerging managers are starting to disappear altogether. Among the biggest funds, Blackstone just raised a $13 billion dollar real estate fund, and then CalPERS recently made a $400 commitment to Riverstone, a multi-billion dollar fund.

Notably, the political tide in Washington is not helping matters. The lower tax rate on “carried interest” was never popular, and last month, Sen. Carl Levin (D-MI) reintroduced legislation supported by the Obama Administration that will classify carried-interest investment income as ordinary income for tax-reporting purposes. As in past versions, the “Cut Unjustified Tax Loopholes Act” submitted by Levin would raise taxes on the carried interest income of investment partnerships from the capital gains rate to the ordinary income tax rate of 39.6%. We are talking about a major tax treatment sea change.

So what’s the alternative? As private equity funds search for different structures, holding companies like Warren Buffett’s Berkshire Hathaway spring to mind. Private equity people are now looking to buy operating business and run them, and use the subsequent cash flows to buy other businesses. Another noteworthy structure is the special-purpose acquisition company (SPAC) which may be a key component of the next evolution.

SPACs are simply a vehicle that facilitates an IPO for unique companies that might not otherwise be able to get through the IPO queue in a timely manner. It’s a great way for a private company to go public without the headache of going through the SEC registration process. Several well-known companies have gone public through SPACs in recent years, including fashion retailer American Apparel, along with the well known New York cupcake chain, Crumbs Bake Shop. SPACs can truly be a viable alternative for small, rapidly growing companies looking to tap the public markets, and have ongoing access to capital via the capital markets. SPACs are a viable alternative that bring together an experienced and industry specific management team for an offering to public market investors.

Importantly, private equity as an asset class is not over; rather investment professionals are changing the way they do business with an eye towards adapting to changing times via specialized vehicles, separate accounts, and in some cases listed vehicles. After 2007 liquidity is king, and flexibility is important. The talent within the space bodes well for future adjustment, but for now the funds in their present structure seem to be losing their luster.

The number of hedge funds going out of business rose for the third year in a row in 2012, according to HFR, a data provider. Last year, 873 funds failed or closed their doors out of the estimated 9,800 total, against 775 in 2011 and 743 in 2010.

Those closures were offset by 1,108 new hedge fund launches, slightly down on the 2011 total. The pace of launches has recovered from the low of 659 funds in 2008, but the rate still lags behind the boom years of 2004 to 2007.

“The environment for launches remains very difficult,” said Anne-Gaelle Pouille, a director for Paamco, a fund of funds group that specialises in small hedge funds with less than $1bn in assets at launch.

Ken Heinz, HFR president, said that for the average hedge fund, “the last two years have been a wash. If you look at the whole HFR Index, you are barely up over a two-year period”.

The average hedge fund gained 6.4 per cent in 2012, after average losses of 5.3 per cent in 2011. A simple portfolio of index funds invested 60 per cent in US stocks and 40 per cent in bonds was up 17.5 per cent over the same two year period.

Mr Heinz said that “costs are going up and the requirements on funds in terms of regulatory reporting are also going up”.

Reflecting that tough environment, fees charged by newly launched hedge funds came under pressure. Annual management fees charged by new launches held steady at 1.62 per cent on average, according to HFR, but the performance fees that managers charged on investment profits dropped 34 basis points on the year before to 17.74 per cent. Pre-crisis, performance fees on new launches peaked at 18.7 per cent.

Some high profile funds attracted significant capital and support. London-based Mike Stewart, JPMorgan’s global head of proprietary trading, and former head of emerging markets, launched Whard Stewart with a team of former traders from the bank.

Stone Milliner, led by Jens-Peter Stein and Kornelius Klobucar, spun out of Moore Capital. And Sutesh Sharma, the former head of proprietary trading at Citigroup launched Portman Square Capital with about $500m.

But Ms Pouille said that most funds were offering fee discounts at launch.“There has been a proliferation of what’s called founders classes”, with up to 5 percentage points off performance fees, and reduced management fees, in return for committing capital for two or three years.

Hedge fund professionals are enjoying fat wallets once again. Their average cash compensation rose 15 percent to $314,000, according to the 2013 Hedge Fund Compensation Report. In addition to analyzing the salaries and bonuses of hundreds of hedge fund pros, the yearly report also examines the impact of fund performance and size on earnings, hiring trends, and job satisfaction.

Fueled by strong fund performance, bonuses contributed strongly to the year-over-year increase in total pay in 2012. The average hedge fund bonus surged by 31 percent, while the mean base salary edged up 4 percent.

“This year, we discovered a significant correlation between fund profitability and bonus size,” said David Kochanek, publisher of 2013HedgeFundCompensationReport.com. “Employees of the best-performing funds took home average bonuses of just over $200,000.”

Kochanek continued, “Given similar performance, we expect 2013 bonuses to rise even further as many funds will reach their high-water mark.”

Firm size had little bearing on compensation, with similar earnings reported by employees from the smaller funds as those from firms with $1 billion under management.

Hiring trends remained roughly on par with the previous year, with 24 percent of firms reporting hiring within research departments, 20 percent adding to operations, and 12 percent seeking to bolster legal departments.

The full report, available for download, contains more than 40 detailed charts and graphs. It provides comprehensive data to help hedge fund professionals set goals and negotiate compensation packages, and assist firms seeking to establish pay benchmarks.

Hedge funds fell 0.4 percent last month, trailing global stocks, as funds including those at John Paulson’s Paulson & Co. and Ray Dalio’s Bridgewater Associates LP posted declines in February.

Multistrategy and macro managers decreased last month, while long-short equity hedge funds rose, according to data compiled by Bloomberg. Hedge funds that gained in February include Steven A. Cohen’s SAC Capital Advisors LP and Renaissance Technologies LLC, founded by Jim Simons. Hedge funds on average rose 1.5 percent this year.

The MSCI All-Country World Index, which has beaten the $2.25 trillion hedge-fund industry in five of the past seven years, rose less than 0.1 percent in February, including dividends, as markets swung between concern and optimism about economic growth. Stocks worldwide fell on Feb. 25, when the Italian election stalemate reignited worries about Europe’s debt crisis. The Dow Jones Industrial Average climbed to the highest level in five years just two days later on better-than-estimated housing data, before hitting a record in March.

“Most strategies were up but dragged down by macro (BBHFMCRO) and multistrategy,” said Don Steinbrugge, managing partner of Agecroft Partners LLC, a Richmond, Virginia-based firm that advises hedge funds and investors. “The economic readings continued to be positive, especially in the housing market. The economic information out of Europe was not as good as the U.S.”

The Bloomberg Hedge Funds Aggregate Index is down 10 percent from its July 2007 peak. The main Bloomberg hedge fund index is weighted by market capitalization and tracks 1,264 funds, 2,763 of which have reported returns for February. The index, with annual data dating to 2006, has fallen short of the MSCI benchmark each year except for 2008 and 2011.

Paulson, Bridgewater

Long-short equity funds, whose managers can bet on and against stocks, rose 0.3 percent in February, bringing yearly gains to 2.3 percent. Multistrategy (BBHFMLTI) funds fell 0.6 percent last month and gained 0.8 percent this year. Macro funds, whose managers make investment decisions based on their reading of economic and political events, declined 1.2 percent in February, paring returns in 2013 to 0.1 percent.

Paulson posted an 18 percent decline in his Gold Fund last month as a slump in the metal, after more than a decade of gains, undermined efforts by the billionaire hedge-fund manager to rebound from two years of losses in some strategies.

The $900 million Gold Fund, which invests in bullion- related equities and derivatives, is down 26 percent this year, Paulson & Co. said yesterday in a client update obtained by Bloomberg News. The $18 billion firm’s Advantage funds also fell in February, while its dollar-denominated Recovery, Credit and Merger funds posted gains. All of the gold share classes of the funds declined.

SAC, Renaissance

Bridgewater Associates’ Pure Alpha II fund fell 2.6 percent last month through Feb. 27 and 2.4 percent this year, according to a person familiar with the matter. Dalio’s Westport, Connecticut-based firm manages $140 billion in assets.

Cohen’s SAC Capital International increased 0.9 percent last month, bringing gains in the first two months of 2013 to 3.4 percent, said a person with knowledge of the matter who asked not to be identified because the information isn’t public. The fund is run by SAC Capital Advisors, the $15 billion Stamford, Connecticut-based firm that was notified in November by the U.S. Securities and Exchange Commission that it may be sued for insider-trading fraud.

Renaissance Technologies, the $22 billion East Setauket, New York-based hedge fund, posted a 2.2 percent February gain in its Renaissance Institutional Diversified Alpha Fund, bringing yearly returns to 4.5 percent, according to a person familiar with the matter. The Renaissance Institutional Equities Fund, advanced 2.3 percent last month and 7 percent this year, said the person, who asked not to be identified because the returns are private.

Hutchin Hill

Hutchin Hill Capital LP, the $1.1 billion hedge fund founded by Neil Chriss, posted a 2 percent advance in February in its Hutchin Hill Diversified Alpha Master Fund, bringing yearly gains to 4.9 percent, according to a person familiar with the matter.

Och-Ziff Capital Management Group LLC (OZM), the New York-based hedge fund run by Daniel Och, posted a 0.4 percent February gain in its OZ Master Fund, bringing its yearly return to 2.8 percent, the firm said in a regulatory filing. The OZ Europe Master Fund advanced 0.3 percent last month and 3.7 percent in 2013. The OZ Asia Master Fund climbed 0.4 percent in February and 4.1 percent this year. Och-Ziff had about $34.6 billion in assets as of March 1, a $1.5 billion increase from a month earlier, the firm said in the filing.

Tudor’s Returns

Tudor Investment Corp., the $12.1 billion global macro hedge fund founded by Paul Tudor Jones, rose 1 percent last month through Feb. 22 in its Tudor Global Fund, bringing yearly gains to 5.3 percent, according to a person familiar with the matter.

Pine River Capital Management LP, the $12.8 billion firm based in Minnetonka, Minnesota, posted a 0.3 percent return in its Pine River Fixed Income Fund run by Steve Kuhn, bringing yearly gains to 6.1 percent, according to an e-mail to clients, a copy of which was obtained by Bloomberg News. The Pine River Fund run by Aaron Yeary climbed 0.8 percent in February and 5.4 percent in 2013, the firm said in a separate e-mail.

Hedge-fund assets grew 2.8 percent to a record in the fourth quarter, according to Chicago-based Hedge Fund Research Inc. Investors deposited $3.4 billion during the period, the firm said in January.

A small bailout in a small state has roiled the global financial markets and triggered a political backlash as far away as Russia.

The bailout of Cyprus, one of the smallest members of the euro zone, was stalled Monday morning over reports that the minority Cypriot government lacked the support to pass the proposed €10-billion ($13-billion U.S.) bailout package, which is to impose a “haircut” on bank depositors.

None of the euro zone’s sovereign and bank bailouts, from Ireland to Greece, has insisted that bank depositors finance part of the bailout bill. The prospect of rich and poor bank customers losing up to 9.9 per cent of their deposits triggered near panic in Cyprus.

Bank customers, some of who called the bank raid “daylight robbery,” were lining up to withdraw cash from cash machines, many of which had run out of euros, and the Cyprus state broadcaster CYBC reported that a man drove a bulldozer into a bank branch in Limassol, the island’s financial centre, to protest the levy.

In Moscow, Russian president Vladimir Putin called the levy “unfair, unprofessional and dangerous.” Cyprus is one of the biggest offshore banking centres for wealthy Russians and Cyprus is the source of most of the foreign investment in Russia. Various reports said that Russians had stuffed between €20-billion and €26-billion in Cypriot banks.

In Europe, the renewed threat of crisis contagion sent the major European stock indices down, along with the euro. Bond yields in struggling euro zone countries rose sharply.

Greek 10-year bond yields rose 62 basis points (100 basis points equals 1 percentage point). Portuguese yields were up 20 basis points, Spain’s 10 and Italy’s 8. Fears that Italy faces a renewed crisis were especially acute because the country lacks a government after an inconclusive election last month. Italian bond yields are up 28 basis points in one month, to 4.67per cent.

In Cyprus, president Nicos Anastasiades defended the bailout, arguing that bankrupt banks and a deep recession, or worse, were the alternative. He also said that the bank deposit levy “avoids taking other tough measures such as wage and pension cuts that were put on the negotiations table.”

The reasons behind the decision to go after depositors to finance the bailout were never made clear. It appears that, minus the deposit levy, the euro zone leaders feared opening themselves to accusations that they were protecting Russian millionaires and billionaires in a banking system known for money laundering.

In a note, Guy Foster, head of portfolio strategy at Londons’s Brewin Dolphin, said “the widespread belief that a meaningful pool of the deposits in Cypriot banks comprises proceeds from Russian money laundering made the idea of bailing out the Cypriot banks particularly unappealing.”

But the bailout, which does not demand sacrifices from sovereign bondholders, violates the principle that deposits up to €100,000 are to be covered by the European Union deposit scheme. Savers with deposits of less than that amount are to take a 6.75 per cent hit; those with deposits higher than that amount are to lose 9.9 per cent.

The bailout bill would rise to about €16-billion from €10-billion if the levy on depositors were not imposed.

On Monday, as the vote to approve the package was delayed until Tuesday, and possibly later in the week, negotiations were under way to reduce the burden on small depositors. One proposal would see the levy fall to 3 per cent on deposits of less than €100,000 and increase it to 15 per cent on deposits of €500,000 or more. But the Cypriot government appears just as worried about going after the rich as the poor. If the wealthy are forced into a higher levy, Cyprus could lose its status as a successful offshore banking centre.

In Germany, finance minister Wolfgang Schaeuble said that his government did not care if the levy split were changed as long as the overall €5.8-billion target – the amount to come from depositors – were achieved.

European policy makers signaled flexibility on the application of an unprecedented bank tax in Cyprus, seeking to overcome outrage that threatened to derail the nation’s bailout. European shares and the euro fell.

While demanding that the levy raise the targeted 5.8 billion euros ($7.6 billion), finance officials said easing the cost to smaller savers was up to Cyprus. A vote on the tax, needed to secure 10 billion euros in rescue loans, was delayed for a second day. Banks may not reopen tomorrow after a holiday today, state-run broadcaster CYBC reported.

“If the government wants to change the structure of the solidarity levy for the banking sector, the government can decide as such,” European Central Bank Executive Board member Joerg Asmussen said today in Berlin. “What’s important is that the planned revenue of 5.8 billion euros remain.”

While Cyprus accounts for less than half a percent of the 17-nation euro economy, the raid on bank accounts risks triggering new convulsions in the financial crisis that began in 2009 in Greece. Moody’s Investors Service said that the move is a significant step toward limiting support for bank creditors across Europe and shows that policy makers will risk financial- market disruptions to avoid sovereign defaults.

The tax is “a worrying precedent with potentially systemic consequences if depositors in other periphery countries fear a similar treatment in the future,” Joachim Fels, chief international economist at Morgan Stanley (MS) in London, wrote in a client note.

On Line

Scenes of Cypriots lining up at cash machines raised the specter of capital flight elsewhere and threatened to disrupt a market calm since the ECB’s pledge in September to backstop troubled nations’ debt. With no government in Italy, Spain in the throes of a political scandal and Greece struggling to meet the terms of its own bailout, more turmoil could hamper efforts to end the crisis.

The Euro Stoxx 50 Index fell 1.9 percent and the euro slid as much as 1.9 percent; the currency was trading at $1.2960, down 1 percent at 11:45 a.m. in Frankfurt.

Borrowing costs in other debt-strapped nations rose. Italian 10-year bond yields climbed 9 basis points to 4.69 percent. The rate on similar-maturity Spanish yields jumped 10 basis points to 5.02 percent. Germany led gains among higher- rated nations’ securities.

Traders ‘Aghast’

“Traders and investors are aghast as these measures,” Michael McCarthy, a chief market strategist at CMC Markets in Sydney, told Bloomberg Television.

Russian President Vladimir Putin called the tax “unfair, unprofessional and dangerous,” according to a statement posted on the Kremlin website. Russian companies and individuals have $31 billion of deposits in Cyprus, according to Moody’s Investors Services.

Cypriot banks had 68.4 billion euros in deposits from clients other than banks at the end of January. Of that, 21 billion euros, or 31 percent, were from clients outside the euro area, 63 percent were from domestic depositors, and 7 percent were from other nations within the euro region, according to data from the Central Bank of Cyprus

Cypriot President Nicos Anastasiades exhorted political factions to support the deposit levy, which he pledged is a one- off measure that will avert a collapse of the financial system that in turn would have led to the country’s exit from the euro.

“A bank collapse would cause indescribable misery,” Anastasiades said in a televised address yesterday. He called the crisis the country’s worst moment since the 1974 Turkish invasion that has left the island divided.

Depositor Swap

In a bid to ease a run on banks, depositors who keep their account for two years will receive securities linked to future revenue from the country’s gas reserves, the president said.

He said he would also seek to soften the impact on savers. The potential changes include taxing deposits less than 100,000 euros at a 3 percent rate, while setting the levy at 10 percent between 100,000 euros and 500,000 euros and at 12 percent for deposits greater than that, Antenna TV reported, without saying how it got the information.

The levy -- as of now 6.75 percent of all deposits up to 100,000 euros and 9.9 percent above that -- whittled the euro- area’s bailout of Cyprus to 10 billion euros, down from an original figure of about 17 billion euros, near the size of the nation’s 18 billion-euro economy.

“Obviously, people would have preferred to pay nothing, but it’s a better deal than it could have been,” said Marshall Gittler, head of global foreign-exchange strategy at Limassol, Cyprus-based IronFX. “It’s unusual to ask depositors to take a hit, but if they hadn’t then the hit would have fallen uniquely on Cypriot taxpayers, so in a sense it’s fairer.”
Ministers’ Call

German Finance Minister Wolfgang Schaeuble said euro finance ministers would discuss modifying the terms of the tax in a telephone conference today. They met for 10 hours overnight in Brussels into March 16 to agree to the 10 billion-euro bailout.

The bank tax was the alternative to imposing losses on bondholders in a so-called bail-in. That step was opposed by the Cypriot government, the European Commission and the ECB, German Finance Minister Wolfgang Schaeuble said on ARD television last night.

“It’s up to them to explain it to the Cypriot people,” Schaeuble said. “Clearly, the taxpayer should not be asked” to rescue banks from insolvency, he said, adding that Cyprus faced a “very difficult time” unless it accepts the tax.

Anastasiades, whose minority government took office less than three weeks ago, holds 20 seats in the 56-seat legislature. The third-biggest faction, Diko, which supported him in his February election, holds eight seats. Cyprus’s communist Akel party, with 19 seats, plans to vote no.
Road to ‘Chaos’

Afxentis Afxentiou, the governor of Central Bank of Cyprus from 1982 until 2002, told the state-run broadcaster CYBC that failure to enact the legislation “opens the road to chaos.”

The ECB’s pledge to buy bonds should prevail over market panic, though the tax on deposits brings the euro area into “uncharted territory again,” Holger Schmieding, chief economist at Berenberg Bank in London, wrote in a note.

“Given the fragile state of the banking systems, especially in Greece and Spain, anything that can impede the needed rebuilding of confidence in these banking systems can potentially cause financial and economic damage,” he said.

They called it a ‘stability levy’, when they meant a tax on Cypriot depositors (including the savings of poor widows and small children) so that they spare holders of Cypriot government bonds (including hedge funds who are now having a party in Mayfair and New York) as well as minimise potential long-term losses by the European taxpayers. In effect, faced with the prospect of lending to Cyprus a sum equal to its GDP, so as to bail out its banks Ireland-style, the Eurozone balked.

They realised, post-Greece and post-Ireland, that something has to give (beyond the minimum working conditions and social welfare provisions of common folk) in order to minimise the size of the aggregate loan. And they chose to hit depositors directly (at a rate of 9.9% if their deposits exceed 100 thousand euros and 6.75% for smaller deposits) before the oncoming austerity-driven plague eats into them instead (as it did in Greece, Ireland and Portugal were savings were used up by stressed household in the daily struggle to survive after jobs and benefits disappeared).

What was astonishing is that, while the peoples of Europe are sick and tired of the gross inequities and regressivity of austerity-fuelled bailouts, they did not set a threshold below which poorer depositors would be untouched. And that they left unaffected the banks’ bondholders (even though the sums involved in these bonds were small, it was utterly unprincipled to spare them). I have no doubt that this decision will haunt them/us for decades.

What alternatives did the Eurogroup ministers have? Several, is the answer. In the context of their own accounting-like logic (i.e. of ‘hitting’ depositors) they could discriminate between bank accounts that are insured by Cypriot law and those which are not: So, any account by a citizen of an EU-member state with less than 100 thousand euros (the maximum account insured by the Cypriot state; the equivalent of the FDIC deposit insurance protection) should be left alone.

All the other accounts could then be hit by a percentage that would deliver the sum of six to seven billions EU finance ministers wanted to reduce the bailout loan sum by. If Berlin was serious about its willingness to curtail Cyprus’ banks money laundering activities, while avoiding a tax on the hard earned savings of the poorer Cypriots (that a Lutheran German should see as an ally in restoring puritan ethics), that is what they would have done. But, it is now clear, they were not serious about their own ethics (indeed, had they been serious about Russian money laundering, they would have raised questions about Latvia’s banks, which are awash with mafia funds).

Of course, while hitting uninsured deposits only (as suggested by the previous paragraph) would have been preferable, it would still not be a solution to the Cypriot drama. The Cypriot economy is in the familiar tail spin that we witnessed in Greece, Portugal, Spain, Ireland and now unfolding in Italy. Even if the bank levy, or bail in, were fairer, the recession would still be fuelled by large scale public expenditure cuts and substantial tax hikes which, taken together, will most certainly lead Cyprus to a dead end. But none of this is specific to Cyprus. In this sense, an alternative strategy for dealing with the island’s fall from grace must involve a Gestalt Shift that will allow Europe a different approach throughout the monetary union. Precisely the Shift that Europe seems unwilling to contemplate, thus resorting to ill-conceived decisions like the recent one on Cyprus.

For the second time Europe has shown that it is not mature enough to even keep the basic fundamentals tenets of an advanced modern state. Banks are not allowed to collapse and senior debt holders as yet are shielded from taking losses. On the other hand violating the sanctity of retail deposits is ok. I wonder what the Eurogroup would force upon the Italians and the Spanish. EU keeps surprising us in a negative way.

...keep your powder dry, let other perma bears talk about the non-existent panic....I  have spoken to at least 10 people that I deal with, ranging from my chauffeur to the head of a major accounting firm, there is no panic.

Left-wing reporters are angry, there are no people on the street, they talk about panic, and their news reals show 5 to 6 old lethargic, meek-looking people lined up in an orderly manner to withdraw from their ATM, seen the same clip on BBC and Sky News.

This is a brilliant deal for Cyprus. There is NO increase in VAT, NO cuts to pensions, No immediate cuts to government employees, corporate tax went from an absurd low of 10 to 12.5, they promised to sell off some state assets, and bring down the banking sector (get rid of Russian deposits) by 2018.. They did not mortgage their natural gas, nor have they mortgaged their future, they addressed the problem by raising 5.8 billion in cash (out of the 10 billion)......people like me and the Russians are bearing the brunt of this bailout, hate to disappoint the perma bears......longer term this is terrible for the euro, but that is another story.

The federal government is offering a carrot to Air Canada to pay down the company’s pension deficit, even as it wields a heavy stick in imposing detailed restrictions on how the company’s executives are paid over the next seven years.

In an unusual move of government intervention in Air Canada’s program of executive performance incentives, Ottawa will allow the Montreal-based airline’s top executives to receive performance bonuses that grow as the company contributes money to its pension deficit.

Those bonuses, based on the company's financial performance, would be paid in full once the airline pays up to $200-million a year toward its pension deficit, according to union leaders who were briefed by Finance Minister James Flaherty about the conditions to be imposed on Air Canada executives.

As part of the deal announced Tuesday between Air Canada and the government, the airline has been given another reprieve on financing its debilitating pension deficit of $4.2-billion.

Over the course of seven years, beginning in 2014, Air Canada only has to contribute a minimum of $150-million a year, or an average of $200-million annually over seven years, towards its pension deficit – far below what regulations would normally require.

Air Canada and its unions have argued that low interest rates, and therefore low returns on pension investments, have made pension funding requirements too onerous, a problem faced throughout much of corporate Canada.

In granting this arrangement, the government has imposed conditions included limiting increases in executive pay to the rate of inflation, a prohibition on special bonuses and limits on executive incentive plans.

However, in a conference call and letters to unions on Tuesday, Finance Minister Jim Flaherty noted that the top 24 executives at Air Canada can still receive bonuses under the company’s annual incentive plan, according to people who were part of the call and received the letter.

Union representatives confirmed that Mr. Flaherty told the unions that if Air Canada makes its $200-million annual pension payment, then the executives will receive their full annual incentive plan bonuses. (The annual incentive plan covers cash bonuses given when the airline meets its financial targets.)

If Air Canada only makes a payment of $175-million to its pension deficit in the year, the top executives would receive only half of their annual incentive plan, or AIP. If the airline only pays $150-million, then no performance incentives would be paid to the executives. Other bonuses, such as retention payments to keep an executive at the company, would be eliminated.

According to union representatives familiar with the arrangement, restrictions on stock options are unclear. As the letter sent to union explained, a “limit will be imposed on equity-based executive compensation and prohibit any special bonuses outside of the AIP while the regulations are in force, as long as Air Canada has not elected to opt out of the regulation.”

Union representatives briefed about the arrangement said that the deal is still being hammered out between Air Canada and Ottawa and that the terms announced Tuesday were just the broad brush strokes.

Air Canada would not comment Thursday about the terms outlined in the conference call and the letter to unions. The arrangement still needs to be approved by an order-in-council before it turns into official regulation for Air Canada, union leaders explained.

Walter Spracklin, an RBC Capital Markets analyst, said he believed Air Canada’s pension obligations would have increased by a further $2-billion in 2013 – partially offset by a $1.1-billion reduction stemming from the agreement reached with its labour unions to move new hires into a hybrid pension plan.

He estimated Air Canada’s pension funding deficit would still have increased in 2013 to roughly $5-billion, which would have left the carrier on the hook for more than $1-billion in annual pension payments starting next year when its current funding cap expires.

“In the current low interest rate environment, Air Canada’s pension solvency deficit funding payments would not be sustainable without the seven-year extension in place,” Mr. Spracklin said in a note to clients.

The seven-year extension buys Air Canada some time, with the hope that interest rates will rise over that period.

Mr. Spracklin, who has an “outperform” rating on the stock and a $3.50 price target, noted for every one percentage point increase in the discount rate, Air Canada’s pension solvency deficit would be reduced by $1.85-billion.

Therefore, if a 2.7 percentage point increase were to occur over the next seven years, Air Canada’s deficit would be effectively “wiped out.”

“The key here is that with the extension in place, what we believe to be a significant risk discount and an overhang will start to lift and the [Air Canada] shares will begin to approach fair valuation,” he said.

Workers and employers in the U.S. are bracing for a retirement crisis, even as the stock market sits near highs and the economy shows signs of improvement.

New data show that powerful financial and demographic forces are combining to squeeze individuals and companies that are trying to save for the future and make their money last.

Fifty-seven percent of U.S. workers surveyed reported less than $25,000 in total household savings and investments excluding their homes, according to a report to be released Tuesday by the Employee Benefit Research Institute. Only 49% reported having so little money saved in 2008.

The survey also found that 28% of Americans have no confidence they will have enough money to retire comfortably—the highest level in the study's 23-year history.

The same forces are weighing on corporate balance sheets. Based on another recent report, the Society of Actuaries said that rising life expectancies could add as much as $97 billion to corporate pension liabilities in coming years, an increase of up to 5%.

While Americans are living longer, the extended life spans will make it tougher for workers trying to stretch retirement savings and put additional strains on pension plans.

Scott Ghelfi, 49 years old, a small-business owner in Falmouth, Mass., and his wife own two candy stores and a children's clothing shop. He said they didn't make their normal $24,000 contribution to their retirement plan two years ago because they couldn't afford to take the money out of the businesses.

The total amount in the couple's retirement accounts is less than $200,000, which he considers inadequate.

"Sales are fine, but we're not growing rapidly like we were several years back, and everything is more expensive," Mr. Ghelfi said.

He isn't alone. The percentage of workers who have saved for retirement plunged to 66% from 75% in 2009, according to the Employee Benefit Research Institute survey.

Only about half of the 1,003 workers and 251 retirees surveyed said they were sure they could come up with $2,000 if an unexpected need were to arise in the next month.

"Workers are recognizing there is a crisis," said Alicia Munnell, director of the Boston College Center for Retirement Research. She noted that companies continue to do away with traditional pensions.

The survey of workers and retirees was conducted in January, even as the U.S. stock market was heading toward new highs.

Many people are struggling to make sure they don't run out of money in retirement, said Jack VanDerhei, research director at EBRI, a nonprofit in Washington, D.C.

The EBRI survey doesn't count traditional pensions, which are designed to provide retirees for steady income throughout their lives.

But pensions have become a much smaller component of Americans' retirement-savings mix over the years. The portion of private-sector U.S. workers covered only by so-called defined-benefit plans fell to 3% in 2011 from 28% in 1979, according to U.S. Department of Labor data compiled by EBRI.

Companies that still offer pensions might have to kick in more money to account for longer life spans.

The Society of Actuaries in September released the first update since 2000 to its mortality projections for U.S. retirement plans, which project life spans for pensioners.

The report offers assumptions that actuaries use to project mortality rates.

Companies are expected to start using the new assumptions this year.

According to the society, a male who reaches age 65 in 2013 is expected to live an additional 20.5 years, up from 19.5 in the earlier projections. Women turning 65 this year are now expected to live an additional 22.7 years, up from 21.3.

Although the increases might seem small, Bruce Cadenhead, chief retirement actuary with Mercer, a consulting unit of Marsh & McLennan Cos., said they are the largest he has seen in more than 25 years.

"It represents a meaningful jump in liabilities," he said.

Goodyear Tire & Rubber Co. cited the growth in the life expectancy for its plan's beneficiaries as one reason its global pension-funding gap widened to $3.5 billion last year from $3.1 billion in 2011. A Goodyear spokesman said it made the mortality adjustment "because we saw an increase in [the] actual longevity of our participants."

U.S. pension obligations for all publicly traded companies based in the U.S. totaled $1.93 trillion at the end of 2012, up from $1.60 trillion in 2008, according to Mercer.

The effect of longer life spans on pension obligations has been dwarfed by the impact of declining interest rates over recent years. Because of the way pension obligations are calculated, lower interest rates means that future obligations are higher today.

But interest rates are likely to rise at some point, which will lessen pension obligations. That is less likely with longevity assumptions.

"Rates can go up," said Rama Variankaval, an executive director in the corporate finance advisory group of J.P. Morgan Chase JPM & Co.'s investment bank. "Mortality is more of a one-way street."

Individuals face the same problem, Mr. Cadenhead said: "If we're asking them to provide for their own retirement, they're living longer, and it takes more money to provide for their own needs over the course of a lifetime."

Joe LaCascia, a 75-year-old retired insurance broker in Polk City, Fla., said he and his wife thought they would have enough savings outside their life insurance policies to last until age 95.

Now, he estimates he only has enough to last until they're 85.

He said he is more concerned about what the future holds for his children, a 51-year-old art director-turned-roadie and a 49-year-old third-grade teacher.

"They're never going to be able to create wealth, other than what our generation leaves them and what they do with it," he said. "They have more uncertainty than we have."

“The president is in the midst of a charm offensive.”

— The Post, referring to President Obama’s meetings with congressional Republicans

We don’t need a charm offensive; we need a candor offensive. The budget debate’s central reality is that federal retirement programs, led by Social Security and Medicare, are crowding out most other government spending. Until we openly recognize and discuss this, it will be impossible to have a “balanced approach” — to use one of President Obama’s favorite phrases. It’s the math: In fiscal 2012, Social Security, Medicare, Medicaid and civil service and military retirement cost $1.7 trillion, about half the budget. If they’re off-limits, the burdens on other programs and tax increases grow ever greater.

It’s already happening. The military is shrinking and weakening: The Army is to be cut by 80,000 troops, the Marines by 20,000. As a share of national income, defense spending ($670 billion in 2012) is headed toward its lowest level since 1940. Even now, the Pentagon says budget limits hamper its response to cyberattacks. “Domestic discretionary spending” — a category that includes food inspectors, the FBI, the National Weather Service and many others — faces a similar fate. By 2023, this spending will drop 33 percent as a share of national income, estimates the Congressional Budget Office. Dozens of programs will be squeezed.

Nor will states and localities escape. Federal grants ($607 billion in 2011) will shrink. States’ Medicaid costs will increase with the number of aged and disabled, which represent two-thirds of Medicaid spending. All this will force higher taxes or reduce traditional state and local spending on schools, police, roads and parks.

The budget debate may seem inconclusive, but it’s having pervasive effects. Choices are being made by default. Almost everything is being subordinated to protect retirees. Solicitude for government’s largest constituency undermines the rest of government. This is an immensely important story almost totally ignored by the media. One reason is that it’s happening spontaneously and invisibly: Growing numbers of elderly are simply collecting existing benefits. The media do not excel at covering inertia.

Liberals drive this process by treating Social Security and Medicare as sacrosanct. Do not touch a penny of benefits; these programs are by definition progressive; all recipients are deserving and needy. Only a few brave liberals complain that this dogma threatens programs for the non-aged poor. “None of us wants to impose new burdens on vulnerable seniors,” write economists Harry J. Holzer of Georgetown University and Isabel Sawhill of the Brookings Institution in The Post. But “for how long will we continue to sacrifice investments in our nation’s children and youth ... to spend more and more on the aged?”

Hypocritical conservatives are liberals’ unspoken allies. Despite constant grumbling about entitlements, they lack the courage of their convictions. Consider House Budget Committee Chairman Paul Ryan’s latest budget plan. From 2014 to 2023, he proposes cutting federal spending by $4.6 trillion. Not a cent comes from Social Security, while Medicare cuts are tiny, about 2 percent. His major Medicare proposal (in effect, a voucher) wouldn’t start until 2024. Most baby boomers escape meaningful benefit cuts. As Holzer and Sawhill fear, most of Ryan’s cuts affect programs for the poor.

What frustrates constructive debate is muddled public opinion. Americans hate deficits but desire more spending and reject higher taxes. In a Pew poll, 87 percent of respondents favored present or greater Social Security spending; only 10 percent backed cuts. Results were similar for 18 of 19 programs, foreign aid being the exception.

Only the occupant of the bully pulpit can yank public opinion back to reality. This requires acknowledging that an aging America needs a new social compact: one recognizing that longer life expectancies justify gradual increases in Social Security’s and Medicare’s eligibility ages; one accepting that sizable numbers of well-off retirees can afford to pay more for their benefits or receive less; one that improves generational fairness by concentrating help for the elderly more on the needy and poor to lighten the burdens — in higher taxes and fewer public services — on workers; and one that limits health costs.

Obama hasn’t talked intelligently or openly about America’s aging. In budget negotiations, the administration has made some proposals (a different inflation adjustment for Social Security benefits, a higher Medicare eligibility age) that broach the subject. But Obama hasn’t put these modest steps into the larger context of social change; nor is it clear how much the administration supports them. It’s true that Republicans should also accept higher taxes — but only after the White House engages retirement spending.

Little is possible while public opinion remains frozen in contradiction. The mistake lies in thinking that the apparent paralysis isn’t policy. It is. Government is being slowly transformed into a vast old-age home, with everything else devalued and degraded.

Canadian pensions and pension systems get widely varying report cards. For example, in the report OECD Pensions at a Glance, the authors rate Canadian pension systems (including OAS, OAP, and CPP) highly by some criteria, but poorly by others. Canadian systems work well for the disadvantaged, guaranteeing nearly 80 per cent or more of pre-retirement income for those earning half or less of the national average income. By this measure, Canada is in the top eight of the 34 OECD countries.

But for Canadians making the national average wage or above, the pension replacement rate in Canada (comparing guaranteed pension income to pre-retirement income) is only about 40 per cent, compared to the OECD average of 59 per cent. This places average Canadians in the bottom 10 OECD countries by this measure. Depending on which group is considered, the flavour of reports on Canadian pensions varies from "pension crisis" to "what crisis?" Who to believe?

Canada is even more extreme by some measures. Only about 5 per cent of elderly Canadians live in poverty, as noted by the Conference Board and International Labour Organization. By this measure, Canada is near best in the world -- only Holland and France do better. A smaller fraction of Canada's elderly live in poverty compared to Canada's children or workers.

On the other hand, a smaller fraction of Canadian workers get a workplace pension plan compared to the other G7 countries. Only about 35 per cent of Canadian workers have an employer-sponsored pension plan; and if public service employees and unionized employees are excluded, across the rest of the workforce (the majority), less than 20 per cent have a workplace pension plan, and that number is falling. Canada is at the bottom of the G7 countries by this measure.

We are generally following an established trend in some comparable countries, away from defined-benefit pension plans -- but with a difference. In the U.S. and U.K., the numbers of employers offering such plans are also dropping. Employers dropping defined-benefit pension plans in those countries are generally shifting to defined-contribution plans, which are safer for employers but less secure for employees. But this is still better than in Canada, where the alternative to an employer defined-benefit plan is, in most cases, no pension plan.

Canadians get complimented internationally for their levels of personal savings for retirement -- along with the Japanese, we are some of the most saving-inclined people on earth. The OECD report noted above comments: "The proportion of retirement incomes coming from private pensions and other financial assets in Canada is one of the highest among OECD countries." But on closer look, this is a mixed blessing: both a fading habit in Canada, and an unfortunate necessity for too many Canadians, because more desirable and efficient employer-based pension plans are unavailable to them.

Canadians have above-average access to enhanced private savings options through RRSPs. But as in similar plans in Australia, the market in Canada is structured so that too many uninformed buyers have too many choices, resulting in a fragmented market with too many players -- leading to excessive fees for Canadian plans. Others (e.g., the U.S. with their 401 plans) have structured their plans so they achieve more vendor consolidation, resulting in better investment results, with lower fees.

Canada has achieved some of the highest levels of national sustainability of pension plans, while providing some of the least security to individual pensioners. In many major countries like Germany, Italy, France or Brazil, some of today's pension payments come from contributions by other current workers -- a "PAYGO" system considered a drain on the national economy, and less sustainable as the ratio of pensioners to workers rises rapidly in the next 20 years.

But thanks to good pension plan rules in Canada, almost all pension income comes from past contributions made by the pensioners (or their employers). Along with good Canadian regulation of pension funds management, the structure of pension plans in Canada is regarded as one of the most secure, sustainable and beneficial, across the OECD countries (see here, for example). On the other hand, the protection of individual plans in Canada is near the weakest. If a pensioner's former employer/pension-sponsor fails, typically their pension is severely reduced, a problem faced by many pensioners who worked for formerly great employers in Canada. The other G7 countries all have some explicit or implicit form of national insurance scheme against this form of pension fund collapse.

When will Canada catch on and correct this injustice? There are at least five good solutions available. Most OECD countries except Canada have adopted one or more. The first three were strongly recommended by the Ontario Expert Commission on Pensions in 2008.

First, stop the windup of pension plans into annuities when a sponsoring employer fails. The annuity-based windup is the easiest for governments to administer, but causes excessive reduction in pension payouts. Second, create an up-to-date pension insurance program for Canadian pension plans. This is an approach taken explicitly by the U.S., U.K., Germany and Japan. Third and longer-term, restructure pension plan laws so multi-company plans become the norm, reducing or eliminating the risk to pension plans because of a single company's failure, and enabling better investing through larger scale. A small number of such plans exist in Canada, but they are more common in the U.S. and some other countries. A fourth option is simply to raise the priority of pension funds as a company creditor in bankruptcy -- probably the easiest and quickest option for our national government to implement, and already in place in numerous OECD countries.

A fifth potential option is an expansion of CPP (or a similar government-sponsored alternative) to cover more of Canadians' pension needs -- more or less the approach of France, Italy, Brazil and others.

The Healthcare of Ontario Pension Plan posted a 17-per-cent return on its investments last year and is running a significant surplus, far outstripping most Canadian pension plans in its financial performance.

The $47-billion pension fund, which represents 274,000 Ontarians working in the healthcare sector, said it was 104 per cent funded at the end of 2012, which means it has assets significantly greater than required on a solvency basis. By comparison, the average Canadian pension plan was just 69 per cent funded at the end of 2012 after years of low interest rates and growing funding obligations, according to a report by consulting firm Aon Hewitt.

HOOPP chief executive officer Jim Keohane said HOOPP’s 17.1-per-cent return on investments was its best result in more than a decade.

“This was a year when all of our investment strategies worked,” he said. “We were firing on all cylinders, with positive returns from every type of investment.”

Canadian pension plans earned an average of 9.4 per cent on their investments last year, according to a survey by RBC Investor Services Ltd. The giant Caisse de dépôt et placement du Québec, for example, earned 9.6 per cent on its investments last year, while the Ontario Municipal Employees Retirement System reported 10-per-cent returns and The Canada Pension Plan Investment Board, which has a March 31 year end instead of a Dec. 31 year end, reported nine-month returns of 5.5 per cent as of Dec. 31.

HOOPP attributes much of its funding success to its liability driven investment (LDI) strategy, which sees the pension fund closely match its assets with its liabilities to try to ensure the plan will remain well funded even when markets are highly volatile. To accomplish the goal, HOOPP invests heavily in bonds with long maturities to ensure their investments match the long-term nature of pension funding liabilities. It has reduced the proportion of stocks it holds, and seeks additional returns through complex derivatives strategies.

HOOPP says its 10-year average rate of return is now over 10 per cent, giving it one of the best long-term investment records for pension plans worldwide.

The Healthcare of Ontario Pension Plan (HOOPP) has posted returns for 2012 of 17.1 per cent, which boosted the pension plan for Ontario healthcare workers to a record $47.4 billion in assets, compared to $40.3 billion at the end of 2011. This strong double-digit return increased HOOPP’s 10-year average rate of return to more than 10 per cent, one of the best long-term records among pension plans worldwide.

At the end of 2012, HOOPP was 104 per cent funded – this fully funded status means the Plan has sufficient assets to pay for every promised member’s pension benefit, with no shortfall.

“HOOPP had a very strong year in 2012 – with our best investment results in more than a decade,” says HOOPP President & CEO Jim Keohane. “This was a year when all of our investment strategies worked. We were firing on all cylinders, with positive returns from every type of investment,” he said. HOOPP’s liability driven investment (LDI) strategy continues to contribute to HOOPP’s success, Keohane added.

The Plan paid out more than $1.4 billion in pension benefits in 2012, an increase of $151 million over 2011, he added.

Created in 1960, HOOPP is the pension plan of choice for Ontario’s hospital and community-based healthcare sector with over 440 participating healthcare organizations. HOOPP’s 274,000 members include nurses, medical technicians, food services staff and laundry workers, and many other people who work hard to provide valued Ontario healthcare services.

HOOPP’s full annual report, as well as a short video featuring remarks by Jim Keohane, will be posted March 21.

1) What were the main drivers of these results? Corporate spreads tightening, stock market rally, illiquids like PE and RE, asset allocation/ sector rotation?

2) What do you attribute HOOPP's success to? (culture, LDI approach, etc.)

3) Do you think other pension plans can adopt your approach? Given low bond yields, is it too late to adopt an LDI approach, especially if the plans are grossly underfunded?

4) Are you changing your asset allocation right now and if so, why? What are the major risks that lie ahead?

5) Please talk about your benchmarks, value added over the policy portfolio and if there is anything there you are revising.

6) What was the cost of delivering these results? (30 basis points or less?)

7) What are your general thoughts on the retirement crisis and how we can deal with it through better policies?

• All their investment strategies worked. They were "firing on all cylinders, with positive returns from every type of investment.” But the major contributor to the Return Seeking Portfolio was the long-term option strategy, adding more than 600 basis points to overall results (more on this below).
• Jim was clear that HOOP's culture and LDI approach are the cornerstone of their success. They manage risk extremely tightly on all investment strategies and their culture is not based on "beating the benchmarks" but on adding value by taking intelligent risks where they present themselves.
• He said that HOOPP is like a multi-strategy hedge fund which continuously focuses on relative value trades in capital markets but also invests in illiquid markets as opportunities arise, always focusing on the transaction and whether the premiums make sense.
• In terms of those relative value trades in public markets, he told me that fixed income markets offer a lot more opportunity than equities. "There is a lot more segmentation in the fixed income markets. Equity markets are more efficient." 
• They do a lot of arbitrage trades of cash vs derivatives in fixed income markets and run their internal absolute return strategies efficiently, always managing credit, interest rate and other risks tightly, knowing the downside risk of every trade. 
• Importantly, HOOPP does not invest in any external hedge fund, preferring to go internally, lowering costs and managing  risk of their investment portfolios more closely.
• In terms of illiquid asset classes, Jim told me he likes private equity and real estate. Real estate is part of their Liability Hedging Portfolio as it also provides an inflation hedge and was a major contributor of returns.
•  Jim thinks risk premiums on infrastructure do not justify an allocation to this asset class at this time (read his comments on pensions taking on too much illiquidity risk). He sees infrastructure as more of an equity play with stable dividends. "These investments are levered, they provide stable, predictable cash flows but if something happens -- like regulations change or you need to sell -- you bear equity risk. Real estate is more liquid, you don't need approval by some regulators to sell and the cash flows are not subject to regulatory risk." HOOPP has invested in infrastructure in the past and will do so again if an excellent opportunity arises."Right now, we just don't see anything particularly attractive. This could change in the future."
• In terms of implementing an LDI approach, Jim thinks it's never too late and pension funds that do not adopt one are going to be in bigger trouble in the future. Importantly, he told me the "risks of not owning bonds is huge" because there is an asymmetric tradeoff depending on whether interest rates rise of fall. In particular, the duration of most pension plan assets is shorter than the duration of their liabilities (for HOOPP, it is 12 vs 15), so if long bond yields fall by one percentage point, it will be destructive. "If we enter a Japan scenario, you will get killed not owning bonds." Conversely, if rates rise, your liabilities will go down more than your assets, so you will not be hurt as much.
• In terms of asset allocation, they are reviewing their bond holdings but are in no rush to make a major move. Jim told me he gets to speak to the CEOs of major US banks and they tell him there is a lot of cash on hand because loan demand is very low, companies are flushed with cash and there are no major capital spending plans. He thinks the most likely outcome is that interest rates go sideways (range-bound like 2011-12) and that stocks keep grinding higher. He's positive on the US economy and still likes financials.
• HOOPP beat its policy (benchmark) portfolio by 2.8%, which tells you it wasn't an easy threshold to beat and they added significantly in terms of active management over this portfolio.
• In terms of benchmarks, he told me that they use appropriate market benchmarks for all investment strategies except private equity, which is under review. There they use a 7% absolute return benchmark but when determining compensation and bonuses, they will add to it if it is a really good year. This figure was based on their previous actuarial target rate of return (it is now 6%). "In good years, you shoot the lights out but in bad years, you significantly underperform. Very hard to find an appropriate benchmark for PE as we had years like 2008 where we underformed by less than other pension funds but they had value added because they beat some market benchmark which went down by a lot more."
• As far as the retirement crisis, he sees this as a problem of demographics and low bond yields. He thinks countries should adopt a supplemental pension approach like in Denmark where ATP manages a supplemental program.

• "We cannot take undue risks in anything we do. We have to match assets with liabilities and the board is vigilant, monitoring our activities very closely."
• "People think taking leverage is taking undue risk. This isn't the case as you can invest in a bond and add an S&P 500 overlay but that is not really leveraging. It's just smart investing."
• "Look at our long-term option strategy, which was a major contributor to our overall results. We entered that trade, selling volatility on the S&P 500 when the S&P was at 1,000 a couple of years ago and immediately collected risk premium of 400 basis points and then added another 200 basis points by investing that premium in arbitrage trades. The S&P would have had to have fallen below 300 for us to lose money. The risk-return tradeoff of that strategy was just too compelling."

"...to my mind, only Warren Buffet entered that trade. The reason people don't do these trades is that it doesn't fit under benchmark activity or absolute return strategies. It doesn't fit anywhere. But people are not thinking about what is good for pensioners."

The big story is the huge win on the option strategy, quite unique in scale and risk/return tradeoff.

Beyond that, its good beta and more than typical focus on the liability profile which is really a governance success story as much as an investment one.

The private equity track record of 15 years is the real story in that area (including the portfolio success during leadership transition, and there is a great experienced guy whom has been hired to lead that area). The benchmark problem is an annual one, but the private equity prize is sustained risk adjusted performance. The track record is also actually disclosed, no one else in Canada does that and hence the short memories and focus on annual returns, without regard to risk.

As head of the country’s largest pension fund, Federico R. Buenrostro wielded vast influence in the money management world.

From 2002 to 2008, Mr. Buenrostro served as chief executive of the California Public Employees’ Retirement System, or Calpers, which allocates more than $200 billion to investment firms across the globe.

Federal prosecutors say that Mr. Buenrostro abused that position. In an indictment filed in Federal District Court in San Francisco on Monday, the United States attorney charged Mr. Buenrostro and his friend, Alfred J. Villalobos, with defrauding the private equity firm Apollo Global Management.

The corruption charges against Mr. Buenrostro and Mr. Villalobos are connected to a nationwide pay-to-play scandal that erupted several years ago. Regulators from numerous states, including California and New Mexico, have cracked down on widespread influence peddling in how their state pension funds were invested.

The scandals focused on the role of middlemen, or placement agents, who charged lucrative fees to help money managers win business from state pension funds. In some cases, placement agents proved to be unlicensed fixers who received illegal kickbacks from pension officials. A number of pension officials and middlemen have served prison time, including Alan G. Hevesi, the former head of New York’s state pension fund.

The government claims that Mr. Buenrostro and Mr. Villalobos invented a crude scheme that tricked Apollo, one of the world’s largest private equity firms, into paying Mr. Villalobos at least $14 million in fees for his help in securing an investment from Calpers.

“We are extremely pleased that law enforcement authorities are moving to hold individuals accountable for activities which violate the public trust,” Rob Feckner, the board president of Calpers, said in a statement.

A lawyer for Mr. Buenrostro, William H. Kimball, declined to comment. Mr. Villalobos, who filed for personal bankruptcy in 2010, could not be reached for comment.

In the insular world of private equity, the charges struck many executives as unusual given Apollo and Calpers deep and lucrative ties. The California fund has invested at least $3 billion with Apollo, including a 2007 transaction in which it paid $600 million for a 9 percent stake in the firm.

For years, Apollo had retained Mr. Villalobos — a former Calpers board member — as a placement agent, agreeing to pay him for his help in securing investments from state pensions. Apollo paid at least $48 million in fees to Mr. Villalobos for his help in arranging for Calpers and other pensions to invest in its firm.

But to comply with securities laws and avoid perceived conflicts of interest, Apollo asked that Mr. Villalobos disclose to Calpers that he would receive payments related to the pension fund’s investments.

Prosecutors said that Mr. Buenrostro, 64, and Mr. Villalobos, 69, worked together, and fabricated letters from Calpers that purportedly signed off on the payments from Apollo to Mr. Villalobos.

“The allegations in the indictment unsealed today by the United States Department of Justice, if true, are troubling,” Charles V. Zehren, an Apollo spokesman, said Monday. “Apollo has always followed best practices in handling its placement agent relationships, and was not aware of any misconduct engaged in by Mr. Villalobos during the time that he worked with Apollo.”

The charges come after a civil lawsuit brought last year against Mr. Buenrostro and Mr. Villalobos by the Securities and Exchange Commission. And in 2011, a Calpers internal investigation concluded that Mr. Villalobos had turned Mr. Buenrostro into “a puppet” who directed Calpers investments to his clients. The firm’s report said that Mr. Villalobos lavished bribes on Mr. Buenrostro, including trips on private jets and gambling junkets at Nevada casinos.

When Mr. Buenrostro left Calpers in 2008, he took a job working with Mr. Villalobos as a placement agent.

The private equity company had hired Villalobos' firm, ARVCO Capital Research LLC, to provide placement agent services to secure investment business at the pension fund, formally the California Public Employee Retirement System. He and Buenrostro conspired to create fraudulent investor disclosure letters sent to Apollo, according to a statement released by the U.S. Attorney for the Northern District of California.

Apollo paid ARVCO about $14 million in fees after receiving the fraudulent letters, the statement said, adding that ARVCO transmitted the last of the letters in June 2008, a few weeks before Buenrostro retired from Calpers and was hired by Villalobos to work for ARVCO.

The statement also said the two men made false statements to authorities investigating the disclosure letters, adding that the grand jury charged Buenrostro with making a false statement and obstruction of justice.

Buenrostro's lawyer and representatives for Villalobos could not be reach for comment.

Apollo and Calpers have cooperated with long-running federal and state probes of placement agent activity at the pension fund, and the investigations spurred it to increase its oversight of placement agents.

"We are extremely pleased that law enforcement authorities are moving to hold individuals accountable for activities which violate the public trust," Rob Feckner, president of the Calpers board, said in a statement.

Apollo said the allegations in the indictment are "troubling" if true.

"Apollo has always followed best practices in handling its placement agent relationships, and was not aware of any misconduct engaged in by Mr. Villalobos during the time that he worked with Apollo," the company said in a statement.

Neither man has entered a plea, but lawyers for both told The Sacramento Bee that their clients were not guilty.

Still, the forged documents provide a smoking gun -- strong evidence of a conspiracy that is simple and easy to prove in a court of law. Were the documents forged? Were they sent through the mail? Did one of the defendants lie to prosecutors about them?

But it's the conduct underlying those documents that goes to the heart of the corruption that has engulfed the highest levels of leadership at the state's $248 billion pension fund. Civil suit allegations filed earlier by the state and the federal governments against Villalobos and Buenrostro previously disclosed lavish round-the- world trips taken by Buenrostro and former CalPERS board member Chuck Valdes that Villalobos paid for.

Villalobos allegedly paid for Buenrostro's 2004 wedding at his Lake Tahoe mansion, treated him to stays at casinos in Lake Tahoe and China and even financed a Lake Tahoe condo.

Buenrostro and Villalobos are entitled to a presumption of innocence. But if they are convicted -- and the evidence against them appears very strong -- it shows dangerous rot at the very top levels of the state pension fund.

A placement agent for The California Public Employees’ Retirement System (Calpers) was indicted Monday for conspiracy to create and transmit fraudulent documents and committing mail fraud and wire fraud.

This long expensive Federal investigation possibly could have been avoided if the U.S. Securities and Exchange Commission (SEC) had not bowed under to Wall Street pressure and dropped its proposed national ban on placement agents in 2009.

The Wall Street lobby is so strong that placement agents still run rampant, cutting backroom deals in state capitols and city halls all over the country. While placement agents claim to widen options to plans, in reality these middlemen serve no useful purpose as most public plans have independent consultants.

New York was the only state to completely ban placement agents and according to The Wall Street Journal they have gone a long way in cleaning up their plan. The WSJ story reported that New York Comptroller Thomas DiNapoli recently completed a review of the ban and confirmed the in-house feeling that banning placement agents didn't close out many investment options.

"The reality is so much of what went wrong under the prior administration had so much to do with that relationship," DiNapoli said. "My feeling was the only way to be sure that kind of corrosive relationship won't happen again is to not do business with placement agents. I think the findings confirmed we have not suffered because of that."

The SEC in May 2009 proposed the outright banning of placement agents, which in New York, California, New Mexico and Kentucky, were the conduit for corruption in those states’ public pensions. However, the Private Equity industry was able to kill this SEC proposal, I believe by getting the Obama administration to pressure the SEC to water down this ban.

Blackstone's billionaire founder, Stephen Schwarzman, personally sent a letter to the SEC opposing a placement agent ban. In California, a state placement agent ban was proposed but opposition led by Private-equity firm Blackstone and their captive placement agent Park Hill were able to water down the bill to mere registration spending millions on lobbying. In Kentucky a ban was proposed in 2011 but like California, came back as watered down registration in 2012.

Dodd-Frank ushered in a new SEC whistleblower program, and a placement agent paid by a private-equity firm for the New York State Pension was an early catch.

A recent Fortune column lamented that Steve Rattner's reputation, “has been rehabilitated, just two years after settling with federal and state authorities over allegedly participating in a kickback scheme to get public pension fund investments for his private-equity firm."

Rattner rather than being shunned has become a media darling appearing on MSBC and writing a column in the New York Times. The SEC has already started to sabotage their own whistleblower program with public pensions last week by refusing to fine Illinois officials. The entire whistleblower program I fear may become another victim of Wall Street power and greed as few claims have been awarded.

Public Pensions have become a crisis in this country and ethical lapses in investment management are in many cases linked to ethical lapses in funding is creating a lethal fiduciary meltdown in many states. The SEC, if it can unchain itself from the Wall Street lobby, could greatly improve the health of public pensions nationwide with a ban on placement agents as they originally proposed in 2009.

Hopefully this criminal indictment will turn into a conviction and send the SEC, Wall Street and their placement agents a strong message.

...for the most part, middlemen are financial parasites who add very little or no value to institutional clients looking to make decisions on which funds to invest with. I would simply ban them altogether. There are some exceptions, but they are few and far between. Either way, disclosure rules for middlemen should be mandatory for all public pension funds.

A federal grand jury this week indicted the California Public Employees' Retirement System's former CEO Fred Buenrostro, on fraud and obstruction of justice charges. Also indicted for fraud was notorious "placement agent" Alfred Villalobos, a Buenrostro pal who was regularly hired by private equity firms seeking fund commitments from CalPERS.

The fraud charges are virtually identical to what was laid out last year in an SEC civil suit, alleging that the two men forged documents related to CalPERS commitments to funds managed by Apollo Global Management (APO). And, like with those SEC charges, this is like nailing Al Capone for tax evasion.

To be sure, Buenrostro and Villalobos were an unholy alliance -- the hen-house gatekeeper and the friendly fox. But these charges don't allege that the pair improperly influenced CalPERS to invest in a fund that it otherwise would not have invested in, or that Buenrostro personally benefited from a successful Villalobos placement.

Instead, they relate Villalobos' attempts to get paid by Apollo for work he actually completed -- but for which CalPERS didn't want to acknowledge. When CalPERS staff refused to sign the verifying documents, Villalobos and Buenrostro took matters into their own hands. Kind of like creating a phony receipt for an expense report, because you lost the real one and no one at the store will create a duplicate (yes, this is far more serious, but you get the picture).

We still have no valid explanation from CalPERS as to why it didn't sign the initial disclosure letter, leading me to believe it was an attempt to establish plausible deniability of Villalobos' dealings in Sacramento. Likewise, Apollo has steadfastly refused to explain why it not only used Villalobos in the first place, but why it paid him more and more money to raise subsequent capital (the opposite of how placement agent compensation usually works).

At this point, I'm beginning to fear that neither Apollo nor CalPERS will ever be asked to answer such questions by someone with subpoena power.