The Trudeau Liberals used their parliamentary majority Tuesday to defeat an NDP motion on closing a loophole that allowed Finance Minister Bill Morneau to retain close control over a significant stake in his family company even as he ran a department with power to affect the fortunes of Morneau Shepell.

The Liberals also continued to dodge questions on whether Mr. Morneau recused himself from internal discussions on Bill C-27, legislation that opposition parties say could be expected to benefit Morneau Shepell, one of four major firms in Canada's human-resources and pension-management sector.

As The Globe and Mail first reported last week, Mr. Morneau ran the Finance Department for nearly two years without putting his substantial assets into a blind trust – as Justin Trudeau did for his family fortune, a move that the Prime Minister holds up as the gold standard for avoiding conflicts of interest in federal politics. After days of defending his conduct, the Finance Minister last Thursday reversed course and pledged to sell his remaining one million shares in Morneau Shepell and put all other assets in a blind trust.

The NDP motion, which also called on Mr. Morneau to apologize for his conduct, drew the support of the Conservatives, the Official Opposition, but was easily defeated 163-131 by the Liberal majority in the Commons.

The motion called for the immediate closing of "loopholes in the Conflict of Interest Act as recommended by the Conflict of Interest and Ethics Commissioner, in order to prevent a Minister of the Crown from personally benefiting from their position or creating the perception thereof."

Ethics Commissioner Mary Dawson's office explained last week that Mr. Morneau was able to keep the shares and avoid a blind trust because he held the shares indirectly through a holding corporation.

NDP ethics critic Nathan Cullen, sponsor of the motion, criticized the Liberals for killing it.

"Every single Liberal voted against closing the ethics loophole," Mr. Cullen said. "Either they don't get it or they don't care."

While the Liberals have the votes in the Commons, Mr. Cullen argued the Finance Minister has suffered permanent political damage. He noted how guffaws erupted in the Commons on Tuesday when Mr. Morneau, during his fall fiscal update speech Tuesday, talked about helping the middle class rather than a privileged few.

"The House burst out laughing. It's hard to see how he can recover from this," Mr. Cullen said. "That is the concern they must have. Does this cloud of scandal stay over him almost regardless of what he does next. …"

Controversy over Bill C-27 continues. It would enable federally regulated businesses to create "target benefit" pension plans that lower the monetary liability for employers by shifting risk to employees.

The proposed law would require actuarial valuations every year for this type of plans, which could also mean more work for firms such as Morneau Shepell.

In the Commons on Tuesday, opposition parties continue to press the government to say whether Mr. Morneau was involved in any discussions on the legislation.

Deputy Conservative Leader Lisa Raitt noted that Mr. Morneau lobbied on behalf of targeted pensions plans when he was executive chair of Morneau Sheppell.

"When he became the minister, he actually brought legislation in to make these law. He also collected dividends from the company, because he still had shares," she told the Commons. "Given all of these conflicts around this issue, did the minister recuse himself from any of the discussions around Bill C-27?"

Mr. Morneau was not in the Commons for Question Period but his parliamentary secretary Joel Lightbound refused to answer the question, saying the minister put in an ethics screen to guard him against potential conflicts of interest.

Prime Minister Justin Trudeau accused the opposition of "torquing up insinuations with no basis" and argued that the ethics screen prevented any potential conflicts of interest.

The ethic screen called for Mr. Morneau's chief of staff to tell the Finance Minister when he had to recuse himself from discussions that involved his former company. Mr. Morneau's office said he has recused himself from cabinet discussions on two occasions but his office would not say if that involved Bill C-27.

WHAT IS A TBP?

The TBP concept is not new. It has existed for many years in the form of negotiated contribution Multi-Employer Pension Plans (MEPPs), which are especially popular in certain industries. What is new is the notion of TBPs in the single-employer environment.

In its most basic form, a TBP is a pension plan that aims to provide a defined benefit (DB), but with fixed contributions. To plan members, it is virtually indistinguishable from a regular DB plan except that accrued benefits are subject to reduction if the funding level falls below a given threshold. To avoid a reduction, TBPs are governed by more formal funding and benefit policies than one typically finds in defined benefit plans. In addition, conservative assumptions can be used in the setting of the target benefit with benefit improvements granted only if there is a significant funding surplus.

TBP assets are pooled for investment purposes and are managed in much the same way as in a DB plan although the TBP fund might be invested a little more conservatively to reduce the chances of a funding deficit.

One variation on the basic TBP allows for contributions to vary within a narrow range rather than being completely fixed. This is the idea behind the Shared Risk Pension Plan that was adopted recently by the New Brunswick Government (see the sidebar “The New Brunswick SRPP”).

REASONS TO CONSIDER TBPs

TBPs are promising because they eliminate the risk of rising costs inherent in DB plans while offering a better solution for most employees than most DC plans.

DB plans have long fallen out of favour in the private sector and are now under increasing attack in the public sector. Much has been written to explain why this is the case but for our purposes it suffices to say that the decline of DB plans is unlikely to be reversed. In the long run, the only DB plans that may survive are those sponsored by organizations with very deep pockets.

For their part, DC plans suffer from two fundamental defects. The first is the uncertainty of the benefits they generate, which complicates retirement planning (see Figure 1 for example). The second is that the members bear the risk, but all too often are not qualified to make their own investment decisions.

TBPs minimize many of these shortcomings. From the employer’s perspective, the following characteristics of a TBP are significant inducements to switch away from DB:

• The contribution level is fixed, with no obligation to contribute more even if funding proves inadequate.
• Accounting (in the ideal case) is based on contributions made, the same as in DC plans. Accounting in DB plans is an elaborate exercise that has produced some unpleasant surprises for employers in recent years. Pension expense has skyrocketed as bond yields have fallen and the situation has been exacerbated by investment losses during the financial crisis. This is the main reason DB plans became so unpalatable to the shareholders of private sector companies. The DC-type accounting that the accounting profession might decide to apply to TBP plans eliminates any such pension expense shocks.
• Pension Adjustment (PA) calculations under a TBP should be easy, being simply the contribution made (assuming the Canada Revenue Agency (CRA) agrees with this treatment). This simplifies plan administration and may also provide more Registered Retirement Savings Plan (RRSP) contribution room for employees.
• The target benefit in TBPs is monitored by means of going-concern funding valuations. Solvency valuations, which have been the source of such volatile funding in recent years as to threaten the very solvency of some companies, would not be required.

The sponsors of DC plans may also want to consider TBPs. The one big advantage they have over DC plans is that the assets are pooled and invested in much the same way as for DB plans. This means the TBP sponsor does not have to offer individual investment choice thus eliminating the onerous and sometimes futile task of trying to educate an entire workforce on investment basics.

While employees are unlikely to prefer TBPs over traditional DB plans, they will probably find them a better alternative than DC plans. There are some good reasons for employees to prefer TBPs:

• While the target benefit is less certain than in a DB plan, it is more certain than the income one can derive from a DC plan.
• The target benefit is paid for life so retirees do not have to worry about outliving their assets. They do have to worry about a potential benefit cut under a TBP but good funding and benefit policies reduce both the chances and the severity of such a cut.
• Various studies indicate that plan administrators, with the advice of investment professionals, make better investment decisions than individual employees. TBPs therefore promise to stretch a dollar of contribution further than it would go in a DC plan.
• For a DC retiree to secure a stable monthly income, she would have to buy a life annuity. The insurance company expenses and anti-selection charges, as well as the very conservative investments underlying the annuity reserves tend to reduce the amount of payout. TBPs avoid all of those problems.
• Unions should appreciate the fact that TBPs promote solidarity. Unlike DC plans, all members in a TBP accrue the same pension for a given year of service.

PROBLEMS WITH TBPs

The biggest drawback to a TBP is that the payout can be reduced if the target benefit is less than 100% funded. This problem is more than theoretical as an estimated 25% of MEPPs have had to reduce benefits in the past decade.

As we will see, benefit reductions should be less likely in single-employer TBPs with the help of intelligent plan design features and the adoption of conservative investment, benefit and funding policies. The downside to conservatism, however, is lower target benefits and a greater transfer of wealth to the next generation, so some compromise is necessary. Hence, the prospect of benefit reductions in a TBP can never be entirely eliminated.

To appreciate the challenge of deriving a stable income from fixed contributions, consider Figure 1,1 which is taken from our last Vision. It shows that historically, a fixed rate of contributions would have generated retirement income that varies from a low of 15% of final average pay to as much as 55% depending on the year of retirement.

For the plan in Figure 1, the plan sponsor could have set the target benefit at 30% of final average pay and could probably have paid out the full basic pension consistently though there would have been some years when post-retirement indexing could not have been paid. Had the target been set at 40%, it certainly looks more attractive but it would mean forgoing indexing for prolonged periods and even basic benefits would have to be reduced in some years. Neither situation is perfect. The 30% target provides better security but in good times it may frustrate some retirees who feel they could have done better in a DC plan and who have no wish to be building up a reserve for the benefit of the next generation of plan members. On the other hand, a 40% target would lead to frequent disappointment.

Another challenge with TBPs is that employers may have to forgo plan provisions that incent certain behaviour, such as retiring earlier. Incentives come at a cost and members in a TBP will resent subsidizing others. Of course, subsidies exist in virtually every DB plan as well, but they do not tend to create problems there because the extra cost is perceived to be borne by the employer rather than coming at the expense of fellow plan members.

The Global Risk Institute in Financial Services (GRI) today announced the creation of a National Pension Hub (NPH) that will serve as a Canadian centre for pension knowledge and research. The purpose of the NPH is to provide pension and income security research that, among other things, will lead to innovative solutions to pension design, governance and investment challenges.

To date, more than a dozen organizations have joined the NPH, including major pension plans, accounting firms, consultancies and public corporations, as well as a number of individual opinion leaders in the field of pensions. Additional members are being recruited, including governments and companies associated with pension plans. The NPH will be administered by the GRI.

“The diversity of our membership in the National Pension Hub is one of our key strengths,” said Barbara Zvan, Chair of the NPH, and Chief Risk & Strategy Officer at Ontario Teachers’ Pension Plan. “It will help us produce innovative ideas and research that reflect a wide range of interests and perspectives.”

The pension industry has been grappling with a number of evolving challenges over the past decade including an aging population with a longer life expectancy, finite resources to invest in, more complex regulations, greater market volatility, and the need to generate strong returns in a slower growth economy. The NPH will provide a pipeline of objective research on pensions and income security that will help pension plan providers, investment managers, policy makers, and government administrators address these and other challenges.

In particular, the NPH will be an incubator for outcome-based research that addresses three primary objectives:

• Provide Innovative solutions to retirement saving challenges;
• Create sustainable capacity for academic research; and,
• Serve as an unbiased source for policy consultation.

“We plan to build a deep reservoir of pension knowledge and research that will inform pension industry stakeholders, encourage debate on pension policy, and lead to consensus on critical issues,” said Richard Nesbitt, CEO of GRI. “At GRI, we’ve developed a proven model of how to create value from research by working with academic and industry leaders. We want to apply this model of thought leadership to the pension industry.”

The NPH’s first meeting will take place at the beginning of November, at which time it will set its initial research topics and projects. Most projects will have a two-year time horizon with ininitialports delivered after the first year.

The member organizations of the NPH at its launch date are: AIMCo, bcIMC, CDPQ, CPPIB, CN Rail, Deloitte University, IMCO, KPMG, McKinsey, Mercer, OMERS, OTPP, Public Sector Pension Investment Board (PSP Investments), PwC and the GRI. Individual members who are pension experts include Hugh Mackenzie and Bob Baldwin.
About GRI: The Global Risk Institute is the leading forum for ideas, engagement and building capacity for the management of risks in financial services. We are a non-profit, public and private partnership with 32 government and corporate members from asset management, banking, insurance and pension management. The institute’s goal is to develop fresh perspectives on emerging risks, to engage members, and to enhance risk-management skills. Our activities support academics, corporations, policy makers and regulators. We take a global view of the risks facing the financial services industry from our base in Toronto, Canada.

About GRI: The Global Risk Institute is the leading forum for ideas, engagement and building capacity for the management of risks in financial services. We are a non-profit, public and private partnership with 32 government and corporate members from asset management, banking, insurance and pension management. The institute’s goal is to develop fresh perspectives on emerging risks, to engage members, and to enhance risk-management skills. Our activities support academics, corporations, policy makers and regulators. We take a global view of the risks facing the financial services industry from our base in Toronto, Canada.

• Longevity risk (see here and here)
• Asset Allocation
• Risks in private markets (see here and here)
• Modelling discount rates to determine future liabilities
• The use of leverage at pensions (see here and here)

CARP, a national non-profit advocacy group formerly known as the Canadian Association for Retired Persons, will be on Parliament Hill on Wednesday to meet with dozens of MPs as it lobbies for legislative change.

"What CARP is asking for is that unfunded pension liability be given 'super priority' status so it goes to the front of the line," said Wanda Morris, vice-president of CARP.

Pensioners hold no priority when it comes to dividing up assets during bankruptcy, and Morris said that typically in this country, defined benefit pensions are underfunded.

"There are about 16,000 [retirees] at Sears, but it just pales compared to the 1.3 million that potentially could be at risk. That's 1.3 million corporate pensioners with defined benefit pension plans," said Morris.

Thirty Canadian and international financial institutions and pension funds representing approximately CAD $1.2 trillion of assets under management today issued a joint Declaration of Institutional Investors on Climate-Related Financial Risks, calling on publicly traded companies in Canada to commit to enhanced disclosure on their exposure to climate change risks, and the measures they are taking to manage them. The Declaration is supported in principle by 13 organizations.

The signatories of the declaration intend to work with publicly traded companies in Canada to help them mitigate their climate change risks. By signing the declaration, they are advocating for other economic and financial institutions to join forces in order to stimulate sustainable world economic growth, while reducing their environmental impact.

"This declaration, which was led by Finance Montréal's Responsible Investment work group, reflects the initiative shown by financial institutions. With more information at their disposal, investors will be able to better assess all the risks faced by their investment portfolios and design investment strategies that are adapted to the realities of climate change," said Louis Lévesque, Chief Executive Officer, Finance Montréal. "This is a positive development for the financial industry in Quebec and Canada, and keeps us aligned with global trends."

"I am proud to see the financial community rallying around this key issue. As institutional investors, we all have a role to play to promote increased transparency and better climate change disclosure practices from the companies we invest in," said André Bourbonnais, President and CEO, PSP Investments, and Responsible Investment Lead, Finance Montréal.

The declaration remains open to new signatories who wish to endorse it. The full text of the declaration, as well as a complete list of signatories, is available here.

Technology is the most important industry for stocks today, indicating that blowout earnings from giants such as Microsoft could be good for the market.

Shares of Google parent Alphabet, Microsoft and Intel soared nearly 6 percent or more in Friday trading after reporting solid quarterly earnings that came in well above Wall Street's expectations. The stocks are among the largest in the S&P 500 by market capitalization. In fact, the technology sector overall has the largest weighting in the index at 23.2 percent, according to a Sept. 29 fact sheet.

The high weighting and strong performance heading into earnings season have tied the S&P 500's performance closely to that of technology stocks, especially over the last three months. During that time period, tech had the highest correlation to the S&P at 0.87, according to Kensho, a quantitative analytics tool used by hedge funds.

The closer a correlation is to 1, the more in sync two parts of the market are. The closer a correlation to zero, the more independent two parts of the market are. Telecommunications had the lowest correlation with the S&P over the last three months at 0.3.

"Frankly, it makes sense the correlation has risen here recently" between tech stocks and the S&P, said David Lebovitz, vice president and a global market strategist on the JPMorgan Asset Management Global Market Insights Strategy Team. "What you're seeing here as breadth has narrowed over the last couple of weeks, investors have [bought stocks of companies] growing both revenue and earnings as people get a little skittish."

The eight-year-old bull market is the second-longest in history, and many investors worry that a sharp drop in stocks is due soon. A bull market is a period without a drop of 20 percent or more in stocks from a recent high.

Lebovitz also pointed out that in a sluggish growth environment, stocks such as technology tend to perform better. The International Monetary Fund's latest global growth outlook this month forecasts a modest rise of 3.6 percent this year.

The relationship between tech stocks and the S&P has not always been this close. Over the last six months, tech has tied with consumer discretionary for the highest correlation with the S&P at 0.82, according to Kensho.

Over the last two years, tech falls to third place behind industrials and consumer discretionary, the analysis showed.

However, consumer discretionary is almost a play on tech as well since e-commerce giant Amazon.com is the largest stock in the sector. Shares of the company leaped 11 percent to all-time highs Friday after reporting a quarterly earnings beat and strong sales growth in its cloud business, Amazon Web Services.

Big tech earnings aren't over yet. Apple, which has the largest market capitalization in the S&P at $821 billion, is scheduled to report quarterly results on Nov. 2. Facebook, the fourth-largest S&P stock by market capitalization, is set to post results a day before.

Going back further into history, the S&P 500 is almost always up when tech stocks are up.

Since the current bull market began in March 2009, whenever the Technology Select Sector SPDR ETF (XLK) has gained more than 2 percent in a month, the S&P 500 has risen 96 percent of the time with an average return of 3.2 percent, according to Kensho.

On the other hand, the S&P has almost no chance of gains without tech stocks rising. When the tech ETF falls more than 2 percent in a month, the S&P falls 92 percent of the time with an average decline of nearly 3 percent, according to Kensho. The study looked at 37 such instances since the beginning of this bull market going back to 2009.

The S&P 500 traded Friday nearly half a percent higher within a quarter of a percent of its all-time high. The tech ETF rose more than 2 percent to a record high as technology stocks led S&P gains, while five sectors traded lower.

To be sure, some analysts worry that technology stocks are rising too quickly as investors chase performance. It's not a healthy sign for the market if only technology-related stocks are rising. In 2015, only Amazon and Netflix doubled, while Alphabet and Facebook were up double digits. But the S&P 500 was barely changed on the year.

"As tech becomes a larger and larger component of the S&P 500, its contribution to risk is larger as well," Lebovitz said.

• A legendary Wall Street strategist lays out the stock market's 'nightmare scenario'
• Dollar surges: Investors chasing hot international markets face day of reckoning
• Bond Kings and the Futures
• Beware of Extremist Bond Calls

• Long US long bonds (TLT)
• Long the US dollar (UUP)
• Short oil (OIL), energy (XLE), emerging markets (EEM), commodities, commodity currencies and stock indexes.

Passive investing could eventually account for 90 per cent of the equity market, according to Jack Bogle, founder of Vanguard and pioneer of the index-based investing that has upended the asset management industry.

Passive investment of stocks through mutual or exchange traded funds that simply track an index — and charge investors much smaller fees — accounts for 47 per cent of the assets managed by the US fund industry, posing a severe challenge to active managers who take higher fees with the promise of beating the returns of major indices.

“As a long-term investment strategy, I don’t think the index fund has any competition at all,” Mr Bogle told an audience at the Ivy League clubhouse for Cornell University in Midtown Manhattan this week.

“There must be some limit somewhere with how much indexing there can be without [reducing] the efficiencies of the market,” he said. “[But] if I had to guess, I’d put [the limit] in the area of 70 or 80 or 90 per cent — very large — because there will always . . . be people looking for values, price discovery and all that kind of thing.”

Passive equity management is expected to overtake funds managed by active advisers by January 2018, analysts with Bernstein forecast earlier this year.

However, after lacklustre performance last year, returns have improved for active stock pickers. Nearly 57 per cent of large-cap US equity fund managers beat the S&P 500 over the past year, according to S&P Dow Jones Indices.

Alina Lamy, a senior analyst with Morningstar, said that the battle was “not completely lost” for active managers, but that investors were paying far more attention to fund fees.

“Bogle . . . is the greatest advocate for passive and this is the principle he founded his company on,” she said. “They started it all and they are still ruling it.”

Mr Bogle, who billionaire Warren Buffett credits with doing more for American investors than anyone else, also cautioned that Vanguard is growing too large. Vanguard, whose corporate headquarters are just outside Philadelphia, manages about $4.7tn. It trails only rival BlackRock, which has almost $6tn of assets.

“We’re now closing in on $5tn and I worry about that,” he said. “Running a large company is a very difficult thing . . . It gets harder and harder as you get bigger and bigger. I’ve spent a lot of time trying to rectify that concept.”

The octogenarian added that he was worried about the risk of high concentrations on liquidity and marketability of some of Vanguard’s funds, particularly those in the $3.8tn municipal bond market. Of the $323bn ploughed into taxable bond funds over the past year, 60 per cent was directed to passive funds, according to data provider Morningstar.

There is also a “significant” risk in the form of possible regulation of the industry, although he said he did not believe it was fair to classify the largest fund managers as systemically important financial institutions.

“We run basically an old oligopoly, Vanguard, BlackRock and State Street,” he said. “State Street is the smallest part of that group. An oligopoly is not necessarily bad but it is subject to challenge by regulators, and particularly European regulators . . . It’s hard to predict where that might go.”

Mr Bogle is not involved in the management of Vanguard; he retired from the company’s top post in 1996. A spokesperson for the asset manager said the company’s growth had “been a force for good” in the industry.

“Growth is not a goal for Vanguard but an outcome of delivering clients superior investment performance and quality service at a low cost,” the spokesperson said. “Vanguard has grown responsibly and governed our growth by being prudent in our product development, offering only funds that meet an enduring long-term need.”

The tragedy of the commons is a fanciful term from economics that describes an action whose benefits accrue mainly to the entity committing it and whose costs are diffused. A typical example would involve a manufacturer polluting the air or water, but the expression can also apply to owners of index funds in the commons that are the financial markets.

What makes indexing a tragedy of the commons is that the benefit — higher long-term returns due to lower costs — only accrues as long as there is an active, functioning market underlying whatever index a fund is trying to capture the performance of. While investors and managers of index funds reap the rewards, the expense of maintaining that healthy market is borne by shareholders in actively managed funds and traders who buy and sell individual stocks.

The market cannot exist without those participants engaging in research, analysis and the transactions that result from them, as well as regulation of the market itself and the businesses whose stocks form it. Index fund shareholders largely avoid the costs involved, so the more investors index, the greater the costs for the ones who don’t, increasing the incentives to index.

John Bogle, the founder of the Vanguard Group and the person who ignited the trend toward index investing four decades ago, acknowledged recently that this circle could turn vicious eventually and cause downright tragic events in the stock market.

“If everybody indexed, the only word you could use is chaos, catastrophe,” Bogle told Yahoo Finance at the Berkshire Hathaway annual meeting last month. “The markets would fail,” he added.

Bogle noted that trading would dry up if the stock market comprised only indexers and there were no active investors setting prices on individual issues. Everyone would just buy or sell the market.

The market is not entirely owned by indexers, of course, and it never will be, and Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place.

Bogle did not elaborate in the interview, but as indexing comprised an ever-larger proportion of trading, the limited trading of the few remaining active market participants would cause exaggerated price swings in individual stocks and perhaps the whole market.

Bogle stressed that there is a long way to go before indexing reaches a level at which market stability begins to crumble. About one-quarter of U.S. stock ownership is done through indexing, he told Yahoo. According to investment researcher Morningstar, 46.7% of assets invested in U.S. stocks via exchange-traded funds or mutual funds was indexed in April, compared with 36.3% three years earlier.

One development could mitigate much of the advantage that index funds enjoy and slow the rush to own them, but you’re probably not going to like it. When the market suffers a prolonged decline, active managers can gain an edge over indexers by moving large portions of assets into cash or into defensive sectors such as utilities and consumer staples.

Shareholders of index funds could then suffer more than owners of actively managed funds, and they could take their losses harder due to the perceived security they feel precisely because they merely own the market and aren’t trying to beat it. That might make active investors feel a bit of schadenfreude for indexers who have been free-riding at their expense, but the feeling probably wouldn’t last. The greater price swings that could ensue in a heavily indexed, less-active market are likely to exacerbate losses for everyone.

Until the next bear market, the indexing trend is likely to accelerate. As with any tragedy of the commons, indexing is the sensible thing for each individual to do, but each individual should remember that many sensible ideas, especially in investing, make less sense as more people put them into practice. When the stock market turns down again, index fund owners will have to become their own active manager and make sure they’re well diversified, with limited exposure to risk, chaos, and catastrophe.

[...] I don't buy the nonsense of the "end of the petrodollars". This is pure nonsense and all this talk of alternative exchanges that will threaten the preeminence of the US dollar or US exchanges is beyond ridiculous.

I suggest Mr. Curran and all of you who buy into this nonsense read Yannis Varoufakis's first book, The Global Minotaur. Let me be clear, I'm no fan of Varoufakis and his pompous leftist nonsense but this book is a must-read to understand why the US is gaining global strength as its national debt mushrooms.

In short, the US runs a current account deficit for years but it benefits from a capital account surplus as all those countries running current account surpluses (China, Germany, Japan, etc) recycle their profits back into the US financial system, buying up stocks, bonds, real estate and other investments as well as subsidizing the US military-industrial complex.

The second book I want you all to read is John Perkins's The New Confessions of an Economic Hitman, an expanded edition of his classic bestseller. You will learn the world doesn't work according to some nice, tidy economic model full of complicated equations. Behind the scenes, there are a lot of dirty things going on.

Importantly, and this is my point, the US dominates global finance and the global economy, which is why I scoff at the idea of China, Russia or any other country is gaining on it and threatens to displace it or displace the greenback as the world's reserve currency.

In recent years, Canada has significantly expanded and improved its retirement income and pension system. The Canada Pension Plan (CPP), which provides Canadians with income security in the case of retirement or disability, has been expanded, and its defined benefit plans for government employees has managed to avoid many of the funding problems plaguing comparable U.S. plans. The country is also making advances in expanding coverage to moderate-and-lower income Canadians. But there’s still work to be done, particularly in improving efforts to target policies to low-to-moderate income workers.

How was Canada able to achieve this expansion, and is there anything in the Canadian experience that Americans can use to advance retirement system reforms in the United States? On November 2, the Retirement Security Project at Brookings will host an event with senior Canadian officials and American experts to discuss the Canadian system and its relevance to American policy debates. The event will be live webcast.

• Get the mission statement right: What is the purpose of this new retirement system and how will the mission statement govern all activities at this new fund?
• Get the governance right: Make sure the board overseeing this new pension plan is experienced, informed on all aspects (not just investments but HR, IT, etc.) and most importantly, independent. This board can then hire a CEO who will hire his or her senior team to carry out the day-to-day operations of this new pension. Most importantly, there can be no government interference whatsoever, and they need to get the compensation right to hire qualified staff able to bring assets internally and manage money at a fraction of the cost of outsourcing to external managers.
• Get the risk-sharing right: If you look at the best pension plans in Canada, they have all adopted a shared-risk model which means higher contributions, partial or full removal of inflation-adjustments when the plan experiences a deficit or both. Investment returns alone will not be able to restore a plan's fully-funded status no matter how good the investment managers are. 

The Ontario Teachers' Pension Plan says it is selling off 30 per cent of its stakes at two United Kingdom regional airports to broaden its investment strategy.

The deal will see Australia's New South Wales Treasury Corporation and Sunsuper Superannuation Fund each acquire a 15 per cent stake of Ontario Teachers' ownership in Bristol Airport and Birmingham Airport.

Ontario Teachers' has been an investor at the two airports since 2001, increasing its stakes to 100 per cent at Bristol and 48.25 per cent at Birmingham in 2014 with the intention of bringing in new partners.

Following completion, Ontario Teachers' will own 70 per cent of Bristol Airport and 33.8 per cent of Birmingham Airport.

The sale is expected to complete in late November.

Bristol Airport is the ninth-largest airport in the U.K. with 7.5 million passengers in 2016 and Birmingham Airport is the seventh-largest airport in the U.K. with 11.6 million passengers in 2016.

"Working with like-minded partners who bring new ideas, capital and expertise to the table is core to our broader investment strategy," said Andrew Claerhout, head of infrastructure at Ontario Teachers'.

"Under the new shareholder structure we will continue to focus on creating long-term value for all stakeholders including the 19 million passengers who fly through these two airports every year."

Ontario Teachers' Pension Plan ("Ontario Teachers'"), and Australia's New South Wales Treasury Corporation ("TCorp") and Sunsuper Superannuation Fund ("Sunsuper"), are announcing they will become investment partners in Bristol Airport and Birmingham Airport, two of the UK's leading regional airports.

Ontario Teachers' has entered a definitive agreement by which it will sell 30% of its stakes in both Bristol and Birmingham to TCorp as trustee of TCorpIM Direct Investment Fund E and Sunsuper Pty Limited as trustee of Sunsuper. TCorp and Sunsuper will each acquire 15% of Ontario Teachers' stakes in Bristol Airport and Birmingham Airport. Following completion, Ontario Teachers', TCorp and Sunsuper will own 70.0%, 15.0% and 15.0% of Bristol Airport and 33.8%, 7.2% and 7.2% of Birmingham Airport respectively.

Ontario Teachers' is Canada's largest single-profession pension plan. TCorp is the financial markets arm of the public sector in New South Wales, Australia, and Sunsuper is one of Australia's largest and fastest-growing superannuation funds.

"Working with like-minded partners who bring new ideas, capital and expertise to the table is core to our broader investment strategy," said Andrew Claerhout, Senior Managing Director, Infrastructure and Natural Resources at Ontario Teachers'. "We look forward to TCorp and Sunsuper joining us as shareholders, alongside the strong teams at Bristol and Birmingham and Ontario Teachers' enduring partnership with the District authority shareholders in Birmingham. Under the new shareholder structure we will continue to focus on creating long-term value for all stakeholders including the 19 million passengers who fly through these two airports every year."

Ontario Teachers' is the largest private investor in airports in Europe, with holdings in five freehold airports: Copenhagen Airports, Brussels Airport, Bristol Airport, Birmingham Airport and London City Airport. Ontario Teachers' has been an investor in Bristol and Birmingham Airports since 2001, increasing its stakes to 100% (Bristol) and 48.25% (Birmingham) in 2014 with the intention of bringing in new partners.

"In addition to the attractive investment characteristics of the individual airports, TCorp was particularly interested in this investment because of the opportunity to partner with Ontario Teachers' Pension Plan and Sunsuper, both experienced and like-minded global infrastructure investors," said Stewart Brentnall, TCorp Chief Investment Officer. "We are excited about working with our partners, not only on this investment but also on future opportunities. TCorp has a strategy of building long-term relationships with other sophisticated investors, which we believe will help to deliver value to our clients and members, both for managing existing investments and for identifying new investment opportunities."

"Sunsuper is an experienced investor in the Australian airport sector, and we are excited to expand our existing portfolio by adding stakes in two high-quality UK airports in Bristol and Birmingham," said Michael Weaver, Head of Private Markets at Sunsuper. "We believe that investments in the infrastructure sector provide greater scope for value creation through responsible stewardship, governance and proactive management of assets to create value for our members. We look forward to our ongoing involvement in the Bristol and Birmingham airports, with a key focus on delivering high-quality outcomes for all passengers and stakeholders."

Bristol Airport is the ninth largest airport in the UK with 7.5 million passengers in 2016, and Birmingham Airport is the seventh largest airport in the UK with 11.6 million passengers in 2016.

The sale is expected to complete in late November.

About Ontario Teachers'

The Ontario Teachers' Pension Plan (Ontario Teachers') is Canada's largest single-profession pension plan, with CAD$180.5 billion in net assets at June 30, 2017. It holds a diverse global portfolio of assets, approximately 80% of which is managed in-house, and has earned an annualized gross rate of return of 10.1% since the Plan's founding in 1990. Ontario Teachers' is an independent organization headquartered in Toronto. Its Asia-Pacific region office is located in Hong Kong and its Europe, Middle East & Africa region office is in London. The defined-benefit plan, which is fully funded, invests and administers the pensions of the province of Ontario's 318,000 active and retired teachers. For more information, visit otpp.com and follow us on Twitter @OtppInfo.

About TCorp

TCorp provides investment management and financial services for the government of New South Wales, which is the largest state in Australia by population and economic activity. TCorp is the third largest institutional investor in Australia. TCorp's investment management business currently manages approximately A$90 billion of funds. For more information, please visit www.tcorp.nsw.gov.au

About Sunsuper

Sunsuper, a profit-for-members superannuation fund, is one of the 10 largest pension funds in Australia. Sunsuper was established in 1987 and is headquartered in Brisbane, Australia. As at October 2017, Sunsuper had A$46 billion in funds under management and over one million members. Sunsuper invests across a diversified portfolio of global assets, including in the infrastructure sector. Sunsuper has been investing directly in infrastructure since the late-1990s, making it one of Australia's most experienced infrastructure investors with a long track record. For more information, visit www.sunsuper.com.au

Canada’s Ontario Teachers’ Pension Plan (OTPP) is looking to sell minority stakes in Britain’s Bristol and Birmingham airports, a source familiar with the matter said on Friday.

OTPP, which manages around $130 billion and is a big investor in British infrastructure projects, currently owns 100 percent of Bristol Airport and around 50 percent of Birmingham Airport, the source said.

While keen to remain invested in the assets, the group is looking to take advantage of strong demand from pension funds and other long-term investors for the often-attractive returns on offer from high-quality infrastructure, the source said.

OTPP would retain its share in London’s 2 billion pound City Airport, which it bought in February 2016 in partnership with two other Canadian pension funds and the Kuwait Investment Authority.

Earlier today, Milliman released their 2017 Public Pension Funding Study which explores the funded status of the 100 largest U.S. public pension plans. Not surprisingly, this study only served to confirm many of the rather alarming trends surrounding public pension Ponzis that we discuss on a regular basis.

Starting with a high-level status update, Milliman figures the largest 100 public pensions were roughly just as underfunded on June 30, 2017 as they were on June 30, 2016...not an encouraging development given that the S&P 500 surged 15% over that same period.

This 2017 report is based on information that was reported by the plan sponsors at their last fiscal year ends—June 30, 2016 is the measurement date for most of the plans in our 2017 study. At that time, plan assets were still feeling the effects of market downturns in 2014-2015 and 2015-2016. Total plan assets as of the last fiscal year ends stood at $3.19 trillion, down from $3.24 trillion as of the prior fiscal year ends (generally June 30, 2015). However, market performance since the last fiscal year ends has been strong, and we estimate that aggregate plan assets have jumped to $3.44 trillion as of June 30, 2017. We estimate that the plans experienced a median annualized return on assets of 11.49% in the period between their fiscal year ends and June 30, 2017.

The Total Pension Liability reported at the last fiscal year ends totaled $4.72 trillion, up from $4.43 trillion as of the prior fiscal year ends. We estimate that the Total Pension Liability has increased to $4.87 trillion as of June 30, 2017. The aggregate underfunding as of the last fiscal year ends stood at $1.53 trillion, but we estimate that the underfunding has narrowed to $1.43 trillion as of June 30, 2017.

Meanwhile, 32% of the top 100 plans were less than 60% funded.

Of course, the discussion gets far more interesting when Milliman analyzes the prevailing discount rates used by public pensions compared to independent analyses of where those discount rates should be set.

As our readers are well aware, we've long argued that public pension funds essentially hide their true funding status by simply choosing artificially high discount rates for future liabilities thus making their present values appear lower than they actually are. It's a clever scam but one that can only persist until the Ponzi runs out of cash.

As Milliman notes, the median expected return of the 100 largest public pension funds in the U.S. is somewhere around 5.9% based on the asset allocations of those funds.

That said, you can imagine our shock to learn that 83 of the top 100 funds used discount rates in excess of 7%.

So, what does that mean? Well, Milliman figures that overstating a fund's discount rate by just 1% artificially reduces its benefit liability by up to 15%. Therefore, given that the aggregate liabilities of the top 100 funds are roughly $5 trillion, each 1% adds about $750 billion in liabilities.

A relatively small change in the discount rate can have a significant impact on the Total Pension Liability. How big that impact is depends on the makeup of the plan's membership: a less "mature" plan with more active members than retirees typically has a higher sensitivity to interest rate changes than a more mature plan with a bigger retiree population. Other factors, such as automatic cost of living features, also come into play in determining a plan's sensitivity. Using a discount rate that is loo basis points higher or lower than the independently determined investment return assumption moves the aggregate recalibrated Total Pension Liability by anywhere from 8% to 15% (see Figure 13).

Adding insult to injury, Milliman notes that the ratio of retired pensioners (those taking money out of the system) to active pensioners (those still funding the Ponzi) has surged 16% over the past couple of years.

Of course, this ratio is only going to get worse over the coming decade as a wave of Baby Boomers retire...unfortunately, that wave of retirements will result in many of them finally realizing they've been sold a retirement fantasy for their entire life.

• Get the mission statement right: What is the purpose of this new retirement system and how will the mission statement govern all activities at this new fund?
• Get the governance right: Make sure the board overseeing this new pension plan is experienced, informed on all aspects (not just investments but HR, IT, etc.) and most importantly, independent. This board can then hire a CEO who will hire his or her senior team to carry out the day-to-day operations of this new pension. Most importantly, there can be no government interference whatsoever, and they need to get the compensation right to hire qualified staff able to bring assets internally and manage money at a fraction of the cost of outsourcing to external managers.
• Get the risk-sharing right: If you look at the best pension plans in Canada, they have all adopted a shared-risk model which means higher contributions, partial or full removal of inflation-adjustments when the plan experiences a deficit or both. Investment returns alone will not be able to restore a plan's fully-funded status no matter how good the investment managers are. 

Now, there are a lot of other things that US plans need to get right, like lower their discount rate to estimate future liabilities which is still unreasonably high for many plans.

The biggest impediment for US plans to adopt the Canadian model is governance. I just don't see US public pensions doling out Canadian-style compensation packages to their public pension fund managers. It's never going to happen and there are powerful vested interests (unions, funds, etc) who want to maintain the status quo even if the long-term results are mediocre at best, especially compared to Canada's large, well-governed DB plans.

And by long-term results, I don't just mean performance, I mean funded status which Hugh O'Reilly and Jim Keohane emphasized in a joint op-ed they wrote last year. Long-term results matter but what ultimately matters most is a plan's funded status.

Now, it should be noted that Canada's large pensions have certain degrees of freedoms that their US counterparts don't have. They are piling on the leverage nowadays to take advantage of their pristine balance sheets which are a direct result of good governance, excellent risk management and to be truthful, a long bull market and investment policies that allow them to leverage their portfolio to improve overall risk-adjusted returns.

Signs of euphoria are creeping into the market, and that's giving one trader déjà vu.

"I'm getting a little worried here," Matt Maley said Thursday on CNBC's "Trading Nation.""We're starting to see some of the traditional signs of getting near a top being explained away for whatever reason."

Specifically, Maley pointed to the flattening yield curve — where short-term and long-term rates compress — as reason for concern.

"If you go back to 1999 and 2007, the yield curve was flattening for a year while the stock market was going straight to the moon, and that's exactly what we're having now," said Maley.

After a disappointing jobs number on Friday, the spread between the U.S. 2-year yield and U.S. 10-year yield fell to around 72.7 basis points, marking a 10-year low. Despite the move, some market participants didn't seem too concerned.

Michael Schumacher of Wells Fargo told CNBC that it was nothing more than a "head fake," explaining that investors shouldn't "leap to any conclusions" based on the report.

"Of course people explained it away that it didn't matter, until it did," added Maley. "I'm not looking for a repeat of any of those two years, but we are seeing some signs that some of the euphoria that people have been worried about is starting to creep into the market."

Furthermore, Larry McDonald of AGC Analytics cautioned that the number of new highs on the New York Stock Exchange has been declining, a sign of a "tired" bull market.

"New highs have been trending down for weeks, the amount of stocks above the 200-day moving average has been trending down," he said Thursday on "Trading Nation."

On the NYSE, 108 stocks hit a new high Friday. That's down from the 166 we saw a week ago, according to McDonald. "Over the last 30 years, rarely have we seen the S&P 500 rate to new highs with so little participation," he added.

"The biggest thing to watch for, however, I think, is the global growth story is picking up, and central banks around the world ... they're all trying to do this ... dovish hike, one and done," McDonald said.

The Bank of England hiked interest rates on Thursday for the first time in 10 years. Meanwhile, the Federal Reserve is expected to hike rates next month for only the fourth time in nearly a decade.

"But at the end of the day they could, because of this global growth surge, the central banks including the Fed could very well be forced to hike ... faster than the market expects," he explained. "And I think that's what's going to happen in the next couple quarters, and the market's not going to like that one bit," he added.

The Dow hit a record intraday high on Friday.

1. A melt-up unlike anything we've seen before precisely because these are the most highly manipulated markets ever as every central bank stands ready to bid up prices. 
2. A meltdown unlike anything we have ever seen before precisely because if investors lose faith in central banks' eternal ability to prop up markets, there will be a severe crisis of confidence, ushering in the worst bear market ever. 

Two top executives at California's teacher pension system are getting big bonuses worth more than $200,000 each following strong investment earnings.

The California State Teachers' Retirement System approved the bonuses without discussion Friday for Chief Executive Officer Jack Ehnes and Chief Investment Officer Christopher Ailman.

The bonuses amount to 53.5 percent of the base salary for each executive. Ehnes will get just under $225,000 on top of his base salary of $420,000. Ailman's bonus is $273,000 on top of his $510,000 base pay.

CalSTRS is the nation's second largest public pension fund with more than $215 billion in assets. Its investments earned 13.4 percent last fiscal year, beating a 7 percent target.

Bonuses are based on a formula in each executive's employment contract, which considers investment performance and personal performance. Ehnes is also evaluated on long-range strategic planning.

Ehnes is eligible for a bonus of up to 80 percent of his base pay while Ailman's maximum bonus would double his salary.

CalSTRS distributes retirement benefits for 900,000 teachers, retirees and their family members.

Pension executives are working to fill a nearly $100 billion gap between projected liabilities and assets. The Legislature in 2014 approved a funding plan that increases contributions from the state, school districts and teachers to fully fund the system by 2046.

The California Public Employee Retirement System, the state's other big retirement fund, also awarded bonuses to top executives this year following its own strong investment performance. Chief Investment Officer Ted Eliopoulos was awarded a bonus of $314,000, while CEO Marcie Frost got $80,000.

Unfortunately, I don't see the US moving to the Canadian pension model anytime soon but if it did partially or fully privatize Social Security to adopt a similar CPP-CPPIB approach, it needs to ensure a few things first:

• Get the mission statement right: What is the purpose of this new retirement system and how will the mission statement govern all activities at this new fund?
• Get the governance right: Make sure the board overseeing this new pension plan is experienced, informed on all aspects (not just investments but HR, IT, etc.) and most importantly, independent. This board can then hire a CEO who will hire his or her senior team to carry out the day-to-day operations of this new pension. Most importantly, there can be no government interference whatsoever, and they need to get the compensation right to hire qualified staff able to bring assets internally and manage money at a fraction of the cost of outsourcing to external managers.
• Get the risk-sharing right: If you look at the best pension plans in Canada, they have all adopted a shared-risk model which means higher contributions, partial or full removal of inflation-adjustments when the plan experiences a deficit or both. Investment returns alone will not be able to restore a plan's fully-funded status no matter how good the investment managers are. 

Now, there are a lot of other things that US plans need to get right, like lower their discount rate to estimate future liabilities which is still unreasonably high for many plans.

The biggest impediment for US plans to adopt the Canadian model is governance. I just don't see US public pensions doling out Canadian-style compensation packages to their public pension fund managers. It's never going to happen and there are powerful vested interests (unions, funds, etc) who want to maintain the status quo even if the long-term results are mediocre at best, especially compared to Canada's large, well-governed DB plans.

And by long-term results, I don't just mean performance, I mean funded status which Hugh O'Reilly and Jim Keohane emphasized in a joint op-ed they wrote last year. Long-term results matter but what ultimately matters most is a plan's funded status.

Now, it should be noted that Canada's large pensions have certain degrees of freedoms that their US counterparts don't have. They are piling on the leverage nowadays to take advantage of their pristine balance sheets which are a direct result of good governance, excellent risk management and to be truthful, a long bull market and investment policies that allow them to leverage their portfolio to improve overall risk-adjusted returns.

I also don't want to leave the impression that Canada's large pensions are perfect on the governance front and they can't learn anything from their US counterparts. This is pure nonsense.

Back in 2007, I did a study for the Treasury Board and can tell you in detail where Canada's large pensions can learn from the CalSTRS and CalPERS of this world. Things like better and more transparent benchmarks for private markets and better communication like public board meetings which are then on YouTube for everyone to see.

1. Before the crisis C chose to employ a much higher discount rate — 50 percent higher!— that allowed it to hide the true size of pension obligations and to inadequately pre-fund those obligations, as explained here. C continues to employ a much higher rate than O.
2. O requires employees to equally share pension costs with citizens and after the crisis made changes to un-accrued future benefits for retirees whereas C imposes most of the pension cost burden on citizens and made no changes to un-accrued future benefits.

In a year when most institutional investors rode out robust public markets, Harvard’s 8.1 percent investment return for fiscal year 2017 placed it last among Ivy League endowments.

Dartmouth, which has one of the smallest endowments in the Ivy League at $4.96 billion, did the best during the year. Its 14.6 percent return, buoyed by strong growth in public equities, grew its endowment to the largest it has ever been.

Yale, often the leader of Ivy League endowments, came in seventh place this year with an 11.3 percent investment return. Experts attribute it to the university’s heavy investment in alternative assets which, they argue, buffer Yale from an unexpected swings in the market or financial crashes.

While most Ivy League endowments were able to capitalize on the bull market in fiscal year 2017, Harvard’s performance was weighed down by a series of high-value markdowns it took on some of its investments. The University’s financial report, released last week, detailed a nearly $10 billion markdown on domestic fixed income assets, which include investments like treasury bonds, junk bonds, and corporate bonds.

It was a surprisingly high markdown for Charles A. Skorina, a financial headhunter who often analyzes the performance of institutional investors. He said the size of the markdown indicates that Harvard Management Company’s new CEO, N.P. Narvekar, has recognized that the portfolio was poorly constructed.

“You seldom see that,” Skorina said. “We usually see markdowns when the market crashes. If they’re writing down stuff, there must’ve been just awful stuff in their portfolio.”

Skorina added that Narvekar likely “bit the bullet,” intentionally setting the markdowns in his first year of leadership so any damaging assets won’t affect future years of performance.

“Narv’s smart. Better to take the big write off now and have nice returns after,” Skorina said. “Everyone will forgive you for the early years if you perform well.”

Narvekar said the firm will spend the next few years “repositioning” its portfolio in his annual endowment report. In some cases, that might mean selling off assets, as HMC has done with some private equity and natural resources investments. In others, the firm might simply mark down an asset. For the fiscal year, Harvard marked down its natural resources portfolio by $1 billion.

The changes are part of an ambitious restructuring Narvekar has launched since he started his tenure in January to address “deep structural problems at HMC.”

David E. Kaiser ’69, an alum who has regularly criticized the firm and pushed for it to become more transparent, said Narvekar’s letter was “the first time that anybody in authority at HMC or the University has admitted that something is seriously wrong, which had been fairly clear for some time.”

These returns mark the first under Narvekar’s leadership, but because he took the helm of the firm in the middle of the fiscal year, next year’s returns may provide a fuller picture of HMC’s performance with him in charge.

Narvekar led Columbia University’s endowment during the first part of the fiscal year. It returned 13.7 percent, the third best in the Ivy League.

Once again, the Crimson cannot seem to grasp that Harvard is in a big capital drive, and its revenues are seriously affected by (and distorted by) recognition of campaign gifts. Those effects are almost certainly huge.

Many Harvard Campaign gifts are bequests or otherwise currently unavailable to Harvard, but contribute hugely to "revenues." Accordingly, the Harvard budget numbers provided in this article, without much more explanation, tell very little about what is happening to the university's finances.

The disposition of assets representing $10 Billion (more than 25 percent of the entire endowment) and the abrupt markdown of the natural resources portfolio, again suggest that, prior to this year, known losses were concealed and not recognized, possibly (but not assuredly) in the vain hope that they might recover. Call it the Haena Park school of endowment fund management, reporting and accounting.

The polite phrase “deep structural problems at HMC” hardly begins to express what must be going at HMC on to warrant such a huge asset turnover and write down. And the pain is not over. In the natural resources portfolio, Narvekar said that “markdowns do not imply sales,” noting that Harvard may hold onto some investments and that it will take years to reposition this part of the portfolio.

That 8.1% return looks awfully massaged. It’s almost exactly the number needed to leave the real value (after inflation) of the endowment unchanged after withdrawals for expenses. The “writedowns” described in this article and in the one to which it links (Harvard Sheds Portfolio Assets in Fiscal Year 2017: “Harvard marked down nearly $10 billion in domestic fixed income assets and nearly $1 billion in natural resource assets during fiscal year 2017...”) are belated recognition of previously concealed losses. There are probably more to come. A lot more: “there must’ve been just awful stuff in their portfolio.” Yes, and there probably still is. That Skorina! So droll and understated. Always good for a quote. And a laugh! Love him.

By the way, a big first-year write down of the type Narvekar has effected (if only to date in part) should also have been pushed through by Mendillo. It’s increasingly obvious that she was not permitted to do so, but was forced to live with huge concealed losses and their drag on performance for her entire time at the helm. Her preposterously large compensation package presumably helped her bear the pain of liquidating her reputation. Or did nobody else ever wonder why Mendillo, a perennially underperforming endowment manager, was paid far more than David Swensen?

Oh, and by the way, this article naively states: “In some cases, that might mean selling off assets, as HMC has done with some private equity and natural resources investments.” That sentence links to articles describing HMC’s intent and desire to sell “some private equity and natural resources investments.” Bloomberg and many other financial news outlets also noted the endowment’s INTENT to sell such assets. But I can find no article or other confirmation that such sales were actually consummated. That suggests that HMC may retain those assets on its books at inflated valuations: more concealed losses.

Summary

• While stranger things have happened, this year’s big winners and the factor exposures that drove their returns were certainly atypical.
• Overall, the Ivies reversed the disappointing results of FY 2016, with all registering positive returns and all but Harvard beating the 60-40 portfolio (only the second time that’s happened since 2009).
• Traditional under-performers outperformed, while traditional outperformers posted more moderate returns.
• Public equity markets rallied strongly, beating private equity markets and boosting Ivy endowment returns.
• Harvard claims bottom performer status for the fourth time in six years and showed large negative unexplained returns (reportedly due, in part, to significant markdowns in its natural resources holdings).
• Endowments’ continued increase in exposures to illiquid investments, a move toward the Yale model of a high-risk, high-return portfolio, appeared to deliver no meaningful benefits in 2017.

Ivy League Endowment Assets

As of July 2017, the total AUM among the Ivy League endowments was $125.56 billion, representing 24.38% of the assets held by universities and related endowments [1]. While final numbers for fiscal year 2017 are still pending, here is a look at how 2016 AUM was distributed across the Ivies.

Endowment         FY 2016 AUM (in Billions)

Harvard                             37.10
Yale                                   27.20
Princeton                           23.80
Penn                                  12.20
Columbia                          10.00
Cornell                                6.80
Dartmouth                          4.96
Brown                                3.50

Performance

In stark contrast to FY 2016, this past year was a strong one for most endowments. In fact, nearly all the Ivy League endowments, Harvard being the only exception, beat the 60-40 portfolio, a commonly cited benchmark that endowments measure their performance against. Only Columbia and Princeton have beaten the 60-40, on average, over the past 10 years.

All endowments managed returns well above their historical payouts of 5%, even after adding 1.65% inflation. Dartmouth, with a return of 14.60%, beat the rest of its Ivy peers, continuing its fairly consistent trend of ranking among top Ivy performers. In fact, only Yale has performed as well as Dartmouth has during the last five years. University of Pennsylvania (UPenn) reversed course this year, ranking a close second with 14.30% returns. And Harvard continues its six-year trend of performing at or near the bottom of the class with 8.10% returns in FY 2017. Yale, which has landed in the top three every year since 2011, delivered mediocre returns this year, relative to its peers, at 11.30%.

By most measures, however, FY 2017 was an unusual year. In fact, Ivy endowments that have historically under-performed their peer group outperformed this year, with Brown and Cornell being the most notable examples. Both endowments beat perennial juggernauts, Yale and Princeton, this year, a feat we’ve only seen once since 2011. Much of this year’s outperformance can be attributed to larger exposure to public equities, which have seen a remarkable rise since Q4 2016.

Exposures

To capture exposures, we analyze each endowment return time series using a common factor set across all endowments, so that we ensure an apples-to-apples comparison. This enables us to create a factor-mimicking portfolio for each endowment that can provide further performance insight. Table 1 displays the factors we used to represent each of the asset classes found in the Ivy League endowment portfolios.

Table 1. Factor Proxies by Asset Class [2]

Asset Class                                           Factor
Bonds and Cash                         Bloomberg Aggregate Bond
US Equity                                  S&P 500
Foreign Developed Equity        MSCI EAFE*
Emerging Market Equity          MSCI Emerging Markets*
Real Estate                                Cambridge Associates Real Estate
Private Equity                           Cambridge Associates Private Equity
Venture Capital                         Cambridge Associates Venture Capital
Natural Resources                     Bloomberg Commodity
Hedge Funds                             Eurekahedge 50

*USD based exposure, assuming no currency hedging

The analysis was conducted using our proprietary Dynamic Style Analysis (DSA) model. DSA is an enhanced (returns-based) quantitative analysis model that provides a more transparent view of opaque or complex investment strategies, funds and products.^[3] Through this model, we compared the returns of the endowments since 2005 to the factors shown in Table 1. The chart displays the asset class exposures obtained for all Ivy League endowments over the past 10 years.

Our factor mimicking portfolios are able to capture the majority of each endowment’s performance. The chart below depicts the cumulative returns of the endowments against the returns of the factor mimicking portfolios:

Performance Attribution

Exposure to Private Equity was the largest contributor to aggregate endowment performance in FY 2017. Additionally, Hedge Funds, US Equity, Venture Capital, Real Estate, Foreign Developed Equity and Emerging Markets also contributed positively to endowment performance. Natural Resources was the only major asset exposure to be a negative contributor to performance in FY 2017.

All public equities outperformed Private Equity in FY 2017. To put that into context, US Equity has outperformed Private Equity only five times since 2001, Developed Foreign Equity has done it six times, and Emerging Market Equity has out-performed 10 of those 17 years. All three outperformed Private Equity this year, just the second time that’s happened in the last 10 years. Additionally, Real Estate and Venture Capital were soundly beaten by public markets, adding to the under-performance of Yale, which had the highest Real Estate exposure, and Princeton, which had the highest Venture Capital exposure.

Looking at the differences in performance in the underlying asset classes and considering the exposure of endowments to these asset classes, it’s easy to see why the performance of FY 2017 was so different from FY 2016: markets, in general, performed well over the last 12 months.

In fact, all asset classes, except for Bonds and Cash, performed significantly better during FY 2017 than they did in FY 2016. The largest magnitude of difference can be seen in foreign equities. Developed Foreign Equities returned 30.42% more in FY 2017 than in FY 2016, and Emerging Markets returned 35.81% more.[4] Yale shows the lowest exposure to these asset classes; with Dartmouth, UPenn and Columbia (the three highest performing endowments) showing the highest exposure.

Unexplained Returns Explained

Clearly, our factor model is not expected to capture 100% of endowment returns variation. And while its explanatory power is high, as we noted in our previous studies and as evidenced by the cumulative growth chart above, we observe some unexplained returns every year. These unexplained returns could be due to security, sector, country, style and strategy bets by underlying managers for marketable securities as well as valuation fluctuations and adjustments for private investments.

Unexplained returns were mostly positive this year, with the exception of Harvard and Yale, hinting^[5] at the ability by the funds to earn abnormal returns over and above their asset allocations. Harvard, in particular, stands out with a negative -2.9% unexplained return after final analysis. In his 2017 fiscal year letter, Narv Narvekar, CEO of Harvard Management Company, pointed to a number of internal changes enacted during the year. Those included markdowns of Natural Resources; unloading of Private Equity, Venture Capital and Real Estate funds in the secondary market; and increased allocations to external managers.

It is important to note that markdowns that affect the performance of the endowment, which are not related to market performance, are captured as a negative unexplained return. It is also important to note that the large positive selection returns by other endowments this year could be a source of concern for the future, especially if related to similar adjustments to the values of illiquid investments.

Changes to Fund Exposures (Movement toward private investments)

The Yale model, pioneered by David Swensen, the manager of the Yale endowment, has swept through the endowment world. This model calls for increased investment in illiquid and higher risk assets in order to harvest the illiquidity premium. These investment properties are more easily sustained by endowments due to their having a larger asset base and a longer time frame than most institutional investors. Using our portfolios of exposure, we can see how investment portfolios have changed over time, especially focusing on illiquid private investments.

The chart above depicts the exposure of the endowments to private investments (Private Equity, Venture Capital, Real Estate and Hedge Funds). We can see that most endowments have increased their exposure to private investments since 2005, indicating broad adoption of the Yale model.

Conclusion

FY 2017 was an unusual year for endowment performance. Ivy League endowment returns were all positive, rebounding from a tough FY 2016. Traditional under-performers outperformed, with traditional outperformers posting more moderate returns. Public equity markets rallied strongly, boosting the returns of the Ivy endowments. Longer term trends show that endowments continue to increase exposures to illiquid investments, moving more toward the Yale model of a high-risk, high-return portfolio.

References

1. http://www.nacubo.org/Research/NACUBO-Commonfund_Study_of_Endowments.html
2. We used preliminary data for the quarter ending on June 30, 2017, representing 61% of active funds updated compared to the prior quarter’s NAV for US Buyout and 68% for US Venture Capital.
3. DISCLAIMER: MPI conducts performance-based analyses and, beyond any public information, does not claim to know or insinuate what the actual strategy, positions or holdings of the funds or companies discussed are, nor are we commenting on the quality or merits of the strategies. This analysis is purely returns-based and does not reflect actual holdings. Deviations between our analysis and the actual holdings and/or management decisions made by funds are expected and inherent in any quantitative analysis. MPI makes no warranties or guarantees as to the accuracy of this statistical analysis, nor does it take any responsibility for investment decisions made by any parties based on this analysis.
4. Foreign equity returns are US Dollar based, and assume no currency hedging. The dollar currency index fell by .5% over FY 2017, indicating small gains from currency translation.
5. This has to be carefully evaluated given the unexplained portion of the returns also contains noise.

The group has committed to putting more than $1 billion into clean energy- and water-related projects that the Obama White House promoted two years ago. In addition, the investors helped create an advisory group called Aligned Intermediary Inc., which functions like a co-op for them, sourcing investments.

The deals Aligned Intermediary identifies are big: They range from $50 million to $500 million, according to co-founder and Chief Executive Officer Peter Davidson. Its members, which also include the Ontario Public Service Employees Union Trust and the New Zealand Superannuation Fund, seek real returns from direct investments in infrastructure—renewable energy, water, even garbage—as well as from loans to projects that help reduce greenhouse gas emissions. “The economic returns are there,” Davidson says. “The responsible investing idea is there. It’s a market imperfection that we need to solve.” The University of California has committed $500 million to these types of projects. While the group’s first transaction, an investment of about $50 million involving water infrastructure in the Western U.S., is on the books, details haven’t been disclosed.

For endowments, these types of direct investments have advantages. They skirt private equity and hedge funds’ controversial 2-and-20 fees, and the projects’ timetables run into the decades, substantially longer than a typical fund life of up to 10 years.

Over the past year we have provided extensive coverage of what will likely be the biggest, most politically charged, and most significant financial crisis facing the aging U.S. population: a multi-trillion pension storm, which was recently dubbed "one of the most heated battles of a lifetime" by John Mauldin. The reason, in a nutshell, why the US public pension problem has stumped so many professionals is simple: for lack of a better word, it is an unsustainable Ponzi scheme, in which satisfying accrued pension and retirement obligations requires not only a constant inflow of new money, but also fixed income returns, typically in the 6%+ range, which are virtually unfeasible in a world where global debt/GDP is in the 300%+ range.  Which is why we, and many others, have long speculated that it is only a matter of time before the matter receives political attention, and ultimately, a taxpayer bailout.

That moment may be imminent. According to Pensions and Investments magazine, Democratic Senator Sherrod Brown from Ohio plans to introduce legislation that would allow struggling multiemployer pension funds to borrow from the U.S. Treasury to remain solvent.

The bill, which is co-sponsored by another Democrat, Rep. Tim Ryan, also of Ohio, could be introduced as soon as this week or shortly after. It would create a new office within the Treasury Department called the Pension Rehabilitation Administration. The funds would come from the sale of Treasury-issued bonds to financial institutions. The pension funds could borrow for 30 years at low interest rates. The one, and painfully amusing, restriction for borrowers is "they could not make risky investments", which of course will be promptly circumvented in hopes of generating outsized returns and repaying the Treasury's "bailout" loan, ultimately leading to massive losses on what is effectively a taxpayer-funded pension bailout.

The bill would also fund a program at the Pension Benefit Guaranty Corp. to finance any remaining needs of pension plans borrowing from the new program.

"Any money needed for the PBGC would be a tiny fraction of what it would otherwise be on the hook for if Congress fails to act," said an analysis by Mr. Brown's office.

Sen. Brown's angle was naturally populist, and aimed squarely at those whose pensions are likely to recoup pennies on the dollar under the current investing climate: union workers. Brown told a group of retired Teamsters in Ohio on Monday that the bill will be out shortly.

"It's bad enough that Wall Street squandered workers' money — and it's worse than the government that's supposed to look out for these folks is trying to break the promise made to these workers. Not on our watch. We won't allow that to happen," he said.

No, instead what will happen "under his watch" is that funds collected from taxpaying Americans will be spent to satisfy the ridiculous retirement promises and obligations made over the past few decades, and while the immediate recipients of the funds, i.e. those looking at near-term retirement will be made whole, everyone else, i.e., taxpayers will lose.

And now that the machinery for pension bailouts is finally in motion, we look forward to the next, and possibly final, tear in the American social fabric, that between workers who can't wait to retire to the generous pension promises (see "Why Illinois Is In Trouble - 63,000 Public Employees With $100,000+ Salaries Cost Taxpayers $10 Billion" and "Mapping The $100,000+ California Public Employee Pensions At CalPERS Costing Taxpayers $3.0B"), and all those other unluckly taxpayers, who will have to fund these promises.

Keep your eye on junk bonds.

An improving global economy and ever-present demand for income has supported high-yield bonds all year. Valuations became stretched, but investors held their noses and bought them anyway, accepting some of the smallest rewards for owning risky debts in a decade because, well, what’s the alternative?

But junk-bond indexes have hit a rough patch, even as the major U.S. stock benchmarks have continued to grind higher. Take the $19 billion iShares iBoxx $ High Yield Corporate Bond ETF, which is down 1.4% over the past two weeks. Wednesday’s drop, 0.4%, was its worst in over a month and cut the price of the ETF, which trades under the ticker HYG, to the lowest since August.

The recent drop sent the ETF knifing below its so-called 200-moving average, viewed by technicians as a long-term market threshold for market momentum. This level has marked HYG's bottom half a dozen times since the middle of last year.

Meantime, junk bond “spreads” perked up from the tightest levels since 2007. The extra premium high-yield bond investors demand to own riskier bonds in lieu of Treasury notes rose to 3.57 percentage points Tuesday, up from 3.38 two weeks ago.

And yet, over in the equity market, the Dow Jones Industrial Average, S&P 500 and Nasdaq Composite Index all closed at fresh highs on Wednesday.

While losses have been relatively small, the divergence between falling high-yield bond prices and U.S. stocks at records is rare. Only one other time since HYG launched in 2007 has the S&P 500 hit an all-time intraday high, as it did Tuesday, on the same day that the HYG fell to its lowest level in at least a month, according to Jason Goepfert, founder of Sundial Capital Research.

Some traders are girding for worse. Volume in protective HYG put options Wednesday jumped to the highest since June, according to Trade Alert. Buyers of put options generally profit from additional declines.

Stocks and junk bonds have moved closely together this year so what comes next could be telling. Will buyers swoop and buy the junk-bond dip, or will the selling extend to other risky assets?

As U.S. markets swim in sea of red, trading in the largest high-yield exchange-traded funds has skyrocketed to dizzying levels.

The iShares iBoxx High Yield Corporate Bond ETF, Blackrock Inc.’s $18.7 billion fund, saw volume spike over five times higher than its average level at 1:19 p.m. in New York, according to data compiled by Bloomberg.

At more than 23.8 million shares, trading in the largest junk-bond fund has already surpassed its one-day average of 11 million for the past year -- outpacing volume notched in August amid saber-rattling between the U.S. and North Korea.

The delay in the Republican tax plan has spurred a sharp selloff across growth-sensitive assets, with the S&P 500 heading for its worst slump since August.

The BlackRock ETF is at its lowest level since March, set for its third consecutive day of declines.

For the $12.6 billion SPDR Bloomberg Barclays High Yield Bond ETF, one or a few of the larger players account for an outsize share of trading, with volumes more than six times higher than normal for the current session. Within 30 minutes through 12:38 p.m., three block trades were executed that totaled $394 million, data compiled by Bloomberg show.

Question: why is it that the financial sophisticates seem to assume that the bond market can only either go up or down and that staying flat over a long period, such as in Japan, is just not a possibility? The cited graphs in the piece you sent are surely a reminder, even if you did not need the more contemporary reminder of Japan, that having declined substantially, yields can stay down for a very long period. It’s as if they think that is just an ontological impossibility.

If it is a possibility, you can own long duration bonds without necessarily being bullish, especially as a retiree: match liabilities and hedge deflation. You just need to be not bearish and want or need the fixed income through retirement years.

BTW, in case you are interested in one retiree’s approach to the issue, I sell TLT puts to get some of my exposure. It materially reduces the volatility associated with owning it and, very importantly, capitalizes the dividend, cutting the tax rate on the coupon in half. Canadians have a great advantage over Americans in this respect, as we do not have a short-term capital gains regime.

The California Public Employees’ Retirement System, the largest U.S. pension fund, is considering more than doubling its bond allocation to reduce risk and volatility as the stock bull market approaches nine years.

Calpers is looking at a menu of options for its fixed-income target ranging from the current 19 percent to as much as 44 percent, according to a presentation for a board workshop in Sacramento coming up Monday. Equities could be cut to as little as 34 percent from 50 percent. Stocks were the best-performing asset class in fiscal 2017, returning almost 20 percent.

“The markets have had a pretty good run and it’s possible Calpers staff is thinking this might be a good time to lock in some of the gains,” Keith Brainard, research director for the National Association of State Retirement Administrators, said in a phone interview.

Calpers oversaw $343.6 billion in assets as of Nov. 8, up about 13 percent this calendar year on a combination of returns and contributions from employees and taxpayers. The fund lost money in past bear markets, including about 25 percent in the 12 months through June 2009 and 7 percent in fiscal 2001.

Bond yields remain at low levels because of persistent weak inflation, central bank easy money policies and global investors chasing income. Raising the allocation would reduce the fund’s discount rate, or average expected return, to 6.5 percent from the 7 percent annual target adopted last year. A lower target would probably require bigger contributions from taxpayers and public agencies to cover pension obligations, a shift that board member JJ Jelincic said he would oppose.

Screaming Employers

“We’ve cut the return expectation to the point that employers are screaming, ‘We can’t afford it. We can’t afford it,’ ” Jelincic said. “I personally would be willing to take on a little more risk.”

The average allocation for public pensions is about 23 percent to fixed income and 49 percent to stocks, according to Nasra data.

The Calpers board is scheduled to vote on the allocation in December. Almost all of the fixed-income and stock holdings are managed in-house while more complex assets, such as private equity and real estate, are overseen by outside consultants. Allocations to private equity and real assets would stay at 8 percent and 13 percent, respectively, under all scenarios under consideration.

The allocation revisions occur every four years. Calpers is working to provide for a growing wave of longer-living retirees.

• The Canary in the Coal Mine? (beware of junk bonds)
• Signs of Euphoria Creeping into Markets? (no thanks to global central banks)
• As Good As it Gets? (for stocks and other risk assets)
• Markets on Edge of a Cliff? (literally but we won't know until well after storm)

OPTrust today announced it is divesting from the tobacco industry. By the beginning of 2018, OPTrust will be divested from all equity and fixed income investments in public companies that derive a majority of their revenue from production or manufacture of tobacco products.

"At OPTrust, we prefer to use corporate engagement – the promotion of better business practices – in our investment and ownership practices," said Hugh O'Reilly, OPTrust President and CEO. "However, there is no such thing as a safe level of consumption of tobacco products. They cause only harm. As a result, investments in tobacco do not align with our responsible investing principles."

"I'm thrilled to hear that OPTrust is implementing a tobacco-free investment policy," said Dr. Bronwyn King, Radiation Oncologist and CEO of Tobacco Free Portfolios. "This sets a new standard amongst Canadian financial institutions and will inspire others to follow suit. As an oncologist, I'm fully aware of the devastating impact of tobacco. It's heartening to see OPTrust take such a positive step, joining with the health and government sectors to address one of the greatest public health challenges of our time."

OPTrust's leadership recognizes that environmental, social and governance factors are key drivers of sustainable/long-term investment performance, and are consistent with the plan's responsible investing approach. This divestment keeps OPTrust at the forefront of responsible investing practices globally.

ABOUT OPTRUST

With net assets of $19 billion, OPTrust invests and manages one of Canada's largest pension funds and administers the OPSEU Pension Plan, a defined benefit plan with almost 90,000 members and retirees. OPTrust was established to give plan members and the Government of Ontario an equal voice in the administration of the Plan and the investment of its assets through joint trusteeship. OPTrust is governed by a 10-member Board of Trustees, five of whom are appointed by OPSEU and five by the Government of Ontario.

First, let me state flat out, bcIMC is one of the best, most ethical pension funds in Canada with first-rate governance which ensures alignment of interests between their managers and stakeholders.

Second, they already take responsible investing seriously and have an entire section on their website devoted to corporate governance and responsible investing.

Third, while it's true that the Norwegian Government Pension Fund has divested from tobacco and arms-producing corporations, it too is having a hard time keeping up with its own rules on responsible investing. In February, it was revealed that Norway invested over $2 billion in 15 companies that manufacture and sell surveillance technologies - and that the government has no plans to divest investments in companies that are complicit in human rights abuses abroad.

More importantly, despite its name, Norwegian Government Pension Fund isn't a pension fund. It's the world's largest sovereign wealth fund and as such, it is in an enviable position because it doesn't have to match assets with liabilities. What it is struggling with is how to manage its explosive growth, a point Richard Milne of the Financial Times discussed in his excellent article (reprinted by the Globe and Mail),  Norway’s massive nest egg spurs investment debate.

Finally, to all those tree-hugging, vegetarian environmentalists from British Columbia fighting for social justice in their Birkenstock sandals, it's time to grow up and realize that the world is a sewer and if you push responsible investing to its limits, the first companies you should divest from are big banks speculating on commodity and food prices. How come you're not hopping mad about pensions gambling on hunger? I'm way more concerned about banksters engaging in financial speculation than tobacco and arms-producing companies. 

The reality is that once you push the envelope on responsible investing, you quickly divest from many companies in all industries, including Big Pharma which some claim thrives on perpetual sickness and slavery, as well as everyone's beloved Apple whose Chinese mega-plant, Foxconn, admits having child laborers in its factories.

Another example is the coal industry, which Harvard students demanded its endowment divest from. I said this was a dumb idea and note that with China and India ravenous for energy, coal’s future seems assured (take it from someone who got scorched last year investing in environmentally friendly Chinese solars!!!).

I'd much rather see large pension funds and sovereign wealth funds invest in these companies and use their clout to bring about important change, ensuring that labor, health, environmental and governance standards are respected while they deliver on performance.

The stock moves that the biggest hedge fund managers made in the third quarter are being revealed today.

Hedge funds of a certain minimum size are required to disclose their long stock holdings in filings to the SEC known as 13-Fs. Of course, the filings only provide a partial picture since they do not show short positions or wagers on commodities and currencies. What’s more is these filings come out 45 days after the end of each quarter, so it’s possible they could have traded in and out of the positions.

Still, it does provide a partial look into where some of the top money managers have been placing money in the stock market.

The stock moves that the biggest hedge fund managers made in the third quarter are being revealed today.

Hedge funds of a certain minimum size are required to disclose their long stock holdings in filings to the SEC known as 13-Fs. Of course, the filings only provide a partial picture since they do not show short positions or wagers on commodities and currencies. What’s more is these filings come out 45 days after the end of each quarter, so it’s possible they could have traded in and out of the positions.

Still, it does provide a partial look into where some of the top money managers have been placing money in the stock market.

Appaloosa Management (David Tepper)
New: Micron Technology (MU)
Boosted: Facebook (FB)
Trimmed: Allergan (AGN)
Exited: Wells Fargo (WFC)

Baupost Group (Seth Klarman)
New: McKesson (MCK), AMC Entertainment (AMC)
Boosted: Allergan, Cardinal Health (CAH), Antero Resources (AR)
Trimmed: Dell Technologies (DVMT), Avis Budget (CAR)
Exited: Qualcomm (QCOM)

Bridgewater Associates (Ray Dalio)
Boosted: SPDR Gold Shares (GLD), Vanguard FTSE Emerging Markets ETF (VWO)
Trimmed: SPDR S&P 500 ETF (SPY), Intel (INTC)

Coatue Management (Philippe Laffont)
New: Tableau Software (DATA)
Boosted: Apple (AAPL), Alibaba (BABA), Shopify (SHOP), Snap Inc. (SNAP)
Trimmed: Symantec (SYMC)
Exited: Disney (DIS), eBay (EBAY)

Duquesne Capital (Stanley Druckenmiller)
New: Citigroup (C), Netflix (NFLX), and Nvidia (NVDA)
Boosted: JD.com, Salesforce (CRM), WorkDay (WDAY), Alphabet
Exited: Delta (DAL), American Airlines (AAL)

JANA Partners (Barry Rosenstein)
New: Jack In The Box (JACK)
Exited: Hewlett-Packard (HPE)

Marcato Capital (Mick McGuire)
New: Itron (ITRI)
Boosted: Terex Corporation (TEX)
Trimmed: IAC/ InteractiveCorp (IAC), Sotheby’s (BID)

Omega Advisors (Leon Cooperman)
New: Aetna (AET), Expedia (EXPE)
Boosted: AMC Networks (AMCX)
Exited: Allergan

Passport Capital (John Burbank)
New: Tahoe Resources (TAHO)
Boosted: Alibaba, Altaba, Amazon (AMZN)
Trimmed: Advanced Micro Devices (AMD)
Exited: Facebook

Third Point LLC (Daniel Loeb)
New: Altaba (AABA), Shire (SHPG)
Boosted: Alibaba (BABA)
Trimmed: Alphabet (GOOGL)
Exited: Humana (HUM), Charter Communications (CHTR)

Tiger Global (Chase Coleman)
New: Despegar.com Corp (DESP), RedFin (RDFN)
Boosted: Netflix (NFLX), Facebook (FB)
Trimmed: Teladoc (TDOC)
Exited: Alphabet (GOOG, GOOGL), American Tower (AMT)

Tiger Management (Julian Robertson)
New: Anthem (ANTM), JD.com (JD)
Boosted: Facebook, JPMorgan (JPM)
Trimmed: Celgene (CELG)
Exited: Teva (TEVA), Priceline (PCLN), Nike (NKE)

[...] you know my market views. I'm openly worried about deflation hitting the US and my most recent market comments tell you that I think it's wise to take some risk off the table:

• The Canary in the Coal Mine? (beware of junk bonds)
• Signs of Euphoria Creeping into Markets? (no thanks to global central banks)
• As Good As it Gets? (for stocks and other risk assets)
• Markets on Edge of a Cliff? (literally but we won't know until well after storm)

Moreover, I don't foresee a big reversal in inflation, and openly worry many market participants still don't get the "baffling"mystery of inflation-deflation.

I have also repeatedly stated on my blog to load up on US long bonds (TLT) on any backup in yields because when the bubble economy bursts and the next deflation tsunami and financial crisis hit us, it will bring about the worst bear market ever.

Of course, central banks know all this which is why the Fed has signaled it's preparing for QE infinity, something which I fundamentally believe is a foregone conclusion, which can explain pockets of speculative activity in the stock market.

1. Load up on US long bonds (TLT) while you still can before deflation strikes the US. This remains my top macro trade on a risk-adjusted basis.
2. A few months ago I said it's time to start nibbling on the US dollar (UUP) and it continued to decline but I think the worst is behind us, and if a crisis strikes, everyone will want US assets, especially Treasuries. I'm particularly bearish on the Canadian dollar (FXC) and would use its appreciation this year to load up on US long bonds (TLT).
3. My third macro conviction trade is to underweight/ short oil (USO), energy (XLE) and metals and mining (XME) as the global economy slows. Sell commodity indexes and currencies too. I'm also short emerging market stocks (EEM) and bonds (EMB).

David Swensen, Yale University’s longtime chief investment officer, said the lack of market volatility in the current geopolitical environment is a major concern and warned that another crash is possible.

“When you compare the fundamental risks that we see all around the globe with the lack of volatility in our securities markets, it’s profoundly troubling,” Swensen, 63, said Tuesday during remarks at the Council on Foreign Relations in New York. That “makes me wonder if we’re not setting ourselves up for an ’87, or a ’98 or a 2008-2009,” he said, referring to previous market crises.

“The defining moments for portfolio management” came in those years, “and if you ignore that you’re not going to be able to manage your portfolio,” Swensen said.

The investment chief, who was interviewed by former U.S. Treasury Secretary Robert Rubin, also said he’s expecting lower returns for the university’s endowment, which he’s run for 32 years with a 13.5 percent average annual rate of return.

For the past 12 to 18 months, Swensen said he has been warning university officials to expect much lower returns in the future, as little as 5 percent annually, which would be down from previous assumptions of 8.25 percent.

“It’s not a very popular change,” he said. “We’re victims of our own success.”

‘Strategic Positions’

Swensen’s widely copied strategy of shifting away from U.S. stocks to alternatives including private equity has generated billions of dollars in gains for the school in New Haven, Connecticut. The fund reached a record of $27.2 billion as of midyear.

“We have to take strategic positions in the portfolio,” Swensen told an overflow crowd. “One of the most important metrics that we look at is the percentage of the portfolio that’s in what we call uncorrelated assets, and that’s a combination of absolute return, cash and short-term bonds. Those are the assets that would protect the endowment in the event of a market crisis.”

Asked why Yale’s uncorrelated assets are higher now than in 2008, he said, "I’m not worried about the economy so much, what I’m concerned about is valuation."

Yale University chief investment officer David Swensen, in a rare public appearance, spoke Tuesday to former U.S. Treasury Secretary Robert Rubin at the Council on Foreign Relations.

During the hour-long session, Swensen, 63, disclosed that annualized returns over his 32-year tenure have been 13.5 percent, higher than the endowment’s assumption of 8.25 percent a year.

Swensen said he favors private equity and doesn’t like quants, and talked about his efforts to get university officials to lower expectations for future returns. The endowment has swelled to a record $27.2 billion, the second-largest in U.S. higher education.

During the interview, Swensen shared thoughts about investing and opportunities:

• On where to invest:“The types of questions that you need to ask with respect to where you are investing are the bedrock for putting together your asset allocation. When I look around the world, there are places that we just won’t invest. Russia. If the rule of law does not follow, then do you know whether or not you own anything? And if you don’t know whether or not you own it, then why would you put your funds there? As we look around the world in spite of the problems we face in the United States, this is one of the best environments in which to invest. I think that the breadth of emerging markets that we were interested in 20 years ago has narrowed dramatically.”
• On China: His level of concern about China has been “pretty constant” over the past 12 or 18 months. “China is an area that makes me incredibly nervous, but at the same time, we’re heavily committed there. I’ve had great relationships with a handful of managers in China that have produced extraordinary returns. The party commitment to capitalism doesn’t seem as steadfast as I might have thought five or ten years ago.”
• On private and public markets: Private equity “where you buy the company, you make the company better and then you sell the company is as a superior form of capitalism. I’m really concerned about what’s going on in our public markets. The short-termism is incredibly damaging. There’s this focus on quarter-to-quarter earnings. There’s this focus whether you are a penny short or a penny above the estimate. There’s this activist mentality that permeates the markets.”
• On quants:“I’ve never been a big fan of quantitative approaches to investing and the fundamental reason is that I can’t understand what’s in the black box. And if don’t know what’s in the black box and there’s under-performance, I don’t know if the black box is broken or if it’s out of favor. If it’s broken you want to stop and if it’s out of favor, we want to increase exposure. And so, I’m an old-fashioned guy that wants to sit across the table from somebody who’s done the analysis and understand why they own the position.”
• On manager selection: Swensen has long attributed much of his success to the selection of managers for their character and the quality of investment principles. The test for character is “subjective, a gut feeling.” He tries to spend time with prospective managers in a social setting when making evaluations. “Track records are really overrated,” Swensen said. “We would miss out on some incredible investment opportunities if we required three or five years of audited returns before backing somebody.”

• On low volatility: Since the summer, I've been warning you the silence of the VIX won't last forever, and when vol picks up, many traders jumping on the short global vol trade are going to be screaming like lambs to the slaughter. When volatility spikes and stays high, it will crush many unsuspecting fools who keep buying exchange-trade products betting that volatility will sink lower. Now is not the time to be picking up dimes in front of a steamroller. 
• On public versus private markets: Swensen loves private equity and I don't blame him. It has been a great asset class for Yale and other institutional investors but I'm much more tempered in my enthusiasm and have taken on those who defend the industry at all cost, stating much of the outperformance in private equity is due to leveraged asset-stripping. In public markets, I share Swensen's concerns on short-termism but I'm also concerned on valuations as euphoria keeps creeping into these markets, no thanks to global central banks who refuse to let markets go down and the universal shift into passive investing. I've been warning my readers that markets are on the edge of a cliff, it's as good as it gets for stocks and if credit markets keep deteriorating and a crisis develops, we are going to experience the worst bear market ever. This won't bode well for public or private markets.
• On China: Unlike Swensen, I'm very worried about deflation headed for the US and what will happen when the bubble economy bursts. Importantly, I don't see any "baffling" inflation-deflation mystery, think deflation remains the clear and present danger, and I'm dismayed at smart people who think a major reversal in inflation is upon us. As such, I'm short emerging market stocks (EEM) and Chinese shares (FXI). Because of deflation, I'm also short oil(USO), energy(XLE), metals and mining(XME) and financials (XLF) and remain long and strong good old boring US bonds (TLT), the ultimate diversifier in these insane markets. 
• On quants and manager selection: I understand Swensen's healthy skepticism on quants taking over the world but there's no denying this trend has been going on for a while and will likely persist. Just because you can't understand the black box, it doesn't mean you can't invest in it. Maybe put them on a managed account platform and monitor and control the risk more carefully. As far as manager selection, he's spot on, you need to look way past track record, get a gut feeling for a potential manager and run with it. You won't always be right but so what, it's an art, not science.

Private equity firms are awash in cash, with nearly US$1trn of available capital, but the industry is facing internal competition as limited partner (LP) investors seek to play a more active role in buyouts, according to David Rubenstein, co-founder and co-CEO of the Carlyle Group.

The structure and composition of private equity funds will change significantly as LPs that would previously have invested in the funds increasingly branch out into arranging buyouts themselves, Rubenstein said.

Rubenstein was giving his views on the future development of private equity firms, based on his 30-plus year career in the industry, at the SuperInvestor Conference in Amsterdam this week.

“I expect we’ll see longer duration funds become more prevalent, with consequently lower fees for LPs and carried interest for general partners [private equity firms].” Rubenstein said.

Many LPs are looking for longer-term investments with lower return targets, which will ripple through the conventional buyout community, Rubenstein said, adding that more permanent capital will also be sought to match longer investment duration needs.

Several LPs that would have previously invested in private equity funds, including Canadian pension funds PSP Investments and the Canadian Pension Plan Investment Board, have built their own operations to buy assets in recent years and some European firms are also looking at co-investment buyouts.

NEW CAPITAL

Rubenstein predicted that sovereign wealth funds will replace US public pension funds as the largest source of capital for buyout firms, and said that retail investors will also play a more significant role going forward.

“Individual retail investors will be the biggest new entry as regulations relax on investing in private equity,” he added.

He also highlighted private debt as a significant growth area and predicted that it could grow to rival private equity. Private debt, which includes direct lending that targets small and medium-sized companies, currently has US$600bn of assets under management, according to Preqin.

While the global private equity industry currently has nearly US$1trn of ‘dry powder’ available to spend, the breakneck development of the shadow banking market means that sponsors now form a smaller part of the investment world, other delegates said.

Rubenstein is expecting public and political opinion, which has been highly critical of private equity’s role in turning around underperforming companies via debt-financed buyouts, to relax as knowledge of how the industry works develops.

“A lot of people still don’t really understand what private equity does,” Rubenstein said.
Private equity firms are gearing up to lobby hard against proposed US tax reforms that could curb the private equity industry’s profitability and make buying and selling companies more difficult.

Rubenstein said that a proposed cap on the tax deductibility of interest payments exceeding 30% of income is unlikely to have a significant impact on private equity firms, as debt forms a smaller proportion of buyouts than in the industry’s early days.

The bill also includes a tightening of the carried interest loophole, which allows private equity managers to have their profits taxed at a lower capital gains rate than income tax rate if they hold a company for more than one year.

“I think we can expect some effect there,” he said.

“God looks favourably on the founders of private equity firms.” That was the conclusion of David Rubenstein as the Carlyle Group co-founder reflected on his generation's staying power, reports FN's sister publication Private Equity News.

Over the past three decades, Rubenstein has been an enduring presence as the business of buying and selling companies has transformed from a niche Wall Street practice into a gigantic industry commanding hundreds of billions of dollars and spanning asset classes.

The late phase of his career—and those of his peers such as Stephen Schwarzman, Henry Kravis and David Bonderman—is now coinciding with sweeping realignments in the industry. Addressing the SuperInvestor conference in Amsterdam, he made five predictions for the future of the buyout business.

US public pensions will lose the top spot…

Saudi Arabia’s pledge to commit $20bn to a Blackstone Group infrastructure fund may show the way the wind is blowing. “The US public pension funds … have been the biggest source of capital for PE firms for much have the past 30 years. I don’t think they will be for the next 30 years,” Rubenstein said.“I think the sovereign wealth funds and the national pension funds will replace the US public pension funds as the biggest source of equity capital.”

...and so will the US

“The biggest source of capital is from the US, the biggest deals are done in the US and more capital is invested in the US than in any other part of the world,” Rubenstein said. “This will change dramatically.” He predicted that the private equity investment will become much more balanced between developed and emerging economies.

Private credit will equal private equity

Private equity funds raised £347bn last year, far surpassing the $97bn raised by debt funds, according to Preqin. But, as Rubenstein said, “private credit is something that more or less started with the great recession...It will become as big as PE over the next 10 years in terms of dollars committed.”

Private equity firms will consolidate

Although the industry is awash with capital, there is never enough to go around. A Preqin survey published in August found four in five private equity fund managers say there is more competition for capital than there had been a year earlier, while just 1% reported a decrease. Ultimately that dynamic will force many small independent firms out of the market, Rubenstein said: “I think you’ll see some of the larger firms increase their market share due to their increased capabilities to raise capital. You’ll see more acquisitions of smaller firms and more consolidation within the industry.”

Long-term funds will become commonplace

“The business model hasn’t changed that dramatically over 30 years, PE still uses the same basic model with a few variations," Rubenstein said. "We’ll see more and more longer term funds where people hold onto capital which is invested over 10 or 15 years where they’ll take lower carry and pay no fee on committed capital.” Like several rivals including Blackstone Group and CVC Capital Partners, Carlyle has recently raised a longer-life fund as buyout firms look for ways to compete with patient investors such as pension funds. Meanwhile, specialists have sprung up such as Castik Capital and Core Equity Holdings.

Last month saw Carlyle pass the leadership torch over to a new generation when the Washington, DC-based firm announced that Rubenstein and his co-founder William Conway will become the firm's joint executive chairmen. They are being replaced as joint CEOs by Carlyle veteran Glenn Youngkin and Kewsong Lee, who joined the firm in 2013 from Warburg Pincus.

Looking back on his career, Rubenstein also recalled some notable investing mis-steps — including passing up an opportunity to invest in Facebook.

The private equity model “is starting to look like a spent force” because more competition and record cash available is leading to lower returns as operators are forced to take on more risk, an adviser to the industry has said.

Professor John Colley, associate dean at Warwick Business School, said the recent collapse of British carrier Monarch Airlines and the potential surrender of UK care homes operator Four Seasons to lenders exposed a weak model of ownership.

In a recent article, Prof Colley argued that private equity’s modus operandi may have run its course, likely to hit managers but also large pension funds, which have increasingly raised their allocation to the asset class.

In the US alone the average US pension fund had 7 per cent of its asset allocation in private equity as of last year.

However, industry insiders have argued that private equity has and will continue to deliver the goods for its investors.

In Prof Colley’s article, published by The Conversation website, he wrote: “The sector is known for turning round companies, slashing costs, increasing cash flow and using debt to reduce tax and mitigate risk, but the model is now looking fragile.”

He added: “An oversupply of rival funds and investor money looking for opportunities is forcing investment in higher-risk business and the acceptance of more marginal returns.”

Prof Colley, who advises various private businesses at board level, said private equity groups were putting up with higher costs in the companies they bought partly because of high valuations in the stock market.

Because of these dynamics, he argued, “it may well be that the model has run its course and is ready to be replaced by something else”.

His comments were in stark contrast with some of the industry’s most ferocious defenders.

Speaking at a trade conference in Amsterdam, David Rubenstein, the billionaire co-founder of the Carlyle Group, said the model of private equity had worked “pretty well” for both managers and investors and that was likely to continue for the next three decades, with minor adjustments.

Mr Rubenstein said: “The basic model of [private equity] has worked. Very few business models have survived for forty years or so. The private equity model is unique in the history of money management.”

The model of asset management charged no carried interest — the cut managers share with investors — for 200 years, he said, but private equity in the 1960s changed it because “money would be committed but not actually invested and more or less 20 per cent of the profits would go to the [manager]”.

He added: “That basic business model with permutations and changes is still the model we use today. Carried interest when it is earned and realised has produced enormous amounts of profits for managers but also has led to large profits for [investors].”

Mr Rubenstein said if carried interest were to disappear the industry would not attract the talent or capital and the returns would not be as good.

“The model has worked pretty well,” he said.

The private equity behemoth, where co-founder Rubenstein is the chief fundraiser, can revisit investor wallets with relative ease, he said Tuesday.

“We have a pretty good ability to get capital when we need it and we really haven’t struggled to raise capital in any recent time,” Rubenstein told investors and analysts while discussing third-quarter results. “We are always looking at different permutations of how you can raise capital, but I’d say right now the model that we have is one that we’re reasonably comfortable with.”

Long-dated and permanent-capital vehicles can reduce the frequency of fundraising, permit longer investments in assets worth holding on to, and generate more predictable fees. Carlyle does have a longer-life private equity fund, championed by co-CEO designate Kewsong Lee. The pool is doing “quite well” and will likely have a larger successor fund, Rubenstein said.

But the appeal to Carlyle doesn’t seem to be as great as, say, at KKR, where a new pair of long-term investor agreements was the centerpiece of the firm’s earnings call last week. The partnerships secured $7 billion in fresh capital.

“When you have a reputation as we do, and as other peers that we compete with do, and you go out and raise a successor buyout fund, while you have to go out and raise it, it’s -- I won’t call it permanent capital -- but it’s very likely you can raise these funds for quite some time into the future,” said Rubenstein.

In his travels to every province and one territory over the last 17 months, British-born Mark Machin was struck most by one thing about Canadians.

“There’s still this myth that’s circulating that the Canada Pension Plan won’t be there when you retire,” said the CEO of the CPP Investment Board, the largest pension fund in the country that manages a $328-billion investment portfolio on behalf of 20 million Canadian workers and retirees.

“You ask the average person — stop anyone on the street — and they’ll say the CPP won’t be there . . . . It’s amazing,” Machin said.

“Overall it’s the envy of the world.”

So the first person from outside of Canada to head up the independent investment arm of the Canada Pension Plan is now on a mission to reassure Canadians that the fund is safe and healthy for generations to come, even in the face of inevitable economic and stock market fluctuations.

Don’t just take the former Goldman Sachs executive’s word for it. The chief actuary of Canada regularly reviews the financial state of the fund and measures its sustainability, and last year estimated the fund is sustainable for 75 years — until 2091 — with an average rate of return of 3.9 per cent.

The CPPIB says its 10-year annual rate of return after accounting for expenses and inflation was 5.2 per cent, and was 10.5 per cent over each of the last five years — well above the threshold set by the chief actuary.

The widely diversified portfolio is invested across 50 countries, including ownership stakes in a slew of assets few Canadians are aware of, from First Canadian Place and Highway 407 to Viking Cruises and the entertainment conglomerate that owns the Ultimate Fighter Championship (Machin pointed out the UFC is very popular with millennials).

He said that in financial circles around the world, the CPP is renowned as “a smart, sophisticated global investor. So I come to Canada and it really surprised me that people around the country who are contributing their hard-earned money into the CPP don’t know what’s going on,” said Machin, who took over the post in June 2016 after running the board’s international division in Hong Kong.

“We have delegations coming from all over the world here to figure out how we do it, what are the elements that make this so successful in Canada.”

Machin said that’s mainly due to “some really brave and far-sighted things” the Canadian government did in the 1990s to fix the then-faultering pension system, which was formed in 1966 (coincidentally the year Machin was born in Cheshire, England.)

Back then there were 6.5 workers for every Canadian retiree. But by 1993, amid falling birth rates and longer life expectancy, benefits paid out started to be higher than contributions and investment income coming in. Projections showed that by 2055, there would also only be two workers per retiree.

So in 1997, Ottawa did two things: raised contribution rates and created the CPPIB as an arm’s-length organization investing the assets of the CPP outside of what was needed for benefit payments to ensure its financial viability into the future.

“Our job is to grow that pot of money so that there’s more than enough to pay the benefits whenever they’re needed,” said Machin.

Though the chief actuary warned in 1995 that there would be nothing left in the fund by 2015 if the status quo continued, it took up until 2015, coincidentally, before investment income exceeded cumulative net contributions, the board said. That year the fund returned 18.7-per-cent interest and had climbed to approximately $265 billion.

As of Sept. 30, the fund reported assets of $328.2 billion. The fund has about $3 billion extra coming in from contributions than is needed to pay the benefits in any year.

Starting in 2021 however, the CPP is expected to begin using a small portion of CPPIB investment earnings to supplement the contributions that constitute the primary means of funding benefits.

Last year the government also announced an “enhanced” CPP that will increase benefits paid out — although many years down the road — through an increase in contributions over five years starting in 2019.

Another reason for the CPP’s success, Machin notes, is that the investment board is free of political interference so that government can’t dip into the fund to take money out when times are bad or good.

“We are protected by an act of Parliament. To change that act of Parliament is a higher bar than to change the Constitution of Canada. That’s part of the secret sauce,” he said.

Though the investment mix has shifted in recent years from roughly 70 per cent equity “equivalent” (since it includes public and private investments) and 30 per cent fixed income to a more aggressive 85-15 ratio, Machin said he is comfortable with the investment strategy, despite fears of an impending market correction after years of bull markets.

“We think it’s an appropriate level of risk for a long-term investor like us,” he said, adding their experts put the investment model through rigorous stress tests. “You can’t make returns without taking some risks,” he added.

The fund is also invested 82 per cent outside Canada. Though Machin said that might seem like a lot to some, Canada represents less than 3 per cent of world financial markets so given that, the investment on home turf is quite substantial.

“We have a really simple mandate: to maximize returns without undue risk of loss,” noted Machin, who began spreading his upbeat outlook at the Economic Club of Canada in Toronto on Monday and will appear later this week in Ottawa and Vancouver.

“The system is sustainable and we’ve got a group of people here in Toronto to make sure the money’s there and is invested wisely both in Canada and around the world on their behalf.”

• CPPIB can pool assets to lower costs internally and with its external managers. It can invest a huge portion of the assets internally and use its clout to lower fees with external managers (through co-investments in private equity or through direct negotiations with public funds).
• CPP pools investment and longevity risk which means Canadians won't outlive their CPP pension. 
• CPPIB invests in both public and private markets allowing it to add significant value-added over its Reference Portfolio over the long run.