Since the Bank of Japan unleashed a massive new easing program last month, European and U.S. investors have waited with bated breath for more BOJ bond buys to push Japanese lifers overseas. The truth: Japanese pension funds are already ahead of them.

They’ve been putting more of the world’s second-largest pool of retirement funds into everything from global real estate to Namibian debt.

According to a survey of 128 funds released in April by J.P. Morgan Asset Management, pensions cut the share of domestic bonds to 29.4% of their assets by the end of March from a targeted level of 35.4% four years earlier, and domestic stocks to 13.9% from about 22%. That’s made room for alternative investments such as real estate and foreign debt to nearly double to 11.8%.

Consultants and fund managers say they’ve got no choice but to find something less risky than stocks, but better yielding than domestic bonds, as payouts for Japan’s aging population rise.

“If you diversify your assets, add some returns from real estate, absolute return products, you can get income no matter whether overall rates are rising or falling,” said Toru Higuchi, head of investment management at the Teachers’ Mutual Aid Cooperative Society.

The fund is in the middle of a two-year overhaul that will put more of its 600 billion yen ($5. 81 billion) in overseas stocks and bonds, and for the first time ever, a maximum of 2% each in hedge funds, global real estate investment trusts and J-REITs, while cutting domestic stock holdings.

Daisuke Hamaguchi, manager of nearly ¥10 trillion at the Pension Fund Association, said his fund will finalize its first infrastructure investment by the end of the year in cooperation with a Canadian pension fund, and will gradually expand its investments in other alternative assets.

Some investors have hypothesized that an improvement in corporate profits on the back of Prime Minister Shinzo Abe’s pro-growth policies could encourage corporate pensions to be more adventurous in taking risk. Expectations for Abenomics have lifted domestic stocks and weakened the yen, potentially clearing the way for investment in equity or unhedged foreign bonds.

“Investors, in general, really appreciate the current market movements, but it’s difficult (for pensions) to react actively to the current market,” said Yoshinori Kouta, who advises 40 corporate pension clients at Mercer Japan Ltd.

Mr. Kouta added that corporate pensions are likely to be cautious about simply increasing their investments in foreign bonds in the coming year as yields on foreign sovereign debt have also fallen, making the risk of going abroad greater than any potential return. Neither will they be looking for more currency exposure even after the yen has fallen against major currencies in recent months, he added.

“We have been suffering from a stronger yen for many years, and some people believe it (the weaker yen) is still just a dream,” Mr. Kouta said.

Pension funds are cutting equity holdings in favor of bonds even as central-bank stimulus helps push the FTSE 100 to the highest level since October 2007. Some 30 percent of respondents to the Mercer survey said they plan to reduce their allocations to domestic stocks further, with 24 percent intending to cut investments in overseas shares.

“Pension schemes across Europe, but particularly in the U.K., remain on a path towards a lower-risk investment strategy,” Nick Sykes, European director of consulting in Mercer’s Investments business, said in a statement today.

The survey covered more than 1,200 pension plans from 13 countries, with combined assets of more than 750 billion euros ($965 billion), according to Mercer, a unit of New York-based Marsh & McLennan Cos.

While pension funds are trimming equity investments, central banks are buying stocks in record amounts amid falling bond yields. In a survey of 60 central bankers last month by Central Banking Publications and Royal Bank of Scotland Group Plc, 23 percent said they own shares or plan to buy them.

The Bank of Japan, holder of the second-biggest reserves, said April 4 it will increase investments in equity exchange-traded funds more than twofold to 3.5 trillion yen ($34.1 billion) by 2014. The Bank of Israel plans to almost double stock holdings to as much as 6 percent of foreign-exchange reserves, or about $4.5 billion, by the end of 2013.

The Portuguese government plans to tap nearly all of its state-owned pension fund to ease it over the hump of a hefty €27.5bn of financing needs over the next two years, according to domestic news reports.

Portugal’s social security minister Pedro Mota Soares is evaluating whether to invest up to 90% of the €10bn Social Security Financial Stabilization Fund (FEFSS) in Portuguese government debt, according to Economico on Tuesday.

The fund had €5.5bn invested in Portuguese public debt at the middle of last year, according to earlier reports in the same newspaper.

The new measures would free up a further €3.5bn, meaning the fund would own around 7.5% of all Portugal’s outstanding government debt, deemed sub-investment grade by all the major ratings agencies and viewed as one of the riskiest assets in eurozone government bond markets by investors.

In Spain, a country hanging to its investment-grade status by a thread, at least 90% of its €65bn social security fund has already been invested into Spanish government debt.

Under FEFSS’s present mandate, the fund has to invest at least 50% in Portuguese government debt, and can also invest up to 40% in investment grade debt.

The Ministry of Finance declined to comment.

Challenges ahead

Portugal has around €120bn in total outstanding debt, according to Reuters data, split between bonds and T-Bills. FEFSS participates in both these markets, said a government official.

“They FEFSS have always bought government debt, but that stepped up a bit at the end of 2010 under the previous government,” said a government official, adding that he would not prefer not to comment on plans to change the fund’s mandate.

Portugal issued its first new benchmark bond since it was bailed out earlier this month, a €3bn 10-year deal which allowed it to round off its funding needs for 2013, and start to pre-fund for next year.

In 2014, Portugal has around €9bn of additional financing needs not covered by state financing sources that will need to be raised in the capital markets. In 2015, this steps up dramatically to €18.5bn, according to an investor presentation compiled by Portugal’s debt agency IGCP.

Portuguese bonds have rallied in recent months, bolstered by investors’ appetite for yield in the wake of the ECB’s rate cut last month and an as-yet untested bond-buying promise from the ECB, which has removed so-called tail risk from eurozone government bond markets.

Despite this tightening bias, however, the country’s economic fundamentals remain on shaky ground. Portugal’s debt-to-GDP ratio is set to hit a peak of 124% next year, according to government estimates, the third highest in the eurozone behind only Italy and another programme country Greece.

The yields on its 10-year bonds – which currently stand at around 5.2% - are also the third highest in the eurozone, behind only those of Slovenia and Greece.

Ireland – the third country to receive an EU/IMF bailout like Portugal - has 10-year yields of 3.4%, while Spain trades at around 4.2%.

German 10-year bonds – a haven for investors – yield around 1.4%.

In order to tackle the funding cliff ahead and capitalise on the recent renaissance in its debt, Portugal plans to return to regular auctions in the coming months.

It is also considering a debt swap of certain bonds approaching maturity in the next few months, something it successfully executed last year and offset around €3bn of redemptions, said a source close to discussions.

“We want to get to the end of the year in a comfortable position, so we can start to pre-fund for 2015 because that’s really the challenge,” said the source.

European stock markets extended gains in choppy trade on Monday, with car makers in the driver’s seat after a broker upgrade, while the broader sentiment tracked the U.S. higher.

The U.K.’s FTSE 100 jumped to the highest close since September 2000.

Volume was low as several markets across mainland Europe was closed for Whit Monday.

The Stoxx Europe 600 index rose 0.3% to 309.77, closing at the highest level since June 2008.

Last week, the index closed with a fourth straight week of gains, boosted by aggressive easing measures from central banks, which offset worries about growth in the euro zone. Lackluster growth data from the currency bloc actually supported the upbeat sentiment last week, as it raised speculations the European Central Bank could cut rates further.

“We’re seeing a bit of a hangover from the mood we had last week, but it’s still very much the same sentiment,” said Victoria Clarke, economist at Investec Securities. “There is further optimism about the months ahead and we’re getting over worries about a soft patch for Q2.”

“There is a lot of good news priced in at the moment, and if we see disappointing data from China or the U.S. it could trigger a move downward,” she added.

According to analysts at Morgan Stanley, however, macro data will start to improve going forward, which should ensure a continuation of the rally in European equities.

Later in the week, durable-goods orders and existing home sales are on tap in the U.S., while the preliminary Chinese manufacturing purchasing managers’ index is out on Thursday.

“Possibly the German Ifo index on Friday will also be one of the main events, because it’ll give us an idea if another rate cut from the ECB is on the table. If we see a big drop, it could open the door for a discussion on further rate cuts at the meeting next month,” Clarke said.

The Ontario Teachers’ Pension Plan says it open up an office in Hong Kong within months, as it pushes to increase their exposure to emerging markets from 15% to 20%.

James Leech, the chief executive of the largest-single profession pension plan in Canada, says the plan on Tuesday received notification that it received the appropriate licensing to open an office in Hong Kong to cover Asia.

“We will be opening up a Hong Kong office in the next couple of months, with some feet on the street there,” he said in remarks at Bloomberg’s Canada Economic Summit Tuesday. “And I think that signals what we’re doing. Most projections show something like 70 to 80% of world trade are going to be intra-Asian trade, and that’s where wealth is going to be created, and that’s where we’ve got to be to be able to take advantage of it.”

The plan, which had net assets of $129-billion as of Dec. 31, 2012, invests and administers the pensions of 303,000 active and retired teachers in Ontario.

But as more teachers retire and the number of teachers in the workforce dwindle, the plan is facing a demographic crunch and is becoming more risk-averse in its investments, said Mr. Leech.

There are 1.4 working teachers for every retired teacher — more than 2,900 of which are over the age of 90, he added.

As such, they have shifted their exposure to equities from 65% about 15 years ago to about 45% range today.

“We’ve just slowly been dialing it back, simply because we can’t afford the volatility,” said Mr. Leech.

In turn, it has shifted towards investments in infrastructure, real estate and emerging markets.

The plan’s view is Europe, as an investment market, has been “dead for a long time,” he said. And in the U.S., while there has been anecdotal evidence of a renaissance, Mr. Leech does not anticipate big growth.

“So, maybe we can get a couple points, 2.5 points growth out of the U.S., over a longer period of time, so that really just leaves you with the emerging markets,” he said.

Ontario Teachers' Pension Plan (Asia) Limited, a subsidiary of Ontario Teachers' Pension Plan, has been granted regulatory approval by the Hong Kong Securities and Futures Commission to conduct regulated activities, including dealing in securities, advising on securities, and asset management (Types 1, 4 and 9 regulated activities).

"I am pleased to confirm that our Asia subsidiary and its proposed responsible officers have received formal approval for these licences," said Jim Leech, President and Chief Executive Officer of Canadian-based parent Ontario Teachers' Pension Plan (Teachers'). "Asia has long been a region of interest to Teachers'. We look forward to continuing to build relationships with local partners and exploring new direct, co-investment and fund investment opportunities in the market."

The Asia office will be located in Hong Kong and staffed by local and Canadian equities staff from the fund's private capital and public equities departments. This office will be the fund's second major regional office. Teachers' European, Middle East and Africa regions private capital office opened in London in 2007.

One day after OPB Finance Trust raised $250-million of nine year debt at 2.90%, more information has emerged about the borrowings by some of the country’s leading public sector pension funds. For instance:

— According to DBRS, the total debt outstanding for OMERS is about $4.43-billion. That debt has been issued by three different entities: OMERS Realty Corp., OMERS Realty CTT Holding and OMERS Realty CTT Holding 2. In numbers provided by DBRS, the total debt for PSP Capital Inc., the financing arm for the Public Sector Pension Investment Board is about $11.8-billion. That debt has been issued through one entity, PSP Capital Inc.

— According to FTSE TMX Global Debt Capital Markets Inc. the entity that manages and publishes the country’s debt indexes, debt issues from five public sector funds have found a home in the all government index.

Of the five, Cadillac Fairview Finance Trust, a unit of Ontario Teachers Pension Plan Board, has three issues in that index: $1.25-billion (with a 3.24% coupon and a maturity date of Jan. 25 2016); $750-million (4.31% and Jan. 25, 2021); and $600-million (3.64% and May 9 2018.) Among the others the Caisse de depot’s CDP Financial Inc. has one issues that’s included ($1-billion, 4.60% and July 15, 2020); OMERS Realty Corp. ($200-million, 4.74% and June 4 2018); OMERS Realty CTT Holding ($170 million, 4.75% and May 5 2016) and OPB Finance Trust ($350-million, 3.89% and July 4, 2042). For its part PSP Capital has two issues included ($700-million, 2.94% and Dec. 3, 2015) and ($900-million, 2.26% and Feb. 16, 2017.) All those issues with the exception of OPB Finance Trust are AAA-rated OPB is split rated: AAA/AA(high). And all the issues are guaranteed by the pension fund.

So what’s the point of all the debt financing? When Cadillac Fairview last raised capital it explained it in these terms. “The Trust will lend the proceeds of the Offering to one or more of the entities comprising the real estate portfolio of Ontario Teachers’ Pension Plan Board referred to as the Cadillac Fairview Group.” In addition the release said that Cadillac Fairview Finance Trust “is a special purpose trust established under the laws of the Province of Ontario. The activities of the Trust are limited to the borrowing of funds from time to time, lending funds to the Cadillac Fairview Group, and holding funds in cash and cash equivalents and other ancillary activities.”

In an early 2013 ratings report by Moody’s Investor Services, it was stated that PSP Capital, a wholly owned subsidiary of the Public Sector Pension Investment Board (PSPIB). PSPIB “uses this subsidiary to add a moderate degree of leverage to increase the return of its investment portfolio by issuing medium term notes and commercial paper.”

You have to wonder how long an industry that underperforms the broader market will stay around.

Goldman Sachs Group Inc. published a chart today comparing the performance of hedge funds that invest in equities with the major stock-market indexes. Based on Goldman's research, the average hedge fund is up just 5.4 percent so far this year. During the same period, the Standard & Poor's 500 Index has risen 15.4 percent, and the average mutual fund has gained 14.2 percent (click on image below).

This kind of subpar showing surely can't sit well with investors who shell out as much as 20 percent of their gains to the fund manager, who also collects a fee that can be as much as 2 percent of the assets under management.

There could be any number of explanations for why hedge funds have done so badly. Goldman says many hedge funds bet against stocks such as Johnson & Johnson, expecting them to fall. They rose instead.

Then there's the lack of volatility. Hedge funds often profit from discrepancies in prices between related assets, and these tend to shrink during calm periods in financial markets.

Based on one of the most widely watched measures of stock-market volatility, the VIX Index, we're in the equivalent of the horse latitudes. The VIX recently registered a read of about 13, compared with a high of almost 90 at the peak of the financial crisis in October 2008 and more than 40 in the summer of 2011, when worries peaked that Greece might exit the euro monetary union. The VIX has been a snore this year, bouncing between 12 and 18.

The biggest reason for the market tranquility might be the Federal Reserve's repeated assurances that it will maintain zero interest rates and provide monetary stimulus until the economy recovers, and unemployment ebbs.

That may just account for the recent flurry of stories about how much hedge-fund managers hate Fed Chairman Ben Bernanke. He's putting them out of business.

As banks abandon debt trading, hedge funds that bet on bonds and loans are pulling in money from investors and hiring traders. Debt-focused hedge funds drew $41.4 billion from pension plans, wealthy individuals, and other investors in 2012, the most since 2007, according to data from Hedge Fund Research. They managed a total of $639.7 billion as of March 31, HFR data show, surpassing stock-trading hedge funds, with $638.7 billion.

Regulators are demanding that banks curb proprietary trading—betting with their own money—and hold more capital to back riskier investments. That’s allowed hedge funds to expand in businesses the banks are leaving, including distressed-debt trading and fixed-income arbitrage, a strategy that seeks to exploit short-term price differentials. “Hedge funds are playing in asset classes where they previously hadn’t played,” says Jason Rosiak, head of portfolio management at Pacific Asset Management.

Hedge funds specializing in debt trading are still minnows compared with Wall Street’s largest houses. BlueCrest Capital Management, Pine River Capital Management, and Millennium Management, three of the fastest-growing funds, have combined assets of about $67.6 billion, according to people with knowledge of the matter who asked not to be identified because the information is private. JPMorgan Chase’s (JPM) corporate and investment bank had an average of $413.4 billion in assets designated for trading in the first quarter.

Still, the hedge funds are growing rapidly, luring bankers from JPMorgan, Deutsche Bank (DB), Barclays (BCS), Bank of America (BAC), and others. BlueCrest doubled its New York staff in the two years through December, while Pine River increased its global workforce by a third in 2012. Millennium expanded its staff by 32 percent, to 1,250 people, last year. James Staley, the JPMorgan executive who was once seen as a candidate to run the company, quit in January to join $13.6 billion hedge fund firm BlueMountain Capital Management. “There’s a continuous brain drain on Wall Street,” says Rosiak.

One reason for banks’ retreat is the 2010 Dodd-Frank Act’s Volcker Rule, which seeks to curb proprietary trading. While the Volcker Rule hasn’t taken effect because regulators are still working out the details, some banks have closed proprietary trading desks.

Hedge funds, which are considered part of the less regulated “shadow-banking” system, are not subject to the rule. The idea behind regulators’ push to move debt trading from banks to hedge funds is to transfer the risk “into relatively small repositories that will be relatively insignificant if they fail,” says Roy Smith, a finance professor at New York University’s Stern School of Business. “The regulatory posture in the U.S. and in Europe is unequivocal. They want to transfer risk to the shadow-banking system.”

Yet moving risk to hedge funds does not make it go away. In 1998 hedge fund Long-Term Capital Management lost more than $4 billion after a debt default by Russia, mostly as a result of a fixed-income arbitrage strategy. The Federal Reserve was so concerned about the impact that it arranged a bailout paid for by banks. “If the hedge fund firms fail,” says Smith, “the real question is, to what degree will the market suffer from it?”

The bottom line: Debt-focused hedge funds now manage $639.7 billion, just topping stock-trading hedge funds, which have $638.7 billion.

Faced with a $10-billion pension-funding deficit, one of Canada’s largest pension funds is considering a drastic proposal that would reduce benefits paid to retiring workers — or force them to work years longer for the same retirement income.

The Ontario Municipal Employees Retirement System (OMERS) Sponsors Corporation, which determines benefits and contribution rates for one of the largest pension operators in the province of Ontario, is mulling a change that would reduce the key figure used to calculate how much money an employee will receive each year in retirement.

A decision on the proposed change to the formula, which would take effect in 2015, is expected by the end of June.

OMERS is an umbrella organization for more than 900 employers and their workers in the province, including paramedics, transit workers, firefighters, police and city workers. It represents almost 429,000 active and retired members.

Changes to the pensions overseen by OMERS are considered annually, but this year’s proposal to reduce the “multiplier” rate at which workers rack up retirement payouts — to 1.85% from 2% — is “more drastic,” according to Simon Archer, a pension specialist at law firm Koskie Minsky LLP in Toronto.

“This is the one that made my eyebrows go up,” he said after looking at the proposals. “Usually plans try not to touch that if they can avoid it.”

Mr. Archer said workers who are close to retirement would see little change, while new employees would be hit the hardest.

A sustained period of low interest rates has made pension promises more expensive for companies, forcing them to raise the amount of money both the employer and employees pay into pension plans, or reduce benefits.

OMERS had a deficit of $7.3-billion at the end of 2011, and already tried to remedy the growing problem by phasing in contribution rate increases over the past three years. At the same time, plan costs have been rising as members age.

There are legal impediments to reducing any benefits that have already been accrued by workers under a plan, but benefits based on future work — including by newly hired employees — are fair game, said Mr. Archer.

The new pension formula at OMERS would be applied to all earnings above a certain threshold beginning in 2015. In order to go into effect at all, it will require approval by two-thirds of the board of the OMERS Sponsors Corporation. The 14 members of the board include an equal number of employer and employee representatives.

Three of the employer representatives proposed the formula change, according to documents posted on the OMERS Sponsors Corp. website. The “key rationale” behind the request for the plan change includes the funding deficit, and the fact that contribution rates are already at an all-time high, the documents say, adding that these factors are “putting a significant strain on members and their employers at a time when our economy is also under stress.”

If the proposal is accepted, it will not affect retirement benefits accrued for work done through the end of 2014. The documents note that the impact on lower-income earners would be reduced because the new formula would be applied only to earnings above the maximum earnings level calculated in the Canada Pension Plan.

In addition, the change would give workers more room for RRSP contributions and they could still receive 70% of their pre-retirement income if they were willing to work longer — 38 years instead of 35 — to build up the additional benefit.

Individual plan members do not get to vote on the proposal, but John Pierce, vice-president of public affairs at OMERS, said feedback or input from them can lead to amendments or even withdrawal of any suggested pension plan changes.

This year’s OMERS proposals, which also include curbs on indexing for inflation and a delay in early-retirement eligibility, appear to address some of the concerns raised in a recent survey by global human resources consultant AON Hewitt. It suggested that Canadian pension plan sponsors have been slow to react to changing demographics and other challenges to pension sustainability.

Awareness of the trends “does not seem to have spurred plan sponsors into addressing long-term sustainability strategies as they struggle with short-term financial pressures and regulatory requirements,” AON Hewitt said in the survey released in early May.

Ontario municipal pension fund giant OMERS has received a proposal from some of its employer members to increase the amount of time it would take for workers in the plan to gain a full pension from 35 years to 38 years.

The proposal will be voted on at the end of June, but would require significant backing from union representatives at the Ontario Municipal Employees Retirement System to be approved.

Under the proposal – made by representatives from the Electricity Distributors Association, the Association of Municipalities of Ontario and the City of Toronto – the so-called multiplier of 2, now used to calculate when a person would be entitled to full benefits, would be cut to 1.85 starting in 2015.

“This is just one of the proposals that has been tabled,” John Pierce, vice-president of public affairs at OMERS, said Friday. He declined to predict whether the measure had enough support to be approved.

OMERS has an annual process of reviewing benefits and pension fund premium payments.

The pension fund has previously had proposals from employers to end inflation protection enjoyed by members, but the requests have not been approved because of the need for benefit reductions to pass with two-thirds support. Votes at the plan are divided equally between employers and worker representatives, making it difficult to get the needed support to approve cuts, which are usually anathema to union members.

OMERS, like many pension plans, is under-financed because of low interest rates and flagging stock market returns, and currently has a deficit of just under $10-billion. OMERS said it is about 86 per cent funded and expects the deficit to be eliminated gradually over the next 10 to 15 years.

The employer groups making the proposal said in a note that the because of the funding deficit, “contribution rates are currently at an all-time high putting a significant strain on members and their employers, at a time when our economy is also under stress.”

They said the change would involve only a small pension reduction for those close to retirement age and would be “not material” for them, while having “an immediate impact on funding.”

Currently, a full pension at OMERS is equal to 70 per cent of a person’s top five years of income. With the current multiplier, it would take 35 years to earn that amount. Those working fewer years receive a lesser amount based on multiplying their years of service by the multiplier of two.

Caisse de Depot et Placement du Quebec is selling some of its European property and redeploying proceeds in assets such as infrastructure while the euro-area economy shrinks, Chief Executive Officer Michael Sabia said.

About 20 percent of the Caisse’s C$18 billion ($17.5 billion) of real estate assets are in Western Europe, according to its 2012 annual report. Canada’s largest public pension-fund manager oversaw net assets of about C$176 billion at the end of last year, including C$6.31 billion in infrastructure such as toll roads and a stake in London’s Heathrow Airport.

“We are selling real estate assets in Europe,” Sabia said in an interview yesterday at the Bloomberg Canada Economic Summit in Toronto. “Real estate pricing among top quality, platinum-quality assets -- the pricing is quite good, and we are trying to benefit from that and in some other asset categories as well, where selectively asset prices are high.”

The euro-area economy contracted 0.2 percent in the first three months of 2013, data from the European Union’s statistics office showed last week. That extended the recession in the zone to a sixth quarter.

While stressing “it’s the right time to be counter-cyclical in Europe,” Sabia said he and his investment team will approach investing in the region with extreme caution. The Caisse had 7.2 percent of its total assets in the euro region at year-end, according to its annual report.

‘Dark and Foggy’

“There’s a dark night going on in Europe, a dark and foggy night where bad things come out of trees and bite you,” Sabia said. “It’s a pretty scary place. In Europe there are investments to be made, and I think it’s possible to be successful there but there’s no place in the world, other than maybe emerging markets, where the word selectivity is fundamentally important.”

Sabia didn’t specify which European properties the Caisse is planning to sell.

On May 7, the Caisse’s Ivanhoe Cambridge real-estate unit sold the Paris building that houses the headquarters of Vivendi SA to French insurer Assurances du Credit Mutuel. Terms of the deal weren’t disclosed.

In addition to infrastructure, cash from asset sales may be reinvested in distressed debt or “situations where a current shareholder needs to liquidate an asset,” Sabia said. “We are trying to, in effect, help build our future by trying to benefit frankly from some of the issues and difficulties that other institutions in Europe have right now.”

Private Equity

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

Real estate was one of the best performing asset classes for the Caisse last year, returning 12.4 percent. The pension fund manager’s overall return was 9.6 percent.

Some of the world’s largest pension funds and SWFs are showing renewed interest real estate, with Canada’s C$160bn (now $176B) Caisse de Dépôt et Placement du Québec saying it intends to increase its real estate allocation from C$30bn to C$40bn during the next 18months.

This will make Caisse one of the world’s largest property investors, as pension funds despair of the low yields on bonds. In January, it completed a £265m deal with private equity group TPG to buy the Woolgate Exchange building in the City of London, but it plans to allocate the bulk of its new property spending to the US and China, where it will build a portfolio of shopping centres.

Ivanhoe Cambridge has pulled the trigger on its largest ever housing deal, joining partners in a slate of multi-residential properties in the United States worth US$1.5-billion.

Ivanhoe said it bought into a portfolio of 27 residential properties containing 8,010 units in all with partners including investment banking firm Goldman, Sachs & Co. and apartment operator Greystar Real Estate Partners. The assets are located in Washington, D.C. and northern New Jersey, South Florida, the San Francisco Bay area, southern California, Phoenix and Denver. Goldman and Greystar bought the properties from Equity Residential with Ivanhoe investing later.

Ivanhoe, the real estate arm of the Caisse de dépôt et placement du Québec, plans to spend an estimated $10-billion on new property as it speeds up asset purchases over the next 18 months. Half of that amount could be deployed in the United States, Ivanhoe global investments president Bill Tresham told the Financial Post in an interview in February.

The club deal announced Tuesday is one of Ivanhoe’s largest investments of the past few years and its largest ever in the multi-residential asset class. Its share of the agreement was not disclosed.

The company is slowly divesting assets including hotels to focus on residential units, office buildings and shopping centres where returns are more predictable. Real estate values in the United States are about 80% of their peak before the last recession whereas values in Canada are at record highs, Mr. Tresham said.

“The number one goal for us geographically is to have more capital invested in the United States,” he said. “We’re finally this year mobilized to really get it done.”

Ivanhoe said the partners have agreed to launch a multi-year maintenance and renovation investment program for their new assets. Most of the income-producing housing were built in between 1990 and 2000 and are located in key U.S. suburban markets.

The high price of Canadian real estate means sellers are getting top dollar for their investments as they move to deploy cash elsewhere.

Ivanhoe’s ownership partner in Montreal’s Place Ville Marie office tower, Alberta Investment Management Corp., is seeking to unload its stake in the building. Under their partnership, Ivanhoe is believed to have the right to match any offer AIMCo receives.

... experts warn of yield compression as the flood of money into some areas, whether geographic (London, Paris, Frankfurt) or strategy specific (core, inflation-linked long lease), is creating far greater risk on capital invested down the line than investors may realise in their quest for short term cash yield.

In some areas, the flood of money has compressed yields to extremely low levels. For example, long lease, inflation-linked real estate with quality tenants, such as supermarket operators, have dropped below 5%, and even as low as 4.25%. Furthermore, the terms of the leases on such properties have weakened.

The Crown Estate, which manages an £8bn property empire on behalf of the sovereign, will work with Ontario Municipal Employees Retirement System on a 270,000 sq ft development of shops, restaurants and offices in St James’s, the central London heartland of the UK hedge fund industry.

The deal marks the latest in a trio of lucrative joint ventures the Crown Estate has entered into with foreign investors. The company is among a handful of large, predominantly London-based landed estates, to have abandoned the traditional business model for hereditary property portfolios by swapping passive rent collection for active asset management.

Under the terms of the deal with Oxford Properties, the real estate division of Omers, the Crown Estate will use the investment to fund a phase of its £1bn overhaul of the St James’s Market area.

The deal, to be announced this week, marks a rare opportunity for an outside investor to gain access to a large area of commercial property in the tightly controlled West End.

Demand for office space in St James’s and Mayfair has risen sharply in the past two years, with rents among the highest in Europe. Average prices in the West End reached £92.50 a square foot at the end of last year, compared with £55 a square foot in the City of London.

As well as co-investor, the Crown Estate will act as development manager on the project.

One of the reasons for seeking a funding partner for the project is that the Crown Estate is not allowed to be in debt. In 2011, it sold a 25 per cent stake in Regent Street for £450m to Norges Bank Investment Management, Norway’s NKr4tn ($720bn) oil fund. The company is also working on a £100m project in London with the Healthcare of Ontario Pension Plan.

The Queen has no powers to liquidate assets belonging to the Crown Estate and cannot buy or sell properties, but she is entitled to a modest slice of the company’s revenues. Under an agreement struck between King George III and the government in 1760, the portfolio was managed by the Crown on behalf of the state, with surplus revenue going to the Treasury. In turn, the Treasury made a fixed annual payment to the monarch.

The agreement was overturned in 2011, however, and replaced with the Sovereign Grant Act, under which the Queen will this year receive 15 per cent of the Crown Estate’s revenues.

In addition to the West End estate, the Crown Estate owns 106,000 hectares of farmland, 14 regional shopping centres and most of the seabed to the 12 nautical mile territorial limit.

Marianne Keestra, a former teacher in the Dutch city of Haarlem, has seen her monthly pension payments cut, and she knows who she blames – her former employer.

“The government stuck their hand in the pension pot,” says Ms Keestra, 71. “And they never paid it back.”

For years, the Dutch government and many businesses systematically underfunded their employee pension plans, relying on high investment returns to make up the shortfall.

Now, a combination of record low rates, sluggish economic growth and lives that last far longer than anyone imagined even a decade ago have resulted in yawning deficits. At the end of 2012, the funds were €30bn short of what is needed to cover promised benefits.

For the Dutch, the cutbacks are the first ever in a nation which has the second largest “defined benefit” system in Europe. But defined benefit provision, under which pensioners are guaranteed a portion of their salary for as long as they live, is unravelling under the pressure of the financial crisis and ensuing recession.

In April, under orders from the Dutch central bank, 66 of the country’s 415 pension funds started cutting their payouts. The average cut is around 2 per cent of the monthly benefit, but that figure conceals a wide range.

ABP, Ms Keestra’s fund and also the country’s largest with 2.8m participants, has cut payments by 0.5 per cent, but smaller funds such as those for barbers and meat packers are cutting pension payouts by 7 per cent or more.

The loss of income to pensioners has dealt a further blow to a Dutch economy that has already shrunk 1 per cent over the past year and is suffering from record-low consumer confidence levels. Meanwhile, anger over the cuts has bolstered the fortunes of the 50Plus party, which won election to the Dutch parliament for the first time last year on promises to defend the interests of pensioners.

While the woes of Dutch pension schemes are far from unique, the Netherlands stands out because its laws allow employers to cut benefits under certain circumstances.

Dutch pension schemes are among the most tightly regulated of any in Europe or North America. By law, they must hold sufficient assets to cover 105 per cent of promised benefits, unlike those elsewhere allowed to run huge deficits. In addition, they have no leeway in setting the parameters that determine estimates of liabilities, such as expected investment returns or the number of years retirees will draw benefits.

Moreover, unlike the US, UK and many other countries, the Netherlands does not operate a pension insurance scheme to pay benefits to the underfunded schemes of insolvent employers. The fallout from the failure of a company or industry-wide scheme could be devastating, which explains why the rules are so tough.

In 2007, Dutch schemes held assets covering 152 per cent of promised benefits. But that fell to 102 per cent last year due to low interest rates – which have the effect of making liabilities balloon – and sharp falls in stock and property markets.

“The law says that accrued benefits can only be reduced if it is the last resort and if it is needed to meet their minimum requirement of 105 per cent,” says Wichert Hoekert, an Amsterdam-based consultant at actuaries Towers Watson.

But Dutch pension funding requirements are less strict than they once were. Last September the parliament, under pressure from older voters, approved new rules that allow pension schemes to use a higher rate to gauge the pace at which inflation will erode liabilities.

This has lowered liabilities, and funding targets. The sector as a whole now has a coverage ratio of 105 per cent under the new rules, but just 101 per cent under the old rules, according to an analysis by Aon Hewitt.

Some Dutch analysts criticise the new rules as gimmickry that will weaken the plans.“Tweaking the discount rate is just a bookkeeping trick to bring down liabilities,” said Bas Jacobs, an economics professor at Erasmus University. While figures using the new discount rate show the pension sector as a whole has just enough assets to meet its liabilities, Mr Jacobs said he “wouldn’t be surprised if the pension plans actually had a shortfall of €100bn-€200bn”.

There are arguments that employers benefited from schemes, too. Hefty investment returns during the 1990s allowed many to avoid putting any cash in at all for years.

In addition, Dutch tax rules allowed employers to offer early retirement, reducing payrolls and improving corporate profitability. As at 2007, a quarter of Dutch retirees were below the age of 60. Early retirement has proved extremely expensive for defined benefit schemes, especially as longevity has risen sharply. On average, Dutch men aged 65 can expect to live for another 18 years as of 2011, up from just 15.5 years a decade earlier.

As equities markets have improved, the pensions funds’ problems have grown less severe. The funds now have €1.07tn in assets, up from €831bn at the end of 2011, and administrators say that once the current round of cuts is complete at the end of the year every plan will meet its minimum coverage ratio.

But for Ms Keestra, that does not settle the story. “It’s not just the benefit cuts. I haven’t seen a cost-of-living increase in years,” she said.

Resuming full indexing for inflation would require the coverage ratio to rise to 135 per cent, and Dutch administrators are making no promises.

Millions of Dutch pensioners – held up as the envy of their British counterparts by campaigners three years ago – have been forced to endure cuts to their pensions because of funding shortfalls in some of their schemes.

A total of 66 Dutch pension funds have been forced to cut pensions because of funding gaps, figures from the Dutch central bank show. The cuts average 1.9pc.

In all, 2 million active pension scheme members face cuts, on top of 1.1 million who are already receiving their pensions and 2.5 million "sleepers" (members who have changed jobs without taking their pension rights with them), European Pension News reported.

The development has sparked a lively debate among British pension experts about the merits of the Dutch scheme.

In 2010, David Pitt-Watson, a former chairman of Hermes Focus Asset Management, said British pensions "should go Dutch". In an article for The Daily Telegraph, he wrote: "If a typical British and a typical Dutch person save the same amount of money for their pension, the Dutch person will end up receiving at least 50pc more income in their retirement than the Briton. There is no trick here. It's just that the Dutch have an efficient architecture for their savings. We do not."

He said the Dutch system enjoyed economies of scale thanks to large schemes that covered a number of firms. These schemes can pay pensions from investment income instead of relying on annuities.

But responding to the recent cuts, John Lawson of Aviva said: "Dutch charges are not cheaper, nor are equities a one-way bet."

Henry Tapper of First Actuarial said the cuts should be put in "a little perspective". He said: "The Dutch system works rather like the with-profits system. Current Dutch pensions have been shown by David Pitt-Watson and others to be producing about 39pc more than our 'guaranteed pensions' [from annuities] in the UK."

These transactions, known as pensions or bulk-annuity buyouts, originated in the UK, where many companies are closing old-style final salary pension funds to new joiners, and no longer want to run them.

About £30bn worth of such deals have been done in the past five years, involving hundreds of companies and more than half a million UK pensioners, according to pensions advisers Lane Clark and Peacock.

Tom Ground, head of bulk purchase annuities and longevity insurance at Legal & General, said: “We have an existing presence in the Netherlands and all the licenses to write annuity business. It’s our intent to do bulk annuities, but quite when is more questionable. We are still working out our strategy.”

He added: “There is an established market there; quite an attractive market. It is the obvious next market to go to after the UK and Ireland.”

The Dutch pension fund sector is Europe’s second-largest behind the UK, but due to the prevalence of large, industry-wide pension funds still open to new joiners, few buyouts have been done. Deals that have been done mostly involved local insurers such as Aegon.

However, consultants say the appetite of Dutch insurers for such deals is waning, opening the door to foreign players. A recent report on the buyout market from Lane Clark and Peacock said: “There are signs that some of the [domestic] players are reducing their appetite as they look to preserve capital and generate higher profit margins. In contrast, insurers from other jurisdictions are now considering entering the Dutch market.”

Legal & General announced its first non-UK deal in April, taking on a €136m annuity book from Irish life insurer New Ireland Assurance.

CEO of the Cern Pension Fund Theodore Economou says pension funds should use the techniques of the best global macro hedge fund managers to control risk and volatility while producing absolute returns.

Pension funds should use the sophisticated risk management tools used by the best hedge funds to lower volatility and achieve better returns, says Cern Pension Fund CEO Theodore Economou.

Cern invests its entire Sfr4 billion ($4.1 billion) pension fund as if it were a large global macro hedge fund. "We manage towards an absolute return target," says Economou. "We believe our model can and should be replicated by pension funds with the same goals as Cern because we think the model represents an answer to the industry's challenges."

For those funds not able to replicate the Cern model, Economou advocates turning over the entire pension fund portfolio to a top hedge fund management company.

If the hedge fund industry works together with pension funds, he believes it has the potential to grow five or 10 times larger than it is today.

Economou made the comments at the European Single Managers Awards 2013 held in London, where Cern Pension Fund was given the award for outstanding contribution to the hedge fund industry by an institution.

Earlier in a video interview he said he believes the hedge fund industry can "come to the rescue of the pension fund industry". He believes the disciplined risk management of hedge funds allows them to control risk while at the same time delivering smooth returns. "This is exactly what pension funds need to do."

Risk management combined with flexibility in allocating assets under the overall objective of preserving capital needs to be embedded in the entire process, he says.

"I believe passionately the Cern model provides an ideal response to the challenge pension funds are facing," says Economou.

The Cern governance model is designed to accommodate a dynamic and flexible asset allocation process, which Economou believes is essential in order for pension funds to avoid losses and meet returns in the long term with minimum volatility.

"The Cern process starts with addressing what really matters to trustees: what losses can be accepted; what is the investment return objective; and what are the constraints in terms of liquidity and permitted instruments? Only after setting these boundaries does the portfolio get built to meet those objectives."

Economou has taken the traditional process and "turned it on its head". "The fact is that the traditional model is failing to deliver," he says.

In his view in order for a pension fund to be more conservative it needs to be less traditional and throw out the 60%/40% stocks/bonds model.

Over the three years since Cern's switch from the traditional model to implement Economou's ideas, the fund has "multiplied the efficiency of taking risk and converted it to return by a factor of 10. It is bringing this risk awareness in the process that has had the most impact."

At 14 years of age, Economou witnessed something that would shape his approach to risk forever. In 1979, he and his family were based in Tehran, the Iranian capital, when the Shah was overthrown, prompting the Islamic Revolution. The country changed overnight and Westerners—along with many others—had to leave immediately. Panic was everywhere—except for Economou’s household.

“My father had already made plans to leave,” he says. “He had gathered information from a network of contacts, not just the official channels, and had known something was about to happen. We didn’t even miss a day of school.” The experience of an entire society changing so rapidly made him realize that it paid to be prepared for any eventuality, not just what you suspect could happen. “It doesn’t mean you have to be pessimistic—this mindset applies equally to seizing opportunities—but you need to be in a situation where you are ready and can react.”

Almost three years on from joining the CERN pension, the lessons he learned in Tehran are evident. The model he introduced to the fund in 2009—which had lost 19% of its value a year earlier—aims to manage risk, preserve capital, and achieve the highest quality absolute returns. This, of course, is a simplistic outline of what Economou, a trained engineer, presented to scientists at one of the world’s finest research organizations. “It helped to speak the same language,” he says. “I explained we were targeting efficiency and control in the same way that they were. We would just deal with investments while they dealt with fundamental particles.”

Despite misguided and so far unfounded concerns, the European Organization for Nuclear Research's (CERN) Large Hadron Collider has not created a black hole that, in turn, has swallowed earth and humanity. If it had, what the European scientific institute famous for smashing together sub-atomic particles did with its employee pension fund would be relatively meaningless. However, since we are all still here, the risk management and portfolio overall currently under way in Geneva matters—for the system's thousands of pensioners, as well as for other capital pools willing to learn from CERN's innovations.

First, an introduction to CERN's team. Theodore Economou is the organization's pension Chief Executive Officer and is potentially the nicest man in investment management. A close second for this title might be his Chief Investment Officer, Gregoire Haenni. They are the types that apologize profusely for even minor incidents of tardiness. They are exceedingly well mannered, as only two non-Americans can be. Together, they comprise the brain trust of the $4 billion pension system, and the work they are doing—focusing on portfolio reconstruction and proprietary risk modeling—is appropriately suited to an institution with multiple Nobel Prize recipients on staff.

“Essentially, what I found when I arrived in October 2009 was a very traditional portfolio that any pension CIO would recognize,” Economou says on a phone call with aiCIO following his October appearance at the aiCIO Summit in London, England. “It was 60% risk assets, including real estate, and 40% bonds. The fund did a strategic asset allocation study every three years, followed by tactical allocation moves, with the fund taking fairly large single bets, such as bets on currency.” Economou, who ran the ITT pension system in New York City before moving to Switzerland, thought it was time for a new approach. “We are in the process of changing it from this legacy, return-based approach, to a risk-based one,” he says. “It's an absolute-return approach to the entire fund—with a key term being ‘liability-aware'.” This last term, Economou notes, means that the fund can be cognizant of its liabilities without being “slavishly tied” to liability-driven investing (LDI). “There is this religious discussion about LDI, but the reality is that it confuses actuarial losses with real cash losses,” he says. “I don't think it's acceptable. What this means is that, if you offset your liability with an asset, particularly a swap, if something happens to interest rates and your liability goes down, it's great—but in an LDI world, your assets also go down the same amount.”

Hand in hand with this allocation overhaul, Economou and Chief Investment Officer Haenni also are looking to retool the fund's risk management procedures—and this is where the truly innovative work is being done. “We look at risk management as two processes,” Economou says. “One: the overall risk management process, showing us the acceptable risk constraints. This tells us what the size of the sandbox we can play in is, and this is a process where we involve an external risk manager.” The metric presently used to measure this risk is conditional value-at-risk-based (CVar), which Economou views as “not a perfect measure, but you need to start somewhere.” (Volatility is not risk, Economou stresses time and time again; the loss of capital is the risk). The result of this first process of risk management is that the fund's board knows whether the risks being taken lie within previously agreed upon guidelines.

The reason Haenni was hired earlier this year was not so much to create this 30,000-foot view of potential problems, but to provide an expertise in portfolio-level risk management modeling. If the first risk management process is about the size of the sandbox, Haenni's work is about how to maximize the fun in the sandbox. “I was asking around about what the best risk management system for portfolio construction was,” Economou says. “That's how I got in touch with him.” Haenni, it turns out, has spent his academic and professional career working on risk modeling. An extension of his PhD thesis at the University of Geneva, this model first went with him to Swiss asset manager Pictit, where he spent a decade refining the system. He now finds himself and his model in Geneva.

The model itself is a sight to behold. Its entire goal is to “illustrate risk and make it actionable,” according to Economou, by answering two questions: how manager x should behave, and how, put together, all managers behave relative to each other. The system looks at 20 dimensions of correlation that, when presented visually, are distilled into three dimensions, making it both more intuitive and easier to act upon. Once this analysis has been done, Economou and Haenni have another process they apply. “The second part is top-down, a macro-view approach,” Economou says. “We don't pretend that we can call the market— that's borderline delusional. People spend hundreds of millions trying to do this, and we can't argue that we can compete with these folks, but what we can do is identify different market regimes, different areas of risk that are excessive, and we can hedge.” In essence, this two-man team is attempting to identify market regimes and position their portfolio appropriately. It's not forecasting. It's identifying risk.

“We refer to it as a capital preservation philosophy,” Economou notes, echoing Benjamin Graham's mantra that to win, the first thing you have to do is not lose. “Losing money is not okay. The traditional approach of running money—the 60/40 strategic asset allocation regime we had here at CERN—is focused on performance versus an index.” There is an assumption in this framework, Economou and Haenni believe, that the index, over time, will meet a fund's needs. “We don't view this assumption as appropriate,” Economou adds. “Market cycles can be very long—look at Japan. And boards don't always understand volatility.” Put another way: They are not bullish on world markets, and they've designed a systematic approach to investing that (they hope) will allow them to act successfully upon this belief.

Of course, Economou and Haenni can't go it alone. Their board, as at any other pension fund, must approve changes to asset allocation and risk controls. “Our board has been superb,” Economou says, noting that an institution that draws upon more than 10 countries for funding and houses some of the brightest minds in the world will naturally produce high-quality board members. Relying on Netherlands-based consultant Ortec Finance to confirm that the new asset allocation fits within the risk scope that the board finds comfortable, the fund has been “very receptive to the changes” Economou and Haenni are implementing. Alongside spending the summer “programming liability risk—our benchmark—into the model so that any incremental manager's risk impact can be identified,” Economou and Haenni worked hard to educate their board on the new paradigm. “It was a success,” notes Economou. “They understand, and they are happy with the ideas underlying the changes. There is a difference between ‘conservative’ and ‘traditional.’ Most boards are ‘conservative'—as they should be—but that doesn't mean 60/40 is ‘conservative.’ Investment boards and executives need to disassociate these two terms—and ours seems to be doing this.”

The inevitable stressful periods, the team knows, are yet to come. “The real test is when markets are up 20% and we're below that,” Economou says. “We have told the board that we look at it as ‘how much have we left on the table on the upside to protect the downside.’ I think they'll be with us in this scenario, due to the usual mantra: education, education, education.”

This could all be for naught, of course. Similar to its pre-2009 pension structure (which, Economou stresses, wasn't wrong— it just needed to be updated) CERN's particle collider is running at only half power due to an explosion in 2007. Yet, by 2013, it is expected to be firing sub-atomic fragments around its 17-mile loop at nearly their full speed—after which, if skeptics are to be believed, none of us will be here to see how either experiment turns out.

• Reduced equities, replacing with alternatives
• Increased bonds, reducing cash
• Reduced index strategies, replacing with asymmetric strategies
• Reduction of risk of real-estate portfolio

New York City’s $140 billion retirement system pays Wall Street money managers about $360 million a year, the only one of the 11 biggest U.S. public-worker pensions that refuses to manage any assets internally. Larry Schloss, the city’s chief investment officer, says the practice must end.

Schloss, 58, points to Ontario’s C$130 billion ($126 billion) teachers’ pension fund, which has returned an average 9.6 percent annually on its investments since 2003 -- 1.6 percentage points better than New York’s funds. The Canadian system reaped those gains mostly without paying outside asset managers. Schloss says the same in-house approach could work in New York.

“I’m not looking for John Paulson,” said Schloss, who earns $224,000 a year, referring to the billionaire hedge-fund manager. “I’m just looking for a VP at MetLife (MET) who makes 500,000 bucks.”

The 38 staff members in the city comptroller’s Bureau of Asset Management oversee five funds for police, firefighters, teachers, school administrators and civil-service workers. They get paid an average of $100,000 a year, less than the median base salary of a first-year Harvard MBA graduate. They farm out asset management to more than 300 firms.

Investing directly means the Toronto-based Ontario Teachers’ Pension Plan doesn’t have to pay outside managers 2 percent of assets they oversee, plus 20 percent of profits, the typical fees for hedge funds and private-equity and real-estate firms. It also gives Ontario Teachers’ more control over investments, Chief Executive Officer Jim Leech said in a telephone interview.

Losing Money

Among New York’s outside arrangements is a $60 million investment by four pensions in a real-estate fund sponsored by Colony Realty Partners, a Boston-based private-equity firm that oversees $3.2 billion. The fund has lost 15.5 percent since 2006, while Colony has reaped $7.7 million in fees, according to the comptroller’s office.

Last year, three city pension funds paid more than $1.2 million in fees on a $160 million investment in a real-estate fund co-sponsored by Fisher Brothers, a New York-based property investor and Morgan Stanley (MS), the New York bank. The fund has returned 0.3 percent since 2004. Another 2004 real-estate investment with Tishman Speyer Properties LP returned 58.8 percent.

California Compensation

Emily Margolis, a spokeswoman for Colony, did not respond to e-mailed and telephoned requests for comment. Suzanne Halpin, a spokeswoman for Fisher Brothers and Matt Burkhard, a Morgan Stanley spokesman, declined to comment.

Managing money internally and paying staff higher salaries and bonuses isn’t always a formula for success. The California Public Employees’ Retirement System, the largest U.S. pension, manages almost two-thirds of its assets, including 83 percent of stocks and 91 percent of bonds. Chief Investment Officer Joseph Dear received $522,540 in compensation in 2011.

Yet its 6.1 percent average annual return for the 10 years ending June 30, 2012 is 1.1 percentage point less than that of the Pennsylvania Public School Employees’ Retirement System. The Pennsylvania fund manages only 26 percent of assets internally and paid Chief Investment Officer Alan Van Noord $269,302 in 2011.

New Jersey’s $75.3 billion pension manages 73 percent of its assets in-house, the most among the 11 biggest U.S. public funds. The system returned 6.4 percent for the 10-year period ending June 30, 2012.

‘Way Ahead’

New York City will pay $8 billion this year toward retirement benefits, a cost that has risen more than fivefold since 2002. That’s why Ontario Teachers’ presents a model, Schloss says.

“They’re way ahead,” Schloss said in an interview in his seventh-floor office in the Municipal Building, which houses more than 2,000 employees across from City Hall. The former global head of private equity at Credit Suisse First Boston (CSGN), Schloss was hired by Comptroller John Liu in 2010 to increase returns and reduce costs.

The Ontario fund employs a staff of investment managers earning an average of C$720,000 a year to increase assets worldwide. Their investments include ownership of Toronto Eaton Centre and other shopping malls, a stake in Seoul-based Kyobo Life Insurance Company, and a 30 percent interest in Copenhagen’s international airport.

Managing Managers

In New York, there’s plenty of talent and it’s “ridiculous” that the city won’t pay enough to hire it, Schloss said. A plan to manage a portion of assets internally, with compensation levels benchmarked to New York City insurance companies, endowments and pensions, hasn’t gained traction with fund trustees, he said.

“We’re not really in the asset-management business,” Schloss said. “We manage managers.”

Bringing Ontario’s approach to New York may be a challenge. While the city’s retirement system has about 60 cents of assets for every $1 in obligations, union officials say they’re wary of tinkering with it.

“Why would you try to dismantle a system that’s performing well?” said Greg Floyd, president of Teamsters Local 237, which represents 24,000 city employees. Floyd sits on the board of the city’s $46 billion civil-employees’ pension. Pension-fund trustees have to approve raising investment staff salaries and authorize internal asset management.

Reduced Fees

There’s “a yearning” among union trustees to manage assets in-house, though “we are never going to be able to pay private-industry salaries to work in government,” said Manhattan Borough President Scott Stringer, a labor-backed Democrat running for comptroller who’s favored to win. Liu, also a Democrat, is running for mayor. His term expires Dec. 31.

“When you get a new comptroller, you get a new chief investment officer,” Schloss said. “It’s not good for performance to have a system where your senior staff turns over every four years.”

The Ontario fund, which also has offices in London and New York, manages more than 80 percent of its assets in-house and is 97 percent funded. By contrast, the total market value of the assets of 109 U.S. state pension plans last year was 69 percent of projected liabilities, according to Wilshire Associates, a Santa Monica, California-based consulting firm.

What sets Ontario Teachers apart is governance and compensation, Leech said.

Wall-Street Caliber

The fund paid its 250-person investment staff C$180 million last year. The workers aren’t government employees, meaning their salaries aren’t subject to civil-service rules. High salaries and bonuses attract Wall Street-caliber talent, Leech said. About 35 percent of assets are in so-called alternatives such as private equity, real estate, and hedge funds.

“We compete with KKR,” said Leech, referring to the private-equity firm founded in 1976 by Jerome Kohlberg, Henry Kravis and George Roberts. “You don’t want to go into that game with a second-stringer.”

The Ontario fund has a nine-member independent board that sets policy and delegates day-to-day management to the professional staff. New York’s five funds have 58 trustees spread across several unions and political jurisdictions.

Two years ago, Mayor Michael Bloomberg and Liu unsuccessfully proposed overhauling management of the five pensions to create a system more like Ontario Teachers’. The mayor is the founder and majority owner of Bloomberg News parent Bloomberg LP.

Accounting Background

The five boards were to be pared down to a single 12-member body that would set investment policy. Asset management would have been separated from the comptroller’s office to insulate it from politics.

Instead of union officials and political appointees, Ontario Teachers’ board members are chosen for their backgrounds in business, finance, economics and accounting. Only one board member is a former teacher.

“What does a kindergarten teacher know about investing?” said Leech.

When Schloss was chosen to oversee the city’s pensions in 2010, Liu described the funds’ structure in a press release as a “cluster$&*$.” Schloss persuaded trustees to increase the investment staff to 38 from 22. The pensions added hedge funds, opportunistic fixed income and leveraged loans to the mix of investment possibilities.

Pay Obstacle

To an inexperienced staff he added Barry Miller, a former managing partner at Nottingham Capital Management, to oversee private equity. He hired Seema Hingorani, former research director at Pyramis Global Advisors to oversee hedge funds. Both earned $175,000 annually. Miller resigned to join Connecticut-based private-equity firm Landmark Partners, the Wall Street Journal reported on May 21.

“We wanted to hire a number of people but couldn’t because of compensation,” Schloss said.

Asset management staff are required to live in New York City unless they get a waiver. Obtaining one involves multiple agencies and City Hall approval, said Matt Sweeney, a spokesman for the comptroller’s office.

The median sales price of a two-bedroom condominium in Manhattan was $1.6 million in the first quarter of 2013, according to appraiser Miller Samuel Inc. and brokerage Douglas Elliman Real Estate.

“It’s just really hard to say, ‘Hey, come work here for $100,000 and you have to live in the five boroughs,” he said.

Japan's public pension fund - a pool of over $1 trillion - is considering a change to its portfolio strategy that could allow its investment in domestic stocks to grow with a rallying market, according to people familiar with the deliberations.

The changes, yet to be finalized, would mark the most significant revision in investment strategy for the world's largest pension fund since 2006 and highlight the game-changing economic policies of Prime Minister Shinzo Abe.

Without the shift, the Government Pension Investment Fund (GPIF) could be forced to buy Japanese government bonds, already the biggest part of its portfolio by far, in a weakening and more volatile market. It could also have to sell Japanese stocks in an equity market that has rallied more than 60 percent since November even after the recent sell-off.

The main idea under consideration would be for the pension fund to change the way it assesses the potential risk and return on assets to allow it more flexibility, the sources said. GPIF would keep its model portfolio, which sets a broad framework on how much money is allocated to different assets, unchanged.

The sources, who declined to be identified because they were not authorized to discuss the pending changes, said the fund is expected to announce the changes as soon as next month.

An official at GPIF declined to comment on the matter.

Abe's economic policies, dubbed Abenomics, are aimed at reviving the economy with 2 percent inflation, more consumer spending and corporate investment.

Tokyo stocks have rallied since Abe began pushing his policies ahead of his December election victory. At the same time, the yield on the 10-year Japanese government bond has risen to near 1 percent, ending a rally in the government debt market that began in 2006.

Those developments have created a problem for GPIF, according to the people familiar with fund's deliberations.

The fund's exposure to domestic bonds has dropped to near the bottom of the allowable limit under its established portfolio. At the same time, the allocations for overseas and domestic equities have neared their maximum limits.

So without changes, the fund would be forced to buy weakening bonds and sell rising stocks. GPIF has not detailed its current risk and return profile, but fund management have used such projections as a benchmark to ensure that the public fund is not overexposed to riskier and more volatile assets.

GPIF manages a $1.1-trillion dollar portfolio equivalent to the size of the annual economic output of Mexico from a non-descript brown skyscraper in Tokyo's Kasumigaseki district. The fund, which is responsible for the retirement savings of Japanese government employees, has relied on a portfolio model that includes a 67 percent allocation for domestic bonds.

Its investment model went unchanged through the global financial crisis of 2008 and served the fund well through the years of slow growth in Japan since.

For the six years through March 2012, the pension fund's investment in yen bonds had returned 2.28 percent. By contrast, domestic stocks lost 9.43 percent over the same period.

A committee of 10 outside advisers that serve as the fund's investment committee have been reviewing GPIF's strategy. The committee has met three times since April.

REVIEW UNDERWAY

GPIF Chairman Takahiro Mitani told Reuters in February that the public pension would review its long-term investment target and portfolio model, in part because it had already come under scrutiny by another public agency.

In October 2012, a report by Japan's Board of Audit had called on the pension fund to consider such a review. The board's 120-page report, which was commissioned by the then-ruling Democratic Party, questioned whether the GPIF portfolio targets remained relevant and whether they should be changed to better reflect considerations of investment risk.

The fund's long-term investment targets, reviewed every five years, must be approved by the health minister. The next review of that target is scheduled to start from next financial year in April 2014.

But GPIF is also allowed to change its investment targets during times of extraordinary market developments. The public fund reviewed its portfolio after the Lehman crisis in 2008 and the March 2011 earthquake and tsunami, but elected on both occasions to keep its targets unchanged.

But the sharp moves in financial markets over the past six months and the critical review by auditors have made fund administrators more serious about considering changes now, people familiar with the matter said.

The fund's model portfolio sets a core allocation of 67 percent for bonds, 11 percent for domestic stocks, 9 percent for foreign stocks and 8 percent for foreign bonds. The fund is allowed to keep allocations within a percentage range centered on those targets.

By the end of December, the fund was about 60 percent invested in domestic bonds, approaching its 59-percent minimum limit.

At the other extreme, it had about 13 percent in foreign equities, close to its allocation ceiling of 14 percent. GPIF had about 13 percent in Japanese equities in December compared to a ceiling of 17 percent.

The yield on the benchmark 10-year Japanese government bond was 0.9 percent on Thursday, compared with a dividend yield of almost 1.7 percent for the Topix.

GPIF is set to announce results for the January-March quarter in late June or early July.

"The rationale behind the yen selling on the back of Japan's GPIF headlines seems linked the hedging behaviour of foreign investors buying Japanese stocks," said Valentin Marinov, head of European G10 FX strategy at Citi.

"If the headline is confirmed, it could fuel a renewed Nikkei rally and hence more demand for short-yen hedges by foreign investors. This could trigger more dollar/yen buying from here."

The yen is impacted when foreign investors buy Japanese equities because they hedge this investment by buying dollars against the yen.

The dollar had earlier slipped against yen on Thursday after faltering equities pushed market participants to opt for the safety of the yen and unwind their bets for a stronger dollar.

Most market participants expect the dollar to continue to gain against the yen over the medium term due to the Bank of Japan's aggressive monetary easing and that buyers would emerge on dips.

The euro was also up 0.6 percent against the yen at 131.67 yen.

Against the dollar, the euro was up 0.1 percent at $1.2952 after briefly breaking the $1.30 mark to hit a peak of $1.3006.

The single currency was also supported by data which signalled an improvement in economic sentiment in the euro zone.

But strategists said there was still a chance of a rate cut by the European Central Bank and this could hurt the euro.

"If euro area economy deteriorates people will take a closer look at the likelihood the ECB will cut rates and that will drive the euro lower," said Paul Robson, currency strategist at RBS.

Strategists also said the dollar would find support on prospects the U.S. Federal Reserve might taper its current $85 billion-a-month stimulus programme in coming months.

"Quantitative easing tapering cannot be ruled out later this year and that is going to continue to support the dollar... we won't see a trend reversal lower in the dollar," Citi's Marinov said.

As Richard Koo, chief economist of the Nomura Research Institute details in his latest research report, past Bank of Japan programs of "quantitative easing"—the large-scale purchase of securities by the central bank—have not produced economic growth. That's even though the Bank of Japan's expansion of its balance sheet has been proportionately bigger than the Federal Reserve's or the Bank of England's, he notes.

In the case of Japan, the central bank's securities purchases—which inject liquidity into the financial system—have failed to produce a similar expansion of the money supply. That requires an increase in bank lending, which hasn't happened either because of banks' reluctance to lend or borrowers' reluctance to borrow. Koo pins the problem on the latter in a balance-sheet recession, where businesses and consumers are more apt to shed debt than take it on—even at interest rates of virtually zero.

As a result, the impact of the Bank of Japan's actions so far mainly has been felt in the currency markets, not the credit markets. Moreover, despite the prospect of heavy, continued purchases of Japanese government bonds by the central banks, JGB yields have been bouncing higher. Again, precisely the opposite of the planned outcome predicted in the textbooks.

Japan's actions mainly have worked to lower the yen, which in turn raises the exchange rate of the currencies of its export competitors around the globe. In effect, that is a tightening of monetary policy for everybody else—at a time that global growth is slowing. Viewed from that perspective, no wonder gold is being battered.

Japan's government is set to urge the nation's public pension funds - a pool of over $2 trillion - to increase their investment in equities and overseas assets as part of a growth strategy being readied by Prime Minister Shinzo Abe, according to people with knowledge of the policy shift.

The steps, which could be announced as soon as Wednesday, represent the first time the Abe administration has looked to mobilize Japan's massive pool of savings to support a growth agenda that aims to spur more consumer spending and corporate investment by pushing the economy toward 2 percent inflation.

It also suggests a new element of risk to the policies known as Abenomics since it would shift funding from the government to the private sector at the risk of driving interest rates higher.

Specifically, the government will set up a panel in July to consider the investment strategies of public funds, which, like other Japanese institutional investors, have relied heavily on investment in Japanese government bonds in recent years.

The panel review will be included as part of a package of steps intended to boost growth set to be announced on Wednesday, according to the people with knowledge of the preparations who asked not to be named because an announcement has not been made.

The panel will look to reach a conclusion as soon as this autumn on strategy and will urge implementation of the new investment guidelines by public funds no later than April 2015, according to the sources.

As part of its deliberations, the panel will consider steps to allow the public funds to invest in alternative investments, including infrastructure financing both in Japan and abroad, the sources said.

The more aggressive investment strategy would apply to the Government Pension Investment Fund, known as GPIF, and about 100 other semi-governmental funds and public funds such as Federation of National Public Service Personnel Mutual Aid Associations, known as KKR.

In recent years, Japanese public funds led by GPIF have followed a conservative strategy that has meant a large allocation of funds to the Japanese government bond market and made them a near-captive source of financing for government spending.

GPIF, for instance, manages a portfolio that includes a mid-point target of a 67-percent allocation for domestic bonds, 11 percent for domestic stocks, 9 percent for foreign stocks and 8 percent for foreign bonds.

GPIF IN FOCUS

Abe has unleashed fiscal and monetary stimulus to boost growth in the short-term. But at the same time, officials have taken steps to reassure investors that Japan will tackle a public debt that is the biggest in the developed world at more than twice the size of the nation's annual economic output.

A government advisory panel warned last month that there was "no guarantee" that domestic investors would keep financing the nation's massive public debt, saying such a move could drive interest rates higher and crimp long-term growth prospects.

Reuters reported last week that GPIF has already been considering change to its portfolio strategy that could allow its investment in domestic stocks to grow with a rallying market. The fund manages the national pension and pension insurance for the private sector.

The Reuters report sent both the dollar higher against the yen and Nikkei futures higher as investors reacted to the prospect that the world's largest public pension fund could increase its exposure to assets other than domestic bonds.

The new government panel will review the investment strategies of public funds more generally, including steps to diversify portfolios and to establish a structure to improve risk management.

Japan's Health Ministry currently supervises the investment strategies of public pension funds.

GPIF's investment model went unchanged through the global financial crisis of 2008 and served the fund well through the years of slow growth in Japan since.

But more recently, the public pension's allocations have been bumping up against the established limits under its conservative portfolio.

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

The main idea under consideration would be for GPIF to change the way it evaluates the potential risk and return on assets to allow it more flexibility, sources have said.

Although Tokyo markets have turned volatile, stocks have rallied since Abe began pushing his policies ahead of his December election victory. At the same time, the yield on the 10-year Japanese government bond has risen to near 1 percent, ending a rally in the government debt market that began in 2006.

More recently, stocks have fallen back from their highs and yields have retreated on the benchmark 10-year bond.

The Nikkei fell 3.7 percent to a six-week low on Monday and the 10-year yield slipped to 0.805 percent.

Shinzo Abe will call on Japan’s giant pension funds to lift their allocations to domestic stocks and to take a more active approach to investment, as the prime minister seeks ways to sustain new-found interest in the world’s second-biggest equity market.

As part of a new national growth strategy to be outlined at the end of next week, the Government Pension Investment Fund and other big institutional investors will be urged to lift automatic caps on their equity holdings while exercising their voting rights more frequently, according to a senior government official.

In theory, such moves could support prices by tipping the balance of supply and demand in the equity market, given the sheer size of the institutions concerned. Total assets at the GPIF, for example, stood at Y112tn ($1.1tn) at the end of December – about the same size as the economies of Mexico or South Korea – with a 60 per cent weighting to domestic bonds.

At the same time, the extra scrutiny from powerful domestic investors could encourage companies to pay more attention to returns to shareholders. Forecast ROEs for the biggest companies on the Topix index this year are about 9 per cent, well below the 15 to 20 per cent average in other mature economies.

“There’s an urgent need for institutions to change their allocations and not to be a sleeping shareholder,” the government official said.

This year’s rally in stocks has helped to carry Mr Abe to the brink of victory in Japan’s upper-house elections next month, thus cementing his hold on power for the next three years. Despite a recent dip, the Topix remains one of the best-performing benchmarks in the world, up 44 per cent over the past six months, buoyed by steady inflows from foreign investors and a revival of trading activity among domestic retail investors.

However, while many investors are convinced that Mr Abe’s determination to revive Japan through stimulus and structural reform will keep pushing the market higher, others are less sure.

A public commitment to support stocks from the GPIF “would be a reason for overseas investors to step up their buying, since we are consistently asked why Japanese investors, and pension funds in particular, have not been doing so”, said Masatoshi Kikuchi, pan-Asian equity strategist at Mizuho Securities in Tokyo.

The GPIF was established in April 2001 to manage funds in Japan’s public pension system. Its current base portfolio, set in 2006, is allocated 67 per cent to Japanese bonds – with a tolerance of 8 per cent either side, due to market moves – 11 per cent to Japanese stocks, 9 per cent to foreign stocks, 8 per cent to foreign bonds and 5 per cent to short-term assets.

Raising the assumption for long-term inflation from 1 per cent to 2 per cent – in line with Mr Abe’s policy – would lift the GPIF’s target return to 4.2 per cent.

Achieving that target return could require lifting the weighting of domestic stocks in the portfolio to a baseline of 17 per cent, according to calculations by Naoki Kamiyama, chief strategist at Bank of America Merrill Lynch in Tokyo.

The government plans to reshape investment strategies for the roughly Y200tn in assets held by 190 public pension funds, aiming to complete the shifts by the end of the fiscal year ending in March 2016.

Mr Abe’s growth programme, dubbed “Abenomics”, depends on investors across Japan rebalancing bond-heavy portfolios towards riskier assets, while allowing the central bank to mop up the debt they offload.

The Canada Pension Plan didn’t become one of the best-funded pension plans in the world – it’s got enough assets to fund our retirements for at least the next 75 years – by simply handing over current workers’ contributions to retirees.

If that were the case, the bulge of baby boomers tapping into the system in the next few years would mean there would be nothing left for the workers of today and tomorrow when they eventually retire.

To avoid that kind of catastrophic shortfall, the CPP Investment Board was created in 1997 as an arm’s length organization that invests CPP funds not needed to pay current benefits. The CPPIB decreased the proportion of funds held in fixed equities and beefed up its holdings in public and private equities, infrastructure and real estate. Its assets now stand at $183-billion, with an annual return of 10.1 per cent for the year ended March 31, 2013.

Within its real estate portfolio, in the past nine months alone, the CPPIB has spent more than $860-million of Canadian’s pension money on buying interests in shopping malls around the world – two in Australia, one in Sweden and one in Britain. While the organization isn’t increasing the percentage of funds it allocates to retail real estate, it’s having to scoop up more properties just to maintain its current asset allocation.

Graeme Eadie, CPPIB’s senior vice-president and head of real estate investments, spoke with The Globe and Mail from his Toronto office about the fund’s recent shopping mall purchases abroad and why it probably won’t be picking up more Canadian properties soon.

As of March 31, the CPPIB’s real estate portfolio accounted for 10.8 per cent of its assets, of which nearly half, or $8.2-billion, was invested in shopping malls. Is that a position you’re comfortable with?

Being around 40 to 45 per cent retail is pretty typical for financial institution investors. The other major component [of a real estate portfolio] tends to be office, and the third, which is usually around 20 per cent, is the industrial sector.

What’s makes retail real estate an attractive investment?

Shopping centres tend to have a more stable income return [than the office sector]. That’s why they tend to be quite attractive for pension plans.

Typically, institutions like high-quality retail shopping centres and, as a result, they don’t trade very often. And one of the things that’s particularly attractive about them is the returns are quite stable. It’s really a reflection of the fact that you’ve got so many tenants in the building. Whereas with office buildings … the tenants tend to be larger within an individual building, so as they move around the marketplace you can end up with larger pieces of vacancy.

What did you like about your most recent investment, Bullring Shopping Centre, in Birmingham?

It’s a very high-quality centre in a good market. It’s really one of those centres that is very hard to find anywhere in the world and this one has a very strong, proven track record. It has all of the major tenants that you’d want to see in a shopping centre so it really dominates that trade area. It is in the effective downtown of Birmingham and well linked to the train station, which is just across the way.

So it has just about everything that you’d want: high-quality tenants, a strong location within the downtown, it’s well connected by public transport and has car parking attached to it.

We see it as a really good asset with long-term value.

How did the CPPIB come to purchase it?

There were three owners and one of the owners wanted to sell. We had a relationship with [British retail property company] Hammerson from other activities, and they called us and asked if we would like to share the interest with them.

Do you consider your shopping centre investments to be long-term investments?

Yes, we do. There’s a huge range of assets within retail, going from strip centres to grocery anchors to B-level malls to the very prime malls. I think that where we can find that prime mall that has all of those attributes [that we value] and has a strong manager, those are things that do not trade very often and therefore you want to buy them and hold them because they will perform well through all of the cycles. They are very valuable. There are other centres, which may be neighbourhood-oriented or, perhaps, in locations that are not as strong. Those we will look at and we might own them for eight or nine years and then find other opportunities and continue to trade up. But something like a Bullring, or a Macquarie Centre in Sydney, those types of assets really have that long-term attraction for us.

Do you foresee more international shopping centre purchases?

We’re always looking.

How about domestic purchases?

There’s very little that we see of that kind of quality that we’d want to add to the portfolio. There are select opportunities that come up from time to time but, obviously, Canada is a relatively small market and it’s quite concentrated in terms of its ownership.

What’s the shopping mall landscape like in emerging markets?

The story is basically the same in emerging markets as it is in the developed markets. But the one nuance I would point out is that, depending on how developed the country is, it can often take a little while longer for new properties to really settle into their trade area and for the customer to get used to shopping in an enclosed mall rather than what they may have done before, which may have been more department-store based or even open-market based. In terms of new development of retail facilities, the emerging markets are really the primary source for that type of product today. There’s not a lot of development going on within the major, developed countries.

This interview has been edited and condensed.

Recent CPPIB acquisitions

What: Bullring Shopping Centre.

Where: Birmingham, Britain.

How much: CPPIB paid $240-million for a 16.7-per-cent stake in the mall.

When: May, 2013.

Stores: More than 160 shops and restaurants. Anchored by Selfridges and Debenhams; other stores include Apple, Forever 21, Gap, H&M, Hugo Boss, Swarovski and Ugg.

What: Kista Galleria Shopping Centre.

Where: Stockholm, Sweden.

How much: CPPIB paid $177-million for a 50-per-cent stake in the mall.

When: December, 2012.

Stores: 180 shops and restaurants, including Adidas, Esprit, Foot Locker, H&M, Levi’s and McDonald’s.

What: Macquarie Centre and Pacific Fair Shopping Centre.

Where: Sydney, Australia, and Gold Coast, Australia.

How much: CPPIB paid $445-million for a 37-per-cent stake in AMP Capital Retail Trust, which owns 50 per cent of Macquarie Centre and 80 per cent of Pacific Fair.

When: October, 2012.

Stores:

Macquarie Centre: 250 shops and restaurants. Anchored by department stores Myer and Target; other stores include Athlete’s Foot, Esprit, Kookai, Nine West and Pandora.

Pacific Fair: More than 130 shops and restaurants. Anchored by Myer, Target, Kmart and Coles; other stores include Billabong, Crocs, Esprit, Foot Locker, Kookai, Quick Silver, Seafolly and Steve Madden.

Some of the world’s biggest quant hedge funds have suffered steep losses in the past two weeks following the sell-off in global bond markets.

So-called “CTAs”, which use computer models to automatically spot and ride market trends, were caught out as investors anticipated an end to the Federal Reserve’s measures to stimulate the US economy, triggering a global rout in fixed income investments.

Bond yields have risen sharply from some of their lowest levels in decades in the past fortnight, leaving funds with large holdings badly hit. Many quant funds have been major buyers of bonds over the past few years as their algorithms have followed yields lower.

“Since mid-May it has been a perfect storm of some of the biggest trends in markets reversing all at once,” said a senior manager at one large quant fund. “It has been particularly brutal.”

AHL, the $16.4bn flagship fund of Man Group, the world’s second-largest hedge fund by assets, lost more than 11 per cent of its net asset value in the past two weeks alone as a result of its huge bond holdings, according to an investor.

News of the fund’s difficulties triggered a 15 per cent drop in Man’s share price on Wednesday.

Aspect Capital, another large European CTA, lost 6.4 per cent in May.

Geneva-based BlueTrend, the $14bn quant division of BlueCrest Capital run by Leda Braga, told investors its fund was down 4.4 per cent for the month as of May 24. The fund has yet to reveal losses incurred last week, but investors say they are likely to be high. BlueTrend runs a more volatile version of the same strategy as Man.

Sources at the funds say this week has also been painful and losses have been extended.

Most quant funds only privately communicate performance data with their investors on a weekly – or even monthly – basis.

Many of them have also had long positions on contracts linked to Japanese equities. The Nikkei has slumped 5.5 per cent so far this week, extending a month-long fall.

“May has rattled investors with large bond portfolios,” said Anthony Lawler, portfolio manager for hedge fund investor GAM. “Across all [hedge fund] strategies, trades that caused pain included long fixed income positions and long exposures to the many markets that reversed or were choppy, including energy, Japanese equities and soft commodities.”

Although CTAs are known to be volatile, the losses are still among the highest reported to investors in years – and have been spread broadly.

Graham Capital, the US’s largest CTA, was down 3.9 per cent for the month, while Holland-based Transtrend was down 3.1 per cent.

Winton, the world’s largest quant fund, managed to sidestep the worst of the losses. The London-based company dropped just 2.5 per cent in May, but is still up 6.5 per cent for the year.

Although almost all of Winton’s losses were attributable to US bond market moves, unlike its peers, Winton has moved to diversify its algorithmic trading programmes into cash equities and away from its traditional focus on futures contracts. The fund also operates with lower leverage than many of its rivals.

Concerns over a potential end to US quantitative easing saw global fixed income markets slump in May, but further sudden sell-offs may be less likely.

The Bank of America Merrill Lynch Global Bond Market Index fell 1.5% last month, its largest loss since April 2004, with 'safe haven' sovereign debt particularly affected.

In the US, investors beginning to position for an eventual 'tapering' of quantitative easing pushed yields on 10-year treasuries from around 1.7% to as high as 2.2%, with benchmark debt losing 3.3% over the month as a whole.

The UK market saw 10-year gilts shed 2.3% in sterling terms last month, as expectations of further QE in the near future declined, while concerns over 'Abenomics' saw Japanese 10-year yields rise from 0.3% to 1% on the month.

According to J.P. Morgan analysts, the only 'materially' worse months for the global bond market in the past two decades were February 1994, when the Federal Reserve surprised investors by raising rates, and the fallout from the 'VaR shock' seen in Japan in July 2003.

Those analysts also noted that bond ETFs in the US saw their largest weekly outflow on record last week, at $1.5bn, but they are skeptical over the prospect of a further sell-off.

"We estimate that a rise of 100bp in yields [from early 2013] would be required to prompt material selling of bond mutual funds. The 30bp rise in yields over the past month, coming on the back of a previously solid YTD rally, still falls some way from meeting that mechanical threshold.

"Bond positions are likely not supportive of a further sell-off."

Barclays' global macro team also said investors may be getting ahead of themselves in anticipating Fed tightening, though they suggest May 2013 may eventually come to be seen as an "inflection point" in the present era.

"Even in the US, which seems likely to lead the way toward normal monetary conditions, there is at the moment almost no reason to fear that the monetary authorities will feel under pressure to act soon, or abruptly," the team said.

However, given current correlations between global bond markets', Barclays notes the "worrisome" potential for contagion from an eventual tightening in the US meaning "tighter financial conditions in regions less prepared for it".

Expectations of such moves have been brought forward in recent weeks. The 'tapering off' of the Fed's QE programme, while conditional on further improvements in the unemployment rate, is now expected to commence towards the end of this year.

CME futures contracts, meanwhile, suggest almost one in three investors now expect a fully-fledged rate hike in the US by mid-2014.

They're convinced bond prices are heading lower, which means interest rates are heading higher.

"Our bond valuation models (Sudoku and GS Curve) and a separate study of the determinants of US Treasury yields which explicitly accounts for the impact of QE, policy ‘guidance’, uncertainty and the European crisis indicate that intermediate yields should be trading in the upper half of this range, given the decline in systemic risks and the brightening US economic outlook," wrote Goldman's Francesco Garzarelli and Silvia Ardagna in their note. "Our model estimates (and, consistently, our forecasts) show 10-year Treasuries reaching 2.5% in the second half of this year, with German Bunds trading at 1.75%."

Garzarelli spoke with the WSJ's Katie Martin about the call (see below).

He noted that interest rates won't rise straight up, but that there would be "speed bumps" along the way. This is why Goldman recently told clients to take some profits on their short positions.

Nevertheless, Garzarelli continues to be convinced that rates are heading higher.

The Global Total Output Index, produced by JPMorgan with research and supply management organisations, rose to 53.1 in May from 51.9, spending its 46th month above the 50 mark that divides growth from contraction.

The PMI was lifted by increased output in the United States, Japan, Britain and India but the euro zone remained in a protracted downturn, JPMorgan said.

New business came in at the fastest pace since February, leading to rising employment levels.

A Global Services Index rose to a five-month high of 53.7 last month from 52.1.

Activity in the vast U.S. services sector picked up slightly in May, though growth was still lackluster and a measure of employment fell to its lowest level in close to a year, an Institute for Supply Management report showed.

Europe's economic woes eased slightly last month, helped by a surge in British services business and signs the downturn in the euro zone is starting to ease, earlier surveys showed.

Global manufacturing only grew marginally last month but with new orders coming in at a faster pace than in April, conditions should improve, a sister survey showed on Monday.

The index combines survey data from countries including the United States, Japan, Germany, France, Britain, China and Russia.

Canada's ten largest public pension funds, dubbed "the Top Ten," provide Canadians with one of the strongest retirement income systems in the world and also contribute significantly to national prosperity, a new study concludes.

The landmark study commissioned by several members of the Top Ten and conducted by The Boston Consulting Group (BCG) provides, for the first time, data on the aggregate impact of these global organizations. The study is an in-depth examination of the economic impact of these pension funds to the end of fiscal 2011. The study concludes the Top Ten are a Canadian success story on the world stage.

The Top Ten represent a major cornerstone of the Canadian financial system and the economy at large. Over the last 10-15 years, the Top Ten have established the reputation of Canadian pension funds management as truly world-class. This reputation has opened doors around the world to investment opportunities that benefit the Canadians receiving pensions as well as their communities as a whole.

"This study is the first of its kind covering a group of financial institutions whose daily activities have an enormous impact on the retirement prospects of current and future generations of Canadians, and on the economy at large," said Kilian Berz, Senior Partner and Head of BCG Canada. "Several factors have enabled their success, with a core factor being a strong governance structure that allows the funds to operate as a business in the best interests of their members."

Among the key findings:

• The Top Ten pension funds are healthy, growing, and increasingly important to Canada as it faces challenging demographics and economics
• They have created a centre of excellence in Canada for managers of quality, large-scale investments
• They manage ~35% of Canada's retirement assets
• Their net assets grew by more than 100% in the previous eight years
• They have invested roughly $400 billion in Canada , including $100 billion in real estate, infrastructure and private equity
• They are strong proponents of good corporate governance practices, ultimately improving the efficiency and effectiveness of capital markets
• They comprise four of the top 20 global commercial real estate investors
• They also comprise four of the top 20 global investors in infrastructure assets
• They directly employ 5,000 professionals in the Canadian financial sector and an additional 5,000 employees in their real estate subsidiaries.

BCG's study focused on the ten largest public sector pension funds (ranked here by size of pension assets): The Canada Pension Plan Investment Board (CPPIB), The Caisse de dépôt et placement du Québec (Caisse), The Ontario Teachers' Pension Plan Board (OTPP), The British Columbia Investment Management Corporation (bcIMC), The Public Sector Pension Investment Board (PSP Investments), The Ontario Municipal Employees Retirement System (OMERS), The Healthcare of Ontario Pension Plan (HOOPP), The Alberta Investment Management Corp. (AIMCo), The Ontario Pension Board (OPB), and The OPSEU Pension Trust (OPTrust).

Global investment scale
The Top Ten funds managed, at the end of 2011*, $714 billion in pension funds - ~35% of Canada's total retirement assets. This total includes all public and private sector pension plans, RRSPs and other registered savings plans. This is broadly distributed among the ten and ranges from the $162 billion managed by the Canada Pension Plan Investment Board (CPPIB) to $14 billion by the OPSEU Pension Trust (OPTrust). Since BCG's study, which was conducted in the fall of 2012, the funds have continued to grow, with recent reporting periods indicating a total of roughly $775 billion in pension assets.

Growing Canadians' retirement investments
The Top Ten's $714 billion in pension assets under management in 2011 is an increase of more than 100% since 2003, over a period in which the world faced one of its most challenging economic periods. Two-thirds of the increase has been driven by solid investment returns of $240 billion vs. net inflows to the funds made by members and their employers of $125 billion .

"During a highly volatile period of time that encompassed the worst financial downturn since the Great Depression, the Top Ten have managed to more than double their pension assets, driven primarily through their investment activities," said Michael Block , the project lead from BCG. "This strong performance underscores the Top Ten's role as a cornerstone of Canada's well-regarded retirement income system."

The funds have focused on prudent investments offering attractive, risk-adjusted returns in public and private equities, infrastructure, real estate and bonds. The Top Ten are "major long-term investors in Canada ," with over $400 billion invested across various asset classes in Canada . BCG also found the Top Ten to have a broader impact on the Canadian financial sector with a $1.5 billion payroll and ability to attract and retain top Canadian talent.

Canadian pension funds are highly regarded around the world, having invested in, for example: one of the largest electricity transmission and distribution companies in the U.S.; the operator of seven UK airports including Heathrow; three Chilean water utilities; and one of the largest and most profitable insurance providers in South Korea ; among many, many others.

The keys to success
Canada has become a centre of excellence for managers of quality, large-scale investments with more than 5,000 men and women employed in investment origination, asset management and operations at the Top Ten. The funds are recognized widely by global media and financial communities as significant long term players, and these institutional investors have participated in some of the largest deals in recent years.

"The Top Ten benefit from two key strengths: professional, active management of diverse assets and a low cost structure," the study concludes. "Management expense ratios of the Top Ten on average are much lower than other actively managed pension funds, and mutual funds, and are comparable to the cost of passive index Exchange Traded Funds."

BCG found the funds' successes can be strongly attributed to a well-developed governance structure that allows them to operate in the best interests of their contributors - a structure BCG believes to encourage good corporate governance practices throughout Canada's capital markets. Other success factors are their discipline and freedom to manage as businesses; sufficient scale to gain access to large, capital intense assets.

Excellence in fund management
Like many other nations, Canada is experiencing challenging demographics and economics that make excellence in the management of these funds even more necessary. These factors include longer lifespans, lower and declining retirement ages, a dwindling ratio of workers to retirees, low interest rates and volatile capital markets.

The study examined external rankings of retirement systems and found Canada's to be among the strongest in the world; ahead of the United Kingdom , the United States and Germany . This achievement is strengthened by professional investment excellence, a consolidated approach to managing capital and recognition that scale is critical to success.

Disclaimer:
These materials excerpted by the Top Ten from the Study referenced are provided for discussion purposes only and may not be relied on as a stand-alone document. The Study was prepared by BCG at the request of several members of the Top Ten using public and/or confidential data and assumptions provided to BCG by the Top Ten. BCG has not independently verified the data and assumptions and changes in the underlying data or operating assumptions will affect any analyses and conclusions set out in the Study. BCG shall have no liability whatsoever to any third party with regard to these materials or the Study, including the accuracy or completeness thereof.

* Due to differences in reporting periods the data quoted for some pension funds is from its fiscal year 2012, which ended on March 31, 2012

The Top Ten represent a major cornerstone of the Canadian financial system and, more broadly, the Canadian economy. They have elevated the reputation of Canadian pension funds to a world-class level, and their ‘best practice’ model has benefitted the pension industry at home and abroad.

Their innovative approach to investing has helped provide stability and solid returns to plan members in what has been a highly volatile period for capital markets. As well, their focus on long-term value creation is a model worth emulation by other investors and by the business community in general.

Canada’s Top Ten public pension funds are truly a Canadian success story and a driver of national prosperity.

Japan's public pension fund, the world’s biggest manager of retirement savings, said it will reduce its holdings of local bonds and buy more shares.

The proportion of assets held in Japanese bonds will be cut to 60 percent from 67 percent, the health ministry said yesterday in Tokyo at a briefing to announce changes to the mid-term plan of the Government Pension Investment Fund. The weighting of local shares will be increased to 12 percent from 11 percent currently. The Health and Welfare Ministry, which oversees pensions, didn’t give a time frame for the changes.

“It was a negative factor as far as bond supply and demand is concerned,” said Makoto Suzuki, a bond strategist at Okasan Securities Co. in Tokyo, one of the 24 primary dealers obliged to bid at government debt sales.

GPIF’s shift toward higher-yielding assets comes as it prepares to fund retirements in the world’s most elderly population and Prime Minister Shinzo Abe tries to revive the economy through fiscal and monetary stimulus. Domestic shares have slid since Abe said on June 6 that a legislative campaign to loosen rules on businesses, the “third arrow” of his economic plan, won’t begin for months.

Changes to GPIF’s asset allocation are effective from yesterday, fund official Masahiro Ooe told reporters. He declined to elaborate on the timing for completion of the portfolio changes.

Investing Abroad

Allocations to foreign bonds will rise to 11 percent from 8 percent, while overseas shares will increase to 12 percent from 9 percent, according to a document on GPIF’s website.

Nikkei 225 Stock Average futures in Chicago rose the most in two months last night, with the June contract gaining 4.1 percent to 13,240. The Nikkei 225 fell 0.2 percent in Tokyo yesterday to 12,877.53, while the broader Topix index slid 1.3 percent and is down about 17 percent from its May high.

GPIF, created in 2006, managed 112 trillion yen ($1.16 trillion) as of Dec. 31. It didn’t alter the structure of its holdings during the worst global financial crisis in 80 years or in response to Japan’s 2011 earthquake and nuclear disaster.

In an interview in February, GPIF President Takahiro Mitani the fund may have to reduce its bond holdings and buy alternative assets to cope with a higher interest-rate environment under Abe. After a review in April-to-May, any portfolio changes would begin in early 2014, he said at the time.

Yields Rise

Yields on 10-year Japanese government bonds increased 2 1/2 basis points to 0.86 percent in Tokyo, according to Japan Bond Trading Co. Futures on the notes recovered from a drop in the afternoon to close at 143.11 on the Tokyo Stock Exchange, the highest since May 10.

“The reaction we have seen in the futures market has been muted,” said Teruyoshi Sotome, a Tokyo-based senior bond strategist at Mizuho Securities Co., one of the 24 primary dealers obliged to bid at government auctions. “We shouldn’t forget the change in GPIF’s portfolio is going to take place over the long term. The announcement is not a declaration that they are going to increase foreign investments by large amounts going forward.”

Japanese households had 1,547 trillion yen in financial assets as of the end of December, according to Bank of Japan data. That compares with 32 trillion yen of debt securities and 106 trillion yen in equities and investments, the data show.

BOJ Buys

Even as GPIF reduces its allocation to JGBs, the Bank of Japan has stepped up purchases. The BOJ said in April it would double monthly buying of JGBs to more than 7 trillion yen, and in May said it would increase the frequency of the operations.

JGBs have lost about 1.64 percent so far this quarter, the most since the period ended September 2003, according to a Bank of America Merrill Lynch index.

Domestic bonds made up about 60 percent of GPIF’s assets at the end of December, according to a document on its website. The fund is amending its targets to bring them into line with the changing value of its holdings, said Hideo Shimomura, who helps oversee the equivalent of $62 billion in Tokyo as chief fund investor at Mitsubishi UFJ Asset Management Co., a unit of Japan’s largest publicly traded bank.

“They don’t have to touch their assets,” Shimomura said. “I don’t think this news could affect markets.”

Japan's public pension fund, the world's largest with a pool of $1.1 trillion, announced on Friday the most significant shift in its asset allocation since 2006 so it can take on greater risk by shifting into stocks and away from Japanese government bonds.

The steps by the Government Pension Investment Fund (GPIF) come after a draft strategy document this week showed Prime Minister Shinzo Abe was considering a push for public funds to increase returns as part of measures to revive the economy's fortunes. The events confirm reports by Reuters this week.

GPIF said it is increasing its Japanese stocks allocation to 12 percent of its portfolio from 11 percent, while lowering its JGB weighting to 60 percent from 67 percent. However, the change largely reflects adjustments already made in the portfolio, suggesting limited impact on markets.

The fund's latest publicly available allocations show that as of December 60.1 percent of the 111.9 trillion yen ($1.1 trillion) under management was already in JGBs. It had already allocated 12.9 percent to domestic stocks.

"GPIF is ratifying the current situation taking into account the moves in the market. GPIF would avoid readjusting its portfolio by doing this," said Eiji Dohke, director and chief JGB strategist at Citigroup Global Markets Japan.

GPIF said it would increase its weighting in foreign stocks to 12 percent from 9 percent and lift its allocation of foreign bonds to 11 percent from 8 percent.

The new allocations were released after the close of Tokyo share trading but expectations of the announcement had pushed stocks up from the day's low. The stock benchmark Nikkei average closed down 0.2 percent on the day.

BONDS REMAIN STAPLE

Masahiro Ooe, a councilor at GPIF, told a news conference that a review of the fund's long-term risk and return profile had concluded the pension could take more risk.

The fund said it will not comment on whether it will trade actively in the market.

Dohke said the changes could still depress JGBs as hopes for GPIF inflows into JGBs could now have receded. Some in the market had thought the fund would have to sell domestic shares and foreign assets to maintain its investment limits and they had speculated some of the cash proceeds would then go into JGBS.

"But this is not likely to happen after today's change, Dohke said.

Government bonds will remain the fund's staple investment however, unlike some other large public funds globally which adopt a much greater weighting in stocks.

Canada's Pension Plan Investment Board, with $183 billion in assets, and Norway's $686 billion pool of government savings from petroleum revenue, known as the Government Pension Fund Global, both allocate most of their money to equities.

GPIF hit its own internal return targets in recent years, or a total return averaging 2.4 percent a year. By comparison, Norway's Government Pension Fund Global, returned almost 6 percent a year over the past decade.

ABENOMICS

A growth strategy outlined this week by Abe marked the first time he had sought to mobilize public savings to support an aggressive growth agenda aimed at defeating years of deflation and sluggish economic growth. GPIF and other Japanese public funds have a collective pool of $2 trillion in assets.

Abe has already pushed through $100 billion in government spending and shaken up monetary policy by prodding the Bank of Japan into a $1.4 trillion stimulus effort to achieve 2 percent inflation within two years.

He won a December election as leader of the Liberal Democratic Party and promised "bold" economic policies, which been dubbed 'Abenomics' by the media.

The Nikkei is up 24 percent this year off the back of Abe's policies, although a bout of profit taking has pulled the average back from its highs of the year.

"Recent weakness in the market represents a little bit of a disappointment for Abenomics," said Kenji Shiomura, an analyst at Daiwa Securities.

"But it would be too extreme to say that hopes for Abenomics have faded completely because the biggest impact Abenomics gave the market was monetary easing, and it is still continuing," he said.

The changes by the GPIF were prompted by a report from Japan's Board of Audit, which had been requested by Japan's upper house. The board called last year for the fund to review its targets and allocations.

People continue to overestimate the risks in the U.S. I would argue that they grossly -- and I'm not using that word lightly -- underestimate the risks in the emerging markets. A lot of the problems that people think are inevitably going to crop up here, including inflation and out-of-control money growth, are actually happening in the emerging markets. We aren't seeing those risks here. But the thinking is that it is inevitable and it has to happen here. A lot of people have talked about how the great rotation will be a shift from bonds to stocks. But that's not right. The great rotation -- and the biggest decision you have to make for your portfolio -- is that for five to seven years, it is not going to be bonds to stocks, but rather non-U.S. assets to U.S assets. We are maybe in the fourth inning of a secular period of outperformance for U.S. assets. Think about this: The Standard & Poor's 500 has outperformed emerging markets now for five years. Nobody cares, and it pains people to admit that the U.S. market has been outperforming.

...the hyperbolic credit creation in China has gotten worse, for example, and the money supply problems in India have gotten worse, as have the corporate fundamentals in China. The Chinese corporate sector is now one of the most levered in the world, and its marginal return on investment is going down. So the efficiency of that economy's credit is getting lower and lower. That's not healthy; that's not a growth story. Expectations are too high. In 2012's fourth quarter, just under 60% of emerging-market companies reported negative earnings surprises, compared with 28% in the U.S. And the corporate fundamentals in emerging markets continue to erode.

...one cyclical, the other secular. Starting with the cyclical: Energy and commodities are traditional late-cycle plays. Why? Because inflation is a late-cycle play. You need bottlenecks in the economy, and you need demand to outstrip supply. I don't care about all these guys who say inflation is imminent because the Fed is printing money. Demand must outstrip supply to get inflation.But we aren't late in the cycle. The Fed isn't tightening. The secular reason is that if you agree with us that emerging markets have been overstimulated by the global credit bubble, that explains the demand for commodities on a secular basis. Again, commodities are very credit-sensitive. I find it quite amazing that people will generally agree that the global credit bubble is deflating. But then they want to play credit-sensitive investments like energy and commodities and gold. That doesn't make a lot of sense.

Alberta Investment Management Corporation is taking a bold step into the movie business.

The province’s $70 billion pension fund manager and an Ontario-based partner have agreed to acquire one of Europe’s top movie theatre chains for 935 million British pounds, about $1.48 billion Cdn.

AIMCo’s joint purchase of Vue Entertainment with OMERS Private Equity — the investment arm of the $61 billion Ontario Municipal Employees Retirement System — is expected to close in July.

Vue Entertainment, currently owned by London-based Doughty Hanson & Co., one of Europe’s largest independent private equity firms, operates 1,321 movie screens in 146 cinemas across Europe and beyond.

“This took a little longer to close than we thought,” AIMCo chief Leo de Bever told the Journal on Monday, after returning to Edmonton from Europe on Sunday evening. “There are always last-minute (snags) and we’d actually expected it to close on Friday, but these things happen.”

Although the purchase of a cinema chain in recession-racked Europe may strike some as an odd move for AIMCo, which is more typically involved in major infrastructure, resource or real estate investments, de Bever says the deal makes sense on several levels.

“It’s a relatively low-risk transaction. The revenue streams are not cyclically sensitive, so they’re reasonably recession-proof, and the returns will ultimately come from really managing this thing from an efficiency point of view,” he says.

“Europe is a little behind us in terms of having very highly optimized networks for movies, and in Eastern Europe there is still a fair bit of growth potential. They’ve never had these kinds of (modern) facilities, particularly in Poland and parts of Germany.”

Vue Entertainment, described by Bloomberg as the second-largest cinema chain outside of North America, also operates in Britain, Ireland, Denmark, Portugal, Latvia, Lithuania and Taiwan.

Since Doughty Hanson acquired Vue for 450 million British pounds ($713 billion Cdn) in late 2010, the chain has expanded rapidly through a series of acquisitions, roughly doubling the number of locations and theatre screens in its network.

Although the eurozone’s economy has shrunk for six straight quarters, and jobless rates — especially among the young — remain at nosebleed levels, de Bever says theatre box office revenues have remained strong.

The Hollywood Reporter, a respected U.S.-based film industry trade publication, recently reported that European theatre revenues hit a new record high of nearly 6.5 billion British pounds ($10.3 billion Cdn) in 2012, with strong markets in Britain, Germany, Finland and Romania offsetting declines in Italy, Greece, Portugal and Spain.

“I think we got it for a bargain. But it was well priced in the sense that, given all the (issues) about the European economy, but also the incomplete optimization of this particular industry, this represented a medium risk, good return combination,” says de Bever.

Although pay-per-view movies also pose a competitive threat to traditional cinemas, he says the latter option is still preferred by many movie patrons who are seeking an affordable night out on the town.

“When we looked at the market, (going to the movies) competes with a number of other things you could do, and it remains relatively inexpensive,” he says.

OMERS and AIMCo were both familiar with Vue Entertainment, since they had taken a look at the company when it was last on the market in 2010.

“There was some history there and we were familiar with it. So when it became available (again) we quickly got into a private negotiation,” says de Bever.

“Often with these kinds of deals, there is more to it than price. People often have strong views on who they want to end up with this kind of an asset, and that often counts for as much as delivering a big cheque.”

Doughty Hanson opted to put Vue Entertainment back on the market after one of its two co-founders died earlier this year. Tim Richards, the theatre chain’s founder and CEO, will remain with the business, Doughty Hanson says.

“As the company moves forward I am confident that we do so from a position of real strength,” Richards said in a release. “We will continue to build on this success by innovating, enhancing and growing the Vue business through our continuing plan for organic growth supplemented by strategic acquisitions.”

Vue Entertainment Ltd. was bought by two Canadian pension-fund managers looking to continue the expansion of one of Europe’s largest cinema operators for 935 million pounds ($1.45 billion).

Ontario Municipal Employees Retirement System and Alberta Investment Management Corp. are buying Vue from private-equity firm Doughty Hanson & Co. and the London-based cinema operator’s management, according to a statement today by the three companies.

Vue, which operates in countries including the U.K., Germany and Portugal, has doubled the number of cinemas it owns in the past three years. Chief Executive Officer Tim Richards will retain an equity stake and remain in charge, according to the statement. Vue, which in recent months bought rivals in Poland and Germany, will continue making “strategic acquisitions” where appropriate, Richards said today.

“This is the most active time in Europe for cinema in probably the past 10 years because the banks are back in business and supporting companies and assets” are for sale, he said in an interview.

The deal should close at the end of July, according to the statement. The Ontario pension fund, known as Omers, and Alberta Investment plan to use their own funds to finance the buyout before finalizing debt financing by early August, according to a person familiar with the deal who asked not to be named as the details are private.

James Devas, a spokesman in London for Omers, declined to comment on the debt financing.
‘Patient Capital’

Vue is the second-largest cinema operator outside North America and has more than 1,300 screens at 146 cinemas across Europe, according to the statement.

“People have suggested that” an acquisition of Odeon and UCI Cinemas Group Ltd. “may be the next step in a consolidation,” Aimco CEO Leo De Bever said in a phone interview from Edmonton, Alberta. “But we’re not in any discussions on that one.”

Omers approached London-based Odeon in 2011 with BC Partners Ltd. to purchase the chain, two people familiar with the plan said at the time. The pension funds may run into regulatory issues if they seek to acquire Odeon because of the large market share it would command, De Bever said.

“Presumably, if you had that kind of concentration, you might get a bit more push back from the regulators,” De Bever said. “That’s not on the table right now.” He doesn’t expect there to be any regulatory issues in the Vue deal.

Canada Pensions

Omers is one of Canada’s largest pension funds with more than C$61 billion ($60 billion) in assets. Alberta Investment has more than C$70 billion under management, according to the statement.

“Our combined ownership gives Vue the distinct advantage of patient capital and deep pockets for organic and acquisitive growth,” Mark Redman, the head of Europe at Omers Private Equity, said in the statement.

Doughty Hanson bought Vue in November 2010. The disposal is the second from its Doughty Hanson V fund after the sale of Norit, a maker of water-purification systems, the company said. The firm is in the process of raising about 2 billion euros ($2.6 billion) for its sixth buyout fund, Doughty Hanson VI. It will be the firm’s first fundraising since the death of co-founder Nigel Doughty in February 2012.

A pair of giant Canadian investors has bought a UK-based cinema group some two and a half years after their initial bid for the company.

The Alberta Investment Management Corporation (AIMCo) and the Ontario Municipal Employees' Retirement System (OMERS) and have agreed terms with private equity leader Doughty Hanson, the company which beat them to buy Vue Entertainment in November 2010.

The deal will see the Canadian duo commit £935 million to the acquisition, more than double the £450 million paid by Doughty Hanson, the company announced today.

To warrant this increased price tag, Vue Entertainment has more than doubled in size since the pension consortium missed out initially.

The entertainment firm has been expanded from owning and running 68 cinemas, offering 678 screens and sitting in third place in the UK sector in 2010, to operating 146 establishments with 1,321 screens.

In the period between the two deals, the entertainment company bought similar businesses in Poland and Germany, and shored up its prominence in the UK with the take-over of Apollo Cinemas last year, making it one of the largest in the world.

"I'm constantly building relationships globally because I believe in the power of trust-based relationships. A network of reliable, global partners will help AIMCo get the local knowledge of foreign markets it needs to succeed," the fund's Deputy CIO, Jagdeep Bachher, told aiCIO last year. He added that AIMCo should "become the first stop for companies and international institutional investors seeking a partner to help them become world class organizations."

Last week, OMERS was part of a consortium making its second bid on UK utility company Severn Trent. The firm rejected the approach, saying it undervalued its worth and today the consortium has appeared to give up its chasing of the firm.

Overall, EU theater goers bought 313 million tickets for European movies last year, a 12 percent jump on 2011, and European titles accounted for more than a third (33.6 percent) of overall admissions, a 5.6 percent increase.

That positive news, however, masks the major drops in EU countries suffering from the Euro crisis, particularly in the recession-wracked south. Admissions were down 10 percent in Italy, 6.7 percent in Greece and 12 percent in Portugal. In Spain, admissions fell 5 percent and would have been much worse without The Impossible, which earned more than $54 million locally, the best-ever performance by a Spanish title. Even France, home to Europe's largest theatrical audience, saw a substantial drop in ticket sales, with admissions falling 6.3 percent year-on-year, to 203.4 million.

On the plus side were Germany (4.3 percent increase), Finland (up 19.7 percent) and Romania (up 15.4 percent), with the U.K. holding steady as Skyfall made up for the lack of a Harry Potter title in release last year.

The UK’s biggest pension fund, the £39bn BT Pension Scheme, plans to increase its investments in inflation-proof assets by as much as £4bn over the next few years, paving the way for it to make more infrastructure investments.

The pension fund, like many others in the UK, is exposed to inflation because it must pay out benefits in line with rising prices. This year, the scheme reviewed its investments in negotiation with BT, and has decided to double its target for these assets from 15% of its portfolio to 31%.

The scheme’s 2012 report and accounts, published last week, show that as of December 31 it had an inflation-linked portfolio worth £8.4bn. This is about 22% of its total assets, more than its previous target but well behind the revised one.

Of that figure, £6.7bn is held in “UK public sector” assets, likely UK index-linked government bonds, which are a good match for pension-scheme liabilities. The rest is invested in other countries’ bonds, inflation-linked corporate debt and infrastructure.

Last year, the scheme handed its in-house fund manager Hermes a new mandate to invest in mature infrastructure assets that generate inflation-sensitive income, including renewable energy. This portfolio, managed by Hermes’s GPE division, was worth £730m at year-end.

UK pension funds, especially larger ones, are increasingly keen on acquiring infrastructure assets outright.

Last week, a consortium consisting of the Universities Superannuation Scheme, the UK’s second-biggest fund; Borealis, which is the infrastructure-management arm of the Ontario Municipal Employees Retirement System; and the Kuwait Investment Office, announced an improved bid of £5.3bn for UK water company Severn Trent.

Ten UK schemes, including BT’s, have also agreed to put up £100m each for a new industry-wide Pensions Infrastructure Platform.

A spokeswoman for the BT scheme declined to comment.

Tom McPhail, a pensions expert at Hargreaves Lansdown, the financial adviser, said: "The BT scheme is looking for greater certainty by 'buying out' its unknown future inflation liability in exchange for a fixed price now. In the process it is shifting that uncertainty on to the member, who will then bear the brunt of any significant inflation in the future.

"If you are in poor health and therefore unlikely to benefit from long-term inflation proofing, this could represent a good deal."

The threat of high inflation concerns trustees of UK defined benefit pension funds for a cardinal reason. They are bound by law to increase pensions in payment, and deferred pensions, in line with inflation, although the liability is often capped. So, when inflation jumps, so do pension fund outgoings.

Such fears may prove unfounded in some cases though, advisers say. This is because if rising inflation exceeds the cap that limits the inflation-matching liability of many pension funds, it can help funds reduce their liabilities.

For example, if the inflation rate rose to 7 per cent bond yields would also be likely to rise. If the cap on a pension fund was set at 5 per cent, the current value of its liabilities would fall as they would be discounted at a higher rate.

“The worst thing that could happen to a pension fund is deflation. If inflation is a bit ahead of the consumer price index or the retail price index rate, then pension funds with a cap wouldn't have to increase their pension payments by more than that," says Jeremy Tigue, manager of the Foreign & Colonial Investment Trust.

Nick Sykes, partner with the pensions consultants Mercer, says the relationship between the rise in inflation and the size of liabilities is complicated as the methodology on inflation-capping varies so much from one pension scheme to the next.

Generous schemes are most at risk, meanwhile, as some still offer pensioners protection against the full brunt of inflation rises. The effects of inflation on pension funds’ assets also have to be assessed, Mr Sykes notes. The array of asset classes in which schemes invest has widened since inflation was last a threat in the UK during the early 1990s, but that may not necessarily help.

Commodities are generally viewed as providing inflation protection, for example, but Mr Sykes discourages pension funds from investing in the asset class. “Long term, we’re unconvinced commodities produce an attractive return. They don’t offer an income stream,” he says.

Real estate, however, remains attractive. “We quite like it. Its returns are strong and it offers some inflation protection,” says Colin Robertson, global head of asset allocation at Aon Hewitt, who is just as negative as Mr Sykes on commodities.

If inflation were to soar to stratospheric levels however, Mr Robertson argues that it would hit asset classes such as equities and be a “net negative” for pension funds. Funds with inflation-linked liabilities also face problems as they tend to underhedge exposure to inflation. Having said that, one must also consider the possibility that inflation may peter out.

Neil Williams, chief economist for Hermes, which looks after BT’s pension scheme, thinks that unless demand returns, the pick-up in UK inflation – which is being driven by rising oil and food prices – may fizzle out in a few months. “For past inflation to guarantee future inflation you need to have strength in the labour market,” he says. “The tension in North Africa and the Middle East and the disaster in Japan have added more threats to the outlook for economic growth.”

Regardless of the consequences, it stands to reason that the volatility whipping through markets in the wake of the situation in Japan and the political upheaval in North Africa, is only encouraging pension funds to rachet up their efforts to hedge portfolios against inflation risks. “There's been a surge in demand for inflation-linked bonds and this suggests to me that the world has in mind an inflationary future,” says Mr Williams of Hermes.

Mr Robertson of Aon Hewitt, and Mike Smedley, a partner in KPMG’s pension practice, agree. “A large number of clients are in the process of putting on de-risking strategies or taking out the inflation or duration risks arising from their liabilities,” says Mr Robertson.

Mr Smedley adds: “We’ve seen a steady growth in the number of clients who are interested in buying inflation protection. But a lot of clients don’t want to pay for it at current prices.”

Historically, index-linked gilts and swaps are the conventional ways to hedge against inflation. Of the two, swaps, a type of derivative by which a scheme pays a fixed rate (over the length of the swap) and receives the retail price index yield from the counterparty bank, remain more popular as they allow managers to deploy, say, just 20 per cent of their capital to gain 100 per cent protection on their portfolios.

However, Robert Gardner, founder of Redington, a UK pensions consultancy, says both investments are now a “quite expensive risk lever” for pension funds to pull.

Desperate times require creative measures. In the past year, Mr Gardner notes that more pension funds have begun to invest in municipal libraries or supermarkets with long-dated leases that are linked to either the retail price index or the consumer price index. “The point to note is that people are looking at property investments via a fixed income lens,” he says.

Mr Smedley says some clients have bought into RPI-linked bonds issued by National Rail. Yet he remains cautious on more unusual methods of inflation proofing. “Schemes out there are trying to do quirky things. But it can be hard to demonstrate that the quirky things are a good match to protect against inflation,” he says.

World stocks were pummeled and the dollar slumped on Thursday as a sell-off on global financial markets in thrall to central bank stimulus accelerated.

European shares fell sharply in morning trading, dropping 1.3 percent after the second biggest fall in Japan's Nikkei in over two years left Asian shares at their lowest level of the year.

Heavy selling hit the dollar, which slumped 2 percent against the yen as investors spooked by the plummeting Japanese stock market unwound hedges. It fell as low as 93.90 yen, its lowest since April 4, giving back almost all the gains made since the Bank of Japan's aggressive monetary easing announced on that day.

The U.S. currency dropped to a 3-1/2 month low against the euro before a slight rebound left the common currency buying $1.3350.

The rout has been triggered by noises from the U.S. Federal Reserve, which meets next Tuesday and Wednesday, feeding into feverish uncertainty about the scaling back of its huge asset purchase program.

"The trend is still in principle a sell-off in markets, a sell-off in riskier assets on the expectations that the Fed might signal further readiness to maybe slow down the rate of purchases," said Daiwa Securities economist Tobias Blattner.

"So all eyes are on the FOMC meeting next week. There is very little else that matters at the moment"

In the debt market, German government bonds rose 40 ticks as investors headed for traditional safe-haven paper. The recent selling of euro zone periphery debt also resumed  as Italy also saw its borrowing costs rise at an of an auction of 3-year debt though yields at a parallel 15-year sale were little changed.

TRICKY TRANSITION

U.S. stock futures pointed to Wall Street starting in negative territory again after its recent falls.

Gold saw a second day of minor gains, but there was no sign of any rush to buy bullion, and with oil almost bang in the middle of its recent $100-105 range, commodity markets were largely devoid of the drama going on elsewhere.

Emerging markets were taking another pounding though, a pattern that has taken hold as the uncertainty about central bank stimulus has driven a global dash back to cash and core economies.

Emerging equities fell to 11-month lows and most emerging currencies remained under heavy pressure with the Indian rupee falling to a record low.

The punishing sell-off in Asian markets saw many of them plummet to multi-month lows as investors scrambled to recalibrate positions for a world with potentially reduced liquidity support.

Both the dollar/yen and the Nikkei fell below the Ichimoku cloud bottom for the first time since their rallies began in November, sending a strong bear market signal. The Nikkei also breached its 50 percent retracement from its November rise.

"If you look at it historically, there has never been a period when the Fed has started to take back stimulus that has left the markets untouched," said Hans Peterson, global head of investment strategy at Swedish bank SEB.

"And this time it is a bigger exercise. We have moved markets from 2009 to 2013 on stimulus and now we are trying to take a step into a world which is more driven by natural growth. That transition will not be easy."

Is Federal Reserve Chairman Ben Bernanke avoiding the word “taper” in order to temper expectations that the U.S. central bank will ratchet down its massive bond buying program? This is one view that’s been widely bandied about in recent days.

But then why is it that the Fed officials who are most eager to “taper” have pretty much stopped using the word, too?

The last time Dallas Fed President Richard Fisher used the “T” word in a public speech was in February. But there’s no evidence at all that he’s backing off from his support of the idea. He’s been adamant the Fed should not yank the punch bowl away (or, in his words, go from Wild Turkey to cold turkey) but should gradually reduce stimulus.

Likewise, Philadelphia Fed President Charles Plosser last used the word in a public speech two months ago. Since then he’s leaned more heavily on “dial back” or “gradually unwind” but still means the same thing. Another supporter of tapering QE3, Richmond Fed President Jeffrey Lacker, has similarly changed up his verbiage, but not his views.

In fact, the only top Fed official who regularly uses “tapering” these days is one who pretty much thinks it’s too soon to touch that $85-billion-a-month dial. “I’d like to see some reassurance that this (low inflation) is going to turn around before we start to taper our asset purchase program,” St. Louis Fed President James Bullard said earlier this week.

-- Is it the austerity, stupid? That giant sucking sound you hear is the government taking demand out of the economy. As you can see on the left axis above, total government spending -- that is, federal plus state and local -- as a percent of potential GDP has been on a steady downward trend since 2010. It's a three-act story of bad policy. First, the stimulus peaked, and then reversed prematurely; then, state and local governments began slashing budgets to balance them as they are required; and now, the federal government is cutting spending in the dumbest way Congress could come up with -- the sequester. Now, QE2 did manage to increase inflation despite some austerity, but there's more of it this time around. The chart above only shows total spending through January 2013; it doesn't include the sequester, or, for that matter, the tax side of austerity. Between the spending cuts and the expiring payroll tax cut, the fiscal contraction the past six months has probably overwhelmed any "money-printing".

But the mystery of our falling inflation rate should make one thing less mysterious: when the Fed will start tapering its bond-buying. The answer is not anytime soon. Yes, 5-year breakevens show that expected inflation is still close to target, but as long as actual inflation is so low, the Fed will not ease off the accelerator. That was Bullard's recent message, and he told me he'd like to see inflation get around its 2 percent target before he'd be comfortable reducing the Fed's monthly bond purchases.

Now the Fed just has to figure out how to increase inflation in an age of (bigger) austerity.

Despite this downbeat assessment of the European economic outlook, the ECB was not prompted to act at its last policy meeting. Nor was it prompted by the fact that core inflation in Europe is now down to barely 1 percent, around half the ECB’s inflation target of “close to but below 2 percent.” Instead, the ECB decided to keep its policy interest rate unchanged and it eschewed any notion of joining the Federal Reserve and the Bank of Japan in another round of quantitative easing.

More troubling than the ECB’s decision not to reduce interest rates is its seeming indifference to the fact that bank credit continues to be cut in the European periphery and that private sector borrowing costs in the periphery remain much higher than in Europe’s core countries. While the ECB recognizes this problem, it takes the view that the primary cause is a shortage of bank capital in the European periphery, which the ECB considers to be beyond its remit. The ECB also doubts the effectiveness of buying asset-backed loans of small and medium-sized enterprises in the periphery, as is now being recommended by an increasing number of private analysts.

A generous assessment of the ECB’s present passive monetary policy stance in the face of a rising risk of a European deflationary trap is that the ECB might be reluctant to be too bold at this stage in the German political cycle. Germany, which is the ECB’s primary shareholder and has a traditional antipathy to monetary policy activism, is scheduled to hold elections on September 22 and the ECB might not want to insert itself into that election.

Meanwhile, the German constitutional court is presently considering the merits of a petition claiming that the ECB’s Outright Monetary Transactions (OMT) program is inconsistent with the German constitution’s limits on the Bundesbank’s participation in that program. The petition points out that the OMT program envisages that the ECB could buy unlimited amounts of Italian and Spanish government bonds with maturities of up to three years in order to keep government borrowing costs for those two countries at reasonable levels. Perhaps, then, it is understandable that the ECB is taking the view that it might be better to wait for a more propitious moment in the German political cycle before risking a renewed German controversy on any new ECB policy initiative.

While discretion might be the better part of valor for the ECB, it is not without its costs. Absent bold ECB policy action to get bank credit flowing again and to reduce private sector borrowing costs in the European periphery, it is difficult to see how the periphery can avoid sinking ever deeper into economic recession in the months ahead. After all, the European economic periphery is still being required to implement budget austerity, albeit at a more moderate pace than in 2012, within the straitjacket of the euro. And it is being required to do so at the same time that its external economic environment is deteriorating and that the euro is appreciating against the currencies of Europe’s main trade partners.

The ECB’s present passivity in the face of a distinct deflationary risk could complicate the European debt crisis. A prolonged period of deflation would make the European periphery’s efforts to restore order to its public finances all the more difficult since it would increase its real borrowing cost. Given the fact that countries in the European periphery are flirting with deflation if not already experiencing it, the ECB would be ignoring the risk of a deflationary trap for the European periphery at its peril.

A clear lesson from Japan’s two decades of struggling with deflation is that a central bank pays a very high price for falling behind the policy curve. Hopefully, that lesson will not be lost on the ECB and it will become more proactive in its policy decisionmaking once the German elections are out of the way.

"[Fed] tapering is a big issue. I think for all economies - U.S., Europe, China, Southeast Asia - the fundamentals still go back to structural reforms," Robert Zoellick, Distinguished Visiting Fellow at the Peterson Institute for International Economics told CNBC Asia's "Squawk Box" on Tuesday.

He added that "The question will be as the Fed eventually moves away from the monetary easing policies, what will be the effect of the [withdrawal of the wall of money that's moved around the world?"

...Zoellick, who served five years as the president of the World Bank up until 2012, said there's been a big structural shift in emerging market economies, which used to depend on strong U.S. demand for their products.

"In the past when you had a U.S. recovery that boosted some of the exports... [Now] you've got a movement to more domestic demand - it's going be less export led growth, and that's obviously the huge story for China's change under the new leadership," Zoellick said, referring to the Chinese government's push towards consumption led-growth.

In Japan, recent monetary and fiscal policies that have spurred optimism in the economy could just be a "sugar high" unless the government really invests in the "so-called" third arrow of structural reforms, Zoellick said.

"The danger is in the past sometimes Japan just used currency devaluation to help its export sector, and when I worked with the Japanese 20 years ago... Japan never was really willing to open up its services market and other areas that would increase productivity - that's the third arrow," Zoellick said.

Researchers at Barclays Capital have looked at which assets are most sensitive to the Fed’s balance sheet, by dividing the change in the asset prices over periods of QE, by the change in the size of the Fed’s balance sheet. At present, markets are adjusting to the Fed’s balance sheet merely expanding more slowly than expected. At some point they will have to adjust to its outright shrinkage.

Since emerging-market equities and European and American high-yield bonds showed the greatest sensitivity to Fed balance sheet expansion, they could be expected to also fall most when it shrinks. Judged by how an asset deviated from its historical value during QE, Turkish equities and "defensive" stocks (those that do not move with the business cycle, like food) are most vulnerable (click on image).