Can Hedge Funds Survive Bernanke?

James Greiff of Bloomberg reports, Can Hedge Funds Survive Bernanke?:

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.

I take these articles on hedge funds with a grain of salt. Sure, most hedge funds are under-performing the broader market but that's hardly surprising since stocks have soared again this year and hedge funds are not long-only mutual funds (they too are under-performing equity indexes). Also, many hedge funds didn't read the macro environment right in the last few years and their bearish stance has cost them a lot of performance.

More importantly, the majority of hedge funds are not  worth paying 2 & 20 in fees. With or without Ben Bernanke, hedge fund Darwinism will continue to impact the industry. The institutionalization of the industry means that only the very best funds will be able to meet the increasingly stringent demands of institutional investors. 

It's also worth keeping in mind that while L/S equity hedge funds are struggling, fixed income hedge funds are growing. In fact, Bloomberg reports that hedge funds are bulking up on bond trading:

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.

I've already covered bankers jumping ship to hedge funds. The growth of debt hedge funds has been fueled in large part by the Fed's quantitative easing which has revived structured credit strategies. Just how well these funds will perform in the future remains to be seen now that bonds hear bubble echoes.

Also, the Fed isn't the only central bank engaging in massive quantitative easing.  I've discussed the seismic shift in Japan and how Abenomics revived global macro funds. But shorting the yen and going long Japanese equities has become a crowded trade and some are worried that Japan is the new Apple.

I don't know. All I know is that the tsunami of liquidity keeps propelling risk assets higher, making nervous investors even more nervous. Some old time traders think it's time to throw out your playbook, reminding us that even though the bears are right to look at the weak macro backdrop, bull cycles often don’t make any sense at all.

I've been warning my readers of a melt-up in stocks for the longest time and think multiple expansion will continue despite rumblings of a Fed pullback. Will a rotation occur out of defensives into cyclical sectors or will defensives be the new bubble? That remains to be seen. All I know is that as long as the music keeps playing, risk assets will go higher, forcing many funds to keep dancing despite their worries of what happens when the music stops.

Finally, I didn't go over top funds' activity in Q1 2013. Those of you who want to look into their top holdings can refer to the links in my Q4 2012 comment. Be careful, however, as the data is lagged and many of the top holdings are way overbought on a weekly basis and others are just languishing and not participating in the broader rally.

Below, Commonfund Hedge Fund Strategies Group CEO Nick De Monico discusses hedge funds and his investment strategy with Deirdre Bolton on Bloomberg Television's "Money Moves."

Ontario Teachers' Shifts Focus to Asia?

Armina Ligaya of the National Post reports, Ontario Teachers’ Pension Plan to open Hong Kong office:

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

Jim 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' put out this press release:

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.

Ontario Teachers' isn't the only (or the first) large Canadian fund opening up an office in Hong Kong. If you refer to the interview with Mark Wiseman, CPPIB's president and CEO, at the end of my comment on CPPIB's FY 2013 results, you will see the first foreign office they opened was in Hong Kong, not New York or London.

Does it make sense for these large funds to open offices in Asia and elsewhere? Yes and no. They can easily invest in large public and private market funds that already have offices in Asia but the truth is there are advantages to having eyes and ears on the ground to explore all opportunities in direct, co-investment and fund investments, as well as cultivate relationships with large Asian pension and sovereign wealth funds in the region.

As far as dialing back risk to deal with their demographic crunch, Teachers' has been shifting out of public equities into real estate, private equity and infrastructure over the last 15 years to dampen volatility but it also recently announced it is absorbing more investment risk. And while investing in emerging markets is volatile, there is no question that over the long-term this region will grow while the developed world struggles with low growth and high debt.

Finally, there was another article that caught my attention. Barry Critchley of the National Post reports that debt financing by pension funds is a steadily growing business:

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 might wonder why large Canadian pension funds are engaging in debt financing but if the conditions are right to issue debt and they have the AAA balance sheet to borrow cheaply, why not borrow to fund investments? The increase in leverage is moderate and hardly something to be concerned about.

Below, Reorient Financial Markets' Uwe Parpart discusses the outlook for the Chinese economy and Federal Reserve monetary policy with Susan Li, John Dawson, Rishaad Salamat and David Ingles on Bloomberg Television's "Asia Edge."

Portugal Plunders State Pension Fund?

John Geddie of the International Financing Review reports, Portugal plunders pension fund to tackle debt cliff:

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.

The use of state pension funds to ease financing needs is controversial but some of the weakest members in the eurozone simply don't have any other option. Struggling with huge debt, they are resorting to tapping the state's pension to address their debt woes, hoping growth will finally kick in and markets will remain favorable so they they can return to regular auctions in the coming months.

Europe remains the biggest obstacle to a strong global recovery.  The focus on austerity in periphery economies has led to a deflationary contraction which risks submerging eurozone into a protracted period of economic stagnation or worse still, a drawn out depression which could easily spread throughout the world.

The FT reports Portugal’s top bankers have called on Europe’s leaders to stop “playing with fire” and moderate their stance towards the eurozone periphery, or risk instilling alarm among bank depositors in future. They argue that Europe's handling of the Cyprus crisis has increased nervousness across the eurozone to dangerous levels.

With Portugal's unemployment rate hitting 18%, it's no wonder most Portuguese are rejecting the latest draconian measures to shore up their economy. Austerity "too fast and too deep' has left Portugal's economy staggering and the political backlash is understandable.

In my opinion, the ECB will have little choice but to follow the Fed and Bank of Japan into massive quantitative easing. It's not a matter of if but when. It's worth noting that European shares, including those of the periphery economies, are rallying, tracking their U.S. counterparts:

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.

I simply can't understand why the ECB won't continue cutting rates and taking a more aggressive stance to combat the ravages of fiscal austerity. For now, global liquidity is very strong and investors in search of yield, including Japanese pensions, are helping drive yields on European sovereign debt to their lowest level in years and European junk bond yields to record lows. This is adding to fears of a global bond bubble but it's also bolstering  the corporate and financial sector, which will help spur economic growth.

But monetary policy and the global liquidity tsunami will not suffice to address deep structural problems plaguing labor markets in eurozone's periphery and core economies. Below, Bloomberg Europe Editor David Tweed reports from a conference in Madrid, Spain on finding solutions to the growth of youth unemployment in Europe. He speaks on Bloomberg Television's "The Pulse."

And Bloomberg's Niki O'Callaghan reports on Europe's creeping comeback, discussing the surge in Portugal's exports is signalling an emerging recovery.

I remain cautiously optimistic on Europe but worry that the recovery is fragile and can easily come to a halt if policymakers don't tackle growth in a more forceful way. Unless growth figures into the equation, plundering state pension funds will do little to address the ongoing debt crisis plaguing eurozone's periphery economies. 

Japanese Pensions Moving Into Alternatives?

Eleanor Warnock of the WSJ reports, Japanese Pensions Moving Into Alternatives Overseas:

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.

The seismic shift in Japan is driving the change in asset allocation among Japanese pensions. Last October, the country's main pension, the GPIF, signaled it was shifting into alternatives and others are now following suit.

Who benefits from all this liquidity? Obviously, U.S. and global stock and bond markets. I've discussed this in a recent comment covering why bonds hear bubble echoes. Who else benefits from the unleashing of this liquidity? Global hedge funds and private equity giants looking to capitalize on distressed debt opportunities across the world. Real estate as an asset class will also benefit, bolstering its already prominent status among pension portfolios.

Investors need to beware, however, as all this liquidity will fuel the global bond bubble, lead to multiple expansions in global stock markets and lead higher multiples and much pricier deals in private market assets. As Leo de Bever told me, everyone is riding the liquidity wave but once the music stops, it will be ugly.

Not all pensions are increasing risk. In fact, British and European pensions are cutting risk. Andrew Rummer of Bloomberg reports, U.K. Pension Funds Cut Equity Allocations as Stocks Rally:

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.

Of course, these pensions are also shifting into alternatives so they too are taking on more illiquidity risk. This can come back to haunt them if there is a major dislocation in global markets but right now global pensions don't have much of a choice but to diversify into alternatives.

Below, Bill Gross, co-chief investment officer at PIMCO, talks about the outlook for bond and stock markets and investment strategy. Gross, speaking with Erik Schatzker and Sara Eisen on Bloomberg Television's "Market Makers,” also discusses Federal Reserve and Bank of Japan policies. I too see bubbles everywhere and think we are still in the early innings despite rumblings of a Fed pullback.

NY and NJ Pensions Recover From Crisis?

Elise Young of Bloomberg reports, N.J. Pension Fund Posts 13.31% Return Fiscal Year to Date:

New Jersey’s public pension fund returned 13.31 percent over the ten months of the fiscal year that began July 1, boosted by stock gains.

Domestic equities in the fund’s portfolio returned 20.52 percent through April 30, while non-U.S. equity gained 24.58 percent. The fund’s assets are valued at $75.3 billion, up from $71.8 billion a year earlier.

The total return missed the fund’s 14.54 percent benchmark, partly because of a reporting lag from alternative investments such as hedge funds. The return may be as much as 14 percent, according to a report by Tim Walsh, director of the state’s investment division. Treasuries and Treasury inflation-protected bonds, or TIPS, underperformed equity and credit markets, while emerging market exchange-traded funds also hurt performance, he said.

“We continue to watch markets, we continue to diversify, we continue to try to make the best decisions we can, even in a volatile world, on behalf of the pension-fund beneficiaries,” Bob Grady, chairman of the State Investment Council, said at a meeting in Trenton today.

New Jersey’s seven public-employee pensions cover more than 780,000 working and retired teachers, police officers and government workers. The funds, minus one for police and firefighter mortgages that are reported on a lag, gained 1.78 percent in April.

The Division of Investment is responsible for the investment management of the seven pension funds that comprise the New Jersey Pension Fund and the State of New Jersey Cash Management Fund. The Director's monthly investment reports are available here and the latest annual meeting presentation is available here.

The results year to date reflect strong returns of U.S. and foreign equities. The underperformance relative to benchmark is because of a reporting lag from alternative investments which include private equity, real estate, and hedge funds (see my last comment on CPPIB's FY 2013 results to understand how reporting lags between alternatives and public markets make yearly comparisons to benchmarks obsolete).

Overall, the results are excellent, in line with other large U.S. pension funds like CalPERS which returned 13% in 2012 on strong gains in public equities. New York state's pension fund recently announced that it reached a record $160B:

The New York pension fund for state and local government workers has topped $160 billion after reporting a 10.4% return on investment for its last fiscal year, the state comptroller's office reported Monday.

The Common Retirement Fund's estimated value was $160.4 billion at the end of March, an all-time high for the fund that pays benefits to more than 413,000 retirees and beneficiaries, said Comptroller Thomas DiNapoli, its trustee. It has now restored all $44 billion lost during the recession starting in 2008 and added $6 billion more, largely from rebounding stock prices.

"It remains well-positioned for growth as the financial markets continue to gain strength," DiNapoli said. The 2014-2015 fiscal year starting next April will be the last with higher employer contributions required reflecting the recession losses, he said.

However, employer contribution rates will rise again before declining. The average employer contribution rate rose this year to almost 21% of salary for most public workers and nearly 29% for police and firefighters.

"We have one more year of rate increases that local governments will have to pay," DiNapoli said. The increase, based on an actuarial study, will be announced in August and should be smaller than recent increases, he said.

The fund had 36% of its assets in domestic stocks, returning 14.5% for last year, and nearly 14% in international equities, returning 9.5%, according to the comptroller's office.

Its fixed-income investments, 28% of the portfolio, returned 4.9%. Real estate, accounting for 7% of the investments, returned 11%.

Private equity, composing almost 9% of the portfolio, returned almost 12%.

The remainder included global equities, returning 13.9%, and hedge funds returning nearly 8%.

"We have had movement away from public equities because of volatility in the stock market," fund chief investment officer Vicki Fuller said. An allocation plan established in 2009 calls for reducing combined domestic and international equities, now accounting for 50% of the portfolio, down to 43%, she said.

They are also restructuring their operations with more emphasis on staff performing due diligence and underwriting on investments and less on outside consultants, Fuller said.

The fund includes almost 650,000 employees with 82% currently working, the comptroller's office said.

The lesson of 2008 for these pensions was to keep their long-term view in equities but also start diversifying away from public equities into alternative investments. Will this strategy work? If they can internalize the due diligence and negotiate hard on terms, cutting costs and minimizing fees in private equity and hedge funds, the added diversification should increase returns and lower the volatility of their funds over the long-run.

Are there risks with alternatives? Of course, especially in this environment of ultra low interest rates where cheap money is flooding the system in search of higher yields. The hardest part is knowing when to back out of deals and funds because you think they're too risky/ pricey and not worth taking on more illiquidity risk.

Even CPPIB, which enjoys a much better liquidity profile than other large funds, is showing concerns over the current environment in private markets and they think deals are poised to taper off this year. Another fund that enjoys very strong liquidity is PSP Investments, which recently purchased Hochtief's airport unit in a direct deal worth $1,4 billion.

But CPPIB and PSP Investments are relatively young organizations with strong cash flows for many years to come. They're in the position to take on illiquidity risk but even they are very selective in the funds, deals and approach they take when investing in illiquid asset classes.

Below, Timothy Walsh, director of the Division of Investment for New Jersey's pension fund, and Bob Rice, managing partner at Tangent Capital Partners, talk about investment strategies and alternative assets. They speak with Deirdre Bolton on Bloomberg Television's "Money Moves."

CPPIB Up 10.1% in FY 2013

Janet McFarland of the Globe and Mail reports, CPP fund returns top 10 per cent:

The Canada Pension Plan fund rode a wave of strong gains in foreign stock markets to push its investments up by 10.1 per cent last year and boost its assets to $183-billion.

While bonds and Canadian equity holdings posted slower growth in the year ended March 31, the Canada Pension Plan Investment Board, which manages the CPP’s assets, said its $64-billion portfolio of foreign equities had a stellar year.

Private equity holdings in foreign countries earned 17 per cent for the year, while publicly traded stocks in foreign countries posted 13-per-cent growth.

“That strength in global equity markets was the primary factor driving our solid returns for the year,” said Eric Wetlaufer, CPPIB’s head of public market investments.

The CPPIB’s overall returns were typical for a Canadian pension plan last year. A survey by RBC Investors Services Ltd. found that pension plans earned an average of 9.4 per cent on their investments in 2012, with the giant Caisse de dépôt et placement du Québec earning 9.6 per cent for the year ended Dec. 31, and the Ontario Municipal Employees Retirement System earning 10 per cent.

Over the past year, CPPIB has been threatening the Caisse’s long-held title as Canada’s largest investment fund. It has been difficult to directly compare the two fund managers, however, because they have different year ends, with the Caisse reporting assets of $176-billion as of Dec. 31, and CPPIB disclosing its assets hit $183-billion as of March 31, up from $162-billion a year earlier.

CPPIB said $5.5-billion of its asset growth in the past year came from net CPP contributions by employers and plan members, while $16.2-billion came from investment gains.

Chief executive officer Mark Wiseman told reporters Thursday the fund had “an excellent” year, but said his focus is not on annual returns but on an extremely long-term investment strategy to cover CPPIB’s long funding obligations.

Mr. Wiseman said CPPIB plans to become a public advocate for long-term investing around the globe, saying funds like CPPIB with a “natural multi-generational nature” don’t get enough credit for their beneficial impact on the economies.

By investing in companies for decades and funding innovation and growth, long-term investment funds spur long-term economic development, he said. Pension funds also act as a “shock absorber” during times of down markets when they become big buyers of stocks to maintain their investment weightings, he argued.

“You’re going to see us becoming increasingly vocal in encouraging market participants to adopt a more long-term lens, actually looking at value of stocks and not just looking at a stock as something that goes up and down on an individual day,” he said.

Mr. Wiseman said his proudest achievement in his first year as CEO of the fund is the 87 deals in 11 countries that CPPIB completed last year, including 36 that were worth more than $200-million each.

But André Bourbonnais, head of private investments, said deals appear poised to taper off this year as many more competitors are looking for bargains with plenty of available cash and cheap credit to fund their investments.

“If the environment remains as it is today, we’re going to be very selective,” he said.

The chief actuary of Canada has affirmed that the CPP is sustainable over the next 75 years if it earns an average of 4 per cent real annual returns after inflation. CPPIB said Thursday its 10-year real rate of return after inflation is 5.5 per cent, while it’s five-year rate of return is just 2.4 per cent, due mostly to large losses in fiscal 2009 when financial markets collapsed and CPPIB posted a 19-per-cent loss for the year.

CPPIB put out a press release going over their fiscal 2013 results, providing fiscal year highlights of investment activity in public and private markets. You should also take the time to carefully read the Annual Report 2013 as it contains a lot more details.

The portfolio returns by asset class are available below (click on image):

The returns of every investment portfolio were positive. The big returns came from foreign public and private equities, up 13.2% and 16.8% respectively, but real estate and infrastructure also delivered solid results, up 9.2% and 8.8% respectively. Other debt, which I think is private debt, was up 15.1%.

The total Fund return in fiscal 2013 includes a loss of $348 million from currency hedging activities and a $1,414 million gain from absolute return strategies, which are not attributed to an asset class.

During fiscal 2013, CPPIB completed 87 deals in 11 countries that CPPIB, including 36 that were worth more than $200-million each. This alone blew me away. The due diligence on these huge deals and presenting them to investment committees and the Board for approval takes an enormous amount of work. These deals are complex, costly and have to be analyzed in detail to understand all the risks involved.

CPPIB's turnaround time to complete these deals is incredible, proving to me they run a very tight operation and are properly staffed to keep up such a breakneck pace. However, André Bourbonnais, head of private investments is right, if the environment remains as it is today, they will have to be a lot more selective.

One thing I know is that CPPIB has relationships with the very best private and public funds throughout the world and it has opened up offices in Asia and South America to capitalize on new opportunities.

As far as Mark Wiseman, CPPIB's President and CEO, he is right to extol the benefits of the long-term view:

Whether they like it or not, investors and company boards globally are going to hear a lot more from Canada’s biggest pension fund on the benefits of long-term thinking.

CPP Investment Board has a mandate to identify investments that earn returns over many years to help cover the future retirement benefits of Canadians, so the fact that it takes a long-term investment view isn’t surprising. But Mark Wiseman, chief executive of the 183.3 billion Canadian dollar ($180.2 billion) fund, had a broader message Thursday for corporate boards and investors–that a pervasive focus on short-term returns could jeopardize the global economic outlook.

Mr. Wiseman likely isn’t about to become Canada’s version of Bill Ackman, the brash U.S. activist investor who last year successfully agitated to replace much of Canadian Pacific Railway Ltd.'s board and install a new chief executive. But he’s speaking out publicly about the merits of a long-term investment horizon.

Currently, “you will see” companies decide against an investment despite its merits to ensure they meet quarterly profit numbers, Mr. Wiseman told Canada Real Time.

But that can be a “terrible decision for shareholders and a terrible decision for the overall economy,” if jobs that could have been created are not, he said.

Last month, CPPIB was part of a group of big institutional investors that opposed a $17 million pay package for Barrick Gold Corp.'s new co-chairman, John Thornton. Shareholders ultimately voted against the miner’s executive-compensation proposals, but that vote was non-binding.

Next week, Mr. Wiseman will speak to Canada’s Institute of Corporate Directors and he said he plans to discuss the importance of long-term thinking for boards.

The executive believes CPPIB and other multigenerational pension funds can make a particular difference beyond their own returns, through investments in infrastructure, private equity and real estate.

These types of investments over time help generate jobs, innovation and overall growth, Mr. Wiseman said. But many investors don’t have the capital that these asset classes often require, or are unwilling to risk an investment that can’t quickly be sold if necessary. In addition, the complexity of arranging and financing these projects is often a deterrent.

CPPIB’s large size, significant resources and long-term investment horizon allow it to overcome these hurdles. And those same qualities allow CPPIB, and funds like it, to act as “shock absorber(s)” for the global economy, Mr. Wiseman said. That was the case during the global credit crisis, when they were able to buy assets other investors were forced to sell, he said.

Mark is right, companies need to think long-term and pension funds have a much longer investment horizon. Their results can't solely be judged on any given year.

Why is it important to understand the long-term view, especially when it comes to large pension funds investing in public and private markets? Look at CPPIB's performance against public market benchmarks in the press release:

CPPIB measures its performance against a market-based benchmark, the CPP Reference Portfolio, representing a passive portfolio of public market investments that can reasonably be expected to generate the long-term returns needed to help sustain the CPP at the current contribution rate.

In fiscal 2013, total portfolio returns closely corresponded to the CPP Reference Portfolio with $204 million in gross dollar value-added. Net of all operating costs, the investment portfolio returned negative $286 million in dollar value-added.

“We have strong conviction that our private market assets will outperform the public markets equivalents of the CPP Reference Portfolio over the long term,” said Mr. Wiseman.“ This result will, however, not necessarily be demonstrated in the short term. Particularly when public markets have rapid moves up or down, our active private market strategies may show short-term underperformance or overperformance vis-à-vis the CPP Reference Portfolio, which does not accurately reflect our long-term value-add expectations for these strategies.”

Given our long-term view, we track cumulative dollar value-added performance since the inception of our active management strategy in fiscal 2007. The cumulative outperformance added $3.1 billion to the CPP Fund net of all operating costs.

Again, 87 deals in 11 countries,  including 36 that were worth more than $200-million costs a lot of money to set up in the short-run, but once these deals start realizing significant gains over the long-run, these costs will be recuperated and the CPP Fund will benefit from these transactions. That is why you can't just look at the negative $286 million in dollar value-added for fiscal year 2013 and jump to any conclusions.

More importantly, as stated in the press release, public markets ran up in the first quarter of 2013, so the CPP Reference Portfolio took off in Q1 while private markets which make up roughly 38% of the Fund are appraised at the beginning of the calendar year. This was the primary reason behind the negative value-added over CPPIB's fiscal year which ended on March 31st. If public equities tanked in Q1, they would have showed considerable added-value over the CPP Reference Portfolio but again, this is meaningless on any given fiscal year. That is why compensation is based on four-year rolling returns and why  it's best to look at cumulative dollar value-added performance net of all operating costs since inception of the active management strategy and forget yearly fluctuations in value-added.

Ultimately, the only thing that counts is the cumulative dollar value-added performance since inception of active management, net of all operating costs, and that is how you should properly judge any pension fund. The short-term comparisons to benchmarks are detrimental and just silly for these large pension funds, and I must confess, I've fallen into this trap in the past listening to my buddies in public markets. When you have significant investments in private markets, you need to look well past a year or two of value added.

Below, you can view the long-term results of the CPP Fund (click on image):

A 7.4% return over the last ten years is solidly above their actuarial target. And if Mark Wiseman and senior managers at CPPIB are right in their conviction that private market assets will outperform public market equivalents of their CPP Reference Portfolio, they will add a lot of value over their benchmark, significantly bolstering the Canada Pension Plan.

Let me end by congratulating Mark Wiseman, the senior managers, and all the employees at CPPIB for their outstanding work and delivering another year of solid results. When you hear about reasons to go slow on expanding C/QPP or how C/QPP expansion is bad news for Canada, you should be very weary and concerned. If we want to improve our retirement system, we need to realize the enormous benefits these large public pension funds have over mutual funds and get on to expanding the CPP and QPP.

Below, Mark Wiseman speaks with Reuters' Chrystia Freeland from the World Economic Forum in Davos, January 24, 2013. He discusses CPPIB's long-term view, the shift into private market assets, the geographical diversification into Asia and South America, and the introduction of new groups looking into drug royalties and timberland.

Just like Ron Mock, his former colleague who was just named OTPP's next leader, Mark is brilliant and genuinely nice. Canadians are very lucky to have him at the helm of the CPP Fund and I share his conviction that the Fund will realize material gains in private market assets around the world over the long-run.

Is Real Estate The Best Asset Class?

Barry Critchley of the National Post reports, After 20 years, real estate as part of pension funds still solid:

Two decades on, Stan Hamilton and Robert Heinkel, both from the University of British Columbia, are working on a revised edition of what can be considered to have been a game changing book about pension fund management.

In 1993, the two finance professors and trustees of the faculty pension fund, penned a 165-page book, The Role of Real Estate in a Pension Portfolio. One of the key conclusions: “Having considered the liquidity and management issues relating to real estate, we conclude that real estate should compose between 5% and 15% of the pension portfolio.”

The two – Heinkel is still at it while Hamilton has retired – argued real estate ”is the only asset class that reacts significantly and positively to expected inflation changes.”

Reached Tuesday, the day after a column about the Canadian arm of LaSalle Investment management launching its fourth institutional real estate fund since 2003, Hamilton, said in the early 1990s it wasn’t that common for pension funds to give an allocation to real estate.

By his estimates, about 4% of the industry’s $250-billion in assets was in real estate — or about $10-billion in total.

“In the main it was really insignificant. The vehicles were not always as convenient as they might be,” said Hamilton. By 2011, according to Canada’s Pension Landscape Report, pension funds had doubled their allocation to real estate to 8.9% — or almost $100-billion.

Consulting firm API Asset Performance Inc. said its clients average an overall weight of 5.4% for real estate but it rises to 11.6% when only those with a dedicated real estate portfolio are considered.

Hamilton, as with Heinkel, is too modest to take credit.

“Maybe we were lucky with our timing,” said Hamilton, noting the growth of REITs, the rise of institutional pools of capital dedicated to real estate, the expansion of new ways to invest, and the further development of specialist real estate managers, has meant “the share of pension funds that has gone into real estate has changed quite significantly.

“It has changed dramatically,” said Hamilton, noting that some of the larger pension funds have more than 10% of their assets invested in real estate. A short while after the book, the UBC Pension Plan gave a major allocation to real estate.

The two made the argument for real estate largely on the grounds of portfolio diversification. “It was a great diversifier and fits into a portfolio. We never tried to sell it on rates of return because we thought that was a fool’s game, said Hamilton. “We said ‘if you approach it properly and not going for the hype on rates of return, it is a valuable tool.’ That message resonated,” said Hamilton, now chair of the B.C. Arts Council.

But real estate is different: it has to be considered as a long term investment. While owing REITs wasn’t similar to owning real estate directly, Hamilton said “we saw reasons to go up to 15% in real estate, but because of liquidity we recommended that mid-and large sized pension funds consider going to 10%.”

And 10% is an allocation that Hamilton feels is suitable today. “That story rings true [but] if you have any liquidity concerns, going much above 10% is probably uncomfortable.”

Along the way real estate has enjoyed a change in status: once considered an alternative asset, “it is now more like a mainstream investment,” said Hamilton.

Every pension fund should have an allocation to real estate. This is arguably the best asset class in terms of risk-adjusted returns over the last 20 years.

But professor Hamilton is right, pension plans with liquidity concerns have to gauge their liquidity risk and adjust their weightings accordingly. The same can be said of private equity and infrastructure, two other popular illiquid asset classes.

There is a debate going on right now on illiquidity premiums. Some very sharp pension fund managers feel that pensions are taking on too much illiquidity risk and market valuations do not compensate them for taking on this risk. Many pensions learned the hard way all about liquidity risk during the 2008 financial crisis. When they needed liquidity the most, it wasn't there, forcing them to sell public market assets at distressed prices.

Still, pension funds remain undeterred. They're picking up their real estate activity and even taking on more opportunistic risk. Craig Karmin of the Wall Street Journal recently reported, Funds See Opportunity in Real Estate:

A glitzy Manhattan real-estate crowd gathered in March to join Barry Sternlicht, chief executive of Starwood Capital Group, at a party celebrating the launch of condo sales at the Baccarat Hotel & Residences, a new development across from the Museum of Modern Art.

The 50-story glass tower, expected to open in 2014 and feature a five-star hotel and Baccarat chandeliers in each condo, is the sort of development rarely seen in the years after the financial crisis. But riskier projects are starting to move forward again, thanks in part to a resurgence of so-called opportunity real-estate funds.

These private-equity funds invest in riskier real estate, such as half-empty office buildings, distressed properties weighed down with debt, or pricey new construction that must find well-heeled buyers to profit. The Baccarat, which is being developed by Starwood and Tribeca Associates for $400 million, is counting on selling condos for as much as $60 million each.

For most of the downturn, these real-estate funds struggled to raise money because their main source, big pension funds, were risk-averse and still licking their wounds from when these bets went wrong. The California Public Employees' Retirement System, the largest U.S. public fund with $263 billion, lost nearly half the value of its real-estate portfolio between July 2008 and June 2009—more than $10 billion.

But these days, many pension funds are reconsidering—or trying for the first time—riskier real estate in an effort to boost returns at a time of low interest rates. These funds project up annual returns as much as 20%.

A pension fund has to "take more risk to get double-digit returns," says Bob Jacksha, chief investment officer of the New Mexico Educational Retirement Board. His $10 billion fund recently committed $50 million to Crow Holdings, which manages opportunity funds.

Pension funds also have been emboldened by the steady rise of commercial-property values since 2009 and a winnowing of some of the worst-performing funds. The economy shows signs of stabilizing after a rough period, and borrowing for real estate is cheap with rates so low.

"Many prices have fallen quite a bit, so there's now a lot of opportunity," says Edward Schwartz, a principal at real-estate consultant ORG Portfolio Management. But some pension funds, he adds, "also have short memories."

In recent months, a public-employees fund in Texas, Kentucky's main public fund and an Oklahoma City police fund all have made commitments to opportunity funds.

Such funds raised about $25 billion in 2012, nearly double the amount in 2009, according to research firm Preqin. Nearly half of pension funds and other large investors allocating to real estate expect to make commitments to opportunity funds in the next 12 months, Preqin said.

Private-equity giants KKR & Co. and TPG Capital also are in the early stages of raising their first real-estate funds, which will focus on riskier investments, say people familiar with the matter. Starwood last month closed a $4.2 billion fund, well ahead of its initial $2 billion to $3 billion target, say people familiar with the fund. Brookfield Asset Management has raised about $2.8 billion for an opportunity fund that is targeting $3.5 billion.

During the downturn, many pension funds largely spurned risk and focused their real-estate investments on the safest, well-leased properties in the healthiest markets. But now they are straining to make these strategies work as high demand for these properties drives up prices.

Calpers acknowledged last month that the shift it started in 2011 from risk and toward more-stable property investments is proving tougher than it expected. It is becoming "hard for Calpers managers to make [real-estate] investments in which they can reasonably expect to generate returns in excess of" liabilities, the pension's real-estate consultant wrote the Calpers board.

While some opportunity funds aim for gold with new projects, others try to profit by turning around troubled buildings. Blackstone Group, which recently raised a record $13.3 billion opportunity fund, last month bought London's Adelphi Building for about £265 million ($412 million). That is a 19% discount from what the building fetched in 2007, but with a tenant occupying half the building departing, Blackstone will have to find a replacement.

Pension-fund investors embracing opportunity funds say they know it isn't a risk-free bet.

"The biggest risk, of course, is the downturn in the economy," says Steven Snyder, chief investment officer for the Oklahoma City Police Pension & Retirement System, who made two recent commitments to opportunity funds. "That could be a negative for our investment."

Mr. Schwartz of ORG says he has put clients such as the Texas Municipal Retirement System and state funds in Maine, Indiana and Kentucky in opportunity funds in part because these funds responded to investor complaints that went beyond poor performance.

I recently covered why the Caisse is betting on multi-family real estate. The Caisse's real estate division, Ivanhoé Cambridge, is one the best institutional real estate investors in the world, which is why it's well worth tracking their activity. They manage over $25 billion, have the internal expertise to go direct, co-invest with top funds as well as do deals with other large pension and sovereign wealth funds throughout the world.

I've also covered the pickup in real estate distressed debt investing, part of the reason behind the return of private equity giants. Why are some of the best funds ramping up their activity in this sector? It's obvious they see tremendous opportunities and are actively looking to capitalize on distressed properties, work them to sell them at much higher multiples.

CPPIB has been very active in real estate deals, partnering up with GE Capital Real Estate (GECRE) to invest in central Tokyo office properties, betting on a bottom in that market. CPPIB also formed a new 50%/50% joint venture with Hammerson to acquire a 33.3% stake in Bullring Shopping Centre for £307 million from the Future Fund.

Finally, while real estate is a stable asset class, Canadian pension funds are increasing their direct investments in infrastructure, an asset class with a much longer investment horizon than real estate and private equity. This is all part of asset-liability matching, finding assets with long durations which can deliver the targeted actuarial rate of return.

PSP Investments recently bet big on airports in a deal that was attractively priced and will likely pay off nicely for their members as the global recovery takes hold. It also owns timberland stakes throughout the world, including New Zealand, where they own properties with Harvard Management Company and the New Zealand Superannuation Fund.

Below, Walker & Dunlop CEO Will Walker discusses commercial real estate on Bloomberg Television's "Market Makers." And Chaim Katzman, chairman of Gazit-Globe Ltd., talks about their success formula in commercial real-estate market. Lastly, Thomas Shapiro, president and chief investment officer of GTIS Partners, talks about the outlook for investment in the Brazilian and U.S. real estate markets.

Ron Mock Named OTPP's Next Leader

Madhavi Acharya-Tom Yew of the Toronto Star reports, Teachers’ pension plan names successor:

Ron Mock will take over as president and chief executive officer of the Ontario Teachers’ Pension Plan when Jim Leech retires at the end of the year, OTPP said Tuesday.

Mock is currently senior vice-president of fixed income and alternative investments at the fund, which manages around $129.5 billion in assets.

He said in an interview that he looks forward to working closely with Leech through the transition period.

“[Jim] is a very successful leader and he’s had an unbelievable term here. He has led the organization on so many different fronts and I will have the luxury of being beside him for the next seven months while we transition through this,” Mock said.

“Our focus has been and will be on our pension plan members.”

Mock joined Teachers’, as the pension plan is known, in 2001 as director of alternative investments.

“Ron brings the ideal combination of experience, knowledge and leadership acumen to the CEO role at this high performance organization,” Eileen Mercier, chair of the pension plan said in a release.

“We have every confidence that he will lead the organization to new levels of success as CEO, as Jim has and Claude Lamoureux did before him.”

Leech is retiring Dec. 31 after more than 12 years at Teachers, the last six as CEO. A selection committee of the board has been in preparation for succession since 2011, the pension plan said.

“I could not be more pleased with the board’s decision to appoint Ron,” said Mr. Leech.

“Ron has a reputation for collaboration and team building, balancing current needs with a view to future possibilities. Plan members, sponsors, our employees and our investment partners all will benefit from his leadership of Teachers’.

Leech joined Teachers’ in 2001 and became chief executive officer in 2007. He is credited with steering OTPP, the largest single-profession pension plan in Canada, through the Great Recession and record-low interest rates.

OTPP, which administers the pension of 303,000 active and retired teachers in Ontario, saw a 26 per cent jump in retirements in 2012.

It posted a return of 13 per cent in 2012. Though the fund has a shortfall of $5.1 billion, it was 97 per cent funded as of the end of January.

Janet McFarland of the Globe and Mail also reports, Ron Mock ascends to the top of Ontario Teachers' Pension Plan:

Ron Mock has completed his rise from the ashes of collapsed hedge fund firm Phoenix Research and Trading Corp., putting a controversial failure behind him to become the new chief executive officer of the Ontario Teachers’ Pension Plan.

Mr. Mock, 60, was named Tuesday as the successor to Teachers CEO Jim Leech, who is retiring at the end of the year. Mr. Mock is currently Teachers’ senior vice-president of fixed income and hedge funds, heading the largest of the pension plan’s six major asset management groups.

The appointment makes Mr. Mock just the third CEO to lead the $130-billion fund since its creation in 1990 to manage pension assets for 303,000 current and retired Ontario teachers. The fund was initially headed by Claude Lamoureux, who was succeeded in 2007 by Mr. Leech.

“I am very excited, because it’s not every day that someone gets to lead an organization like this,” Mr. Mock said in an interview. “Teachers is a leader in this field, and to be the one chosen to lead it, I’m thrilled.”

Before joining Teachers in 2001, Mr. Mock was CEO and co-founder of Phoenix Research and Trading, a hedge fund management company that collapsed in 2000 with losses of over $125-million (U.S.).

The failure came after Mr. Mock discovered bond trader Stephen Duthie had secretly taken a massive and unapproved $3.3-billion position in U.S. benchmark Treasuries in 1999.

Mr. Mock notified the Ontario Securities Commission about the discovery and reached a settlement agreement with the regulator in 2003, accepting a six-year prohibition from acting as a director or officer of a public company, and a reprimand after acknowledging he did not do enough to supervise Mr. Duthie’s trading. The OSC settlement said Mr. Mock’s supervision was “wholly inadequate” and the trading scheme could have been detected with scrutiny.

Mr. Duthie, meanwhile, received a 20-year ban from trading securities or acting as a director or officer of a company after an OSC hearing panel ruled he mispriced and hid a huge volume of unauthorized trading. The panel ruled his conduct was “duplicitous.”

Mr. Leech said in an interview the Teachers board considered Mr. Mock’s role at Phoenix, but felt he had broken no laws and had been a highly respected leader in his 12 years at Teachers.

“Anybody who has been in the securities business for 25-plus years is going to have some scars – Lord knows, I’ve got mine,” Mr. Leech said. “The name of the game is to make sure you learn, and he learned that the buck stops at the top.”

One of the victims of the firm’s collapse was Teachers itself, which lost $10-million on investments, Mr. Lamoureux said.

Mr. Lamoureux, who was Teachers’ CEO at the time, said he was initially astonished when another Teachers executive suggested the pension plan hire Mr. Mock in its hedge fund division.

But after conducting an investigation, Mr. Lamoureux said he became convinced the failure was the fault of the bond trader and Mr. Mock was not to blame.

“I think he had a rough time for a couple of years after he was hired because the OSC was all over him, when in fact he went to them of his own free will – and many people don’t do that,” Mr. Lamoureux said. “But we kept him, and I knew that the board of Teachers was very pleased with him when I was there. He did a great job on fixed income when he took that over.”

Mr. Lamoureux said fixed income had not been generating high enough returns when Mr. Mock joined Teachers, and he helped turn around its performance.

Mr. Mock is one of five senior vice-presidents at Teachers who run different portions of the fund’s investment portfolio.

“He did a fabulous job. I’ve been at many meetings with him with these hedge funds and you can see that Ron knew more than a lot of people who came to visit us and were trying to sell their stuff.”

Mr. Mock said Tuesday he is ready to oversee a far broader portfolio of assets. But with Mr. Leech still in the top job for another seven months, Mr. Mock said it is too soon to talk about his vision for Teachers or any changes he would foresee.

In her article, Katia Dimitrieva of Bloomberg reports, Ron Mock Succeeds Jim Leech as CEO of Ontario Teachers:

Ron Mock, senior vice president of fixed income and alternative investments at Ontario Teachers’ Pension Plan, will succeed Jim Leech as chief executive officer and president next year.

Mock, 60, takes over Jan. 1 when Leech retires after 12 years with the plan and six years as CEO, the Toronto-based fund said today in a statement.

“I want to stay focused on ensuring we are the leader” in the pension plan industry, Mock said in a phone interview. “The world’s a changing place so you have to navigate the organization along the way. I’m comfortable with the team that’s here that we’ll be able to do it.” He declined to comment on his strategies or plans for Ontario Teachers.

Mock joined Teachers’ in 2001 as director of alternative investments and in 2008 was promoted to senior vice president, overseeing all fixed-income assets and hedge funds. He’s also a board member of Cadillac Fairview, which manages Teachers’ C$21 billion ($21 billion) commercial and retail real estate portfolio.

Mock was previously CEO of Phoenix Research and Trading Corp. and was responsible for all of Phoenix Canada’s fixed income business, including the Phoenix Fixed Income Arbitrage LP, a hedge fund. The hedge fund collapsed in 2000 when it lost $125 million in the U.S. bond market, according to an Ontario Securities Commission settlement document from 2003.

Probe Costs

The OSC ordered Mock to pay C$45,000 for investigation costs and banned him from being an officer or director for six years. The regulator said Mock failed to adequately supervise Stephen Duthie, a former Phoenix employee whose trading of U.S. government bonds was “directional, unhedged, and contravened” the company’s investment parameters. Mock’s failure to supervise Duthie was “material to the collapse” of the company, the OSC said.

“We were 100 percent aware of the OSC case and we are fully confident in his abilities and integrity,” Deborah Allan, spokeswoman for the pension fund said in an e-mailed statement. “What the OSC found was an oversight issue, however many years ago. We’re going into this with eyes wide open.”

Leech, 65, was chief executive of the pension fund during the financial crisis, raising net assets to C$130 billion. The fund manages money for 303,000 retired and active teachers in Canada’s most-populous province.

A committee made up of board members has been preparing for the succession since 2011.

Ontario Teachers' put out this press release announcing that Ron Mock will be succeeding Jim Leech on January 1st, 2014.

You will read a lot of news articles on Ontario Teachers' soon to be new chief but let me share with you why I believe Ron Mock is an incredible individual and why he will be an outstanding leader, continuing the organization's tradition of excellence, ensuring their place among the best pension plans in the world.

I first met Ron back in 2002 when I was working as a portfolio analyst for Mario Therrien at the Caisse covering directional hedge funds and a few fund of funds. That first meeting left a lasting impression on me. In fact, I was so blown away that kept thinking how I wish I worked for him.

I remember taking a lot of notes in that meeting. I was a junior asking an industry veteran a lot of questions. I was fascinated by hedge funds and didn't want to squander the opportunity to learn as much as possible from one of the world's best hedge fund investors.

Ron started the meeting by stating: "Beta is cheap but true alpha is worth paying for." What he meant was you can swap into any index for a few basis points and use the money for overlay alpha strategies (portable alpha strategies). His job back then was to find the very best hedge fund managers who can consistently deliver T-bills + 500 basis points in any market environment. "If we can consistently add 50 basis points of added value to overall results every year, we're doing our job."

He explained to me how he constructed the portfolio to generate the highest possible portfolio Sharpe ratio. Back then, his focus was mainly on market neutral funds and multi-strategy funds but they also invested in all sorts of other strategies that most pension funds were too scared to invest in (strategies that fall between private equity and public markets; that changed after the 2008 crisis). He wanted to find managers that consistently add alpha - not leveraged beta - using strategies that are unique and hard to replicate in-house.

At one point I asked him why is he was invested in over 130 hedge funds. That is when he brought up his experience at Phoenix Research and Trading Corp., the fixed income arbitrage fund he co-founded, and how a rogue trader led to its downfall. Ron took the fall for that blow-up, accepted full responsibility, and it cost him a lot on a personal and professional level. He learned a lot from that experience which is a big reason why he was able to put it behind him and excel in his roles at Ontario Teachers.

His experience at Phoenix also taught him the importance of covering operational risk. He was obsessed with operational risk and told me one reason for investing with so many funds was to diversify operational risk and mitigate blow-up risk. Till this day, the alternatives team at Teachers' along with the finance department conduct one of the most comprehensive due diligence on operational risk management (they even perform due diligence on administrators). They also make sure alignment of interests are there and not paying huge fees to large asset gatherers who fail to perform or deliver leveraged beta.

Ever since that first meeting, we kept in touch. I remember another meeting at the Caisse afterward where he spoke in front of Henri-Paul Rousseau, Gordon Fyfe and other senior managers. He wooed them all with his expert knowledge. 

When I moved over to PSP Investments in 2003, I remember meeting him again with Gordon Fyfe, PSP's president, CEO and CIO, at Teachers' offices.  He repeated a lot of the same stuff and took his time to explain to us their investment approach and process. Gordon and I came away from that meeting very impressed. "Nice guy and he really knows his stuff," Gordon told me after that meeting.

Ron Mock definitely knows his stuff, more than most of the hedge fund superstars I've invested with in the past. He has extensive experience and a global network of contacts most pension fund managers and fund of hedge fund managers can only dream of. He's also one of the nicest guys I've ever met in this industry. He has been through hell and back but this is what makes him an incredible individual and an outstanding leader.

In my last conversation with him last week, we went through hedge fund strategies and alignment of interests. He told me that the "sweet spot" they find lies with funds managing between $500M and $2B. "Those funds are generally performance hungry and they are not focusing on marketing like some of the larger funds which have become large asset gatherers." He told me the hedge fund landscape is changing and he's dismayed at the amount of money indiscriminately flowing into the sector. "Lots of pension funds are in for a rude awakening."

I also told Ron that I'm going though a very rough patch struggling to find work. He took the time to listen to me, asked me how my health is, told me to stay positive and he will keep me in mind and help me in any way he can. It's that human side of Ron Mock that I really appreciate most and what I believe makes him a truly outstanding leader. He cares deeply about his team and the members of Ontario Teachers' Pension Plan.

On behalf of all those who know him well, I congratulate Ron Mock for this appointment. There is no doubt in mind he will continue the tradition of excellence that this organization is well known for. He has an outstanding team to back him up and I'm sure they feel the same way I do about him on a professional and personal level. Ontario Teachers' members are extremely lucky to have Ron Mock as their next leader.

Also want to congratulate Mario Therrien, my former boss at the Caisse, for being nominated Senior VP, External Portfolio Management in Public Markets. I hooked up with Mario for a coffee recently and told him that he offered me one of the best jobs in my life because I got to meet all sorts of interesting hedge fund managers. If it wasn't for that job, would have never met Ron Mock. I think highly of Mario too on a personal and professional level and know he will do a great job in his new role as a senior VP.

Let me end this comment by publicly asking Ron Mock, Mario Therrien, Gordon Fyfe, Michael Sabia, Mark Wiseman, Leo de Bever,  Jim Leech, Jim Keohane, and others that know my situation for their help. I have made my mistakes in the past, learned from them, and would like to move on and work at doing what I love doing most, researching and contributing positively to an organization. Now more than ever, if there is anything you can do to help me, it will be greatly appreciated.

Below,  Guggenheim Investment Advisors CIO Charles Stucke discusses hedge fund strategies with Deirdre Bolton on Bloomberg Television's "Money Moves." Wish it was Ron Mock being interviewed telling us where he thinks money is to be made in hedge funds and other strategies. I guarantee you he's busy working hard on his four-year strategic plan, always worried about the risks that lie ahead.