Pension Pulse: Caisse’s High-Speed Push Into Infrastructure

transit

Last week, Canada’s Caisse de dépôt et placement du Québec acquired a 30 percent stake in Eurostar International, a high-speed rail service that runs between London, Paris and Brussels.

The deal came just months after Caisse partnered with Quebec’s government to take over some of the province’s major infrastructure projects.

Leo Kolivakis of Pension Pulse dove deeper into the Eurostar deal in a post on Wednesday. It is re-printed below.

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By Leo Kolivakis, Pension Pulse

This is a huge deal for the Caisse, which is increasingly shifting its focus on domestic and international infrastructure. It signed a deal with Quebec’s government to develop some of the province’s future infrastructure projects and is now going after prize assets in other developed markets.

But unlike the Quebec project, which is essentially a greenfield project full of critics, the Eurostar International is a mature and coveted infrastructure asset that is profitable and can offer the Caisse and Hermes Investment Management steady cash flows over the next decades, if the deal passes regulatory approval and isn’t nixed by the majority shareholders.

And that’s where things get tricky. Canada’s mighty pensions already own a huge chunk of Britain and there will be fierce opposition to this deal. This is a strategic infrastructure asset with important economic and security concerns. It’s not just any old boring infrastructure asset, it’s a real prize, one of the most recognizable infrastructure assets in the world.

Also, if for any reason the British and European economy stumbles and the dark forces of nationalism rear their ugly head, there could be problems down the road. Just look at what’s going on in Greece with this new leftist government threatening to nationalize key infrastructure assets.

Still, this is a great deal for the Caisse even once you factor in all the economic uncertainty and regulatory risks. If Europe is able to finally turn the corner, which seems to be the case but with lingering risks, then this will really be a great deal for the Caisse. Even if Europe stagnates, people are still going to use high-speed trains to travel within Europe and tourism will boom, adding to the profits of this asset.

As far as pricing, I can’t tell you if the Caisse overpaid but I will take Macky Tall’s word that they didn’t. Keep in mind, these are ultra long-term assets which pay steady cash flows, which is what the Caisse and other large Canadian pensions are increasingly looking for to match their long-dated liabilities. And by going direct, they avoid paying fees to third parties.

 

Photo by  Renaud CHODKOWSKI via Flickr CC License

Pension Pulse: Diving Deeper Into Caisse’s Big 2014

Canada

The median U.S. public pension fund returned 6.8 percent in 2014.

But north of the border, one of Canada’s largest public funds blew that figure away.

Caisse de depot et Placement du Quebec, Canada’s second-largest pension fund, posted investment returns of 12 percent in 2014, nearly doubling the returns of its U.S. peers.

Over at Pension Pulse, Leo Kolivakis dives deep into Caisse’s 2014 results. What did he find? The post is re-printed below.

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By Leo Kolivakis, Pension Pulse

You can gain more insights on the Caisse’s 2014 results by going directly on their website here. In particular, the Caisse provides fact sheets on the following broad asset classes:

Keep in mind that unlike other major Canadian pension funds, the Caisse has a dual mandate to promote economic activity in Quebec as well as maximizing returns for its depositors.

In fact, the recent deal to handle Quebec’s infrastructure needs is part of this dual mandate. Some have criticized the deal, questioning whether the Caisse can make money on public transit, but this very well might be a model they can export elsewhere, especially in the United States where CBS 60 Minutes reports infrastructure is falling apart.

Whether or not the Caisse will be successful in exporting this infrastructure model to the United States remains to be seen but if you follow the wise advice of Nobel laureate Michael Spence on why the world needs better public investments, public pensions investing in infrastructure could very well be the answer to a growing and disturbing jobs crisis plaguing the developed world.

As far as the overall results, they were definitely solid, with all portfolios contributing to the overall net investment of $23.77 billion (click on image below):

fp0226_caisse_de_deopt_620_ab-e1424897313958

Of course, what really matters is value-added over benchmarks. After all, this is why we pay Canadian pension fund managers big bucks (some a lot more than others).

In fact, in its press release, the Caisse states in no uncertain terms:

“[its] investment strategy centers on an absolute return approach in which investment portfolios are built on strong convictions, irrespective of benchmark indices. These indices are only used ex post, to measure the portfolios’ performance. The approach is based on active management and rigorous, fundamental analysis of potential investments.”

I’ve already discussed life after benchmarks at the Caisse. So how did their active management stack up? For the overall portfolio, the 12% return edged out the fund’s benchmark which delivered an 11.4% gain, adding 60 basis points of value-added last year (do not know the four year figure).

Below, I provide you with the highlights of the three main broad asset classes with a breakdown of individual portfolios (click on each image to read the highlights):

Fixed Income:

Fixed Income

Inflation-Sensitive:

Inflation-sensitive

Equities:

Equities

Some quick points to consider just looking at these highlights:

  • Declining rates helped the Fixed Income group generate strong returns in 2014 but clearly the value-added is waning. In 2014, Fixed Income returned 8.4%, 10 basis points under its benchmark which gained 8.5%. Over the past four years, the results are better, with Fixed Income gaining 5.6%, 70 basis points over its benchmark which gained 4.9%. Real estate debt was the best performing portfolio in Fixed Income over the last year and four years but on a dollar basis, its not significant enough to add to the overall gains in Fixed Income.
  • There were solid gains in Inflation-Sensitive assets but notice that both Real Estate and Infrastructure underperformed their respective benchmarks in 2014 and the last four years, which means there was no value-added from these asset classes. The returns of Infrastructure are particularly bad relative to its benchmark but in my opinion, this reflects a problem with the benchmark of Infrastructure as there is way too much beta and perhaps too high of an additional spread to reflect the illiquid nature and leverage used in these assets. More details on the Caisse’s benchmarks are available on page 20 of the 2013 Annual Report (the 2014 Annual Report will be available in April).
  • In Equities, Private Equity also slightly underperformed its benchmark over the last year and last four years, but again this reflects strong gains in public equities and perhaps the spread to adjust for leverage and illiquidity. U.S Equity led the gains in Equities in 2014 but the Caisse indexes this portfolio (following the 2008 crisis) so there was no value-added there, it’s strictly beta. However, there were strong gains in the Global Quality Equity as well as Canadian Equity portfolios relative to their benchmarks in 2014 and over the last four years, contributing to the overall value-added.

If you read this, you might be confused. The Caisse’s strategy is to shift more of its assets into real estate, private equity and infrastructure and yet there is no value-added there, which is troubling if you just read the headline figures without digging deeper into what makes up the benchmarks of these private market asset classes.

The irony, of course, is that the Caisse is increasingly shifting assets in private markets but most of the value-added over its benchmarks is coming from public markets, especially public equities.

But this is to be expected when stock markets are surging higher. And as a friend of mine reminded me: “It about time they produced value-added in Public Equities. For years, they were underperforming and so they came up with this Global Quality Equity portfolio to create value.”

Also, keep in mind private markets are generating solid returns and as I recently noted in my comment on why Canadian pensions are snapping up real estate:

… in my opinion the Caisse’s real estate division, Ivanhoé Cambridge, is by far the best real estate investment management outfit in Canada. There are excellent teams elsewhere too, like PSP Investments, but Ivanhoe has done a tremendous job investing directly in real estate and they have been very selective, even in the United States where they really scrutinize their deals carefully and aren’t shy of walking away if the deal is too pricey.

There is something else, the Caisse’s strategy might pay off when we hit a real bear market and pubic equities tank. Maybe that’s why they’re not too concerned about all the beta and high spread to adjust for leverage and illiquidity in these private market benchmarks.

But there are skeptics out there. One of them is Dominic Clermont, formerly of Clermont Alpha, who sent me a study he did 2 years ago showing the Caisse’s alpha was negative between 1998 and 2012. Dominic hasn’t updated that study (he told me he will) but he shared this:

I had done a study two years ago that showed that the Caisse’s alpha was close to -1% and close to statistically significantly different from zero and negative. Part of that regular value lost is compensated by taking a lot more risk than its benchmark by being levered. That leverage means doing better than the benchmark when the markets do perform well, and being in a crisis when the market tanks…

I asked him to clarify this statement and noted something a pension fund manager shared with me in my post on the highest paid pension fund CEOs:

Also, it’s not easy comparing payouts among Canada’s large DB plans. Why? One senior portfolio manager shared this with me:

First and foremost, various funds use more leverage than others. This is the most differentiating factor in explaining performance across DB plans. In Canada, F/X policy will also impact performance of past 3 years. ‎It’s very hard to compare returns because of vastly different invest policies; case in point is PSP’s huge equity weighting (need to include all real estate, private equity and infrastructure) that has a huge beta.”

Dominic came back to me with some additional thoughts:

I would love to do proper performance attribution, but I had limited access to data. But we can infer a lot with published data. We do have historical performance for all major funds like the Caisse, CPP, Teachers, PSP, etc. in their financial statements. They also publish the performance of their benchmark.

I agree that because of different investment policies, it is difficult to compare one plan to the next. But we can compare any plan to itself, i.e. its benchmark.

Again, I like to do proper performance attribution in a multivariate framework and that is one area of expertise to me. To do it on a huge plan like the Caisse would require a lot of data which I do not have access to. But a simple CAPM type of attribution would give some insight. In this case, the benchmark is not an equity market as in the base case of CAPM, but the strategy mix of the Caisse.

Thus if we regress the returns (or the excess returns over risk free rate) of a plan, over its benchmark return (or excess over RF rate), we would obtain a Beta of the regression to be close to one if the plan is properly managed with proper risk controls. That is what I obtain when I do this exercise with the returns of a well-known plan – well known for its quality of management, and its constant outperformance.

When I do this for the Caisse, I get a Beta of the regression significantly greater than 1 – close to 1.25. It looks like the leverage of the Caisse over the 15 years of the regression was on average close to 25% above its benchmark! Now part of that as you mentioned and as I explain in my study could come from:

  • Investment in high Beta stocks,
  • Investment in levered Private equity
  • Investment in levered Real Estate and Infrastructure
  • Investment in longer duration bonds
  • Leveraging the balance sheet of the plan: Check Graphic 1 on the link: http://www.clermontalpha.com/cdpq_15ans.htm

It shows the leverage of the Caisse going from 18% in 1998 to 36% in 2008! So my average of 25% excess Beta is in line with this documented leverage.

The chart also shows Ontario Teachers’ and OMERS’ leverage. The difference is that Teachers’ leverage is IN its benchmark, while the Caisse is NOT. Thus the Caisse is taking 25% more risk than its clients’ policy mix! You would think that all these clients risk monitoring would be complaining… They are not. 

Of course, that leverage is good when markets return positively and you can see that on the colored chart. But that leverage is terrible when the markets drop 2008, 2002, 2001. When that happen, it is time to fire the management, restart with a new one and blame the previous management for the big loss. Some of those big losses were also exaggerated by forced liquidation accounting (we all remember the ABCP $6 billion loss reserve which was almost fully recovered in the following years inflating the returns under the new administration).

By not doing proper attribution, we are not aware of the continuous loss (negative alpha) hidden by the excess returns not obtained by skilled alpha, but by higher risk through leverage. The risk-adjusted remains negative… And we are not focusing our energies into building an alpha generating organisation with optimal risk budgeting. Why bother, the leverage will give us the extra returns! But that is not true alpha, not true value added.

Which brings me to the alpha of the regression. I told you that this other great institution which does proper risk controls, gets a Beta close to one. They also get a positive alpha of the regression which is statistically significant (t stat close to 2). Not surprising, they master the risk budgeting exercise, and they understand risk controls.

For the Caisse, the Alpha of the regression is close to -1% per year and it is statistically significant. Nobody in the private market could sustain such long period of negative alpha. Nobody could manage a portfolio with 25% more risk than what is requested by the client.

In my report, I also talk about the QPP contribution rate. When Canada created the CPP in the mid-60s, Quebec said “Hey, we want to better manage our own fund.” That led to the creation of the Caisse de Depot and it was an excellent decision as the returns of the QPP were much better because they were managed professionally in a diversified portfolio (vs provincial bonds for the CPP). Unnoticed by everyone in Quebec, the contribution rate started to increase in 2012 and will continue to increase up until 2017 at which time Quebecers will pay 9% more than the rest of Canadians for basically the same pension plan (some tiny differences). And the explanation is this negative alpha.

I also explained that with proper risk budgeting techniques at all levels, the Caisse could deliver an extra $5 billion with 20% less risk! Instead of increasing the contribution rate of all CDPQ clients QPP, REGOP, etc., we could have kept them at the same level or lower. And part of that extra $5B return every year would find its way into the Quebec government coffer through reduced contributions and higher taxes (the higher contributions to QPP, Regop, etc. that Quebecers pay are tax deductible…)

For how long are we going to avoid looking at proper attribution? For how long are we going to forfeit this extra $5B per year in extra returns?

I shared Dominic’s study with Roland Lescure, the CIO of the Caisse, who shared this with me:

You are right, we have significantly lowered leverage at the Caisse since 2009. Leverage is now solely used to fund part of our real estate portfolio and the (in)famous ABCP portfolio which will be gone by 2016. As you rightly point out, most Canadian pension funds use leverage to different degrees. Further, we also have significantly reduced risk by focusing our investments on quality companies and projects, which are less risky than the usual benchmark-driven investments. And those investments happen to have served us well as they did outperform the benchmarks significantly in 2014. You probably have all the details for each of our portfolios but I would point out that our Canadian equity portfolio outperformed the TSX by close to 300 bps. And the global quality equity portfolio did even better.

I thank Dominic Clermont and Roland Lescure for sharing their insights. Dominic raises several excellent points, some of which are politically sensitive and to be honest, hard to verify without experts really digging into the results of each and every large Canadian pension. Also, that increase in the contribution rate for public sector workers is part of tackling Quebec’s pension deficits, slowly introducing more risk-sharing in these plans.

Again, this is why even though I’m against an omnipotent regulator looking at systemic risks at pensions, I believe all of Canada’s large pensions need to provide details of their public and private investments to the Bank of Canada and we need to introduce uniform comprehensive performance, operational and risk audits at all of Canada’s major pensions.

These audits need to be conducted by independent and qualified third parties that are properly staffed to conduct them. The current auditing by agencies such as the Auditor General of Canada is simply too flimsy as far as I’m concerned, which is why we need better, more comprehensive audits across the board and the findings should be made public for all of Canada’s large pensions.

And let me say while the Caisse has clearly reduced leverage since the ABCP scandal which the media keeps covering up, it is increasingly shifting into private markets, introducing more illiquidity risk that can come back to haunt them if global deflation takes hold.

As far as stocks are concerned, I see a melt-up occurring in tech and biotech even if the Fed makes a monumental mistake and raises rates this year (read the latest comment by Sober Look to understand why market expectations of Fed rate hikes are unrealistic). It will be a rough and tumble year but my advice to the Caisse is to stay long U.S. equities (especially small caps) and start nibbling at European equities like Warren Buffett. And stick a fork in Canadian equities, they’re cooked!

Will the liquidity and share buyback party end one day? You bet it will but that is a topic for another day where I will introduce you to a very sharp emerging manager and his team working on an amazing and truly unique tail risk strategy.

As far as U.S. equities, I think the Caisse needs to stop indexing and start looking at ways to take opportunistic large bets using some of the information I discussed when I covered top funds’ Q4 activity. This would be above and beyond the information they receive from their external fund managers.

By the way, if you compare the Caisse’s top holdings to those of the Bill and Melinda Gates Foundation, you’ll notice they are both long shares of Waste Management (WM), one of the top-performing stocks in the S&P 500 over the last year.

I’ll share another interesting fact with you, something CNBC’s Dominic Chu discussed a few days ago. Five stocks — Apple (AAPL), Amazon (AMZN), Biogen Idec (BIIB), Gilead (GILD), and Netflix (NFLX) — account for all of the gains in the Nasdaq this year. If that’s not herd behavior, I don’t know what is!!

Lastly, it takes a lot of time to write these in-depth comments and you won’t read this stuff in traditional media outlets which get hung up on headline figures and hardly ever dig deeper. Please take the time to contribute to my blog on the top right-hand side, or better yet, stop discriminating against me and hire the best damn pension and investment analyst in the world who just happens to live in la belle province!

Below, Michael Sabia, CEO of the Caisse, discusses the Caisse’s 2014 results with TVA’s Pierre Bruneau (in French). Michael also appeared on RDI Économie last night where he was interviewed by Gérald Filion. You can view that interview here and you can read Filion’s blog comment here (in French).

Also, some food for thought for the Caisse’s real estate team. A new report from Zillow shows that rents across the U.S. are increasing, and not just in the expected regions of New York City, San Francisco and Boston. Overall, rents increased 3.3% year-over-year as of January. But many cities outpaced that, including Kansas City, which saw rent grow more than double the national average, jumping 8.5% year-over-year. St. Louis saw rent increase by 4.5% over the same period. Rents in Detroit grew by 5.0% and rents in Cleveland grew by 4.2%.

 

Photo credit: “Canada blank map” by Lokal_Profil image cut to remove USA by Paul Robinson – Vector map BlankMap-USA-states-Canada-provinces.svg.Modified by Lokal_Profil. Licensed under CC BY-SA 2.5 via Wikimedia Commons – http://commons.wikimedia.org/wiki/File:Canada_blank_map.svg#mediaviewer/File:Canada_blank_map.svg

Canadian Pensions Bought $2.75 Billion in Commercial U.S. Property in January

skyscraper

Canadian pension funds have collectively invested $2.75 billion in commercial U.S. real estate in 2015, according to a survey conducted by the Financial Post.

Canadian entities, including pension funds, invested $9.7 billion in U.S. real estate in 2014.

More from the Financial Post:

The quick start to 2015 comes on the shiny heels of 2014, in which Canadians dominated the U.S. investment scene, easily doubling the country’s closest foreign rival, Norway, according to real estate research company CBRE.

[…]

While Canadian investment in the U.S. is impressive, it’s still a fraction of the entire investment market in America, which was worth US$434 billion in 2014.

Whether a falling dollar will impact future purchases, Jeanette Rice, Americas Head of Investment Research at CBRE, said, “It could mitigate investment, but there are a lot of other positives to balance each other out.

“We know that since September, 2012, the dollar has [gained] 20%, so it has been significant,” she added.

Proximity and similar customs factor into Canada’s U.S. interest, but the limited ability to grow domestically has also created a need for pension funds to invest abroad, Ms. Rice, the author of the study, pointed out.

“If you want to invest in China, it takes a lot of homework. It’s a lot easier to come visit a property, talk to professionals and so on [in the United States],” she said.

The Canadian invasion has been led by pension players who are heavily weighted in real estate compared to their American peers. Canada’s five largest pensions funds by asset size hold on average 12.7% of their investments in real estate compared to an average of 8.7% for 11 similar U.S. pension funds, according to CBRE.

Read more Pension360 coverage of Canadian pension investments here.

 

Photo by Sarath Kuchi via Flickr CC License

CPPIB CEO Urges Canada to Look Overseas for Growth

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The CEO of the Canada Pension Plan Investment Board (CPPIB) told the Toronto Region Board of Trade on Monday that Canada should be looking overseas and around the world for growth opportunities.

More on Mark Wiseman’s remarks from the Times Colonist:

Meanwhile, Wiseman said in a speech prepared for Monday’s annual dinner of the Toronto Region Board of Trade that Canadian organizations should be looking overseas for growth.

He noted that the CPPIB already invests 70 per cent of its capital outside of Canada, with a particular focus on China, India and Brazil.

“Most of you are familiar with Wayne Gretzky’s style of playing hockey — he staked to where the puck was going to be, not to where it was,” Wiseman said in his speech to the business audience.

“To put it bluntly, Canada needs to follow Gretzky’s practice.”

Wiseman says Canada should leverage its strong reputation overseas and its large population of immigrants, who possess a wealth of global experience that can help Canadian companies expand abroad.

“Having international skills and knowledge is a key asset — and it’s one that won’t rise and fall in value along with global commodity prices,” Wiseman said.

The CPPIB managed $201.1 billion in assets at the end of last fiscal year.

 

Photo by  Horia Varlan via Flickr CC License

Canada Pension Funding Declined in 2014

Canada map

The collective funding ratio of Canada’s defined-benefit pension plans declined by 2.7 percentage points in 2014, according to Aon Hewitt.

From Benefits Canada:

The median solvency ratio of 449 Aon Hewitt administered pension plans from the public, semi-public and private sectors stood at 90.6% at Dec. 31, 2014.

That represents a decline of 0.5 percentage points over the previous quarter ended Sept. 30, 2014, and a 2.7 percentage-point drop from plan solvency at Dec. 31, 2013.

Since peaking at 96.6% in April 2014, overall plan solvency has declined by 5.9 percentage points, continuing the trend towards worsening plan solvency that began in the third quarter of 2014 (when the solvency ratio dropped to 91.1% from 96.2% in the previous quarter).

About 18.5% of plans were more than fully funded at the end of the year, compared with 23% in the previous quarter and 26% at the end of 2013. Plan sponsors that must file valuations as at Dec. 31, 2014 could see the amount of their deficiency contributions double in 2015 as a result of the lower solvency ratio, says Aon Hewitt.

“Plans that stayed exposed to interest rates really took a beating in 2014,” says William da Silva, senior partner, retirement practice with Aon Hewitt. “Those plan sponsors who have implemented or fine-tuned their risk management strategies performed much better than traditional plans amid interest rate declines.”

Aon Hewitt also said that new mortality tables from the Canadian Institute of Actuaries could lead to a further funding decline in the future.

Ontario Teachers Pension Buys Storage Company

Canada

The Ontario Teachers’ Pension Plan has announced it will buy PODS, a moving and portable storage company.

Ontario Teachers’ will purchase the entire company; the sale will be finalized in early 2015.

From the Tampa Bay Business Journal:

“We are excited about our new ownership by Teachers’ and are also appreciative of the support we received from Arcapita and our board of directors the past seven years. We look forward to working with Teachers’ to continue our growth and our commitment to our customers,” John B. Koch, president and CEO at PODS, said in a statement.

Teachers’ has a diverse portfolio of companies across the globe including Burton’s Biscuits in the United Kingdom, Canada Guaranty Mortgage Insurance Co. in Toronto and Mattress companies Serta and Simmons in the United States.

The price of the deal has not yet been released.

Arcapita bought PODS in 2007 for $430 million, according to sister publication Atlanta Business Chronicle. PODS says it pioneered the portable moving and storage industry and now operates in more than150 locations, both corporate and franchise owned, in the U.S., Canada, Australia and the U.K.

The OTPP manages $138.9 billion in assets.

Pension Funds Criticize Excessive Private Equity Fees; More Look To Direct Investing

broken piggy bank over pile of one dollar bills

Pension fund officials from Canada and the Netherlands expressed their frustration with private equity fees during a conference this week.

The chief investment officer of the Netherlands’ $220 billion healthcare pension fund said it needs “to think about” the fees it is paying, according to the Wall Street Journal.

Ruulke Bagijn, chief investment officer for private markets at Dutch pension manager PGGM, said a Dutch pension fund for nurses and social workers that she invests for, paid more than 400 million euros ($501.6 million) to private-equity firms in 2013. The amount accounted for half the fees paid by the PFZW pension fund, even though private-equity firms managed just 6% of its assets last year, she said.

“That is something we have to think about,” Ms. Bagijn said.

Among the things pension officials are thinking about: bypassing private equity firms and fees by investing directly in companies. From the Wall Street Journal:

Jane Rowe, the head of private equity at Ontario Teachers’ Pension Plan, is buying more companies directly rather than just through private-equity funds. Ms. Rowe told executives gathered in a hotel near Place Vendome in central Paris that she is motivated to make money to improve the retirement security of Canadian teachers rather than simply for herself and her partners.

“You’re not doing it to make the senior managing partner of a private-equity fund $200 million more this year,” she said, as she sat alongside Ms. Ruulke of the Netherlands and Derek Murphy of PSP Investments, which manages pensions for Canadian soldiers. “You’re making it for the teachers of Ontario. You know, Derek’s making it for the armed forces of Canada. Ruulke’s doing it for the social fabric of the Netherlands. These are very nice missions to have in life.”

But an investment firm executive pointed out that direct investing isn’t as cost-free as it sounds. From the WSJ:

[Carlyle Group co-founder David Rubenstein] warned that investors who do more acquisitions themselves rather than through private-equity funds will have to pay big salaries to hire and retain talented deal makers.

“Some public pension funds will just not pay, in the United States particularly, very high salaries and will not be able to hold on to people very long and get the most talented people,” Mr. Rubenstein said at the conference. “I don’t think there are that many people who will pay their employees at these sovereign-wealth funds and other pension funds the kind of compensation necessary to hold on to these people and get them.”

[…]

Mr. Rubenstein had a further warning for investors seeking to compete for deals with private-equity firms. “If you live by the sword you die by the sword,” he said. “If you are going to do disintermediation you can’t blame somebody else if something goes wrong.”

Pension360 has previously covered how pension funds are bypassing PE firms and investing directly in companies. One such fund is the Ontario Municipal Employees Retirement System. The fund’s Euporean head of Private Equity said last month:

“The amount of fees that we were paying out for a fund, 2 and 20 [percentage points] and everything that goes with that, was a huge amount of value that we were losing to the fund,” Mr. Redman said. “If we could deliver top quartile returns and we weren’t hemorrhaging quite so much in terms of fees and carry that would mean that we would be able to meet the pension promise.”

 

Photo by http://401kcalculator.org via Flickr CC License

Lessons In Infrastructure Investing From Canada’s Pensions

Roadwork

Canada’s pension plans were among the first in the world to invest in infrastructure, and they remain the most prominent investors in the asset class.

Are there any lessons to be learned from Canada when it comes to infrastructure investing? Georg Inderst, Principal of Inderst Advisory, thinks so.

In a recent paper in the Rotman International Journal of Pension Management, Inderst dives deep into Canada’s infrastructure investing and emerges with some lessons to be considered by pension funds around the world.

The paper, titled Pension Fund Investment in Infrastructure: Lessons from Australia and Canada, starts with a short history of Canadian infrastructure investing:

Some Canadian pension plans, notably the Ontario Teachers’ Pension Plan (OTPP) and the Ontario Municipal Employees Retirement System (OMERS), were early investors in infrastructure in the late 1990s and early 2000s, second only to Australian superannuation funds. Other funds followed, and the average allocation has been growing steadily since, reaching C$57B by the end of 2012 (5% of total assets). Here, too, there is a heavy “size effect” across pension funds: bigger pension plans have made substantial inroads into infrastructure assets in recent years (see Table 2), while small and medium-sized pension funds have little or no private infrastructure allocation.

The main driver for infrastructure investing appears to be the wish to diversify pension funds’ assets beyond the traditional asset classes. While Canadian pension funds have been de- risking at the expense of listed equities, regulators have not forced them into bonds, as was the case in some European countries. Real estate and infrastructure assets are also used in liability-driven investing (LDI) to cover long-term liabilities.

Canada frequently makes direct investments in infrastructure, an approach that is now being tested by pension funds around the world. From the paper:

According to Preqin (2011), 51% of Canadian infrastructure investors make direct investments, the highest figure in the world. This approach (known as the “Canadian Model”) has attracted considerable attention around the world, for several reasons:

• lower cost than external infrastructure funds

• agency issues with fund managers

• direct control over assets (including entry and exit decisions)

• long-term investment horizon to optimize value and liability matching

This direct approach to infrastructure investment must be seen in the context of a more general approach to pension plan governance and investment. Notable characteristics of the “Maple Revolutionaries” include

• Governance: Strong governance models, based on independent and professional boards.

• Internal management: Sophisticated internal investment teams built up over years; the top 10 Canadian pension plans outsource only about 20% of their assets (BCG 2013).

• Scale: Sizable funds, particularly important for large-scale infrastructure projects.

Potential challenges for the direct investing approach include insufficient internal resources, reputational and legal issues when things go wrong, and the need to offer staff market-based compensation in high-compensation labor pools.

Despite these challenges, however, the direct internal investment approach of large Canadian pension funds is now being tried in other countries. Other lessons from the Canadian experience include the existence of a well-functioning PPP model, a robust project bond market, and long-term involvement of the insurance sector.

Finally, the paper points to some lessons that can be learned from Canada:

Lessons learned include the following:

• Substantial infrastructure investments are possible in very different pension systems, with different histories and even different motivations.

• Infrastructure investment vehicles can evolve and adjust according to investors’ needs. In Australia, listed infrastructure funds were most popular initially, but that is longer the case.

• Pension plan size matters when investing in less liquid assets. Private infrastructure investing is driven primarily by large- scale funds, while smaller funds mostly invest little to nothing in infrastructure. In Australia, two-thirds of pension funds do not invest in unlisted infrastructure at all.

• Asset owners need adequate resources when investing in new and difficult asset classes. Some Canadian plans admit that their own estimates of time and other inputs were too optimistic at the outset.

• New investor platforms, clubs, syndicates, or alliances are being developed that should also attract smaller pension funds, such as the Pension Infrastructure Platform (PIP) in the United Kingdom or OMERS’ Global Strategic Investment Alliance (GSIA). However, industry experts stress the difficulties of such alliances with larger numbers of players, often with little experience and few resources. Decision time is also a critical factor.

The full paper offers much more insight into Canada’s approach as well as Australia’s. The entire paper can be read here.

Video: CFO of Canada’s 2nd Largest Pension Asset Manager Talks Investment Strategy

 

Here’s a 24-minute talk with Maarika Paul, chief financial officer at Caisse de Depot et Placement du Québec, Canada’s second-largest pension fund.

Paul touches on infrastructure, e-commerce and real estate investing, as well as investing in Europe.

The video was taken at the Bloomberg Canadian Fixed Income Conference in New York.

Funded Status Of Canadian Pensions Falls in Third Quarter

Canada blank map

The funded statuses of Canada’s defined benefit plans collectively fell in the third quarter to 91.1 percent, marking a 4.9 percent decline over the last three months; at the end of the second quarter, plans were 96 percent funded.

The data comes from Aon Hewitt, who surveyed 275 of Canada’s defined benefit plans, both public and private.

From MarketWired:

[The DB plans’] median solvency funded ratio — the market value of plan assets over plan liabilities — stood at 91.1% at September 26, 2014. That represents a decline of 4.9 percentage points over the previous quarter ended June 30, 2014, a 5.5% drop from the peak of 96.6% reached in April 2014, and a 3.1% increase over the same quarter in 2013. With the decline, this quarter’s survey results reverse a trend throughout 2013 and 2014 of improving solvency positions for the surveyed plans. As well, approximately 23% of the surveyed plans in Q3 were more than fully funded at the end of the third quarter this year, compared with 37% in the previous quarter and 15% in Q3 2013.

[…]

“Canadian DB plans have strung together a nice run of winning quarters, but as we have been saying for some time now, market volatility continues to present significant risks and plan sponsors should be implementing or fine-tuning their de-risking strategies in order to stay current and optimized in the face of ever-changing capital market conditions,” said William da Silva, Senior Partner, Retirement Practice, Aon Hewitt.

“Now that we have seen plan solvency decline for the first time in over a year and a half, hopefully this will serve as a wake-up call to all plan sponsors to consider their funding and investment strategies with risk management as their key objective. Overall Canadian plan solvency is still relatively strong compared to where things stood just a few years ago, so there is still time to act. But with new mortality tables coming into effect, we expect material increases in liabilities for many plans. Clearly, that is another signal that the time to act is now.”

The 4.9 percent drop in funding was the first funding decline in nine quarters, or over two years.