Monday, July 24, 2017

PSP Investments Moving Into Asia?

Barbara Shecter of the National Post reports, PSP Investments seeking Asia base but London remains key hub despite Brexit fears:
Canada’s Public Sector Pension Investment Board is establishing a base in Asia to pursue deals in private debt and equity, real estate, and infrastructure, mirroring a strategy already deployed in London.

The office, to be located in either Hong Kong or Singapore, will complement a London hub that is to be expanded by as much as 50 per cent in spite of the looming prospect of Brexit, André Bourbonnais, chief executive of PSP Investments, told the Financial Post.

“We’re looking very actively to have a presence either in Hong Kong or Singapore,” he said, adding that both the Asia base and the expansion of the London office to as many as 45 people will be in place by the end of the current fiscal year in March.

“London is and will remain a key financial market,” Bourbonnais said, noting that British politicians have recently soothed Brexit fears with reassurances that bankers and dealmakers from other parts of the European Union will be allowed to stay if and when Britain exits the EU.

While some banks have pulled staff, it’s mostly been back and middle office employees, Bourbonnais said.

“People that are client-facing will remain there,” he said, adding that London continues to be a draw for top deal-making and financial talent.

“The talent pool that’s available is so much larger than (those willing to locate in) Canada, let alone Montreal,” Bourbonnais said.

In a wide-ranging interview, he said the geographic expansion at PSP Investments will be complemented by a continued focus on breaking down barriers within the pension management firm to find investments that benefit the portfolio as a whole.

Those aims were at the top of his list in March of 2015 when he took the top job at PSP, which invests funds for the pension funds of Canada’s public service, the Canadian Armed forces and reserves, and the Royal Canadian Mounted Police.

Another priority was to establish private debt as a new asset class at the pension investment manager, which had $135.6 billion in assets under management on March 31, the end of its most recent reporting period.

“In this environment, it’s a very good asset class, as evidenced by the $4 billion or so that we’ve been able to deploy,” Bourbonnais said, adding that the new business also led PSP Investments to establish an office in New York.

Prior to taking his current job, Bourbonnais was global head of private investments at the much larger Canada Pension Plan Investment Board, a job he says influenced his vision for the public sector pension manager he now runs.

The CPP Fund has more than $300 billion in assets, and deals are sourced from CPPIB’s seven international business hubs in locations including London, New York, and Hong Kong.

In addition to the geographic coverage, Bourbonnais says he was also influenced by his former employer’s focus on the total portfolio, a strategy he introduced at PSP Investments.

“The place had been built in a very entrepreneurial fashion where… nobody was really looking at the total fund,” he said. “One of the big objectives I had was to break those silos and force people to work together at the beginning, but now it’s becoming much more spontaneous and natural for them to do it.”

He said the more co-operative strategy was evident in a deal struck in March to acquire Vantage Data Centres with partners Digital Bridge Holdings LLC and TIAA Investments.

“We couldn’t quite figure out if it was private equity, if it was infrastructure, if it was real estate, so we stopped the debate, we put all three groups together, and we did that transaction with our partners,” Bourbonnais said, adding that other prospective transactions now in the pipeline would combine dealmakers from private debt and equity, and real estate and infrastructure.

“We’ve created a structure where a group of people including myself are looking at … (transactions) that don’t quite fit nicely in one asset class but are beneficial to the total fund,” he said.

“We really foster collaboration between asset classes and (are) really making sure people work together and are rewarded for it.”

PSP’s one-year total portfolio net return of 12.8 per cent generated $15.2 billion of income in fiscal 2017, net of all investment costs. Gross portfolio return stood at 13.2 per cent, compared to a one per cent return in fiscal 2016.
I missed this article which came out at the end of June but it doesn't surprise me. In fact, when I recently examined whether pension funds are displacing private equity funds, I wrote this:
So, are pension funds displacing private equity funds? Yes and no. Where they can compete effectively, they will and this is most notable in Canada where large public pensions have the right governance which allows them to hire industry experts and pay them properly.

But in the buyout world, large private equity funds reign supreme, and there's not a pension in the world that will ever displace them from their bread and butter. It won't ever happen, ever, and the reason is simple, when there's a major deal on the table, the first phone calls bankers make is to Schwarzman et al., not the CEO of a major pension fund.

In other words, while Canada's large pensions can compete with private equity funds in private debt, ramping up their operations in the US and Europe and pretty soon Asia, they will never compete with private equity titans on major deals and still need them to generate returns in the traditional buyout space where they invest and co-invest with top private equity funds.

But there is no question that large Canadian pensions are increasingly muscling into private debt an they are delivering stellar results in this area which was once dominated by top PE funds. Just look at the results of CPPIB and PSP Investments in fiscal 2017 to underscore this point.
PSP is basically catching up to CPPIB, moving into Asia and taking a total portfolio approach. You need boots on the ground to find the right partners and deals, especially in Asia.

The good news is Asian private equity has found something good about the region's aging population, and private equity can take off in this region. There is no doubt PSP, CPPIB and other large Canadian pensions will team up with the right partners to gain access to these deals.

Apart from investments into funds and co-investments alongside them to lower fees, PSP will look to set up private debt operations in Asia and this too can be profitable if they have the right team originating these debt deals.

This is all positive and part of PSP's strategic long-term plan. Once operations are set up and they gain prominence in the region, it will add geographic diversification in a region with real long-term growth potential.

Will there be bumps along the way? You bet. You can execute the best strategy, hire the best team and still suffer setbacks along the way, especially in Asia where private markets are opaque, often dominated by a handful of wealthy families.

Still, over the long run, this move will pay off in spades and PSP needs to move into Asia now to capitalize when markets there get whacked and opportunities in private markets arise.

One last note on PSP. I've been getting emails from a few people asking me about where its former CIO, Daniel Garant, went. I have no clue, none whatsoever. Institutional Investor recently published an article stating he abruptly resigned, which may or may not be true.

Rumors have swirled that he will be replacing Roland Lescure at the Caisse where they will groom him to take over Michael Sabia's job. I also heard rumors that he will join Gordon Fyfe and Jim Pittman at bcIMC where he will assume the role of CIO.

So far, these are nothing but rumors, nothing has been announced anywhere. Mr. Garant is a big boy, he can take care of himself and I'm certain he will land on his feet (they all do). I've never spoken to the man nor am I privy to his future plans. Just because this blog is called "Pension Pulse", doesn't mean I know everything going on at Canada's large pensions (trust me, I don't want to know everything).

Below, from the Milken Institute conference, a panel discussion on the coming US infrastructure boom featuring PSP's CEO André Bourbonnais and Michael Burke, Chairman and CEO at AECOM.

Thursday, July 20, 2017

HOOPP Warns of the Next Crisis?

At the end of June, The Healthcare of Ontario Pension Plan (HOOPP) put out an article, Senior Poverty: The Next Crisis?:
HOOPP is launching a series of articles to deepen the conversation around retirement security and to bring awareness around the benefits of defined benefit (DB) pension plans.

In the first article, we discuss how an increasing number of Canadians are heading into their senior years financially ill-equipped to adequately support themselves when their working lives end. A stark illustration of this has been set out in a slew of new statistics and studies that show poverty among seniors is on the rise once again after nearly two decades of decline.

Two key shifts have contributed to the rise of senior poverty in Canada:
  • Canadians are living longer than ever before
  • The number of seniors is growing at a faster rate than any other segment of the population, with those over 85 leading the way
In our first paper, we provide highlights from a growing body of statistics and research on senior poverty in Canada and explain why workplace savings plans must play a role in generating a healthy and stable income in retirement.
You should all take the time to read this report here. It is excellent and I applaud HOOPP for having the foresight for launching a series of articles to deepen the conversation around retirement security and to bring awareness around the benefits of defined benefit (DB) pension plans.

When it comes to communication, I give HOOPP an A++ and they deserve it. Not only are they the best pension plan in the world along with Ontario Teachers' and a handful of others, but they are taking the looming retirement crisis very seriously and by writing these articles, they are enhancing the policy discussion around retirement and rising senior poverty.

This report focuses on Canada, which arguably has the best defined-benefit plans in the world. The situation in other countries including the United States is far worse, all part of the $400 trillion pension time bomb.

I'm very conservative in my economic views but I fundamentally believe that a well-functioning democracy has three main pillars:
  1. Universal healthcare which provides access to great healthcare for every citizen, rich or poor
  2. Great public education for everyone, especially the poor who need it
  3. A solid retirement system that ensures hard-working people can retire in dignity and security no matter what happens in the bloody stock market
I've said this plenty of times on my blog, good pension policy is good economic policy over the long run.

Again, take the time to read HOOPP's short report here, it is superb. A few things that I will bring to your attention. First, CPP is not a pension plan (click on image):

Here, I agree, CPP is not the solution to Canada's retirement crisis, at least not yet. However, if it were up to me, I would significantly enhance CPP far more than what the federal and provincial governments did to make sure every Canadian can retire in dignity and security.

The truth is Canadians are poor savers, many are buying houses they can't afford and will regret it big time down the road, and they are financially illiterate. Even smart Canadians who save their money don't really know what to do with their money, and others are taking out huge mortgages to buy a nice house because "house prices never go down" (yeah, right).

There is a nice man is Vancouver, a retired securities lawyer who is quite astute and reads my blog religiously. Unlike others, he has significant savings and understands options strategies and markets.

He asked me for advice and what I trade. I showed him how to go on to make daily and weekly charts of various stocks and how I get ideas of which stocks are worth looking at using information from what top funds are buying and selling and what are the top gainers in the market.

But I told him, I start out with my macro views to guide my trading and they haven't changed in a long time. I still fear global deflation lies straight ahead (the global retirement crisis and rising senior poverty will only exacerbate it).

And I didn't sugarcoat it. I told him I track and trade many biotech stocks, take huge risks and have endured 80%++ drawdown in my personal account, made it all back and more. I told him flat out, trading stocks is a full-time job and it's extremely stressful but if you want, follow my ideas on Stocktwits and roll the dice if you like any of them:

In fact, here is my latest Stocktwits post on biotechs (click on image):

But I also told him if I was retired and had substantial savings, half my money would be in US long bonds (TLT) and the other half in dividend paying stocks like Bell (BCE.TO), Enbridge (ENB.TO) and Bank of Nova Scotia (BNS.TO), which is the only Canadian bank that actively manages its mortgage risk.

In other words, if you already have a nice retirement nest egg, it's not about capital expansion, it's about capital preservation and being able to sleep well at night.

And let me share another Stocktwits post that I posted on Friday afternoon on US long bonds (TLT) which is my highest conviction trade going into year-end (click on image):

Now, this individual is savvy about options and he wanted to know more about my friends at OpenMind Capital, so I put him in touch with them as they can explain their options strategies far better than I can.

Most retired Canadians are not in his position and don't have his knowledge of markets and options. We cannot expect people to manage their own money in these brutal markets where even macro gods are struggling.

These markets are brutal, I know, I trade them and often see big quantitative sharks raping clueless retail investors. I don't like using the word "rape" but that is what it is. I would love to take you into the real stock trading world where ruthless market makers and quants take out all the stops so they can load up on shares and make off like bandits.

It's brutal, trust me, and unless you've traded, you just don't know how brutal it really is.

And this leads me to my other point, we can't expect Joe and Jane Smith to trade these markets or even to retire by picking "safe" ETFs and dividend stocks. We need to provide them with a defined-benefit pension, something they can count on for the rest of their lives.

I firmly believe in large, well-governed public defined-benefit plans that pool investment and longevity risks, lower costs by managing the bulk of assets internally and invest all over the world across public and private markets and invest with the top hedge funds and private equity funds all over the world.

Period. This is my gold standard but as I also stated in my comment on the pension prescription, large public pensions need to adopt a shared-risk model:
The biggest problem with pensions these days are stakeholders with inflexible views. Unions that don't want to share the risk of their plan, governments that shirk their responsibility in topping out these public pensions and making the required contributions, pension funds with poor governance and unrealistic investment targets, and powerful private equity and hedge funds that refuse to cut their fees in order to contribute to solving this crisis.

From a social and moral view, I truly believe that a case can be made to a group of elite private equity and hedge fund managers that they need to cut their fees in half and be part of the pension solution. In return, public pensions can perhaps allocate more assets to them over a longer period, provided alignment of interests and performance are maintained.

I don't know, I've been thinking long and hard of a pension prescription which will go a long way into solving a looming crisis that is only going to get worse. There are no easy solutions but in my mind, we absolutely need to bolster defined-benefit plans and avoid defined-contribution plans, and make sure we get the governance and risk-sharing right. And to do this, everyone needs to be committed to the best interests of the plan, including unions, governments and alternative investment managers.
Interestingly, in its report, HOOPP recommends five best practices from the DB space that policymakers can look to for making progress in pension coverage right now (click on image):

Take the time to read the entire report here, it is brief and to the point and these recommendations can be used everywhere, not just in Canada.

Below, HOOPP's President & CEO Jim Keohane discusses Healthcare of Ontario Pension Plan’s overall pension plan performance and explains how the Plan’s funded status, which stands at 122%, acts as a cushion for the Fund.

If only all Canadians had access to this plan, there would be no looming retirement crisis.

Update: After reading my comment, the retired securities lawyer from Vancouver sent me two comments (added emphasis is mine):
  1. While I fully accept everything they, and you, say on the issue, there is a part of me that bristles at a moral problem that goes untouched. Specifically, a portion, probably relatively small, of the population had the means to ensure adequate pension assets, or at least ensure a better outcome than they have achieved, but failed to do so due to spending habits that would have kept Depression-era babies up at night. One need only look at the awesome increase in Canadian debt levels over the last 30 years to see that baby boomers brought forward spending at the expense of retirement savings. I believe strongly in protecting those who really had no chance to protect themselves, and most no doubt fall into this category. For the rest, fixing and preventing the problem in the future begins with acknowledging the role of reckless spending patterns, a lesson it appears the millennial generation might have learned from their profligate parents.
  2. Regarding defined benefit plans and the recent bankruptcy of Sears Canada, I have always been puzzled that legislation does not rank pensioners claims in first place, even ahead of CRA. We have reams of idiotic securities laws that are designed to protect the investing public because the investing public is judged to lack the sophistication to protect itself. Yet employees, many of whom aren’t even as sophisticated as the lowly investing public, are left to fend for themselves. Essentially, the pension promises made to them are substantively “securities” even if not technically. The holders of the pension promise have no way to protect themselves, unlike the holder of a bond. It’s a moral outrage that we let banks step in front of pensioners. Indeed, even CRA is in a better position to protect itself than pensioners and should therefore rank behind. Plus, there’s the economic point you and HOOP have made: a pensioner made whole is probably much more likely to generate economic activity than a bank made whole. Unless I’m missing a compelling counter-point, public policy considerations cry out for pension claims to rank in first place.
I thank him for sharing this and his comments only reinforce my view that corporations shouldn't be in the pension business, something I discussed in my comment on how GE botched its pension math:
I envision a future where all corporations get out of the pension business to focus only on their core business and retirement will be handled by the federal and state (provincial) governments using large, well-governed public pension plans. There will be resistance to such change but it's the only way forward and it makes good pension and economic sense to do this.

One thing is for sure, the status quo isn't working and is leaving too many Americans exposed to pension poverty. It's not just GE's botched pension math that worries me, it's that of the entire country where too many public and private pensions are chronically underfunded.
Think about it, why are corporations in the pension business at all? Many US corporations are grossly underfunded and the situation isn't that much better in Canada (with a few exceptions).

Wednesday, July 19, 2017

bcIMC Gains 12.4% in Fiscal 2017

Canada News Wire reports, bcIMC Reports 12.4% Annual Return For Fiscal 2017:
The British Columbia Investment Management Corporation (bcIMC) today announced an annual combined pension return, net of costs, of 12.4 per cent for the fiscal year ended March 31, 2017, versus a combined market benchmark of 11.7 per cent. This generated $680 million in added value for bcIMC's pension plan clients.

Infrastructure, private equity, real estate, and renewable resources outperformed for the calendar (error: fiscal) year and delivered above-benchmark returns. Tactical decisions to underweight fixed income in favour of public equities provided value-added returns. A key contributor was the outperformance of global equities relative to their benchmark. In a low return environment for fixed income, the decision to underweight nominal bonds added value and was further enhanced by outperformance relative to the benchmark. Strong performance in illiquid asset investments also provided value-add.

"I am proud of the bcIMC team and the strategic investment decisions they made to generate $680 million in additional value, as well as deploying new capital into long-term investments. This is a significant contribution to securing our clients' financial futures," said Gordon J. Fyfe, bcIMC's Chief Executive Officer and Chief Investment Officer. "Although annual returns provide us with a short-term perspective, it is the longer term that matters. Over the twenty-year period, we have exceeded their actuarial return requirements and have added $7.7 billion in cumulative value add."

Fiscal 2017 Highlights
  • Committed $9.9 billion to illiquid assets — infrastructure, mortgages, private equity, and real estate
  • Established QuadReal Property Group, a real estate asset and property manager 100 per cent owned by bcIMC
  • Transitioned $2.8 billion of externally managed public equity funds to bcIMC
  • Raised $750 million in debt financing for our real estate program
  • Expanded the team by 74 and added expertise in asset management, data governance, derivatives, illiquid assets, portfolio management, quantitative analysis, and tax
"We are required to work in our clients' best financial interests, and it influences our strategies, asset selection, and operations," said Fyfe. "bcIMC's new investment model emphasizes a greater degree of active management over indexing strategies, and creating new and diversified sources of market return and active return to increase the probability of meeting our clients' actuarial rate of return."

bcIMC's operating costs were 24.2 cents per $100 of net assets under management; compared to 23.7 cents in fiscal 2016. Costs incurred on our behalf by third parties and netted against investment returns are not included in operating costs. Our strategy refocuses bcIMC to become an in-house asset manager that uses sophisticated investment strategies and tools. By increasing the percentage of assets managed by bcIMC's investment professionals, we will transition from a reliance on third parties to a more cost-effective model of managing illiquid assets.

In fiscal 2017, bcIMC increased our managed net assets to $135.5 billion, an increase of $13.6 billion from the previous year. bcIMC's asset mix as at March 31, 2017 was as follows: Public Equities (48.3 per cent or $65.5 billion); Fixed Income (19.2 per cent or $26.0 billion); Real Estate (13.5 per cent or $18.2 billion); Infrastructure (8.1 per cent or $11.0 billion); Private Equity (5.8 per cent or $7.8 billion); Mortgages (2.1 per cent or $2.9 billion); Other Strategies–All Weather (1.5 per cent or $2.1 billion); and Renewable Resources (1.5 per cent or $2.0 billion). bcIMC's 2016–2017 Annual Report is available on our website at

About bcIMC

With $135.5 billion of managed assets, British Columbia Investment Management Corporation (bcIMC) is a leading provider of investment management services to British Columbia's public sector. We generate the investment returns that help our institutional clients build a financially secure future. With our global outlook, we seek investment opportunities that convert savings into productive capital that will meet our clients' risk/return requirements over time. We offer investment options across a range of asset classes: fixed income; mortgages; public and private equity; real estate; infrastructure; and renewable resources.
At last, we get bcIMC's results so we can close out the year in terms of reporting the performance of all of Canada's large public pensions.

You should note there is only one blogger in the world who properly covers the results of large Canadian pensions. Let's briefly recap the performance of Canada's large pensions:
And now we see bcIMC gained 12.4% in fiscal 2017 (fiscal year ends March 31st). While the results are in line with those of CPPIB and PSP, it's important to note that bcIMC is relatively underweight private market asset classes relative to the former two and its large peer group (it's also important to note that no two pensions are the same, so making comparisons is trickier than just looking at headline results).

But with the arrival of Gordon Fyfe three years ago, the focus has shifted to private markets in a meaningful way. In fiscal 2017, bcIMC committed $9.9 billion to illiquid assets — infrastructure, mortgages, private equity, and real estate. That is a huge shift into private markets.

In order to do this properly, Gordon hired Jim Pittman, formerly of PSP, to be the SVP of Private Equity at bcIMC. Lincoln Webb is the SVP of Infrastructure and Renewable Resources and Dean Atkins is the SVP Mortgage and Real Estate Investments. Together, these three indivduals are responsible for private market investments.

Now, I want you all to take the time to read bcIMC's Annual Report for 2016-2017 which is avaliable here. You can begin by reading the Chair's Message and then the Report from the CEO/ CIO. The entire Annual Report is well written and contains most of the pertinent information for my analysis below.

First, let me begin with the table below from page 3 of the Annual Report which shows a profile of assets under management as of the end of March (click on image):

When I look at this table above, I see the weighting in Private Equity (5.8%) is well below its peer group. Jim Pittman is going to be in charge of ramping up operations in this asset class and his team was very busy in fiscal 2017.

Second, the table below from page 15 of the Annual Report provides a summary of returns by asset class for bcIMC's combined clients (click on image):

As you can see by looking at one-year results, the bulk of the outperformance in fiscal 2017 came from Fixed Income, Mortgages, Global Public Equity, Private Equity and Infrastructure. Real Estate and Renewable Resources also outperformed in fiscal 2017. Lastly, the All Weather strategy (Bridgewater) also outperformed in fiscal 2017, earning 14.3%, well above its benchmark of 9.8%.

I will let you read the notes of each asset class in the Annual Report, but I note below the activities in Private Equity and Infrastructure which are described on pages 20 and 21 of the Annual Report (click on images):

The results for fiscal 2017 are excellent and it's important to note all asset classes contributed to these results (public and private) but going forward, it's clear the focus will primarily be on private markets to deliver the added-value and attain and surpass the actuarial target rate of return over the long run.

Below, as I customarily do when I go over results of large Canadian pensions, I provide you with the summary compensation table of bcIMC's five senior officers (click on image):

As always, keep in mind that compensation is based on long-term results, something Gordon Fyfe rightly emphasized in his Report from the CEO/ CIO. Gordon also mentioned this in his message:
In 2016—2017 we saw the retirement of Paul Flanagan, who led our fixed income & foreign exchange department for the past 11 years. We wish him all the best in this new chapter of his life. Chris Beauchemin, who has been with bcIMC since 1989, stepped into the position as acting senior vice president, fixed income & foreign exchange. Jim Pittman joined and leads our private equity department and Lawrence Davis also joined to lead our finance department.
One final note on compensation at bcIMC. A friend of mine who worked at BC Hydro told me that public sector compensation in British Columbia is "abysmal". He also told me "Gordon is going to have a hard time convincing his board and the government apparatchiks that they need to improve comp at bcIMC'.

I told him not to underestimate Gordon and the truth is bcIMC needs to improve its compensation at all levels for all sorts of reasons, chief among them is they need to attract and retain qualified people to do all sorts of sophisticated strategies across public and private markets. You need to pay for skill and this is in the best interests of bcIMC's contributors and beneficiaries.

Lastly, I did reach out to Gordon to gain more insights on bcIMC but his assistant Maria told me he's away on business (the old Gordon would have called me right away no matter where he was).

I was also happy to hear that my old colleague from PSP, Mihail Garchev, landed on his feet and is now working at bcIMC doing very similar work that he was doing at PSP.

I hope that Gordon, Mihail and Jim (Pittman) are all doing well and congratulate all of bcIMC's employees for a great fiscal year. Keep up the great work.

One last critical point, just like AIMCo, bcIMC flies too low under the radar and needs to significantly improve its communication. The leaders at both these large public pensions are smart and articulate, there is simply no good reason as to why they shun the media and don't give interviews to Bloomberg and other media just like their counterparts out east regularly do.

Proper communication is pension governance 101. PSP's CEO, André Bourbonnais, was absolutely right when he said: "If you don't take control of your brand and communication, someone else will." I wholeheartedly agree and I'm glad PSP is more active on social media, more present in traditional media and more engaged with its community.

On that note, a lot of people in British Columbia are struggling as wildfires rage in that province, wreaking havoc on communities and displacing thousands from their home. Below, a recent report from the CBC's The National. The Globe and Mail posted an article on the extent of the devastation and how you can help here.

Tuesday, July 18, 2017

CalPERS Goes Canadian in Private Equity?

Robin Respaut of Reuters reports, CalPERS says considering making own private equity investments:
The California Public Employees' Retirement System (CalPERS) on Monday said it was considering making direct investments in private companies, a potential major shift in strategy that would be the first such action by a U.S. public pension fund.

The change, discussed at a meeting of CalPERS board in Monterey, would be closely watched by other U.S. public pensions as they look to improve returns on their investments, in part by cutting fees.

The $323 billion pension fund, the largest in the country and a trend setter, has been under increasing pressure to achieve returns closer to the fund's assumed rate of return of 7 percent by 2020.

In the fiscal year ended June 30, private equity investment returned 13.9 percent, the second best performer behind public equities, or stock portfolio. The asset class helped to boost the fund's total year-end returns to 11.2 percent, exceeding expectations for the first time since 2014.

Private equity has been CalPERS' best performing asset class in the past two decades and accounts for about $26 billion of its portfolio. But CalPERS mainly invests in private equity funds and has been criticized for accepting the high fees and limited disclosures typically associated with the asset class.

The shift in strategy, if adopted, is likely to require a considerable investment in staff and expertise in the years ahead to handle the strategic shift.

CalPERS Chief Investment Officer Ted Eliopoulos told Reuters he would recommend CalPERS "explore setting up a separate vehicle" for direct investments and expand the current co-investment program.

Eliopoulos suggested CalPERS focus on opportunities that do not compete with its current private equity investments, such as owning companies for longer than 10 years, and investing in technology and life science companies.

"CalPERS has a unique opportunity to be a leader in the co-investment space," Sandra Horbach, U.S. buyouts co-head at The Carlyle Group, told the board on Monday.

CalPERS' massive size would make it a formidable player and allow the fund to dictate some investment terms, Horbach said.

Most U.S.-based funds shy away from such investments, while Canadian pension funds are considered leaders in the strategy.

By its own account, CalPERS has developed somewhat of a negative image among private equity firms as being difficult to work with and slow to make decisions, John Cole, CalPERS investment director, told the board at Monday's meeting.

A number of funds "have told us that we have become too unpredictable to do business with, and many larger general partners are cutting back the amounts that they are willing to allocate to us in their new funds", Cole said.
So, CalPERS is going Canadian, or at least attempting to by exploring the creation of a separate vehicle for direct investments and co-investments with top private equity funds.

The key passage in the article above is this:
"The shift in strategy, if adopted, is likely to require a considerable investment in staff and expertise in the years ahead to handle the strategic shift"
Why? Because in order to attract and retain qualified individuals to do direct lending (private debt), purely direct investing and co-invest with top private equity funds, they need to compensate these individuals properly or else this venture will be a failure.

This is why CalPERS' CIO Ted Eliopoulos told Reuters he would recommend CalPERS "explore setting up a separate vehicle" for direct investments and expand the current co-investment program.

Unlike Canada's large pensions, CalPERS doesn't have the governance to pay people to come to its pension fund to engage in these direct investing activities and therefore needs to create a separate vehicle to pay them properly.

Canada's large public pensions have the right governance to pay people properly to bring these activities in-house but they too have seeded specialized platforms when they need the expertise of people they cannot pay internally.

But the difference is Canada's large public pensions are way ahead of the game, having developed their fund investments and co-investments and entering private debt in a huge way.

Go read a comment I posted last week on whether pension funds are displacing private equity, where I wrote this:
So, are pension funds displacing private equity funds? Yes and no. Where they can compete effectively, they will and this is most notable in Canada where large public pensions have the right governance which allows them to higher industry experts and pay them properly.

But in the buyout world, large private equity funds reign supreme, and there's not a pension in the world that will ever displace them from their bread and butter. It won't ever happen, ever, and the reason is simple, when there's a major deal on the table, the first phone calls bankers make is to Schwarzman et al., not the CEO of a major pension fund.

In other words, while Canada's large pensions can compete with private equity funds in private debt, ramping up their operations in the US and Europe and pretty soon Asia, they will never compete with private equity titans on major deals and still need them to generate returns in the traditional buyout space where they invest and co-invest with top private equity funds.

But there is no question that large Canadian pensions are increasingly muscling into private debt an they are delivering stellar results in this area which was once dominated by top PE funds. Just look at the resuts of CPPIB and PSP Investments in fiscal 2017 to underscore this point.

Is private debt foolproof and the pinnacle of all asset classes? Of course not. I worry about public an private debt as the US and global economy slow over the next year but if the principals at large Canadian pensions can still originate great deals, they will be able to weather the storm ahead.
I have no worries that the individuals doing private debt at PSP and CPPIB know what they're doing, I am a little more worried about how CalPERS is going to engage in direct lending, direct investments, and co-investments.

Can it be done? Of course, it can. Should it be done? You bet as long as they get the governance right. If not, it will be doomed from the get-go.

Below, I embedded all three parts of the CalPERS' Investment Committee (June 19, 2017). Listen carefully as CalPERS' CIO Ted Eliopoulos attacks critics of their private equity program, stating that CalPERS is way ahead of its peers when it comes to transparency of fee disclosure (Part 1).

Monday, July 17, 2017

OPTrust Diversifying its Returns?

Colin McClelland of Bloomberg reports, Pension plan OPTrust seeks illiquid assets to diversify returns:
In a world of lower returns, OPTrust Chief Executive Officer Hugh O’Reilly is moving into riskier investments as contributors to the retirement pot age.

“We can’t just match cash flows, we have to take risks,” O’Reilly, whose company oversees $19.2 billion of investments for Ontario government workers, said in an interview. “We don’t want to increase contributions or reduce future benefit accruals where the active members will bear the whole risk.”

OPTrust is starting a $300 million venture-capital portfolio and is considering derivatives linked to insurance risk, O’Reilly said. The firm has allocated 1.5 per cent to these riskier assets and 3 per cent in hedge funds, though the latter is under review, O’Reilly said without elaborating. The fund more than doubled assets in hedge funds in 2016 compared with the previous year, according to the 2016 annual report.

“We want to allocate relatively small amounts of capital into new and different investment areas,” O’Reilly said. OPTrust will then “see if they’re viable, see if they make sense, see if we can incubate them and bring them back and put them where they best belong on the investment team.”

Falling Returns

OPTrust, which manages pension assets for almost 90,000 former and current members of the Ontario Public Service Employees Union, generated a return on investment of 6 per cent for last year. That was down from 8 per cent in 2015 and was less than half the 2016 return of Canada Pension Plan Investment Board, the country’s largest pension plan.

“Investment returns are unpredictable and can result in a wide range on any one year basis,” O’Reilly said. “We know that our portfolio can deliver on our pension sustainability objectives over the long run.”

O’Reilly declined to say what OPTrust targets in returns, saying the company is focused more on the amount of risk exposure it can tolerate.

The new venture-capital fund, known as the Incubation Portfolio, will target late-stage startups that are mostly already profitable, O’Reilly said. Another large Canadian pension fund and a venture-capital firm, which he declined to name because the details are still being worked out, will help fund and guide some of the investments, he said.

‘It’s the Future’

“Venture capital is where the future is in terms of Canada, understanding risk and disruption,” O’Reilly said. “We’re going to get active in this area.”

The strategy tweak comes at a time when the number of workers that support the Toronto-based fund is falling. Between 2007 and 2016, its retirees rose 60 per cent to more than 36,000, while its active members fell 8.7 per cent to almost 44,000, according to the pension fund.

The pension will keep outside management for most of its equity trading because of attractive pricing and the ability to learn from industry experts, O’Reilly said.
Let me begin by stating something you should all note whenever you read anything on OPTrust or OMERS. Unlike HOOPP and OTPP, these pension plans do not have conditional inflation provisions when their plans suffer a deficit.

What this means is that when there is a deficit, active members of the plan bear all the risk because they cannot partially or fully remove inflation protection which impacts retired members.

This is the basis of what I call a shared risk model. I have discussed it in my comment on the pension prescription which you all need to read, and it allows plans like HOOPP and OTPP to restore their plan to a fully-funded status a lot quicker when they run into trouble.

Now, what about the article above? It certainly caught my attention for many reasons which is why I emailed OPTrust's president and CEO, Hugh O'Reilly, to see if the statements are accurate.

Hugh was on vacation last week but put me in touch with Darcy McNeil who got in touch with managers at OPTrust to answer three questions of mine:
  1. $300M in venture cap, isn't this a bit risky given how hard it is to make money in VC (albeit this is late stage which is less risky)? We established an Emerging Alternatives Investment Group with a mandate to investigate and incubate strategies in the illiquid asset space where we currently do not have exposure. This currently includes Insurance Linked Securities, Agriculture and Emerging Growth (or late stage venture). This is the incubation portfolio which totals $300million. It is not exclusively VC. Also, at $300M it constitutes a fairly small portion of our total portfolio.
  2. Derivatives linked to insurance products? Can you please explain. Insurance Linked Securities have attractive characteristics that could potentially help improve risk efficiency in the Total Fund portfolio. We are considering the full spectrum of ILS related strategies. It is a relatively new asset class and we are taking our time in fully understanding the underlying risk profile.
  3. Doubled your allocation to hedge funds last year? Please explain which strategies you favor. We don’t think about hedge funds as a standalone program but in the context of how they fit into our Total Fund portfolio. Hedge Funds are valuable to pension plans because they offer uncorrelated risk premia to provide diversification to traditional asset classes (e.g. equities, fixed income). As a result, the Total Fund portfolio becomes more balanced from a risk exposure standpoint. Hedge Fund strategies are risk efficient (e.g. attractive return per unit of risk employed) which is aligned with our overall MDI investment philosophy that focuses on managing risk. We think about Hedge Funds not as a standalone program but in the context of how they fit into our Total Fund portfolio. It is our intent to build this portfolio to about 10% of the Total Fund – over a protracted period of time.
I thank Hugh O'Reilly and Darcy McNeil for answering my three questions and clarifying this article. It's clear the Bloomberg reporter didn't get what the Incubation Portfolio is all about (maybe it wasn't communicated well or maybe he just didn't understand what it's all about).

Apart from that, let me publicly recommend four absolute return funds in Montreal that fit well into OPTrust's portfolio or the portfolio of other institutional investors:
  1. Crystalline Asset Management: Founded in 1998 by Marc Amirault who formerly worked at the Caisse, this is one of Canada's oldest hedge funds running a great arbitrage fund.
  2. OpenMind Capital: Founded by Karl Gauvin and Paul Turcotte (the latter is also formerly of the Caisse), this fund is performing exceptionally well using very smart option strategies. They don't charge hedge fund fees and offer a lot more than just great returns.
  3. Razorbill Advisors: Founded by Pierre-Philippe Ste-Marie, a veteran of the National Bank of Canada and someone who was a classmate of mine in Honours Economics courses at McGill, this fund offers beta+ and portable alpha products and offers great risk-adjusted alpha at low cost. The alpha over bond indexes is particularly exceptional. Denis Senecal, the fomer SVP Fixed Income at the Caisse recently joined the fund to help them with their business development.
  4. LionGuard Capital Management: A L/S fund founded by Andrey Omelchak, an experienced investment professional. Prior to founding LionGuard in April 2014, Andrey worked as a Portfolio Manager, Canadian Equities, at a Montreal-based buy-side investment management company. The fund uses fundamental bottom-up research & analysis and offers industry leading investment products focused on small and medium capitalization equities. Their performance since inception is exceptonal.
Now, there are larger, more well-known funds in Montreal like Jarislowsky Fraser, Letko, Brosseau and Associates, Fiera Capital and Hexavest which are all excellent asset managers but they are mostly long-only shops (except Fiera is expanding its absolute return strategies and Hexavest uses rigorous macro analysis to help build its portfolios).

I have nothing againt the big shops in Montreal and think highly of all of them. But we need to bring attention to some of the smaller shops, including Jean Turmel's Perseus Capital, a macro fund run by a legend of the National Bank who also happens to be the Chair of the Board at Ontario Teachers' Pension Plan. If anyone can weather the storm ahead, it's Jean Turmel.

Now that I am done plugging Montreal asset managers, let me conclude by congratulating OPTrust's President and CEO Hugh O’Reilly for having been elected to the Board of Directors of the Canadian Coalition for Good Governance (CCGG).

The Chair of CCGG's board is Julie Cays, the Chief Investment Officer at the Colleges of Applied Arts and Technology (CAAT) Pension Plan which is the jointly sponsored, defined benefit pension plan for 43,000 members from 38 employers in the postsecondary sector in Ontario. I think very highly of Julie and need to cover CAAT more closely.

OPTrust's President and CEO is also very active on LinkedIn where he posts great articles and pension related stories even from fellow plans, like HOOPP's recent post on the changing retirement landscape (read it here, a must read).

I covered how OPTrust is changing the conversation and how it's boosting its internal management. This is another great Canadian pension plan which is focused on risk-adjusted returns and remaining fully-funded, which is the ultimate measure of success at any pension plan.

Below, Ontario eased its rules for its pension funds as years of low interest rates, poor equity returns and a looming retiree glut pressure companies. The biggest of a complex series of proposals would reduce the so-called “solvency funding” requirement of certain plans to 85 percent from 100 percent. That means companies would be in compliance if they had enough to pay 85 cents on the dollar if they were wound-up immediately. Hugh O'Reilly, president and CEO, speaks with Lily Jamali on "Bloomberg Markets Canada."

And OPTrust unveilled a brand new trading floor recently, as part of its plan to bring the management of foreign-exchange, fixed-income and derivatives portfolios in-house. The pension fund's Capital Markets Group will oversee about half of the company's $18.4 billion of assets. CEO Hugh O'Reilly speaks with Lily Jamali on "Bloomberg Markets Canada."