Wednesday, February 21, 2018

The Caisse Gains 9.3% in 2017

Jacob Serebrin of the Montreal Gazette reports, Caisse posts $24.6-billion profit, says it's ready for market correction:
The head of the Caisse de dépôt et placement du Québec said he believes a market correction is coming but that the provincial pension fund manager is much better prepared than it was in 2008.

While corporate profits have risen, Michael Sabia, the president and CEO of the Caisse, said the market returns that reflect future expectations are rising faster.

And that is leading to a more fragile market, he said Wednesday.

In 2008, the Caisse lost almost $40 billion.

This time, Sabia said, the fund manager sees a correction as an opportunity.

“Unlike the situation of la Caisse in 2008 and 2009, where we did not have any room to manoeuvre, we were not able to move assets and capital to benefit from the resurgence of the markets,” he said. “This time, we are prepared. This time, we have the flexibility to move substantial capital in a highly liquid way from one or two asset classes into others as we benefit from what would be a repricing of the market.”

But he doesn’t know when that correction will come.

“Our job is not to try to predict the markets. It’s not to try to time the markets. Our job is to be ready,” he said.

The comments came as the Caisse announced net investment results of $24.6 billion in 2017. That’s an annualized return rate of 9.3 per cent, which brought its net assets to $298.5 billion.

It’s the Caisse’s strongest annualized return since 2014, when it generated an annualized return of 12 per cent, or $23.8 billion.

In 2016, the Caisse reported an annualized return of 7.6 per cent, worth $18.4 billion.

Sabia also addressed the decision to not choose Bombardier’s bid to build train cars for the Réseau express métropolitain, the light-rail network being built by the Caisse.

He said the Caisse wears two hats: it’s an investor in Bombardier and a project manager when it comes to the REM.

“As an investor, we made an investment of $2 billion in the Bombardier Transport during one of the most difficult times in the history of that company,” he said.

That investment helped save Bombardier, he said, and shows the Caisse’s commitment to the company’s success.

“From a project manager point of view, our job is to build the best possible project at the best possible price, and that’s what we’re doing,” he said.

Sabia said the Caisse nearly abandoned the project in November.

“We got proposals in November, on the engineering and construction side of the REM, that were highly problematic,” he said. “It just wouldn’t work from a user point of view, from a cost point of view.”

But by “sticking to our guns, negotiating the way we did,” the Caisse was able to find solutions and save the project, he said.

The Caisse, which manages Quebec’s public pension plan as well as several other para-public pension and insurance plans, said it generated returns of between 10.9 per cent and eight per cent for its eight primary clients in 2017.

That variation is because different clients have different risk tolerances and different approaches to funding, Sabia said. While the provincial pension fund has a very long-term strategy, other funds, like the Commission de la construction du Québec pension plan, have less risk tolerance.

Equities, which represent 50 per cent of the Caisse’s overall portfolio, generated a return rate of 13.6 per cent and net investment results of $17.6 billion.

That was driven by strong stock market performance, particularly in the United States and emerging markets like China and South Korea, where the Caisse has invested in technology companies.

Real assets generated net investment results of $4 billion and had a return rate of 8.7 per cent.

Daniel Fournier, the CEO of Ivanhoé Cambridge, the Caisse’s real-estate subsidiary, said it is narrowing its portfolio of shopping centres, focusing on the most profitable ones and selling others. As well, it is making investments in distribution and logistics, particularly in China.

Fixed income, the category that includes bonds, generated net investment results of $3.2 billion, a return rate of 3.5 per cent.

During the past two years, Sabia said, the Caisse has diversified its holdings in this asset category.

That includes a credit portfolio focused on corporate credit and specialized financing, like the $1.5-billion loan it made to SNC-Lavalin in April to help it acquire WS Atkins, a British competitor.

The pension fund manager said it made $6.7 billion in new investments and commitments in Quebec alone in 2017.

Sabia said the Caisse has increased its focus on investing in Quebec’s private sector, describing it as the motor for economic and employment growth in the province.

Its assets in Quebec’s private sector have risen from $27.6 billion in 2012 to $42.5 billion in 2017.

A big part of that is a focus on helping Quebec companies grow internationally, said Christian Dubé, the Caisse’s executive vice-president for Quebec.

The Caisse is also making investments in Quebec’s AI industry, he said.

“For us, it’s the new economy,” Dubé said.

Investing now will allow the Caisse to position itself and give it a sense of who the major players will be in five to 10 years, Dubé said.
Second, Reuters reports, Canada's Caisse fund reports 9.3 percent return in 2017:
Canada’s second-largest pension fund, the Caisse de depot et placement du Quebec, on Wednesday reported a 9.3 percent return on its clients’ funds in 2017, helped by a strong performance from its equities investments.

The Caisse said its net assets totaled C$299 billion ($236 billion) at the end of 2017, up from C$271 billion a year earlier.

The fund manages public pension plans in the Canadian province of Quebec. It has diversified to become one of the world’s biggest investors in infrastructure and real estate as well as a major investor in global equity and fixed income markets.

Chief Executive Michael Sabia said the fund was continuing to build a portfolio that can withstand geopolitical risks and market volatility.

“We are putting a big emphasis on resilience. Resilience is exactly what we need in this environment,” Sabia told reporters.

He said investors were currently “incredibly sensitive” to the actions of central banks, amid concerns about how changes in monetary policy to curb inflation could impact interest rates.
Allison Lampert and Matt Scuffham of Reuters also report, Caisse CEO urges Bombardier to be ready for M&A activity:
Bombardier should be “on alert” for merger opportunities that will enable its transportation unit to compete with larger rivals in an industry that is consolidating to help reduce costs, the chief executive of its biggest independent shareholder said on Wednesday.

“I think, in an industry that’s consolidating to the degree that it is and given the scale issues associated with the size of the Chinese presence in that industry, the company needs to be always alert to M&A opportunities,” Caisse de depot et Placement du Quebec CEO Michael Sabia told reporters.

Germany’s Siemens AG last September opted to merge its rail business with France’s Alstom SA instead of Bombardier’s rail unit, leaving Bombardier facing a challenge to compete in a market dominated by China’s state-owned CRRC, the world’s largest train maker, and the combined Siemens and Alstom group.

Sabia was speaking after Canada’s second-biggest public pension plan reported a 9.3 percent return on its clients’ funds in 2017, helped by a strong performance from its equities investments.

The Caisse, which invests on behalf of workers and retirees in the Canadian province of Quebec, has a near 30 percent stake in Bombardier’s rail division, which has a $33 billion backlog and reported strong earnings last week.

However, earlier this month, it missed out on a contract to provide rail cars for one of the world’s biggest light rail systems in Montreal, a project led and financed by the Caisse, its largest independent shareholder.

Ontario transit agency Metrolinx also cut its vehicle order from Bombardier following a dispute over Bombardier’s ability to fulfill its contract.

“The core challenge (for Bombardier) is improving execution,” Sabia said.

The Caisse also has a 2.5 percent stake in the parent.

The Caisse said its net assets totaled C$299 billion ($236 billion) at the end of 2017, up from C$271 billion a year earlier.

The fund has diversified to become one of the world’s biggest investors in infrastructure and real estate as well as a major investor in global equity and fixed income markets.

Sabia said it was positioned to take advantage if the prices of assets decline.

“If a correction arises I would see that as a very significant opportunity,” he said. “We have the flexibility to move substantial capital from one or two asset classes into others.”

Sabia said the Caisse was looking at possible investments in blockchain technologies but dismissed the idea of investing in bitcoin.

“I‘m not signed up for lottery tickets. That’s what I think bitcoin pretty much is,” he said.
Lastly, Ross Marowits of the Canadian Press reports, Caisse ready to pounce as market fragility makes it open for correction:
The fragility of global markets caused by soaring stock prices has opened the door to a correction that Quebec’s Caisse de depot pension fund manager is ready to pounce on, CEO Michael Sabia said Wednesday.

“If a correction arrived to be honest with you, I would see that as a very significant opportunity,” he said during a news conference about its improved 2017 results.

The Caisse said it earned a 9.3 per cent return in 2017, ending a three-year streak of decreasing returns. The performance marginally surpassed its reference index and compared with a 7.6 per cent return in 2016.

Unlike the situation during the economic crisis of 2008-2009, the large institutional investor has the flexibility to move substantial capital between asset classes to benefit from a fall in stock prices, Sabia said.

Although economic growth is strong and largely synchronized around the world, he said markets are fragile, making them more susceptible to shocks from unexpected interest rate increases or a geopolitical crisis.

“Because of that fragility that we see in the markets today, we’re very focused on this fundamental principle of resilience so that we’re ready in the event that something does change in the markets,” he told reporters.

The U.S. faces the possibility of higher interest rates to curb inflation, he said, but urged the Canadian government to be “measured” in its response to lower U.S. corporate taxes or contentious trade disputes.

“I don’t think there’s an immediate need for significant reaction with respect to the Canadian tax system,” he said.

The federal budget is scheduled for Feb. 27 but Finance Minister Bill Morneau has said that the government has no plans to “act in an impulsive way” in response to tax cuts south of the border.

In response to questions from reporters, Sabia said the Caisse isn’t looking to invest in marijuana stocks or the Bitcoin, which he likened to lottery tickets.

Total Caisse assets as of Dec. 31 were $298.5 billion, up $24.6 billion in one year, while net deposits totalled $3.2 billion.

Its eight main clients received returns between eight and 10.9 per cent last year.

Returns were $110 billion over five years for a 10.2 per cent annualized return over the period. Net assets have increased by $122 billion since 2012, including $12.6 billion from its clients.

In 2014, the fund manager posted a return of 12 per cent, marking the beginning of a three-year streak of decreasing returns. It finished 2015 with a return of 9.1 per cent and 7.56 per cent in 2016.

Equities did the heavy lifting last year, rising 13.6 per cent to $149.5 billion, while fixed income was up 3.5 per cent to $96.7 billion. Real estate increased 8.7 per cent to $50.4 billion.

Real estate was the only portfolio that failed to exceed its reference index. However, Ivanhoe Cambridge CEO Daniel Fournier said it faced heavy competition from sovereign and international pension funds and the impact of the shared economy.

“A return of eight per cent is more than respectable in our sector for the years to come,” he said.

The Caisse said it has diversified its geographic exposure over the last five years by expanding global presence and more than doubling its exposure in growth markets.

Canada’s second-largest pension fund manager made $6.7 billion in new investments with Quebec’s private sector, which it said is the main driver of the economy and jobs. It is now a partner with more than 750 companies based in the province.
Remember, unlike other large Canadian pensions, the Caisse has a dual mandate to achieve its required actuarial return and to promote Quebec's economy. And both these mandates need to be profitable over the long run.

You can also read Nicolas Van Praet's Globe and Mail article on the Caisse's 2017 returns here. From that article, I note the following:
Over nine years as Caisse boss, Mr. Sabia has helmed a sweeping strategic shift that has seen the pension fund expand its international investments while increasing its exposure to what it calls more concrete, "less liquid" assets such as real estate in a bid to generate more stable returns. At last count, about 60 per cent of the Caisse's asset exposure was outside Canada.

Emerging-market equities did particularly well for the Caisse last year, generating a return of 28.4 per cent. Chinese and South Korean markets made up the bulk of the gains, boosted by the information technology sector as smart selection by external investment advisers paid off. Big stock holdings for the Caisse in Asia include positions in Chinese internet giants Alibaba, Tencent and Baidu.

The Caisse's two equity portfolios generated combined returns of 13.6 per cent for 2017. So-called "real assets," like infrastructure and real estate, returned 8.7 per cent while fixed income returned 3.5 per cent.

Among Mr. Sabia's highest priorities right now is the renamed Réseau Express Métropolitain (REM), a $6.3-billion light rail transit system cutting across Montreal that the Caisse is shepherding as the project's manager and main financier.

The CEO has already met with a handful of U.S. state governors to explain the greenfield infrastructure project and promote the Caisse's model. That approach reverses the typical government-leads scenario for big public works projects and sees the pension fund take the helm while Quebec and Canada participate as minority investors.
And the Globe and Mail article ends with this interesting note:
Mr. Sabia's mandate as Caisse president and CEO was renewed last year until March, 2021. No changes were made to his compensation.

The pension fund still hasn't hired a replacement for chief investment officer Roland Lescure, who left nearly a year ago to help Emmanuel Macron become president of France. Mr. Sabia said it was never his intention to replace Mr. Lescure with one person and that a broader shakeup of the senior ranks is coming as the Caisse seeks to build its capability. Mr. Lescure was elected to France's National Assembly and now sits as the representative of French residents living in Canada and the United States.
So, this answers my question of why the Caisse has yet to name a replacement for Roland Lescure.

You'll recall last week I covered the Caisse's $300 million REM cost overrun, dispelling many myths on this project:
 A few key points I want to make here:
  • The price tag of this project moved up to $6.3 billion, but this isn't a $300 million cost overrun. Basically, the CDPQ Infra group had estimated costs for constructing and for operating this project and went out to get bids (a very competitive bidding process). 
  • The group came a little short on its estimates of the capital expenditure of the project, so when the bids came in for construction, they fell short by $300 million, well within the normal margin of error for a mammoth infrastructure project of this size
  • However, the group overestimated the cost of operating this project so even though their estimates of capital expenditures were lower than the bids, the estimates of operating were higher than the bids, so it will cost less to operate meaning the margins are higher
  • Importantly, over the long run, this extra $300 million which the Caisse is kicking in as an equity stake (not debt, the Caisse isn't borrowing to fund this project) to construct this project is trivial if user fees stay as planned. Moreover, the lower operational/ maintenance cost will offset this higher capital expenditure, allowing the Caisse to generate an 8-9% annualized return for Quebecers over the long run (see Michael Sabia's interview below).
  • These are subtle but critical points which have been lost or glossed over by the media as they rush to claim "the price tag will be $300 million higher and the project is delayed by a year."
By the way, the media got that wrong too, the first phase of the project will commence in 2021, it's impossible for the entire project to be ready and operational by 2021.
It's funny because just today I had lunch with a wise former employee of the Caisse and he asked me: "Where does Michael Sabia come up with his 8%-9% projected returns on the REM and where is the independent governance on this project? Why don't they nominate an independent board to oversee it?"

I actually shared these concerns with an expert who told me as far return projections, "concessions were making 12-13% annualized with no revenue risk, so the return projections sound right."

On the governance, he said: "The Caisse assumes all the risks of the REM. The Quebec and federal government have contributed a sizable amount but once the project gets going, it's off their balance sheet. For them, it's an investment and they will both earn a return. The Caisse put over 50% equity in this project and assumes all the risks. I don't understand why an independent board overseeing this project is needed if the Caisse assumes all the risks. That doesn't make sense. Moreover, alignment of interests are there and if they do a great job, everyone walks away happy."

Anyway, the Caisse's 2017 results are out and you can read the press release here. It's important to note the full 2017 Annual Report is not available yet. It will be available in mid-April and when it is you can read it here.

From the press release, it's important to emphasize long-term (5-year) results:

It's not just that compensation is based on these long-term results, it's also that these are the results that ultimately matter for depositors and Quebec pensioners.

The press release states:
La Caisse focuses on equities that provide stable and predictable returns to reduce sensitivity to market highs and lows. In 2017, la Caisse’s return reflects strong equity market performance, but does not fully capture the surge in multiples for tech companies and companies with an accelerated growth profile. Conversely, la Caisse’s portfolio should also provide greater resilience in volatile markets.

Detailed information on the returns of each asset class is provided in the fact sheets included with this news release.

The most important table is the one below showing returns by asset class over the last five years and for 2017 (click on image):

A quick glance shows me that apart from Emerging Markets stocks, Private Equity really performed well in 2017, returning 13% versus a benchmark return of 10.6%. I also noted solid performance in Real Assets (Real Estate and Infrastructure) and decent performance all around.

Unfortunately, I can't get into more details as the 2017 Annual Report isn't available yet. When it is in mid-April, you will be able to read more details here, including details on compensation, benchmarks, and a lot more.

One thing I was curious to know is whether F/X cost the Caisse returns given the decline in the US dollar in 2017. I'm not sure if the Caisse partially of fully hedges foreign exchange risk, I know CPPIB and PSP don't so their performance will be impacted by the decline in the US dollar last year.

Other than that, it was another solid year for the Caisse but it will be interesting to see how the portfolio withstands a real correction that lasts. Just like CPPIB and others, I'm sure the Caisse bought the last correction.

Below, CTV News Montreal reports the return for Quebec's pension fund, the Caisse de Depot, was up in 2017 to 9.3 per cent, two points higher than in 2016.

Tuesday, February 20, 2018

Private Equity's Dark Cloud?

Jarrett Renshaw of Reuters reports, Refiner goes belly-up after big payouts to Carlyle Group:
Throughout 2016 and 2017, a rail terminal built to accept crude oil for the largest East Coast refinery often sat idle, with few trains showing up to unload.

Although little oil flowed, plenty of money did.

Under a deal Philadelphia Energy Solutions (PES) signed in 2015, the refiner paid minimum quarterly payments of $30 million to terminal owner North Yard Logistics LP - even if little crude arrived. Much of that cash, in turn, flowed to the investors that own both PES and North Yard, led by the Carlyle Group, a global private equity firm with $178 billion in assets.

The deal in effect guaranteed lucrative payouts to Carlyle regardless of whether the refinery benefitted from the arrangement. When oil market conditions made the rail shipments unprofitable later that year, the refinery took heavy losses while its investors continued to collect large distributions for two more years.

The rail contract exemplifies the financial demands Carlyle imposed on PES in the years leading up to the refiner’s bankruptcy in January. The Carlyle-led consortium collected at least $594 million in cash distributions from PES before it collapsed, according to a Reuters review of bankruptcy filings. Carlyle paid $175 million in 2012 for its two-thirds stake in the refiner.

(For a graphic detailing how PES went bankrupt, see: )

More than half the distributions to the Carlyle-led investors were financed by loans against PES assets that the refiner now can’t pay back, the filings show. The rest came from the refiner’s operating budget and payments PES made under the terminal deal to North Yard, a firm with no offices or employees that PES spun off in 2015.

PES has blamed its bankruptcy on environmental regulations that require all U.S. refiners to cover the costs of blending corn-based ethanol into the nation’s gasoline. But the ill-fated train terminal deal and other large payouts to investors played key roles in the refiner’s collapse, according to filings and five current or former PES employees who were involved in the refinery’s decision-making. The employees spoke to Reuters on condition of anonymity.

The investor payouts, along with a slump in refining economics, left PES unable to cover its obligations under the decade-old U.S. Renewable Fuel Standard or the loans it took to finance the distributions to Carlyle, the filings show.

PES had $600 million in debt and $43 million in cash on hand when it filed bankruptcy last month. It now hopes to restructure and continue operations, which employ about 1,100 people.

Carlyle Group spokesman Christopher Ullman declined to comment on whether the distributions or the rail-terminal deal contributed to the refiner’s bankruptcy. PES spokeswoman Cherice Corley defended the payments to Carlyle and said the biofuels regulations played a “significant” role its collapse.

“We feel our capital structure was appropriate, and any suggestion that it was the cause of our restructuring is completely ignoring the significant effect of the flawed Renewable Fuel Standard (RFS),” Corley said.

Other refiners and Pennsylvania officials have also blamed biofuels regulation for the South Philadelphia refinery’s failure, triggering renewed debate about the program on Capitol Hill.

Refiners without the necessary blending facilities, such as PES, are required to purchase regulatory credits, known as RINs, from firms that do such blending. The cost of compliance for PES rose from $13 million in 2012 to $218 million in 2017 as prices increased for the credits, which are traded in an open market.

The refiner, however, failed to pay a large portion of that obligation. In addition to its conventional debt, PES still owes the U.S. Environmental Protection Agency (EPA) regulatory credits worth about $350 million, an amount tied to the fuel it produced over the past two years, according to filings. The firm stopped buying RINs last year - and instead sold them to other refiners for what likely amounted to tens of millions of dollars, Reuters reported in November.

The corn and ethanol lobby has pushed back on the argument that biofuels regulation sunk PES, pointing out that other refiners governed by the same law are raking in their highest profits in years. The refinery’s failure had more to do with the hefty profits it paid to Carlyle as its cash reserves dwindled and its debt soared, said Brooke Coleman, head of the Advanced Biofuels Council.

“The Carlyle Group looks more like a corporate raider than a savior in this deal,” Coleman said.

Carlyle would not lose any of its gains on the PES investment under the refiner’s proposed restructuring plan, which has the support of almost all creditors, according to filings. PES also asks the bankruptcy court to entirely absolve its $350 million obligation to the EPA.

EPA spokeswoman Liz Bowman declined to comment on the delinquent PES credit obligations, citing the bankruptcy proceedings.


Carlyle bought its stake in PES as many other East Coast refineries were closing down because of weak margins. The previous owner, Sunoco - now Energy Transfer Partners (ETP.N) - contributed the refinery’s assets and became a non-controlling partner.

The $175 million Carlyle paid was its only investment in PES, filings show, and the firm soon recouped its acquisition costs through a loan against the refinery.

PES then spent $100 million building the rail terminal that year and $30 million in 2014 to double its capacity. At the time, U.S. oil production was skyrocketing as improved drilling technology unlocked new reserves in places such as North Dakota. Carlyle saw an opportunity to tap this cheaper supply and wean PES off costly imports.

The plan worked well at first, in 2013 and 2014, and PES posted earnings of about $500 million for the two years combined.

In January 2015, PES spun off the terminal, creating North Yard as a separate firm. PES then signed a ten-year agreement with North Yard to pay $1.95 for each barrel unloaded and agreed to a minimum quarterly volume of 170,000 bpd, guaranteeing the $30 million quarterly payments to North Yard. For any barrel PES unloaded above the threshold, the refinery paid North Yard 51 cents.

The system was designed to reward PES for success, but had no contingency plan to protect the refiner against the failure that would quickly follow the deal. The rail terminal has averaged just 58,000 bpd since the contract was signed, according to figures provided to Reuters by energy intelligence service Genscape, because Carlyle and PES could no longer access crude at prices low enough to make the rail shipments profitable.

That left PES paying millions of dollars to Carlyle, through North Yard, for oil shipments it never received.


Carlyle’s purchase of PES and the rail terminal investment were bets that U.S. oil would remain cheap relative to imports. A glut of domestic production had caused U.S. crude to sell at a deep discount to imported barrels, with the gap averaging about $8.60 between 2012 and 2015.

But by late 2015, an oil price rebound slashed the domestic discount to less than $3 a barrel – not enough to cover the cost of a long rail journey.

PES nonetheless continued to pay North Yard a total of $298 million between 2015 until August 2017, filings show. The Carlyle-led investor group received $151 million, in eight distributions, of the total paid to North Yard.

In November of that year, PES took on more debt to finance more payouts to investors, borrowing a total of $160 million in two loans against the rail terminal and delivering the proceeds its Carlyle-led backers, filings show.

Corley, the PES spokeswoman said terminal investment more than paid for itself during its more profitable period. But for last two years, PES said in filings, the refinery remained largely cut off from the cheap crude it needed to survive.

“Perversely, it became cheaper to transport crude oil from North Dakota to points in Western Europe than it was to transport the same crude oil to Philadelphia,” the firm said.

At the direction of its investor-controlled board, PES borrowed $550 million in March 2013 and paid $200 million of that to investors, according to bankruptcy filings.
If you ever want to understand why private equity has an image problem, keep this article in mind. There's a reason why the book The Iron Triangle is still popular for people trying to understand the enormous power private equity firms yield.

Now, investors in Carlyle's funds might read this and think "great, who cares if Philadelphia Energy Solutions (PES) went belly-up, as long as we receive great returns, we're not going to complain."

And to be sure, they're right, this isn't an isolated case, private equity firms routinely load companies up with debt and extract a pound of flesh. It's all part of PE's asset-stripping boom.

Moreover, certain environmental groups and people living near the refinery worried about their health are rejoicing, thinking they can't wait to see it shut its operations for good.

Still, global pensions investing in private equity are increasingly worried about the optics of these deals because in theory, they're long-term investors looking to create, not destroy jobs.

There is also a problem of private equity's misalignment of interests which I've discussed in the past and the need to make sure there is robust alignment of interests between GPs (general partners: private equity funds) and LPs (limited partners: institutional investors).

But while I welcome critical thoughts, there are a lot of myths in private equity too which is why I wrote a comment back in October defending the industry but with a critical eye.

Still, criticism of private equity abounds. In his latest comment, "Private Equity", Josh Brown of the Reformed Broker blog took on a lot of claims that private equity will continue to generate outsized returns and notes the following (added emphasisis mine):
A few things worth pointing out – as a very experienced private equity portfolio manager explained at our Evidence-Based Investing conference this fall, the multiples PE investors are paying for companies are systematically higher than anyone ever thought possible. Massive amounts of capital coming into the space have fundamentally changed the starting point at the mid to high end for valuations, and it’s not possible to say that this won’t have an effect on forward returns.

As Jason Zweig noted recently, get a few drinks into anyone in the PE space and they’ll start lamenting the lack of reasonably priced opportunities – from this standpoint it’s no different than the public equity markets.

Additionally, the space has become incredibly crowded with intense competitors, which has to make it harder to produce high returns as the alpha is competed away. If every team in the league is the Golden State Warriors, then no team is the Golden State Warriors. People have trouble coming to grips this concept, that absolute skill level is not the problem, it’s a relative skill level game.

Finally, one of the primary reasons so much money is pouring into PE is because the institutions are using the past as their guide for expected returns – and allocating more heavily to a strategy that has produced high returns in the past makes the return assumptions in their model easier to theoretically hit, thus obviating the need for any kind of tough political spending decisions. No need to cut any programs, we’ll just generate higher returns to pay for it all.
I will let you read Josh's entire comment here as he ends with a bunch of links to make his point on why he's skeptical that private equity will continue to generate great returns.

A lot of the arguments are all too familiar, like leveraged small cap value is as good as if not better than many private equity funds. I emphasized many because large institutional investors investing in top funds like Blackstone, KKR, Carlyle, Apollo, TPG, Apax, and many more top funds know all these academic arguments.

The reality is that top pension and sovereign wealth funds don't care about academic articles on private equity, they care about maintaining great, long-standing relationships with top private equity funds where they can invest and co-invest sizable amounts to reduce overall fees (you pay no fees on co-investments, a form of direct PE investing).

The critical thing here is to focus on top funds because in private equity there is evidence of performance persistence and it's true, if you can't invest with top funds, you're better off investing in the S&P 500 because median returns aren't worth it once you factor in liquidity and leverage (a lesson CalPERS learned the hard way investing in way too many private equity funds over the years and generating returns which were decent but below those of its large peers investing in a concentrated portfolio of funds).

Are there good mid-sized or smaller private equity funds? Of course, there are. Are all the funds the big PE funds raise generating huge returns? Of course not. It depends on the vintage year and what is going on in public markets where private equity funds exit their investments (if public markets tank, it has an impact on private equity but because they don't have to sell at depressed levels and aren't marked to market, they can ride out a short storm like 2008).

It's also important to remember pensions are all about matching assets with long-dated liabilities. An allocation to private equity therefore makes perfect sense from a liability investing standpoint.

Moreover, by their very nature, private equity funds invest in private markets where there are more inefficiencies to exploit. Yes, they are less liquid and employ leverage, but that means they're less volatile than public markets and are able to generate higher returns over a longer period, which is what pensions are looking for.

If private equity is that good, why not just put all the pension assets in it? Well, pensions also pay out benefits, so they need to manage liquidity risk carefully and strike a balance between public and private markets (private equity, real estate, and infrastructure).

Most of Canada's large pesions invest anywhere betewen 10-12% in private equity, 15% in real estate and roughy 10%-12% in infrastructure (I'm giving you rough approximations, it varies). They all co-invest in private equity to reduce fees and are increasingly doing purely direct deals, trying to compete with PE giants (they will never fully compete with them and will always need to invest in their funds). Having roughly 40% of their assets in private markets is how they generate great long-term returns.

Are there risks in private equity and other issues? Yes, no doubt about it, but sophisticated investors are on top of these risks and issues and they're continuously working hard to improve alignment of interests.

Lastly, take the time to read a CAIA document on investing like Harvard and Yale endowment funds which you can find here. There's a reason why sophisticated investors have adopted this approach, it makes great long-term sense.

But there are issues confronting private equity and some of them are the same issues confronting the digital economy, namely, does private equity destroy more jobs than it creates?

Below, Chris Hughes, who made a fortune as a co-founder of Facebook, told CNBC on Tuesday American workers who make less than $50,000 per year should get a government stipend of $500 per month — paid for by raising taxes on the wealthy 1 percent.

Before you dismiss his idea as socialist hogwash, listen carefully to his views because I think in the not-too-distant future this will become a reality, especially if rising inequality continues unabated, threatening the foundations of social democracies everywhere.

Friday, February 16, 2018

Top Funds' Activity in Q4 2017

Brandon Kochkodin, Hema Parmar and Katia Porzecanski of Bloomberg report, Hedge Funds Are Dumping Facebook and Google:
Billionaire David Tepper’s Appaloosa Management more than tripled its stake in Apple Inc. and almost doubled its holding of Facebook Inc. in the final three months of last year.

Appaloosa reported shares in Apple worth $777 million as of Dec. 31, which represented 7.4 percent of the hedge fund firm’s U.S. stock holdings, according to a regulatory filing Wednesday. Tepper added to his stake in Facebook, his second-biggest position, by more than 2 million shares. That position was valued at $976 million at the end of the fourth quarter.

The FAANG stocks have posted mixed performance this year. Apple is down about 1 percent, while Inc. and Netflix Inc. have soared.

Other big names also expect that the two tech darlings have more room to run. Louis Bacon’s Moore Capital Management added 900,000 shares of Apple, boosting its holding to about $200 million, according to filings. Chase Coleman’s Tiger Global Management pumped up its position in Facebook.

Stephen Mandel’s Lone Pine Capital added a $900 million wager on Amazon snapping up 770,000 shares in the fourth quarter of 2017. The online retailer accounts for nearly 5 percent of the hedge fund’s U.S. stock holdings. The hedge fund firm also started a $625 million stake in Alphabet, buying up about 598,000 shares in the fourth quarter. Meanwhile, it reduced its Facebook position, selling about 632,000 shares of the company.

Some prominent hedge funds retreated from the FAANGs in the fourth quarter.

Philippe Laffont’s Coatue Management, which rode the FAANG wave last year, sold 2.84 million shares of Apple, bringing the value of its holding to $730 million as of Dec. 31. In September, Laffont called the new iPhone X “groundbreaking” but its sales have since disappointed. The firm also reduced its Facebook position by 1.71 million shares, according to regulatory filings Wednesday.

Tiger Global dumped 1.3 million shares of Netflix, leaving it with a stake worth $337 million, and trimmed its Amazon position. Maverick Capital, run by Lee Ainslie, reduced its Facebook and Alphabet Inc. stakes.

It's that time of the year where we get a sneak peek into the holdings of top funds, lagged by 45 days.

From the large, well-known hedge funds, Chase Coleman's Tiger Global just had an astounding year, gaining 50% on its long positions but losing 19% on its shorts:
As Charles “Chase” Coleman looks back on 2017, with his hedge fund Tiger Global up 50% on long exposure but down 19% on the shorts, he has no regrets, sort of.

“TGI’s hit rate on its long positions was the highest ever in our 17-year history and the portfolio generated four times as much profit from its three largest gainers as it lost on its three worst performing positions,” he told investors in  year-end review letter reviewed by ValueWalk ( the letter is dated January 31st, 2018). “On the short side of the portfolio, we felt similarly good about our research process in 2017, but the outcomes were more frustrating. Our short portfolio consists largely of businesses we believe are on the wrong side of change, frauds, and cyclical assets that are over-earning and trading at peak multiples.”
According to Bloomberg, Mr. Coleman's fund also recently amassed a stake of about $1 billion in Barclays Plc, according to a person with knowledge of the hedge fund’s investment:
The New York-based firm’s holding now amounts to about 2.5 percent, the person said, asking not to be identified as the investment hasn’t been publicly disclosed. The purchase makes Tiger Global a top 10 investor in Barclays, the person said. It would be the seventh largest holder, according to data compiled by Bloomberg.

A spokesman for Barclays declined to comment, while officials for Tiger Global in New York could not be reached outside regular business hours on Monday. The Financial Times reported Tiger Global’s investment earlier.

Tiger Global, headed by former Julian Robertson protege Chase Coleman, bought some of its stake in Barclays when the bank’s shares slumped to a 52-week low of less than 180 pence in November, the person said. The investment comes amid Barclays Chief Executive Officer Jes Staley’s strategy to focus on the firm’s U.S.-led investment bank and its U.K.-based consumer banking operation.
Smart money buys shares when opportunities arise. Warren Buffett’s Berkshire Hathaway Inc (BRK-A) on Wednesday disclosed a new stake in generic drugmaker Teva Pharmaceutical Industries Ltd (TEVA) and said it bought more shares of Apple Inc (AAPL), which surpassed Wells Fargo & Co (WFC) as its largest common stock investment.

I've discussed Teva Pharmaceuticals a few times on this blog, noting that David Abrams, Jonathan Jacobson, Ken Griffin and other top managers bought big stakes before and after shares plunged in Q4 (click on image):

You can see a list of Teva's top institutional holders here

Now, full disclosure: After some initital reticence, I listened to my friend in Trois-Rivières, Quebec and bought Teva's shares at $14 after the big plunge. I see more upside and have yet to sell but that can change depending on many factors.

Why was I hesitant? Because I typically don't buy broken charts and huge dips on any stock but when I saw David Abrams and Highfields’ Jonathan Jacobson -- two deep value gurus -- buying a big stake back in Q3 before the big plunge, I inititiated a position after the big dip in Q4 and added to my shares. This week's Berkshire announcement was icing on the cake.

But I'm constantly looking at stocks, hundreds and thousands of stocks and while I'm making great money on Teva shares, I kicked myself for not holding a huge position in Mirati Therapeutics (MRTX) when it was trading at $5 (click on image):

That's the type of chart I like, a big dip, huge consolidation over many months, and then "BAM!", breakout to the upside and making new highs.

And if you look at the top institutional holders of Mirati here, you won't find Warren Buffett and other deep value gurus, but some great biotech funds I track regularly every quarter (see links to all of them below).

Why am I bringing this up? Because when I told you it's time to take a closer look at hedge funds, I wasn't just referring to the large, well-known funds, I was also referring to smaller funds that crushed it in 2017, like Joseph Edelman's Perceptive Life Sciences fund which surged 43 percent last year (that's him at the top of this comment).

Edelman’s Perceptive Advisors and a few other top biotech funds have been generating incredible returns, above and beyond the biotech indexes, and they are part of a new generation of highly specialized sector managers who really know their stuff (still, in biotech, for every home run, you're going to have a few bombs, and even Perceptive has had its share).

I mention this because it's important to look at some of the smaller funds that are delivering alpha. For example, CNBC used data from hedge fund tracking firm to find the top 10 managers and their biggest bets, according to recent filings. Take the time to read this article here.

Whatever you do, stop chasing after Chase Coleman and other large hedge funds coming off great years. You need to really look into their portfolio and think about the positions they're taking given the macro environment.

This is why I spend so much time focusing on macro, because if you don't get your macro calls right, chances are you won't get your hedge funds right and will likely get burned.

Take the time to read some of my macro and market comments form the start of the years:
These comments alone will allow you to gain a much better understanding of my macro concerns and how I view market risks in relation to these concerns.

Why am I sharing this? Because you can be the best stock picker but if the macro winds change abruptly and go against you, it will hurt your portfolio and you will suffer material losses.

This is why I keep telling you to hedge your portfolio risk by putting 50% of your money in US long bonds (TLT) and another 50% in the S&P 500 low vol ETF (SPLV) and "just relax and sleep well at night”. Forget what top funds are buying and selling, if you follow them blindly, you will get crushed.

However, I realize there are traders, portfolio managers and investors who like buying a portfolio of stocks and know how to critically examine what top funds bought and sold last quarter. That's why I put up these quarterly comments.

All I can tell you is analyzing and trading markets and stocks is a passion of mine. I regularly look at the YTD performance of stocks, the 12-month leaders, the 52-week highs and 52-week lows. I also like to track the most shorted stocks and highest yielding stocks in various exchanges and I have a list of stocks I track in over 100 industries/ themes to see what is moving in real time.

When I'm not looking at thousands of stocks and charts and who bought or added to positions, the other thing I love doing is thinking macro. If I were to write a macro comment this week, it would have been titled "Much Ado About US Inflation?", basically ridiculing the inflation scare story because all you need to do is look at the US dollar over the last year to understand this is cyclical (temporary) inflation, not something which is sustainable going forward (lower US dollar, higher import prices, not higher wages!!).

Anyway, have fun looking at the fourth quarter activity of top funds listed below. The links take you straight to their top holdings and then click on the fourth column head, % chg, to see where they decreased (click once on % chg column head) and increased their holdings (click twice on % chg column head).

Top multi-strategy and event driven hedge funds

As the name implies, these hedge funds invest across a wide variety of hedge fund strategies like L/S Equity, L/S credit, global macro, convertible arbitrage, risk arbitrage, volatility arbitrage, merger arbitrage, distressed debt and statistical pair trading.

Unlike fund of hedge funds, the fees are lower because there is a single manager managing the portfolio, allocating across various alpha strategies as opportunities arise. Below are links to the holdings of some top multi-strategy hedge funds I track closely:

1) Citadel Advisors

2) Balyasny Asset Management

3) Farallon Capital Management

4) Peak6 Investments

5) Kingdon Capital Management

6) Millennium Management

7) Eton Park Capital Management

8) HBK Investments

9) Highbridge Capital Management

10) Highland Capital Management

11) Pentwater Capital Management

12) Och-Ziff Capital Management

13) Pine River Capital Capital Management

14) Carlson Capital Management

15) Magnetar Capital

16) Mount Kellett Capital Management 

17) Whitebox Advisors

18) QVT Financial 

19) Paloma Partners

20) Weiss Multi-Strategy Advisors

21) York Capital Management

Top Global Macro Hedge Funds and Family Offices

These hedge funds gained notoriety because of George Soros, arguably the best and most famous hedge fund manager. Global macros typically invest across fixed income, currency, commodity and equity markets.

George Soros, Carl Icahn, Stanley Druckenmiller, Julian Robertson and now Steve Cohen have converted their hedge funds into family offices to manage their own money and basically only answer to themselves (that is my definition of true investment success).

1) Soros Fund Management

2) Icahn Associates

3) Duquesne Family Office (Stanley Druckenmiller)

4) Bridgewater Associates

5) Pointstate Capital Partners 

6) Caxton Associates (Bruce Kovner)

7) Tudor Investment Corporation (Paul Tudor Jones)

8) Tiger Management (Julian Robertson)

9) Moore Capital Management

10) Point72 Asset Management (Steve Cohen)

11) Bill and Melinda Gates Foundation Trust (Michael Larson, the man behind Gates)

12) Joho Capital (Robert Karr, a super succesful Tiger Cub who shut his fund in 2014)

Top Quant and Market Neutral Hedge Funds

These funds use sophisticated mathematical algorithms to make their returns, typically using high-frequency models so they churn their portfolios often. A few of them have outstanding long-term track records and many believe quants are taking over the world. They typically only hire PhDs in mathematics, physics and computer science to develop their algorithms. Market neutral funds will engage in pair trading to remove market beta.

1) Alyeska Investment Group

2) Renaissance Technologies

3) DE Shaw & Co.

4) Two Sigma Investments

5) Numeric Investors

6) Analytic Investors

7) AQR Capital Management

8) SABA Capital Management

9) Quantitative Investment Management

10) Oxford Asset Management

11) PDT Partners

12) Princeton Alpha Management

13) Angelo Gordon 

Top Deep Value,
Activist, Event Driven and Distressed Debt Funds

These are among the top long-only funds that everyone tracks. They include funds run by legendary investors like Warren Buffet, Seth Klarman, Ron Baron and Ken Fisher. Activist investors like to make investments in companies where management lacks the proper incentives to maximize shareholder value. They differ from traditional L/S hedge funds by having a more concentrated portfolio. Distressed debt funds typically invest in debt of a company but sometimes take equity positions.

1) Abrams Capital Management (the one-man wealth machine)

2) Berkshire Hathaway

3) Baron Partners Fund (click here to view other Baron funds)

4) BHR Capital

5) Fisher Asset Management

6) Baupost Group

7) Fairfax Financial Holdings

8) Fairholme Capital

9) Trian Fund Management

10) Gotham Asset Management

11) Fir Tree Partners

12) Elliott Associates

13) Jana Partners

14) Gabelli Funds

15) Highfields Capital Management 

16) Eminence Capital

17) Pershing Square Capital Management

18) New Mountain Vantage  Advisers

19) Atlantic Investment Management

20) Scout Capital Management

21) Third Point

22) Marcato Capital Management

23) Glenview Capital Management

24) Apollo Management

25) Avenue Capital

26) Armistice Capital

27) Blue Harbor Group

28) Brigade Capital Management

29) Caspian Capital

30) Kerrisdale Advisers

31) Knighthead Capital Management

32) Relational Investors

33) Roystone Capital Management

34) Scopia Capital Management

35) Schneider Capital Management

36) ValueAct Capital

37) Vulcan Value Partners

38) Okumus Fund Management

39) Eagle Capital Management

40) Sasco Capital

41) Lyrical Asset Management

42) Gabelli Funds

43) Brave Warrior Advisors

44) Matrix Asset Advisors

45) Jet Capital

46) Conatus Capital Management

47) Starboard Value

48) Pzena Investment Management

Top Long/Short Hedge Funds

These hedge funds go long shares they think will rise in value and short those they think will fall. Along with global macro funds, they command the bulk of hedge fund assets. There are many L/S funds but here is a small sample of some well-known funds.

1) Adage Capital Management

2) Appaloosa LP

3) Greenlight Capital

4) Maverick Capital

5) Pointstate Capital Partners 

6) Marathon Asset Management

7) Tiger Global Management (Chase Coleman)

8) Coatue Management

9) Omega Advisors (Leon Cooperman)

10) Artis Capital Management

11) Fox Point Capital Management

12) Jabre Capital Partners

13) Lone Pine Capital

14) Paulson & Co.

15) Bronson Point Management

16) Hoplite Capital Management

17) LSV Asset Management

18) Hussman Strategic Advisors

19) Cantillon Capital Management

20) Brookside Capital Management

21) Blue Ridge Capital

22) Iridian Asset Management

23) Clough Capital Partners

24) GLG Partners LP

25) Cadence Capital Management

26) Karsh Capital Management

27) New Mountain Vantage

28) Penserra Capital Management 

29) Silver Point Capital

30) Steadfast Capital Management

31) Brookside Capital Management

32) PAR Capital Capital Management

33) Gilder, Gagnon, Howe & Co

34) Brahman Capital

35) Bridger Management 

36) Kensico Capital Management

37) Kynikos Associates

38) Soroban Capital Partners

39) Passport Capital

40) Pennant Capital Management

41) Mason Capital Management

42) Tide Point Capital Management

43) Sirios Capital Management 

44) Hayman Capital Management

45) Highside Capital Management

46) Tremblant Capital Group

47) Decade Capital Management

48) T. Boone Pickens BP Capital 

49) Bloom Tree Partners

50) Cadian Capital Management

51) Matrix Capital Management

52) Senvest Partners

53) Falcon Edge Capital Management

54) Park West Asset Management

55) Melvin Capital Partners

56) Owl Creek Asset Management

57) Portolan Capital Management

58) Proxima Capital Management

59) Tourbillon Capital Partners

60) Impala Asset Management

61) Valinor Management

62) Viking Global Investors

63) Marshall Wace

64) Light Street Capital Management

65) Honeycomb Asset Management

66) Rock Springs Capital Management

67) Whale Rock Capital

68) Suvretta Capital Management

69) York Capital Management

70) Zweig-Dimenna Associates

Top Sector and Specialized Funds

I like tracking activity funds that specialize in real estate, biotech, healthcare, retail and other sectors like mid, small and micro caps. Here are some funds worth tracking closely.

1) Armistice Capital

2) Baker Brothers Advisors

3) Palo Alto Investors

4) Broadfin Capital

5) Healthcor Management

6) Orbimed Advisors

7) Deerfield Management

8) BB Biotech AG

9) Ghost Tree Capital

10) Sectoral Asset Management

11) Oracle Investment Management

12) Perceptive Advisors

13) Consonance Capital Management

14) Camber Capital Management

15) Redmile Group

16) RTW Investments

17) Bridger Capital Management

18) Boxer Capital

19) Bridgeway Capital Management

20) Cohen & Steers

21) Cardinal Capital Management

22) Munder Capital Management

23) Diamondhill Capital Management 

24) Cortina Asset Management

25) Geneva Capital Management

26) Criterion Capital Management

27) Daruma Capital Management

28) 12 West Capital Management

29) RA Capital Management

30) Sarissa Capital Management

31) Rock Springs Capital Management

32) Senzar Asset Management

33) Southeastern Asset Management

34) Sphera Funds

35) Tang Capital Management

36) Thomson Horstmann & Bryant

37) Venbio Select Advisors

38) Ecor1 Capital

39) Opaleye Management

40) NEA Management Company

41) Great Point Partners

42) Tekla Capital Management

Mutual Funds and Asset Managers

Mutual funds and large asset managers are not hedge funds but their sheer size makes them important players. Some asset managers have excellent track records. Below, are a few funds investors track closely.

1) Fidelity

2) Blackrock Fund Advisors

3) Wellington Management

4) AQR Capital Management

5) Sands Capital Management

6) Brookfield Asset Management

7) Dodge & Cox

8) Eaton Vance Management

9) Grantham, Mayo, Van Otterloo & Co.

10) Geode Capital Management

11) Goldman Sachs Group

12) JP Morgan Chase & Co.

13) Morgan Stanley

14) Manulife Asset Management

15) RCM Capital Management

16) UBS Asset Management

17) Barclays Global Investor

18) Epoch Investment Partners

19) Thornburg Investment Management

20) Legg Mason (Bill Miller)

21) Kornitzer Capital Management

22) Batterymarch Financial Management

23) Tocqueville Asset Management

24) Neuberger Berman

25) Winslow Capital Management

26) Herndon Capital Management

27) Artisan Partners

28) Great West Life Insurance Management

29) Lazard Asset Management 

30) Janus Capital Management

31) Franklin Resources

32) Capital Research Global Investors

33) T. Rowe Price

34) First Eagle Investment Management

35) Frontier Capital Management

36) Akre Capital Management

37) Brandywine Global

38) Brown Capital Management

39) Victory Capital Management

Canadian Asset Managers

Here are a few Canadian funds I track closely:

1) Addenda Capital

2) Letko, Brosseau and Associates

3) Fiera Capital Corporation

4) West Face Capital

5) Hexavest

6) 1832 Asset Management

7) Jarislowsky, Fraser

8) Connor, Clark & Lunn Investment Management

9) TD Asset Management

10) CIBC Asset Management

11) Beutel, Goodman & Co

12) Greystone Managed Investments

13) Mackenzie Financial Corporation

14) Great West Life Assurance Co

15) Guardian Capital

16) Scotia Capital

17) AGF Investments

18) Montrusco Bolton

19) CI Investments

20) Venator Capital Management

Pension Funds, Endowment Funds, and Sovereign Wealth Funds

Last but not least, I the track activity of some pension funds, endowment and sovereign wealth funds. I like to focus on funds that invest in top hedge funds and have internal alpha managers. Below, a sample of pension and endowment funds I track closely:

1) Alberta Investment Management Corporation (AIMco)

2) Ontario Teachers' Pension Plan

3) Canada Pension Plan Investment Board

4) Caisse de dépôt et placement du Québec

5) OMERS Administration Corp.

6) British Columbia Investment Management Corporation (bcIMC)

7) Public Sector Pension Investment Board (PSP Investments)

8) PGGM Investments

9) APG All Pensions Group

10) California Public Employees Retirement System (CalPERS)

11) California State Teachers Retirement System (CalSTRS)

12) New York State Common Fund

13) New York State Teachers Retirement System

14) State Board of Administration of Florida Retirement System

15) State of Wisconsin Investment Board

16) State of New Jersey Common Pension Fund

17) Public Employees Retirement System of Ohio

18) STRS Ohio

19) Teacher Retirement System of Texas

20) Virginia Retirement Systems

21) TIAA CREF investment Management

22) Harvard Management Co.

23) Norges Bank

24) Nordea Investment Management

25) Korea Investment Corp.

26) Singapore Temasek Holdings 

27) Yale Endowment Fund

Below, CNBC's Leslie Picker highlights 13F filings which include investments in retailers. She also highlights Berkshire Hathaway's new stock positions from their fourth-quarter 13F filing.

Hope you enjoyed reading this comment. As always, please remember to kindly donate or subscribe to this blog on the top right-hand side, under my picture and show your support for the work that goes into these comments. I thank all of you who value my efforts and support my blog through a monetary contribution, it's greatly appreciated.