Thursday, November 12, 2009

Beta Boosts CPPIB's Q2 FY2010 Results


CPPIB released its second quarter results for fiscal year 2010. The CPP Fund is up $7.2 billion to $123.8 billion:
The CPP Fund ended the second quarter of fiscal 2010 on September 30, 2009 at $123.8 billion compared to $116.6 billion at the end of the first quarter on June 30, 2009. The $7.2 billion increase in assets after operating expenses this quarter consisted of $5.4 billion in investment income, reflecting a 4.6 per cent rate of return, and $1.9 billion in CPP contributions not needed to pay current pension benefits.

For the six-month fiscal year-to-date period, the CPP Fund has increased by $18.3 billion from the $105.5 billion level of the prior fiscal year end of March 31, 2009. This increase in assets after operating expenses is comprised of $5.4 billion in CPP contributions and $13.0 billion in investment income reflecting a 12.0 per cent rate of return. The CPP Fund is now above the previous highest year-end level which was recorded on March 31, 2008.

“The continued strength in the public equity markets has been the major factor in the CPP Fund’s increase of over $13 billion of investment income since March 31, 2009,” said David Denison, President and CEO, CPP Investment Board. “We are pleased with the Fund’s performance this quarter and year to date. At the same time, we remain focused on performance over the long term in line with our long investment horizon.”

“In the second quarter we continued to execute our long-term strategy and were able to capitalize on current market conditions by making a number of significant public, private and real estate investments. We expect these investments will be a strong source of investment income over the long term.”

In just over 10 years since the CPPIB began investing in April 1999, the Fund has generated $37.2 billion in investment income reflecting an annualized rate of return of 5.2 per cent. Another relevant measure is the four-year annualized investment rate of return through September 30, 2009 which was 2.3 per cent representing $8.3 billion in investment income.

Long-term Sustainability

In July 2009, the Chief Actuary reaffirmed that the CPP is sustainable throughout the 75-year timeframe of his 2007 report; the Chief Actuary will publish a new projection for the CPP in 2010.

The Chief Actuary of Canada estimates that a 4.2 per cent real rate of return, or approximately 6.2 per cent on a nominal basis, over the span of the 75-year timeframe covered by his 2007 report, is required to sustain the plan at the current contribution rate.

“Although our four-year results are currently below this long-term rate of return, we remain confident the CPP Fund will generate returns in excess of this 4.2 per cent threshold over its long investment horizon,” said Mr. Denison.

Asset Mix

At September 30, 2009, equities represented 55.8 per cent of the investment portfolio or $69.2 billion. That amount consisted of 44.6 per cent public equities valued at $55.3 billion and 11.2 per cent private equities valued at $13.9 billion. Fixed income, which includes bonds, money market securities, other debt and debt financing liabilities represented 30.7 per cent or $38.1 billion. Inflation-sensitive assets represented 13.5 per cent or $16.6 billion. Of those assets, 5.6 per cent consisted of real estate valued at $6.9 billion, 4.8 per cent was infrastructure assets valued at $5.9 billion, and 3.1 per cent was inflation-linked bonds valued at $3.8 billion.
CPPIB's strong results in Q2 of FY2010 is all about beta. The rally in stocks boosted the returns of most pension funds that are overweight stocks in their asset mix. CPPIB happens to have 45% of its assets in public equities so we shouldn't be surprised with these results.

There were a few articles that covered these results. Karen Mazurkewich of the National Post reports that markets boost Canada Pension Plan's return:

After navigating the public equities turbulent waters at the beginning of the year, the Canada Pension Plan Investment Board has eased into calmer waters. Its second quarter results reveal a $5.4-billion growth in investment income which represents an overall 4.6% rate-of-return.

While fixed income "has done well," the growth was largely due to public equities markets, according to David Denison, president and chief executive of CPPIB. The public equities market has had a significant run-up, but those returns were moderated somewhat from foreign exchange effects, he added.

The fund, which also added $1.9-billion of contributions this quarter, now reports that the overall assets under management have hit $123.8-billion, which exceeds the level the fund reached before the economic crisis.

"We are happy that returns are positive, but we weren't unduly influenced by the commentary of last year's performance because we had the conviction of our strategy," said Mr. Denison.

While it's too early to determine how valuations of the fund's private-equity and real estate holdings have fared to date, Mr. Denison said they are seeing more of their private-equity partners working through public offerings of their underlying investments.

CPPIB is hoping to benefit from the IPO of Dollar General Corp. which if it raises close to US$800-million will be one of the largest IPO's this year. CPPIB has a direct holding in Dollar General and is also invested in the U.S. private-equity firm KKR, which took Dollar General private in 2007.

Meanwhile, CPPIB is still trolling for infrastructure assets, said Mr. Denison, adding that despite market improvements, there are still opportunities in the asset class.

Earlier this month, CPPIB and the Ontario Teachers' Pension plan made a A$6.7-billion over for the Australian toll-road operator Transurban Group. That offer was rejected by Transurban as “incomplete, highly conditional and non-binding." No doubt the Canadian pension plans are sharpening their pencils for a second go around. Mr. Denison would not comment on the offer.

Weren't unduly influenced by the commentary of last year's performance because you had conviction in your strategy? What strategy? What conviction? With an asset allocation of 45% in public equities and 11% in private equities - by far one of the more aggressive asset mixes among the large pension funds - it's all about beta. If equity markets tank next quarter, so will CPPIB's performance.

To hammer in the point on beta, which is not unique to CPPIB, I note that Bloomberg reports the following:

Canadian pension funds posted investment gains of 14.3 percent in the first nine months of the year, RBC Dexia estimated. Canada’s benchmark Standard & Poor’s/TSX Composite Index rose 9.8 percent in the quarter, and surged 51 percent from a March 9 low.

“I don’t think any market observer, us included, would predict the same level of equity-market appreciation over the next three or six months as we’ve seen over the past six months,” Denison said. “But we’re all seeing positive signs of economic recovery on a global basis.”

As far as private markets, CPPIB does not report the performance of these assets on a quarterly basis so we will have to wait until the end of their fiscal year (March 31st) before we find out how they fared in real estate, private equity and infrastructure investments.

Reuters reports that Canada Pension Plan sees acquisition opportunities:

"We do see continued opportunities for us to make investments, particularly in the private market, private equity, infrastructure and real estate," CPPIB President and Chief Executive David Denison told Reuters in an interview after the fund's quarterly results were released.

"We have seen infrastructure assets that come available in large part because some of those assets were overleveraged in their existing structures and need fundamentally to be restructured. We think there are more of those that we'll have an opportunity to look at," he said.

"We think there is opportunity in real estate yet to come to the market, particularly in the United States, so we'll be focused on that."

There will be plenty of opportunities to snap up US commercial real estate but I would really appreciate it if CPPIB can clearly publish its benchmarks governing all asset classes, including private markets.

If Canadians' pension contributions are going to used to compensate CPPIB's senior managers for performance, let's make sure they're being evaluated against proper benchmarks that accurately reflect the risks they're taking in all asset classes, especially in private markets. And let's pay senior managers bonuses for delivering alpha, not beta.

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