Thursday, February 25, 2010

Caisse Reports 10% Return for 2009

Paul Delean of the Montreal Gazette reports that the Caisse de Dépôt reports $11.5 billion gain for 2009:
It didn’t do as well as its peers or as badly as some expected.

Quebec pension-fund manager La Caisse de Dépôt et Placement du Québec generated a return from its investments of 10.04 per cent in 2009, a sub-par number when compared to other Canadian pension funds but a dramatic turnaround from its catastrophic loss of $40 billion in 2008.

“We had a lot of issues to deal with at the start of the year. They’re dealt with. We put the train back on the track. Now we’ve got to get it up to cruising speed,” said president and CEO Michael Sabia, the former BCE chief who’ll mark his first full year at the helm next month.

The Caisse ended the year with assets under management of $131.6 billion, up $11.5 billion from a year earlier.

Its returns lagged its benchmark index by four points, but Sabia said it actually beat the benchmark in the second half of the year, an indication the many changes at the institution are having an impact. All 2009 gains came in the last six months.

“We believe that the worst consequences of the (economic) crisis are behind us,” Sabia said. “Ultimately, we are building solid foundations for the future, but this is just the beginning.”.

According to RBC Dexia Investor Services, the median return for Canadian pension funds with assets of more than $1 billion was 15.4 per cent in 2009, though comparative figures were nowhere to be found in the Caisse documents released at its news conference Thursday. In the past it used to highlight its performance relative to others, but it now says short-term comparisons aren’t crucial.

“We’re long-term investors,” Sabia said. “What matters for us and our clients is long-term results.”

Michel Nadeau, a former top executive of the Caisse who now serves as general manager of the Institute for Governance of Private and Public Organizations, said the 2009 results were “a bit disappointing,” but he doesn’t fault Sabia and his team for the underperformance.

“He (Sabia) had to complete the cleanup of the stables. He worked hard to get rid of the derivatives and financial-engineering products. Risk management has improved with Mr. (Roland) Lescure (the Caisse’s newly-appointed chief investment officer). Next year will really be his first full year and the Caisse appears to be on the right track for 2010,” Nadeau said.

Sabia effectively lowered expectations for 2009 in a round of media interviews a month ago, noting the Caisse was still “in transition” last year and had been underweight in equities when stocks began their spectacular recovery last March.

It added to its equity position as the year went on and ended 2009 with about 34 per cent of its assets in stocks, up from 22 per cent in the spring.

Stocks generated the best return in its portfolio last year, gaining 31 per cent, paced by emerging markets (up 50 per cent) and Canadian equities (36 per cent).

The fixed-income portfolio made 5.8 per cent and private-equity group 17.5 per cent.

Real estate was the weak link, plunging 15.8 per cent, with the European and U.S. markets particularly depressed.

Sabia called 2009 a year of challenges, progress and evolution. He said the Caisse has withdrawn completely from one of its main trouble spots, non-Canadian real estate debt, which erased $2.3 billion from its assets in 2009.

It has also reduced its derivatives exposure by $15 billion, exited commodities and trimmed operating expenses and external management fees by 14 per cent or $43 million.

The goal, Sabia said, is to simplify the investment portfolio and refocus the Caisse on its proven areas of expertise, which include Canadian stocks, fixed income, private equity and real estate operations.

“Are we done? No. Are we in much better shape (than a year ago)? Yes, tremendously better shape,” Sabia said. “It (2008) will never be a happy memory, but we’ll at least try to make it a distant one.”

You can read the full press release and following comments on the Caisse's 2009 performance (*Update: As of April 15thl, the annual report is available here):

Fact sheet – Returns (PDF)
Fact sheet – Fixed Income (PDF)
Fact sheet – Equity Markets (PDF)
Fact sheet – Private Equity (PDF)
Fact sheet – Real Estate (PDF)
Fact sheet – Valuation of Investments (PDF)

I am actually surprised with the results because while they're subpar, they weren't as bad as I thought. Just like CPPIB, the money in 2009 came came from riding the monster beta wave. And just like CPPIB and the rest of the pension herd, the Caisse was late to change gears and go long stocks in 2009.

The Caisse was upfront about this and even provided this chart in their press release (click on it to enlarge):

In private markets , the Caisse was clear that real estate was very weak:
In 2009, the real estate market saw weakening fundamentals, such as rising vacancy rates and shrinking investments, against a backdrop of global economic recession. This environment led to significant decreases in value, particularly in the U.S. and Europe.

Financing conditions improved throughout the year, but credit spreads remain high by real estate standards. Within this climate, there were less non-performing loans in Canada than the U.S., where credit continued to deteriorate.

Although the impact was not as severe in the second half of the year, the real estate and commercial mortgage loan markets remain fragile.
If you read the Real Estate fact sheet carefully, you'll see that the losses were concentrated in the real estate debt portfolio:
The return on this portfolio was -20.3%, 28.8% below its benchmark index. This underperformance is primarily due to participation in third-party subordinated debt and structured products originated by third parties outside Canada. The Caisse ceased these activities in August 2009. The Canadian portion of the portfolio returned -2.0%, while the international portion yielded -46.5%.
I also noted the following on valuations of private markets:
The Caisse conducts a complete evaluation of its less liquid investments semi-annually, on June 30 and December 31. These investments represent nearly one-third of the Caisse’s net assets. External appraisers and valuation committees composed of independent experts review the Caisse's investment valuations.

  • Investments whose fair value exceeds a pre-established materiality threshold are subject to independent valuation committee or external appraiser review.
  • Nearly 80% of the fair value of the portfolio is reviewed this way.

  • Chartered external appraisers certify the fair value of real estate assets.
  • 95% of properties are valuated this way.
Judging by the underperformance relative to benchmarks, you can tell that the Caisse uses the toughest benchmarks in private markets compared to their peers. The benchmarks will be available when the annual report is released next month. It's too bad the Caisse did not release the benchmarks along with the fact sheets on specialized portfolios.

My only concern with the 2009 performance centers around foreign exchange hedging. Recall what was stated last year, when the Caisse lost 25% in 2008:
The first factor that explains the variance in relation to large Canadian pension funds in 2008 is the cost resulting from foreign exchange risk hedging policy.

Hedging is not a currency speculation activity. It is a means of mitigating risk, which has been in place for at least 15 years with the objective of mitigating or offsetting an increase or a decrease in the value of the Caisse’s foreign investments solely as a result of fluctuations in the Canadian dollar.

Currency hedging is a characteristic of the various investment portfolios offered to the depositors. The private equity, real estate investments and hedge funds are 100% hedged. As for equity markets, the U.S. Equity and Foreign Equity portfolios are partially hedged (an average of 29% as at September 30, 2008).

The cost of hedging was unusually high in 2008. The decline of the Canadian dollar, which occurred mainly in October, increased the value of the Caisse’s foreign investments by $11.3 billion, once converted into Canadian currency. The currency hedging policy, which is designed to smooth out the currency effect, incurred a hedging cost of $8.9 billion. This is a record amount, most of which, 78%, is due to 100% hedging of private equity and real estate outside Canada.

“By adopting a long-term policy of 100% hedging of private equity and real estate, the Caisse enables its managers to concentrate on their investment responsibilities without being concerned about currency risk. This policy is also consistent with the fact that our depositors’ commitments are in Canadian dollars,” Mr. Perreault explained.

The annual effect of currency hedging was therefore highly unfavourable in 2008. The long-term effect of this measure is neutral. Over 10 years, including 2008, it is slightly positive.

“This factor undoubtedly explains a good portion of the 2008 variance vis-à-vis large Canadian pension funds of $1 billion or more, since the Caisse has a much larger proportion of private equity and real estate outside Canada, and does more extensive overall hedging,” Mr. Perreault concluded.
The table below shows the losses from currency hedging in 2008 (click on image to enlarge):

If the Canadian dollar came roaring back in 2009, you'd expect there to be favorable gains from currency hedging activities but nothing was mentioned in Thursday's press release. Why? Did the currency hedging activities not make money in 2009? If not, why not?

Finally, if you read the press release, you'll see the Caisse bolstered its financials by cutting risk:
Over the past year, the Caisse strengthened its financial position, reducing its liabilities by $27.7 billion, including $14.5 billion in derivatives. Liabilities fell from $66.8 billion to $39.1 billion, a 41.5% decrease.

Under a new refinancing program, the Caisse recently replaced certain short-term debt with $7.2 billion in longer-term debt, better matching the duration of its financing sources and uses.

In 2009, the Caisse also reduced its operating expenses and external management fees by $43 million or 13.7% to $271 million in 2009 from $314 million a year ago.
In addition, improving credit conditions led to $479 million in ABCP provision reversals, as at December 31, 2009 (renamed asset-backed term notes – ABTM).

The Caisse's President & CEO, Michael Sabia, ended off by stating:
“In 2009, we simplified and improved the way we work. We now have greater operational and financial flexibility to execute investment strategies. In 2010, we plan to vigorously pursue our five strategic priorities, making our depositors – our clients – our everyday focus. We want to lay the cornerstone for sustainable, long-term returns, that meet the needs of our depositors," added Mr. Sabia.
Mr. Sabia and his team have their work cut out for them. In the coming weeks, their performance will be compared to that of other large Canadian pension funds which likely outperformed the Caisse in 2009.

I will be examining these returns and comparing apples with apples, looking at benchmarks, especially private market benchmarks where most of the shenanigans take place. Before you slam the Caisse for underperforming their peers, I will let you in on a little secret: they got the toughest private market benchmarks in Canada. There is no free lunch at the Caisse.

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