Friday, July 23, 2010

Comparing CPPIB and PSPIB FY 2010 Results

Given that PSP Investments reported its FY 2010 results, I think it would be useful to compare their results to those of CPPIB who reported back in May (fiscal year for both funds ended on March 31st, 2010).

First, let me apologize, as I just noticed I never covered CPPIB's FY 2010 results, only some quarterly results. Let's go back to the May 20th press release:
The CPP Fund ended its fiscal year on March 31, 2010 with net assets of $127.6 billion, an increase of $22.1 billion from the prior year end. The increase in assets essentially put the Fund back to its previous highest level reported on June 30, 2008, prior to the onset of the financial crisis. The Fund rose due to increases of $16.2 billion in investment income and $6.1 billion in CPP contributions, minus operating expenses. The portfolio returned 14.9 per cent for fiscal 2010 compared with a prior year decline of 18.6 per cent.

“The CPP Fund delivered one of its highest-ever annual returns, driven largely by strong public equity markets,” said David Denison, President and CEO, CPP Investment Board.

One of CPPIB’s goals for fiscal 2010 was to capitalize on investment opportunities arising in the aftermath of the financial crisis. During the year we were able to put our comparative advantages as an investor to good use, acquiring assets in private equity, real estate, infrastructure and private debt. Our long time horizon, distinct investment approach, available capital and specialized investment expertise allowed us to make significant investments last year that were beyond the reach of many investors.

“We have the benefit of being able to look beyond short-term market cycles, and to deal with volatility better than the majority of market participants,” Mr. Denison said. “Unlike many other investors, we did not suffer from capital or liquidity constraints last year. In fact, our experienced investment teams completed a number of significant transactions during the year.”

These included the acquisition of Macquarie Communications Infrastructure Group, as well as our partnerships with other investors to acquire IMS Health and Skype, investments which are expected to generate strong returns over the long term.

Five and 10-year Returns

For the five-year period ending March 31, 2010, the CPP Fund generated an annualized rate of return of 4.0 per cent, or $18.5 billion of cumulative investment income. For the 10-year period, the Fund had an annualized rate of return of 5.5 per cent, or $39.3 billion of cumulative investment income.

Canada’s Chief Actuary has estimated that an annualized 4.2 per cent real rate of return, or approximately a 6.2 per cent equivalent nominal rate over the last 10 years, will be needed to sustain the CPP at its current contribution rate.

This 4.2 per cent real rate of return is an annual average over the 75-year time frame used for the CPP projection, and while returns are expected to vary in individual years, CPPIB is confident it will be able to meet and exceed this rate of return over longer periods of time.

“Our five and 10-year results should be viewed in the context of the performance of major global financial markets over the same period. The past 10 years of investing have taken place during the worst calendar decade of performance for equity markets in the nearly 200 years of recorded stock market history,” said Mr. Denison. “If we look back over the span of the last 25 years the CPP Reference Portfolio, which serves as the market-based benchmark for the CPP Fund, substantially outperformed the 4.2 per cent real rate of return on a rolling 10-year basis in all periods except calendar 2008 and 2009. We are confident that with the Fund’s current portfolio composition and reasonable levels of capital market returns, we will be able to generate the returns required to sustain the CPP at its current contribution rate over the longer term.”

Performance Against Benchmarks

As noted above, CPPIB measures performance against a market-based benchmark, the CPP Reference Portfolio. It seeks to generate value-added returns above this benchmark over the long-term. For purposes of accountability CPPIB looks at performance over rolling four-year periods.

While absolute returns for fiscal 2010 were strong, value-added returns for the four-year period ended March 31, 2010, underperformed the benchmark. For the four-year period ending March 31, 2010, the annual total portfolio return underperformed the CPP Reference Portfolio by 0.34 per cent. The annual total portfolio return for fiscal 2010 was 5.87 per cent below that of the CPP Reference Portfolio, and offset the value-added performance recorded in each of the previous three years.

“The nature of the Fund’s private investments in real estate, infrastructure, private debt and private equity means their value typically lags that of the public market indices that comprise the CPP Reference Portfolio,” Mr. Denison said. “It can take additional time for appraised values of private assets to reflect public market levels, particularly in the face of a significant rally such as that experienced in global public equity markets in the past 12 months.”

“Private investment returns are expected to play out over the long-term and cannot be captured within just a 12-month snapshot. For example, we believe there is considerable value embedded in our real estate and infrastructure investments that will be realized over time,” Mr. Denison added.

You can download CPPIB's FY 2010 Annual Report by clicking here. On page 7, CPPIB's President & CEO, David Denison, discussed the key factor influencing the Fund's performance:
One key factor influencing both overall Fund returns for fiscal 2010 and the calculation of the value-added return over that same time period is an inherent valuation lag between our public and private market holdings. We now have over 25% of the CPP Fund’s holdings invested in private assets including private equity, real estate, infrastructure and private debt.

In contrast to public market holdings, which are of course valued in accordance with daily observable market prices, our private holdings are typically valued comprehensively only once a year using independently verified appraisal practices.

In our experience, especially during a period where public equity markets have increased as rapidly as they have over these past 12 months, it takes additional time for appraised values to catch up to these public market levels. We recognize that investing in private market assets has had a negative near-term impact on value-add returns, but believe without qualification that this is the right strategy for delivering the kinds of returns needed to help sustain the plan over the longer term. We are confident that our private holdings will perform very well over the coming years and provide considerable value to the CPP Fund consistent with our long investment horizon.
You can click on the image above to see a breakdown of the performance by asset class. As mentioned above, Private real estate (-11.8%), Private foreign developed market equities (-9.4%), Private emerging market equities (-4.3%), and Infrastructure (-6.4%) all had a negative impact on the CPP Fund's portfolio in FY 2010.

As shown below (click on image to enlarge), the underperformance of Private Markets relative to the Policy Benchmark had a material impact on CPPIB's value added, as the 1-year value added fell by 587 basis points, and the cumulative 4-year value added fell by 34 basis points (whereas it was up 487 basis points in FY 2009).

By contrast, Private Equity and Infrastructure, up 28.8% and 7.2% respectively, were the main asset classes that allowed PSPIB to outperform its Policy Benchmark in FY 2010. Real Estate was marginally up (+0.6%), but it certainly didn't get hit as hard as CPPIB's Real Estate portfolio, primarily because the portfolio was concentrated in Canada and much more defensive as it is invested in residential, retirement and long-term-care facilities.

The significant outperformance of Private Markets at PSPIB relative to CPPIB is a little perplexing, but the portfolios differ in terms of geography, risk profile and maturity. Still, I wonder if there is something else going on in the appraisal of these investments because I am much more comfortable with the explanation CPPIB provided in its annual report. Importantly, it does take time for appraised values to catch up to public market levels, which means CPPIB will realize gains on those private market investments next year if all continues to go well in public markets.

As far as Public Markets, CPPIB outperformed PSPIB in Canadian public equities (43.7% vs. 40.4%) and public foreign developed equities (24.7% vs. 24.5%), but underperformed in public emerging market equities (45.9% vs 47.4%).

In my opinion, PSPIB has to further develop its Canadian public equities department. It was a huge mistake to let go of two seasoned Canadian portfolio managers back when I was there. Moreover, there should be more internal teams focused on global equities, developing long-only strategies and long-short strategies.

Finally, it is worth noting that CPPIB doled out huge compensation to its senior officers, much more than what PSP's senior officers received. The summary compensation table below can be found on page 73 of their 2010 Annual Report.

But CPPIB did add this note on compensation:
Consistent with our compensation framework, which measures investment performance over rolling four-year periods, fiscal 2010’s negative value-added will affect short- and long-term incentive compensation for the next three fiscal years as well. This impact is demonstrated in Table 6; the total estimated LTIP payout value as at March 31, 2010, for the named executive officers, excluding the CFO, is $2,360,400. This represents a 61% decline from the value of $6,053,822 as at the end of the previous fiscal year reflecting the impact of the negative value-added investment performance for fiscal 2010.
This business of compensation gets very messy. I will be the first to admit that it's not easy to find a proper framework of compensating senior officers who deal in private markets, especially when they are ramping up operations. Public markets is another story, either you outperform your index or you don't.

I invite you to read through CPPIB's 2010 Annual Report as well as PSPIB's 2010 Annual Report. There are similarities between these two funds, but there are also important important differences. CPP is partially funded plan whereas the plans PSPIB manages on behalf of are fully funded plans.

The annual reports contain a lot more information on these two large Canadian Crown corporations. CPPIB even lists its investment partners on page 54 of its annual report. A few funds in there caught my attention for good (and bad) reasons.

Let me end by telling you that comparing two pension funds isn't as simple as it sounds. Some comparisons are straightforward, but others aren't. This is especially true when comparing performances in private markets, which by their very nature, are much more complex and don't lend themselves easily to simple comparisons.

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