Inside CPPIB's $153 Billion Portfolio?
Nobody likes losing every cent they have invested in something. And $288 million is a lot to lose on one investment. Especially when it’s money that Canadians are expecting to retire on.
It was early 2011 when André Bourbonnais, the head of the private investing group at Canada Pension Plan Investment Board, got the news that Citibank, EMI Group’s secured creditor, had just seized the music publishing company that CPPIB had started buying an interest in back in 2007. But Bourbonnais wasn’t at all shocked. CPPIB had already written down the investment.
The $288 million that had gone poof represented $17 from every one of the 17 million Canadians whom Bourbonnais was investing for. But in this game, as in so many others, it’s lose some, win some—tomorrow would be another day. Even Bourbonnais’s boss, Mark Wiseman, who is executive vice-president, investments at the Board, is philosophical about this sort of setback: “If we don’t lose money in investments, we’re not taking enough risk.”
And, in fact, $288 million isn’t a lot of money in Bourbonnais’s job. CPPIB made more than 30 times the EMI loss for its fiscal year ended March 31, and recorded a return of 6.6% on its funds. The place had $153 billion in assets as of Dec. 31 (that number grew to $162 billion as of March 31). And by the time I forget to slip on my Depends 20 years from now, CPPIB should be tracking close to half a trillion dollars under management, according to the actuaries.
We’d better hope they make the target. As countless politicians, think tanks and news stories have warned, Canadians are not saving enough on their own for their retirements. To make things worse, the tradition of company-funded defined-benefit pensions is eroding and, come 2023, Ottawa is going to make us wait longer for the Old Age Security benefit.
It all means the other basic federal payout for retirees—CPP—is under pressure to perform. So then—just where has that deduction on your paycheque been going all these years?
The model for investing that money has gone through a rapid evolution, leaving the sleepy world of government bonds far behind and culminating in something the CPPIB’s managers call “risk budgeting.” All told, CPPIB has emerged as one adventuresome investor.
It’s all run by investment professionals like Wiseman and Bourbonnais, guys who, for some mysterious reason, think it’s more rewarding to invest on behalf of the Canadian public than make far more dough on the other side of the Street. As a Bay Street professional myself, I want to know what makes these guys tick.
CPPIB owes its existence to the bad old days of the early 1990s, when Ottawa was creaking with debt. The CPP obligations that the federal government had on the books amounted to only part of the fiscal shortfall, but it was a wakeup call nonetheless. Previously, the government thought it was enough to simply collect money from Canadians’ paycheques and invest it in federal and provincial bonds. It was a safe way to invest money, but also self-serving because it kept the money in Ottawa.
Back in 1966 when the CPP took effect, nobody really had a clue how much a national pension scheme would cost. The government made a best guess at contribution rates based on how much it was paying out. In this pay-as-you-go scheme, contribution rates were low. For the first 20 years, the CPP slice was only 3.6%.
But by 1994, Canada had suffered through one recession in 1990-91 and was heading for another slowdown. Government bonds didn’t look so good any more: Some bonds were barely selling at auction, and others had been downgraded from AAA to AA+ by Standard & Poor’s.
So just investing in bonds wouldn’t be enough. The future burden of the CPP, lumbering along with its fixed-income portfolio, stuck out like a sore thumb in each year’s parliamentary budget reports.At both the federal and provincial levels, the idea bubbled up that responsibility for investment of the funds should be taken away from the government. That way, politicians wouldn’t be on the hook for potentially poor investment performance. The CPPIB was conceived in get-rid-of-the-problem meetings beginning in 1994, and the CPPIB was founded in 1997.
In Paul Martin’s 1998 federal budget, the CPP was moved on from pay-as-you-go financing. Ottawa jacked up contribution rates from slightly more than 6% of pay to 9.9% (subject to a maximum dollar value). The increase allowed for both the demographic bulge of boomers heading for retirement and the additional cash flow needed to make up for past miscalculations.
John MacNaughton, who had recently retired as the president of investment firm Nesbitt Burns, became CPPIB’s first CEO. On his watch, a portion of the cash coming in from CPP contributions was moved into the equity market in a broad-based index portfolio.
The CPPIB had to take on risk to make better returns, it was true. But in the opinion of early members of the CPPIB team, making all the equity investments in Canada would be a whole other type of risk, written into federal pension laws that allowed only a small percentage of equity portfolios to be invested internationally. That was fixed with a change of the law in 2005, and since then the fund has been able to buy anything that is legal in Canada.
Under David Denison, who has been CEO since 2005, CPPIB has proven its savvy in passive equity investments and also lately in private equity. In fact, in less than a decade, CPPIB has stepped up a league, and it’s Denison who gets the credit for turning the fund into a respected global giant. With the possible exception of the Caisse de dépôt et placement du Québec, it has eclipsed all the other major Canadian public pension funds, some of which have been in business much longer. That league includes Teachers’ and OMERS in Ontario, PSP Investments and British Columbia Investment Management Corp.
Many major funds now share what was originally a provocative (and, we’d like to think, made-in-Canada) idea, of which CPPIB was an early adopter: Instead of paying outside fee-taking managers, practise do-it-yourself mega-investing. It’s just cheaper to do it that way. But that works for the long term only if you’re smart enough to keep up with your competition. Unfortunately, everyone else on the planet now has the same idea.
CPPIB’s quest, stated most simply, is to find long-term investments that have predictable cash flow. “Long-term” to CPPIB is decades. It doesn’t matter if anyone at CPPIB likes music (EMI), or drives cars on toll highways (Ontario’s Highway 407), or makes video calls to Uzbekistan (Skype). They know lots of people do, and that means cash flow, and cash flow for a long, long time means sustainability. When you think that way, EMI really was a good investment idea: Sales of recordings are down, but song-publishing rights can produce consistent revenues from year to year.
Starting this July, CPPIB will have a new leader—current head of investment Mark Wiseman. There’s a reassuring continuity here. For the last seven years, Denison and Wiseman have been a design-and-execute team as the fund has morphed and grown. “I think Denison’s legacy was that he raised the bar for other pension funds in Canada,” says Tim Hodgson, a former head of Goldman Sachs Canada who helped Denison and then Wiseman rise through the investment ranks. “Mark and David taught a bunch of people how fast you can move in investments. Firms like ADIA [Abu Dhabi Investment Authority] can take as long as six months to make up their mind.” CPPIB’s relative speed is a competitive advantage, Hodgson says.
Denison is all about process. Wiseman is all about events. Denison, although taciturn by nature, has made it a habit to meet every new employee in the firm personally. Given the growth of the staff, what started out as one-to-ones has grown into group breakfasts. At Fidelity, where Denison was head of the Canadian operations, he was known as a superintelligent but control-obsessed manager. He has apparently mellowed in the Canada Pension job. But the bone-thin executive still gets up at 4:30 to run 10 kilometres before he shows up for work at 7:30.
The design-and-execute team is now just execute. At 42, Wiseman looks too young for the job until you check his resumé. A lawyer and Fulbright Scholar who also has an MBA, he started his career with a dream legal job—apprenticing as a law clerk for Supreme Court Justice Madame Beverley McLachlin in Ottawa. Wiseman then moved to Paris with his girlfriend, Marcia Moffat, and worked on deals with storied Wall Street law firm Sullivan & Cromwell.
In 2000, Wiseman and Moffat moved back to Toronto, he to work with investment über-mensch Brent Belzberg at Belzberg’s Harrowston Corp. (Moffat now runs the mortgage business at RBC.) Belzberg, one of the most focused and best-connected private equity managers in Canada, remembers Wiseman as a “force of nature,” and also highlights his obsessive focus on finding the best investments. To Belzberg, Wiseman epitomizes a famous saying of former Intel CEO Andy Grove: “Only the paranoid survive.”
Wiseman, still in his 20s at Harrowston, had already established a reputation for working brutal hours and answering all e-mails within minutes (which is still true today). He quit Harrowston after it was sold to TD Capital in September, 2001. When he turned down Belzberg’s offer to help start a new investment firm, Wiseman was at loose ends. “No one was hiring after 9/11, and I thought it was over,” he says with a smile. But he didn’t have to wait long for an offer. He received a call from Jim Leech in the private equity investing group at Ontario Teachers’ Pension Plan. Wiseman soon began a four-year stint there.
Wiseman potentially has almost a quarter of a century of managing the investment board before he gets his own CPP payments. He states his goal simply: “to find a group of people, and manage them to make sure that the investments they make will do better than picking just anything to buy.”
When pushed to name some of the issues the Board has to deal with, all that senior managers talk about is minimum investment size. If each investment were as “small” as $150 million, that’s more than 1,000 investments to manage—an oversight nightmare. CPPIB’s minimum investment cutoff now is in the range of $75 million to $100 million for private equity investment. That cuts out a lot of interesting opportunities.
A related issue is the how-to and who-to and when-to of selling large-scale investments. It’s one thing to write a cheque; it’s another to convert an investment into cash. Public markets are tricky, and CPPIB will eventually get stuck with some albatrosses.
Hiring is also a special issue at CPPIB. Attempts to find great people can be a little stressful for management. A couple of times, Wiseman and his team have had people bail at the last minute after signing up to work in senior positions at the firm. Wiseman takes it all very personally. He realizes that the issues for the last-minute walk-aways have been complicated, including rigorous competition for talent from the companies the Board invests with. The big issue is the superior compensation the private sector can offer.
Yet to any normal working person, the compensation received by senior management and the investing staff at CPPIB is plenty generous. Wiseman made north of $3.1 million in fiscal 2011; yet, to prospective hires, he says, “Don’t come here looking for a fat paycheque.” He and others liken their job to a public service—and there is indeed some sacrifice involved, but only by the standards of the investment industry.
In any case, there are other attractions to working at CPPIB. Ask Eric Wetlaufer, 50, the first senior executive who is not Canadian to make the move from the heady investment world in the U.S.
“I’m an investor, full stop,” says Wetlaufer, who has been running active investing for the fund for less than a year. He came because he thought he would find the perfect world of investing. No restrictions on where to look and what to put money into. No cap-in-hand looking for money for a new fund every five years or so. Equities, fixed income, commodities, short-horizon trading, strategic stakes in public companies, they’re all good. An investment job “where we are limited only by our creativity” is, to him, a dream job. Then he stops himself: “Wow, that sounds a lot like Disney.”
And there’s another thing, he says: “I really like my boss.” Indeed, Tim Hodgson counts another competitive advantage in CPPIB’s ability, led principally by Wiseman and Denison, for finding and keeping investment talent for the firm.
The Board can think—and has had to think—about more radical approaches than almost all other investors, who typically have to stick to a defined mix of assets: this much in stocks, this much in real estate, and so on. CPPIB’s solution was to start a unique investment philosophy that differed radically from a normal asset allocation strategy—one that they, and now others, call “risk budgeting.” In tandem, another new strategy is to cultivate relationships that will pay off in deals.
The person in charge of the strange and complicated science of changing the mix of invested assets is Don Raymond, 51. He is what you would expect of someone who has to think about this very question for a vocation. He is quiet, measuring his answers to even simple questions, a friendly and all-smiles nerd.
Raymond has been an RCAF pilot; service engineer in Mongolia for Schlumberger; bond manager at Goldman Sachs; and academic: He has a PhD in electrical engineering with a speciality in non-linear systems theory, which helps with the complicated calculations on non-linear pension payouts. Still, he was an unusual hire; it reflected the Board’s determination that its investment strategy would not be handcuffed by the fund’s eventual enormous size.
Before risk budgeting could be applied, restrictions on foreign investments by pension funds had to be lifted. By 2005, given some effective lobbying by CPPIB and others, the cap was removed. Other large funds, such as Ontario Teachers’ Pension Plan, had been cleverly complying with the letter of the foreign ownership rules for years by investing in Canadian derivative funds that mimicked the returns of foreign stock and bond indexes. But MacNaughton had shied away from that. “Using derivatives to bend the rules was not something I wanted to do,” he says. “I made a judgment call that we wouldn’t do a workaround.”
When Raymond arrived at CPPIB, he only had a little room to innovate. The Board had $11 billion invested with two external equity managers, TD Asset Management and Barclays Global Investors (now BlackRock), and it was required by law to invest the money passively. Shortly thereafter, however, these restrictions were removed, and Raymond moved quickly to establish internal passive management and hire external managers who could invest actively in equities and deploy currency hedging strategies for foreign holdings.
Raymond is widely credited with coming up with two radical ideas for investing. He believed that there was no point in hiring external asset managers if they didn’t beat the CPPIB’s benchmark equity portfolio, mostly consisting of index-fund-type investments based on the S&P/TSX 60, S&P 500 and others. He came up with a plan to allow managers to target portions of the portfolio and substitute other investments that they figured would perform better. The managers were only paid if they outperformed. Few took up the challenge, but a couple did so and have consistently beat their targets.
Raymond also recommended to his board that they should adopt the novel risk-budgeting approach. Simply put, all assets have risk, and each one behaves in a particular way. Raymond and his team’s strategy was to “budget” for the amount of risk each asset class had, and then focus on finding investments that would generate a higher return for taking the same amount of risk, regardless of whether the investments were in the same asset class or not.
This meant doing a massive amount of research into the behaviour of different assets. Real estate, for example, exhibits different return characteristics based on project age and size. A new apartment building has many of the same potential risks and rewards as the shares of a new company—it has big start-up costs, and the upside comes from the growth of revenue and profits as the buildings fill up. Old buildings or shopping malls are like bonds—start-up costs have been amortized, and they provide a steady stream of income.
Raymond’s idea could be tested. He asked external equity portfolio managers to target portions of the portfolio the CPPIB already had—which would be the benchmark—and propose alternatives. The essence of the strategy is telling money managers who claim that they can do better that they will only be paid if they tell the truth.
From the other side of the investing equation—sellers—CPPIB has a sticky sort of pitch. The size of its marketing literature speaks to this. The paper version of the CPPIB’s pitch deck—its spiel for potential partners—is 40% smaller than its competitors’. It’s the elevator pitch, which goes something like this: “We do our homework ahead of time, we move faster, we’ll stay far longer, and might buy everybody out at the end, and we’re nice.” Time will tell if they can keep all their promises.
To a private equity firm looking for dough, the pitch is compelling. CPPIB now has access to, and investments in, the largest private equity funds in the world. With more money than most could handle, the fund gets preference in “co-investing”—putting up money beside the PE outfits in deals that might be too large even for the largest firms to handle.
By all accounts, CPPIB competes effectively in the market of global investing. That said, it seems short-sighted that it has only two foreign offices, in London and Hong Kong. After all, there are other giant pools of capital around the world trying to do almost exactly the same thing as CPPIB.
Even though it ranks in the pack of supersize funds globally, the Board got started a long time after some others, and it is not the largest by any stretch. The United Arab Emirates, for example, has $627 billion (U.S.) to invest. Also in the big leagues is Norway, which realized that it ought to save some of its North Sea oil revenues for a rainy day. It has $560 billion (U.S.) in its kitty. China, meanwhile, has a positive balance of payments so high that it invests through two funds that together have about $1 trillion (U.S.) under management.
Given the size of these pools of capital, efficiency and scale of investing is a hot topic these days. Last year, two University of Toronto academics, Alexander Dyck and Lakasz Pomorski, tried to figure out if managing more money meant more efficiency. They looked at the efficacy of funds both large and small, both internally and externally managed, and found that larger plans outperform smaller ones by almost half a per cent annually. Half a per cent doesn’t sound like much until you manage $160 billion. That’s $800 million a year extra for Canada’s pensioners that comes from CPPIB’s sheer heft and from not paying external managers. (The Board does outsource work that falls below its minimum-investment thresholds, to the tune of more than $500 million in management and performance fees in 2011.)
In competing with others who also have billions to invest in good ideas, CPPIB has a mantra: “We’re here, we’re steady and we are not going away.” The goal is simple—to be the first call from anybody selling anything that might be valuable for CPPIB to buy.
Much of the job of letting everybody know who CPPIB is and how much money that it has to invest was completed many years ago. Now the direction is reversed. Sitting quietly in the Board’s 26th-floor lobby in downtown Toronto on any given weekday are salespeople from all over the world, waiting to offer their asset wares to a very hungry investor.
The job of getting excess return is really about finding unique investments. That job largely rests with Bourbonnais, who runs private investments and took the EMI hit. He personifies the competitive-investor cast of CPPIB in 2012. He flies his own plane for sport. It’s a Cirrus SR20, a plane that comes with its own parachute so it can coast to the ground if the engine conks out. That’s a little like having a hedge on adventure.
The confidence is quiet in Bourbonnais, but firm. When asked if he gets mad when he hears about a large potential investment that CPPIB wasn’t informed of, he responds, “I’m pissed, but it doesn’t happen very often.” He has more than 100 people who not only follow investments, but who have models for assets not yet for sale. They also track competitor investors and their abilities to stay with their assets over the long term.
According to Wiseman, CPPIB was “very underwater” on some investments at one point during the credit crisis in 2009. But while the market value of its portfolio was way down, it wasn’t under pressure to sell near the bottom to raise cash—the way many mutual funds, hedge funds and pension fund managers were, because their clients were bailing on them. And the CPPIB still had money—more than half a billion a month—coming in from contributions.
It was a huge structural advantage. The investment team realized that there could be assets for sale from other investors who were forced to sell. Speed at decision-making, advance preparation and the ability baked into the fund based on risk budgeting—and not a percentage allocation to certain asset classes—turned CPPIB into one of the few games in town (that would be the global town) for making investments.
When the market turned bad, funds that had allocation maximums for certain asset classes were forced to sell. CPPIB stepped in, for instance, when CalPERS, the fund that invests the retirement assets for employees of the State of California, had too much money in private equity investments compared to its equity holdings. Since 2008, CPPIB has scooped up $3.6 billion in such investments from 19 parties.
More daring, perhaps, was the investment in the Canadian asset-backed commercial paper market. Some of the paper was bank-backed, some not—and the latter type went all pear-shaped and no-bid ugly in the fall of 2007, contaminating the bank-backed stuff in investors’ minds as well. Canadian banks, and other large funds, had all been active in the now-frozen market. CPPIB stepped in and bought nearly all the bank-issued asset-backed paper available in the industry, or nearly 40% of the market, at a large discount. The paper was later sold for a large profit as the market stabilized.
Another substantial investment that the Board made during this time was in the 407 toll highway north of Toronto. The highway was originally funded by the province and then leased in 1999 to a consortium that included a subsidiary of Spanish construction colossus Ferrovial, Montreal-based SNC-Lavalin and, later, Macquarie Infrastructure Group from Australia. But by 2009, both Ferrovial and Macquarie had run into issues with their investors thanks to the recession, and became motivated sellers.
The private investment team had its eyes on the asset because it was in the CPPIB’s sweet spot. The 407 can charge as much as it likes, and there is no prospect of new competition.
The fund was looking to pick up the Macquarie piece, and had an agreement to buy part of the Ferrovial stake in place. But then SNC-Lavalin tried to step in front by exercising its right of first refusal on the Ferrovial stake; SNC-Lavalin planned to flip its interest into a public vehicle in 2010 at a price roughly 25% higher than CPPIB was bidding.
That almost scuppered the deal. Fortunately, the market realized that large assets can’t be bought at a discount by one investor, and sold at a premium at the same time by another, and the SNC IPO ended up dead in the water. CPPIB got its piece: 40% of the highway at a cost of $4 billion. It has since syndicated part of the stake, reducing its share to 29%.
As we’ve seen, the team doesn’t spend a lot of time looking around for smaller deals. They leave that to outside managers. On the other hand, one thing CPPIB does look for is the ability to top up existing investments. It makes sense: no more work and better returns, if the investment is performing well.
More money will flow into the fund if Ottawa acts on the idea of forcing Canadians to save more for their retirements by simply raising contributions. Wiseman confirms the fund is prepared. I’m in, but can they handle a trillion dollars under management? That kind of kitty could be a possibility.
And what happens if the CPPIB team turn out to be the worst investors the world has ever seen, and lose most or all of the money? Notwithstanding all of the checks and balances in place, Wiseman cracks a smile and says, “If they raise the amount taken off your paycheque by 50%, in less than five years we’re right back where we are now.”
When he puts it that way, it sounds a little like all this investing is a bit of a high-paid make-work project for a bunch of people. But more likely, as long as we’re all investing, driving our cars on toll highways, making long-distance calls on our laptops and listening to Coldplay on our iPods, what CPPIB is really doing is quite simple: making sure we’re all ready for when our earning days are over.
This is a long article but well worth reading to understand the structural advantages that CPPIB has over its competitors. Apart from them, only PSPIB has a similar liquidity profile but it's a much smaller fund. In fact, the article above doesn't account for the latest figures showing CPPIB assets now standing at $161.6 billion, making it the largest Canadian pension fund.
A couple of days ago, I covered CPPIB's fiscal 2012 results, and referred my readers to an excellent speech by departing President and CEO, David Denison, on what it means to be a long-term investor. If you've never read this speech, read it carefully.
As far as the article above, the only disagreement I have is with the size of CPPIB. While I understand the advantages and disadvantages of size, I see more problems arising as funds grow to mammoth levels as economies of scale kick in. Everyone wants bragging rights, but what's in the best interests of Canadian contributors? That is what ultimately counts.
Importantly, I would like to see the creation of new public funds and limit their size to promote competition among them and keep them lean and mean. The focus has to be on generating value added while maintaining world leading governance standards.
Keep in mind, the two best defined-benefit pension plans in North America (and among the top in the world) are the Healthcare of Ontario Pension Plan (HOOPP) and the Ontario Teachers' Pension Plan (OTPP). I can assure you they couldn't care less about their size. All they care about is delivering top results and matching their assets with their liabilities.
The other quip I have with CPPIB is how they benchmark their private market portfolios using a complicated risk budgeting approach. I get what they're doing but at the end of the day, I believe they are better off keeping it simple so that the 90 year-old grandmother receiving her CPP payments can understand how to properly benchmark $1 invested in private markets.
Finally, there are smart and competent people in every major Canadian public pension fund, not just CPPIB. I have spoken with many senior pension fund managers who are unbelievably bright and dedicated professionals. Think the Globe and Mail should cover all them in great detail.
Below, Bloomberg reports on how the world's richest man, Carlos Slim, sees Europe’s debt crisis as a “good moment” to apply his strategy of investing in times of turmoil, said the billionaire’s son, America Movil SAB Co-Chairman Carlos Slim Domit. Betty Liu reports on today's "Movers & Shakers" on Bloomberg Television's "In The Loop." I agree with Mr. Slim and think CPPIB is in full agreement too.