Friday, July 20, 2012

PSP Investments Gains 3% in Fiscal Year 2012

On Thursday, the Public Sector Pension Investment Board (PSP Investments) announced its fiscal year 2012 results:
The Public Sector Pension Investment Board (PSP Investments) announced today that its consolidated net assets increased by $6.5 billion, or 11%, to a record level of $64.5 billion during the fiscal year ended March 31, 2012 (fiscal year 2012). PSP Investments generated investment income of $1.7 billion after expenses and received $4.7 billion in net contributions. The total portfolio return for fiscal year 2012 was 3.0%, exceeding the Policy Portfolio benchmark return of 1.6%. For the three-year period since the financial crisis of 2008-2009, PSP Investments achieved an annualized return of 12.7%, generating $16.5 billion in investment income and $2.4 billion of value added, over and above benchmark returns.

The overall performance for fiscal year 2012 was driven primarily by strong results in Fixed Income portfolios, Real Estate, US Large Cap Equity and Private Equity, and was partially offset by the negative performance of public equities in the Canadian, European and Emerging markets. Over the course of the year, PSP Investments reduced its exposure to Public Market equities and increased its exposure to the Private Market and Real Return asset classes.
"PSP Investments delivered a solid performance in fiscal year 2012, in the most volatile investment environment since the financial crisis of 2008-2009," said Gordon J. Fyfe, President and Chief Executive Officer. "In terms of relative performance, a majority of our portfolios outperformed their respective benchmarks, highlighted by performances from Real Estate, Public Markets equities and Fixed Income portfolios which surpassed their benchmarks by a good margin."

For fiscal year 2012, returns on Public Markets Equities ranged from negative 9.8% for the Canadian Equity portfolio to 11.4% for the US Large Cap Equity portfolio. The Fixed Income portfolio generated a return of 10.1% while the return for the World Inflation-Linked Bonds portfolio was 15.3% for fiscal year 2012.

In Private Markets, the Real Estate and Private Equity portfolios posted strong investment returns of 13.4% and 7.7%, respectively. The Infrastructure portfolio earned an investment return of 2.7% while the newly created Renewable Resources asset class recorded an investment return of 5.1% for fiscal year 2012.

The asset mix as at March 31, 2012 was as follows: Public Markets Equities 51.0%, Private Equity 10.0%; Nominal Fixed Income and World Inflation-Linked Bonds 22.0%; Real Estate 10.9%, Infrastructure 5.6% and Renewable Resources 0.5%.

For more information about PSP Investments' fiscal year 2012 performance, consult PSP Investments' Annual Report available at www.investpsp.ca.
At this writing, no major Canadian newspaper reported on PSP's annual results which leaves me wondering why this $65 billion organization, which manages the pensions of federal public sector workers, the RCMP and the Canadian Armed Forces, even has a communications department. In fact, if you look at PSP Investments' news releases, the last major news item was last year's annual results, which they have to report by law.

I also blame Canadian financial reporters who are fixated on the Caisse, Teachers' and CPPIB as if no other major public pension funds exist in Canada. The paltry, sporadic and flimsy reporting of all our public pension funds was one of the reasons why I started blogging on pensions. Most reporters are completely clueless about what is really going on at public pensions.

Back to PSP Investments' fiscal year 2012 results (ended March 31st, 2012). I invite my readers to carefully go over the 2012 Annual Report. I used to work at PSP Investments and know firsthand the amount of work involved in writing and putting together these annual reports. Everything you need to know is explained in detail in the annual report.

On page 6 of the Annual Report, PSP's President and CEO (and CIO), Gordon Fyfe, writes his message going over results:
For the three-year period since the financial meltdown of 2008-2009, PSP Investments had an annualized return of 12.7%generating $16.5 billion in investment income, and $2.4 billion of value added, over and above benchmark returns. It was the third consecutive year that we have outperformed our key benchmark. A majority of our portfolios outperformed their respective benchmarks during fiscal year 2012, highlighted by particularly strong relative performances from Real Estate,
Public Markets equities and fixed income portfolios.

PSP Investments’ overall performance for fiscal year 2012 was impacted by the negative performance of global equities, most notably in the Canadian, European and Emerging Markets. Fixed Income markets, on the other hand, posted one of their best performances of recent years.

During the year, we reduced our exposure to public equities and increased our exposure to Private Market and Real Return asset classes. Our Real Estate, Private Equity, Infrastructure and Renewable Resources asset classes all posted positive returns ranging from 2.7% to 13.4%.



While markets can be challenging in the short-term, we continued to diversify the portfolio and take advantage of PSP Investments’ exceptional liquidity as markets offer attractive opportunities for patient investors with deep pockets to
acquire some outstanding assets at very favourable valuations.

Taking into account investment income of $1.7 billion after expenses as well as $4.7 billion of funds transferred by the Plans, PSP Investments’ consolidated net assets increased by 11% to a new peak of $64.5 billion as at March 31, 2012. Over the three years since the global financial crisis, the value of our total net assets has increased by 91% from their fiscal 2009 year-end level.

Another noteworthy event during the year was our capital market medium-term notes issuance in which we benefited from the lowest fixed coupon rate ever attained by a Canadian pension fund investment manager in the Canadian market.

This is a further testament to the triple “A” credit rating that the organization continues to maintain.
Gordon goes on to highlight some noteworthy investments in private markets in fiscal 2012:
Early in fiscal year 2012, we made our first investment in a new asset class — Renewable Resources — with the acquisition of a 50% interest in TimberWest Forest Corporation, the largest owner of private timberlands in Western Canada. TimberWest owns approximately 808,000 acres (327,000 hectares) of private land on Vancouver Island and additional crown rights to harvest on government timberlands. The Renewable Resources asset class will initially include farmland as well as timber.

Over the course of the fiscal year, our Real Estate team made more than 30 direct investments. Included were additional properties in Brazil and Colombia, reflecting PSP Investments’ intensified focus on high-growth emerging markets where burgeoning middle-class populations are driving demand.

The acquisition of a strategically located lower-Manhattan office building — which ranks among the largest buildings in all of New York City — was one of a number of additions to our increasingly diversified portfolio of properties in the US which
now also includes warehouse and industrial properties.

Other noteworthy real-estate transactions included office properties in key cities in Europe and North America in collaboration with local partners, further enhancing a portfolio that generated the second best returns of any asset class during the latest fiscal year.

Infrastructure is an asset class that tends to require both persistence and patience, given that attractive investment opportunities are limited in number and generally of a complex nature. Several years of hard work seeking out suitable opportunities and partners led to accelerated growth in fiscal year 2012, when our Infrastructure team made investments totalling some $1.5 billion. This brought the value of the portfolio to approximately $3.6 billion at year’s end.

Included among the Infrastructure acquisitions was PSP Investments’ second major investment in the ports sector — a participation in Forth Ports Limited, one of the United Kingdom’s largest maritime operators with seven ports in London and Scotland. As well, we acquired an ownership interest in Gassled, one of the largest offshore pipeline systems in the world. Gassled transports the majority of the natural gas sourced from the Norwegian Continental Shelf to markets in the U.K. and Western Europe.

Private Equity is another area where we have increased our asset allocation. In November 2011, PSP Investments along with two partners acquired Kinetic Concepts, Inc. (KCI) in a transaction valued at approximately US$ 6.3 billion. Texas-based KCI, with some 7,000 employees and a market presence in more than 20 countries, has the leading global market share in negative pressure wound therapy. This is a very attractive asset that provides exceptional opportunities for growth and value creation.
I've covered the Timberwest deal which was done with bcIMC as well as the Kinetic Concepts deal in a comment on pensions paying premium of pipe deals. These, and other transactions in private markets, are all good deals.

In real estate, I am much more bullish on US properties and see risks in emerging markets, particularly in Brazil where the 'boom' might end up a bust. In infrastructure, PSP is lagging and so are many other Canadian public pension funds.

A buddy of mine, an expert in field, shared with me the following comment on infrastructure after I shared with him the range of results in this asset class from various funds, including those at PSP:
A 2.7% return for infrastructure sounds a bit on the light side. This makes no sense. The target return on equity for infrastructure investments by Concession companies is 12-15%. They typically achieve over 10%.
He also told me that Canadian pension funds typically hire people with little or no infrastructure operating experience, just financial backgrounds, which is fine but this leads them to overestimate the risk of greenfield projects and underestimate risk of managing mature infrastructure investments. He sees negative surprises ahead for many Canadian pension funds investing in infrastructure.

Back to PSP's results. The table below shows the portfolio and benchmark returns for all asset classes (click on image to enlarge):

Here are my quick comments on the results:
  • First, I found results in Public Markets were exceptionally strong. Significant outperformance was registered in Fixed Income (10.1% vs 9.4%) and strong results in US Large Cap (11.4%) and Small Cap Developed World (+7.6%). Emerging Markets (-4.3%) and EAFE Large Cap (-2.7%) were negative for the fiscal year but they beat their benchmarks (Canadian equities are indexed). The outperformance in Fixed Income was mainly due to an overweight position in corporate credit, as well as directional and relative value strategies on interest rates and sovereign credit.
  • Second, significant added value came from Real Estate as that team outperformed their benchmark by 6.7% (13.4% vs. 6.7%). While these are impressive, I am less impressed than the outperformance in Public Markets. Why? Because it once again shows me that the benchmarks in Real Estate and other private markets at PSP and other major Canadian funds do not reflect the underlying risks taken at the portfolio level. Benchmarks for Real Estate, Private Equity and Infrastructure are disclosed on page 13 of the Annual Report and they are all "custom benchmarks" reflecting real cost of capital (whatever that means).
  • Third, Private Equity matched its benchmark, delivering a solid gain of 7.7%. Infrastructure, however, significantly underperformed its benchmark by 6.9% (2.7% vs, 9.6%) but still managed a positive gain (see comments above).
  • Lastly, overall results were decent given their fiscal year ended March 31st but they lagged those of CPPIB, which returned 6.6% in fiscal 2012, and those of AIMCo which returned 7.4% in fiscal 2012 (same fiscal year). Admittedly, it's not fair to make direct comparisons as different pension funds have different portfolios, but overall PSP's results were not spectacular by any measure. They were spectacular in Public Markets, however, where external and especially internal managers delivered stellar results.
Reactions from my network were mixed. Bernard Dussault, the former Chief Actuary of Canada, sent me these thoughts:
That 3% annual return is less by at least 3% than what is required to maintain the applicable contribution rate of about 20% of payroll. If the fund were to earn only 3% on average, the cost of the plan would jump up to at least 32% of payroll.

I dislike this emphasis on the benchmark because it just indicates how well or bad you performed compared to your peers.
Excellent point on the cost of the plan, one that PSP's board of directors and stakeholders need to keep in mind. Another union representative from Ottawa shared these thoughts with me:
My reading of the report is that PSP Investments returned a paltry 3.0% overall for 2011-2012. This is significantly less than the 6.4% nominal rate requirement estimated by the Office of the Chief Actuary (OCA) to keep the Federal Public Service Plan fully funded. This is also less then the returns earned over comparable periods by other major public sector funds (CPPIB, OMERS, OTPP, CDP, etc.)

Since PSP Investments has been at the helm, (i.e. April, 2000) the Public Service Pension Fund has accrued a $4.4 billion actuarial liability according to the OCA.

However, most importantly, Fyfe and company do know how to pay themselves (p.52)!
Indeed, as shown in the table below, Mr. Fyfe and his senior managers enjoyed millions in total compensation (click on image to enlarge):

While this will surely raise eyebrows with federal public sector workers and their union members, compensation is based on beating the overall benchmark over a 4-year rolling period, not attaining the actuarial rate of return, and it is comparable to what other large Canadian pension funds pay their senior managers.

One senior industry professional shared this with me on compensation and results:
Overall results were ok, and quite problematic relative to funding requirements. Comp...not that surprising, that's about market for accomplished people these days. My only discomfort is the four year performance period is still too short for private equity, and the performance (post crisis, like the crisis didn't count) is not really noteworthy.
I agree, performance post-crisis is a sneaky way of hiding facts. All pensions funds should include one year, 5-year and 10-year annualized returns relative to benchmarks.


Those are my thoughts on PSP Investments' results for fiscal year 2012. Once again, I invite you to carefully go over PSP's 2012 Annual Report. If there is anything to correct in this blog comment, I will ask PSP to send over their response.

Below, Lincoln Ellis of the Strategic Financial Group, warns the P/E game is a sham, starting with the notion that 14x is a genuine average. "That multiple is really only indicative of the last 25 years" Ellis says in the attached video. "We are in a very difficult and different earnings environment." Yes we are, one that pension funds better get used to.