Monday, November 11, 2013

CPPIB Hits an Investment Impasse?

Janet McFarland of the Globe and Mail reports, CPPIB chief cites investment challenges as alternative assets become ‘fully valued’:
The Canada Pension Plan fund has slowed its pace of investment in alternative assets such as infrastructure as the market becomes more competitive and more expensive, says chief executive officer Mark Wiseman.

The giant plan, which reported Friday that its assets have reached $192.8-billion as of Sept. 30, has been an active investor in so-called alternative investments such as real estate and infrastructure, which match the long-term nature of the fund’s investment horizons. But Mr. Wiseman said the asset class is becoming “fully valued” and bargains are getting harder to find with a growing array of other investors competing on deals.

“We’ve been growing them more slowly in the last 18 months than we did previously because we haven’t seen as much near-term opportunity,” Mr. Wiseman said in an interview Friday. “So we’re doing less, but what we are doing is consistent with the long-term approach that we take.”

Mr. Wiseman said the fund hasn’t done a major infrastructure deal in more than a year because pricing is high, but said the caution can give way to buying when market conditions change in any asset class or country.

“All of these markets are cyclical in the long term, and we’ll have a benefit being an enduring investor building a diversified portfolio that’s not focused on the next 90 days – for us a quarter is 25 years,” he said. “When we do see opportunity, we’ll be able to move in and take advantage of it.”

The Canada Pension Plan Investment Board, which manages the assets of the Canada Pension Plan, has $22-billion invested in real estate holdings and $11-billion in infrastructure assets, but has the bulk of its portfolio – $97-billion – in public and private equity holdings, and a further $62-billion in fixed income holdings such as bonds and other debt.

Mr. Wiseman’s comments echo those last week of Leo de Bever, chief executive officer of pension manager Alberta Invesment Management Corp., who also said the alternative investment landscape is looking expensive and over-competitive after being a staple for large pension funds over the past 10 to 15 years.

Mr. de Bever said he now believes pension funds like his have to get more aggressive or innovative to find good deals or even create new opportunities themselves by helping initiate new projects.

Also Friday, the CPPIB reported the fund had assets of $192.8-billion as of Sept. 30, up by $3.9-billion from $188.9-billion on June 30. Most of the gain in value – $3.3-billion – came from investment gains and the rest from new contributions.

CPPIB said it earned a 1.8-per-cent return on its investments in its fiscal second quarter this year, a below-average return for Canadian pension funds during that period.

A recent pension survey by RBC Investor & Treasury Service said pension funds on average earned 3.6 per cent in the three months ended Sept. 30, while consulting firm Mercer said a typical balanced pension fund earned 3.3 per cent in the quarter ended Sept. 30.

Mr. Wiseman said the CPP fund is so much larger and invests so differently from other pension plans that its portfolio is not comparable to most smaller pension plans, and its results are not comparable.

“The structure of our portfolio and what we’re trying to do is not comparable to smaller plans, to more mature plans, to plans that don’t have the scale to invest on a global basis or in private assets,” he said. “It’s almost like comparing apples to hockey sticks, it’s so different.”

He said the CPP fund is also different from most pension plans because it is not required to contribute to payouts to plan members until 2021, so it has no immediate funding obligations to meet.

The pension plan said its 10-year annualized return of 6.8 per cent, or 4.9 per cent after inflation, is still ahead of the long-term 4-per-cent annualized return after inflation that the fund is required to earn to meet its 75-year payout commitments.
I stopped covering CPPIB's quarterly performance for the simple reason that it's irrelevant given their significant exposure to long-term private market assets which should be valued over years, not quarters.

On Friday, I discussed how AIMCo's Leo de Bever sounded the alarm on alternatives, stating they're too rich for him:
Overvalued. Expensive. Competitive. This is how the alternative investment landscape looks to Leo de Bever, chief executive of pension manager Alberta Investment Management Corp.

The non-traditional asset class, which includes infrastructure, real estate, commodities and other unusual derivative investments, has become a focal point among fund managers in recent years as rock bottom interest rates and uneven markets push investors toward the potential for a bigger payoff.
You have to subscribe to read that article but I've been warning my readers about the bubble in private equity, infrastructure, real estate and hedge funds.

Back to CPPIB.  Barbara Shecter of the National Post reports, Bargains hard to find but Neiman Marcus worth the price:
In a quiet quarter when bargains were admittedly hard to find, the Canada Pension Plan Investment Board scooped up luxury retailer Neiman Marcus Group Inc. in a $6-billion deal with partner Ares Management.

Mark Wiseman, chief executive of the CPPIB, said Friday it was one of the few deals examined in late summer and early fall where executives at the investing arm of the Canada Pension Plan decided it was worth paying fair value.

The winning combination was the strong and storied brand and the potential to profit in the long haul from economic recovery in the United States that “will take years to play out,” Mr. Wiseman said in a telephone interview

“We’re willing to pay fair value for an asset like that,” he said of the retail chain purchased in partnership with Ares Management. “We can patiently wait for that [recovery to come].”

Mr. Wiseman said it was a “relatively slow… quiet quarter” for deals because assets across most sectors including real estate were deemed too expensive. However, he said, the nearly $200-billion fund “will always be able to find those opportunities” like Neiman Marcus because it has a longer investment horizon than many other buyers in the private market.


Returns don’t have to come immediately, or even within the first few years, said Mr. Wiseman, who is fond of pointing out that the pension giant thinks of quarters in terms of a century, rather than three-month chunks of a single year, because its job is to ensure the long-term sustainability of the national pension scheme.

But he said CPPIB’s general strategy of buying assets that are under pressure, and therefore available below fair value, has not changed.

“We prefer to buy when there’s stresses in the markets,” he said. These days, “it’s a very, very tough environment to invest in. You have to be very disciplined.”

The CPP Fund ended the second quarter on Sept. 30 with net assets of $192.8-billion, up from $188.9-billion at the end of the previous quarter. The growth was driven primarily by $3.3-billion in investment income after operating costs.

The portfolio delivered a gross investment return of 1.8% for the quarter, with gains driven by foreign and domestic equity markets, and the performance of each of CPPIB’s active investment programs.

The fund’s five and 10-year nominal returns are 6.4% and 6.8%.

The returns “demonstrate our commitment to focusing on the long term, as we continue to take actions today for the benefit of CPP Fund contributors and beneficiaries for decades to come,” Mr. Wiseman said in a statement reporting the fund’s performance.
You can view CPPIB's latest quarterly performance by clicking here. You will notice the biggest deal by far was the $6 billion acquisition of Neiman Marcus which was a co-investment with Ares Management. I covered that deal in a comment of mine on Canadian pensions flying solo:
One finding of the academic paper I did find interesting is that the performance of co-investments was lower than that of fund investments. Pension funds don't pay fees on co-investments, they are done as part of a fund investment program and they are typically done on big transactions.  I quote professor Lerner:
“The problem was, it seems, that the co-investments were doubly cursed,” Mr Lerner says. “They were done at exactly the worst possible time in the cycle and, second, these deals tended to be substantially larger than what the fund managers used to do, in the order three times larger – and those deals seemed to perform poorly.”
If that is the case, then we should worry about large co-investment transactions like the Neiman Marcus deal. If you read the Reuters article, TPG Capital and Warburg Pincus took the luxury retailer private in 2005 for $5.1 billion. CPPIB and Ares are buying it for $6 billion eight years later. That's a nice premium but not outrageous given the success and growth potential of Neiman Marcus.

CPPIB recently stated it will make fewer deals if rising investor confidence drives prices too high. As I covered  in my recent comment on CPPIB investing Gangnam style, it seems like they and PSP Investments might lose out to an ex-Blackstone top executive on their bid to buy the French assets of TDF, Europe’s largest telecoms tower operator.

This is a highly competitive environment. CPPIB, PSP Investments and all other large pension and sovereign wealth funds looking to invest in private equity are competing to find great deals. The problem is there are not that many great deals in this environment and that is putting the pressure on top private equity funds and their big investors who require increasing scale to keep up with their allocations to this asset class.

The one big advantage Canadian pension funds have over private equity funds is their long-term investment horizon. They don't need to realize on their direct private equity investments every six years or worry about fundraising. And unlike their U.S. counterparts, Canadian pension funds got the governance right, and they properly compensate their investment staff. 
The biggest issue mega funds like CPPIB are facing in this environment is there aren't enough market dislocations for them to buy private market assets on the cheap. When markets tank, CPPIB and other large pension funds can take advantage of their long-term investment horizon to invest in public and private markets. But given CPPIB's sheer size, it needs to get into very big deals, which aren't always easy to find, especially in this environment.

CPPIB and PSP Investments have the added advantage of a positive liquidity profile, meaning they don't have to pay members for many more years. They were both bidding on France's TDF but CPPIB dropped out of that process for valuation reasons (PSP teamed up with European infrastructure fund Arcus to bid on TDF's assets). 

In the latest deal, Bloomberg reports Dexus Property Group (DXS), Australia’s biggest listed office landlord, and CPPIB reached an agreement with Commonwealth Bank of Australia to buy the bank’s listed office trust for A$2.83 billion ($2.66 billion):
Dexus and the Canadian fund increased their cash-and-stock bid to A$1.2052 a share, from A$1.15-a-share last month, Dexus said in a regulatory filing. A binding agreement must be reached by mid-December, according to the statement.

The takeover would be the latest in a string of investments in Australian property by CPPIB and adds to the Toronto-based fund’s C$5.8 billion ($5.5 billion) of investments in the country. Dexus, which agreed to buy a 14.9 percent interest in the fund in August after Commonwealth Bank said it planned to exit its property business, would own and manage a quarter of the commercial buildings in Sydney following a successful takeover.

“There’s a tremendous amount of money around the world that wants to be invested in good quality assets in a safe country, and that’s what CPA is,” said Adrian Atkins, a Sydney-based analyst at Morningstar Australasia Pty. “Dexus is paying an OK price to boost their assets, get more funds under management and get greater scale and more visibility with a bigger portfolio.”
There is too much money chasing too few deals which are increasingly expensive and that worries me. While AIMCo and OTPP are still small enough to do some innovative direct deals in private equity, mega funds like CPPIB need to co-invest with solid partners in much bigger deals. This presents opportunities but also challenges in this frothy environment.

One area where CPPIB does engage in direct deals is infrastructure. Below, Mark Wiseman, president and CEO of CPPIB, explains how his fund assesses investments in infrastructure projects and how governments can compete more successfully for investment capital by reducing risk for investors (March 2013).