Monday, May 26, 2014

CPPIB Gains 16.5% Gross in FY 2014

Janet McFarland of the Globe and Mail reports, CPPIB’s active investment plan scores big with 16.5% rate of return:
The Canada Pension Plan fund saw its assets swell by $36-billion over the past fiscal year after recording its highest annual rate of return on investments in the past decade, but warns that good investment deals are harder to come by as more large investors flood into acquisition markets.

The Canada Pension Plan Investment Board (CPPIB), which manages Canada’s largest pool of pension assets, said total assets hit $219-billion as of March 31, up from $183-billion a year earlier, which is the highest annual gain in dollar terms that the fund has ever earned.

“At the end of the day, the reason we’re most pleased about that is that it’s really what pays pensions,” chief executive officer Mark Wiseman told reporters Friday. “Those returns will help pay pensions for the next 75 years and beyond. ... It continues to enhance the overall sustainability of the Canada Pension Plan.”

CPPIB says its long-term rate of return is on track to cover all anticipated CPP payments for at least the next 75 years, which is the time frame measured by Canada’s chief actuary. The fund needs to earn a 4-per-cent annualized rate of return above the rate of inflation to be sustainable for the long term, and currently has a 10-year rate of return of 5.1 per cent, which is ahead of the required level but a decline from 5.5 per cent at the end of 2013.

The 16.5-per-cent rate of return on investments in fiscal 2014, ended March 31, is the second-highest annual return earned by CPPIB in its 15-year history, outpacing all annual performance results except 2004, when the fund earned a 17.6-per-cent rate of return.

A major part of the return last year came from a $9.7-billion gain from converting foreign holdings into Canadian dollars for reporting purposes.

CPPIB said its 2014 return almost exactly matched the rate of return that would have been earned by a passive “reference portfolio” that simply invested in public stock indexes and government bonds. CPPIB earned $62-million less than a passive investment strategy would have produced after including operating costs.

The performance measure is closely watched because CPPIB decided eight years ago to begin actively investing its assets instead of passively investing in investments that matched indexes.

Mr. Wiseman said public stock markets earned “exceptional gains” during CPPIB’s fiscal year, ended March 31, so it was a difficult year to outperform public market benchmarks in the reference portfolio.

He said returns are typically expected to lag the passive benchmark over the short term when public markets perform strongly because there is a a valuation lag for private market holdings – including private equity and real estate – that are difficult to revalue on an annual basis. CPPIB has about 40 per cent of its portfolio in private investments.

Mr. Wiseman said he remains committed to a strategy of increasing investments in private markets, which reduces risk by adding diversity to the portfolio. He said private investments have a lot of “embedded” value that is not easily measured until they are sold.

“We believe it’s an extraordinary result to keep up with the reference portfolio in a period of time where there is extremely bullish equity markets,” he said. “We would have expected generally in market conditions like these that we would have underperformed the reference portfolio, and we were quite pleased we were able to keep up with it.”

In the eight years since CPPIB created its reference portfolio, the fund said it has earned $3-billion of additional returns above the passive benchmark after excluding operating costs.

Mr. Wiseman said Friday that the fund is seeing increasing competition for investment deals as more investment funds look to invest in alternative assets such as private equity and real estate, especially while interest rates remain low and credit is plentiful.

As a result, he said the fund is in a period of “patient” investing, selling some assets that are highly valued and being careful about new investments.

“In my career as an investor, this is probably the toughest market today to operate in as a value investor,” Mr. Wiseman said.

He said most assets are “fairly priced,” and better deals are often more complex or involve emerging markets like China and India that require time and expertise to handle well.

The fund said its $35.8-billion increase in assets last year included $5.7-billion from worker and employer contributions, and $30.1-billion from investment returns earned on the portfolio.

CPPIB also published its executive compensation report Friday, showing Mr. Wiseman earned a total of $3.6-million last year, up from $2.8-million in fiscal 2013. Most of the increase came from incentive programs based on CPPIB’s four-year investment return. André Bourbonnais, senior vice-president of private investments, earned $3.5-million, an increase from $2.6-million last year.
The Canadian Press reports, How your pension is doing: a 16.5% annual return:
The 2013-14 financial year was an unusually strong one for the Canada Pension Plan Investment Board, which earned a 16.5 per cent annual return on the billions of dollars in assets it manages for the national retirement system, but its CEO cautions that level of growth likely won't soon be repeated.

"Although we are pleased with these annual results, this relatively short-term performance is far less meaningful than our long-term results as financial markets can move sharply in either direction over shorter time horizons," CPPIB chief executive Mark Wiseman said Friday as the fund manager released its annual report for the year ended March 31.

Wiseman said all of CPPIB's investment teams made material contributions last year, producing CPPIB's largest level of annual investment income since inception, but noted the Canada Pension Plan isn't expected to need to draw money from the fund until at least 2023 and, even then, at a relatively small amount for several years.
$219B in assets

For the financial year ended March 31, CPPIB had $219.1 billion of assets under management, up from $183.3 billion a year earlier, with the vast majority of the increase coming from investments.

About $30 billion of the increase was due to investments and $5.7 billion came from excess contributions paid to the pension plan by working Canadians and their employers outside of Quebec. By comparison, investments provided only $16.2 billion of net contributions in fiscal 2013 and only $9.5 billion in fiscal 2012.

The CPPIB, one of Canada's biggest pension funds, invests money not currently needed by the Canada Pension Plan to pay benefits. The plan receives its funds equally from payroll contributions from the people who work in Canada — outside of Quebec which has a separate plan — and matching contributions from their employers.

The board has been dealing with the volatility of publicly traded stocks and low returns from government bonds by diversifying into other forms of assets, including equity in private companies and investments in infrastructure such as highways and real estate.

There has been a public debate about whether Canadians will have sufficient income in retirement given that generally people live longer, that there are more people of retirement age and that savings rates are low debt levels high.
Public or private pension savings?

In Ontario, for instance, Liberal Premier Kathleen Wynne has included a separate provincial pension counterpart as one of her party's key election promises ahead of the province's June 12 election. On a federal level, the Harper government has steered clear of calls for increasing mandatory employee-employer contributions to the CPP in favour of a policy that enables voluntary contributions under professional management.

Wiseman says the CPPIB takes no position on whether the Canada Pension Plan is sufficient given overall retirement needs or what changes may be required, but says it has the organization has a "platform" of people, relationships and assets that can be expanded if policy-makers decide that's necessary.
"We are built for scale," Wiseman said. "We know that the fund today is going to grow by 2050 to something like a trillion dollars and we are designing our platform to be able to invest in scale."

Wiseman cautioned that the CPPIB — despite its large size in Canadian terms — competes against much bigger investors in the global market such as private equity funds, sovereign wealth funds and other public pension plans that are also on the hunt for similar types of investments.

He said that makes it difficult to find new investments at a price that provide the returns that are required so the Canada Pension Plan can deliver on its commitments.

"My view is that, at least in my career as an investor, this is probably the toughest market today to operate in as a value investor," Wiseman told reporters in a briefing Friday.
Looking for opportunity

"When you look around the world, you don't see assets are grossly overpriced and you don't see assets that are grossly under-priced."

"In areas where there is opportunity, it tends to be complex and hard to transact."

Wiseman said there may be opportunities in China but there's a limit on what foreign investors can do there and while there may be opportunities in India, they can be complex to execute.

Earlier this year, the fund partnered with residential developer China Vanke Co. Ltd. to invest US$250 million in the Chinese residential market.

CPPIB also recently launched a couple of strategic alliances in India, one focused on office buildings and another on financing for residential projects.
Ben Dummett of the Wall Street Journal also reports, Canada Pension Fund CPPIB Posts 16.5% Return:
Canada's biggest pension fund on Friday posted a 16.5% return for its latest fiscal year, led by gains in its public and private equity holdings in developed and emerging markets.

CPP Investment Board had 219.1 billion Canadian dollars ($201.1 billion) of assets under management at the end of its fiscal year on March 31, up C$35.8 billion from a year ago. The increase included C$30.1 billion in investment income, after subtracting costs to operate the fund, which is the largest level of annual investment income since the fund's inception, CPPIB said. The remaining C$5.7 billion reflects pension contributions.

The fund's performance, despite the big gain, was largely in line with CPPIB's internal benchmark return of 16.4%.

Mark Wiseman, CPPIB's chief executive, said the fund's relative performance isn't surprising, and was actually better than it might seem, when the greater diversity of the fund's holdings compared with its benchmark is taken into account.

CPPIB's internal benchmark comprises a passive portfolio of about 65% publicly traded equities and 35% publicly traded bonds. By comparison, it only has about 60% of the fund in publicly traded securities and the rest in private assets. That means CPPIB couldn't reap the full benefit of equities that soared in 2013 in the U.S., Europe and Japan amid growing investor confidence over the global economic recovery. The fund's private assets include real estate, infrastructure, farmland and equities in private companies.

CPPIB's more diversified portfolio "ought not to keep up in a bull market" in public equities, but in a bear market, "we should outperform" because of the fund's relatively lower exposure to public markets, Mr. Wiseman said at a news conference. In addition, the value of private assets typically declines at a slower rate than public securities in a bear-market environment. But the fund actually outperformed on that basis, since the return was in line with the benchmark, Mr. Wiseman said.

Increasingly, Canada's pension funds are investing more of their money in private assets. That diversification strategy guards against overexposure to any one particular asset. Historically, private assets have also proven to generate bigger relative returns, in part because private markets tend to be less efficient. While public-market gains typically average in the mid- to high-single digits, private assets are expected in some cases to generate gains close to 15% to 20% on average.

Over the last five years, the value of CPPIB's private-asset holdings have more than tripled to C$89.1 billion from C$25.6 billion, and now represent about 40.6% of the fund's holdings.

In the latest year, some of CPPIB's private-equity investments included the acquisition of U.S. life insurance and reinsurance provider Wilton Re Holdings Ltd. for $1.8 billion, giving it a platform to expand into that sector. It also closed the $6.0 billion acquisition with U.S. private-equity firm Ares Management of luxury retailer Neiman Marcus Group Ltd. In the real-estate sector, it formed a new venture with China Vanka Co., China's biggest residential developer, and new real-estate ventures in India.

CPPIB's large size and its long-term investment horizon that it measures over decades, can give it an advantage over other institutional investors in scouring and bidding for investments. But Mr. Wiseman says the current investment climate "is probably the toughest" he has seen in his career for a value investor like CPPIB.

That is because assets are "by and large fairly priced," making it difficult to find investments the fund believes the market is mispricing or undervaluing, he said.

Some opportunities exist in China and India, but the complexity of operating in those countries makes investing there difficult, Mr. Wiseman noted.
Finally, Andrea Hopkins of Reuters reports, CPPIB notches 16.5 percent return, eyes developing markets for deals:
The Canada Pension Plan Investment Board, one of the world's biggest dealmakers, said it is hard to find good deals because most assets are fully priced, but it will be patient and focus on emerging markets to find deals that offer long-term value.

CPPIB, which manages Canada's national pension fund, said on Thursday its assets rose to a record C$219.1 billion ($201.39 billion) at the end of fiscal 2014, as its investment portfolio returned 16.5 percent for the year ended March 31.

Chief Executive Mark Wiseman said CPPIB will put a disproportionate amount of effort into finding deals in developing markets because its long-term investment horizon allows it more time than many competitors to reap the benefits.

"We are continuing to try and develop our portfolio in growth markets, places like India, Brazil, China - we see those markets providing good long-term value for the fund over all," Wiseman told Reuters following the release of the fund manager's results.

CPPIB opened an office in Sao Paulo in April to access Latin American markets including Brazil, Peru, Chile, Colombia and Mexico.

Wiseman said the flow of acquisitions will likely remain subdued in 2015 because competitors have come back into the market after stepping back in the wake of the financial crisis, and there are lots of capital chasing investment opportunities.

"In my career as a investor this is probably the tightest market to operate in as a value investor," he told reporters. "Assets are by and large fully priced ... and if I had to use one word to describe the mentality around here it is 'patient.'"

The fund manager struck 103 global deals in fiscal 2014, 45 of which were over C$200 million.

Wiseman said CPPIB will focus on assets like infrastructure, real estate and private equity, and build out its public market capabilities in those developing markets.

The eighth year of active management of the fund has boosted foreign assets to 69 percent of the portfolio, while Canadian assets make up 31 percent of the book.

The 16.5 percent 2014 investment gain was up from 10.1 percent a year earlier and its fifth straight gain after the fund manager suffered losses in 2008 and 2009.

Investment returns were led by a 36.8 percent gain in private emerging market equities, a 35.1 percent rise in private foreign developed market equities, a 30.1 percent gain in Canadian private equities, a 26.3 percent gain in public foreign developed market equities, a 20.0 percent gain in "other debt," an 18.0 percent gain in real estate and a 16.6 percent gain in infrastructure.

Weaker parts of the portfolio included investments in Canadian public equities, which returned 15.6 percent, public emerging market equities, which returned 5.8 percent, bonds and money market securities, which returned 0.3 percent, and non-marketable bonds, which notched a negative 0.1 percent return.
You can read more on CPPIB's FY 2014 results on their website here. The 2014 Annual Report is available here. I will provide my general thoughts on these results and refer to the table below (click on image):


Here are my general thoughts:
  • Except for bonds, these results are very strong across the board. If you look at the table above, you will see exceptional returns in both public and private markets except for bonds which were basically flat in fiscal 2014.
  • Almost $10 billion of the gain came from foreign exchange as the Canadian dollar slid in FY 2014 (I warned all of you to short Canada back in December). And it could have been better if CPPIB didn't hedge F/X. Footnote #4 in the table above explicitly states that the total fund return in fiscal 2014 includes a loss of $543 million from currency hedging activities and a $1 billion gain from absolute return strategies which are not attributed to any asset class.
  • CPPIB should follow AIMCo and others and report net returns in their headlines. Their press release, however, does state the following: "In fiscal 2014, the CPP Fund’s strong total portfolio return of 16.5% closely corresponded to the CPP Reference Portfolio with $514 million in gross dollar value-added (DVA) above the CPP Reference Portfolio’s return. Despite the strong CPP Reference Portfolio return, we outperformed the benchmark due to strong income and valuation gains from our privately-held assets. Net of all operating costs, the investment portfolio essentially matched the CPP Reference Portfolio’s return, producing negative $62 million in dollar value-added."
  • The press release, however, emphasizes long-term results: "Given our long-term view and risk/return accountability framework, we track cumulative value-added returns since the April 1, 2006 inception of the CPP Reference Portfolio. Cumulative gross value-added over the past eight years considerably outperformed the benchmark totalling $5.5 billion. Over this period cumulative costs to operate CPPIB were $2.5 billion, resulting in net dollar value-added of $3.0 billion. "
  • I realize CPPIB is running a mammoth operation and is being "built for scale" but operating costs matter and they include fees being doled out to external public and private managers. This is why I'm a stickler for transparency on all costs, fees and foreign exchange fees. At the end of the day, whether you are running a pension fund, hedge fund, mutual fund, or private equity fund, what matters is the internal rate of return (IRR) net of all fees and costs, including foreign exchange transactions.
  • Mark Wiseman is a very smart and nice guy. I've spoken to him on several occasions and he knows his stuff. He's absolutely right, in markets where public equities roar, CPPIB will typically under-perform its Reference Portfolio but in a bear market for stocks, it will typically outperform its Reference Portfolio. Why? Because private market investments are not marked-to-market, so the valuation lag will boost CPPIB's return in markets where public equities decline. Over the long-run, the shift in private markets should offer considerable added value over the Reference Portfolio which is made up of stocks and bonds.
  • But while I understand the diversification benefits of shifting a considerable chunk of CPPIB's assets into private markets, this shift presents a whole host of operational and investment risks which need to taken into account. My biggest fear is that too many pensions and sovereign wealth funds are chasing big deals around the world, enriching private equity and real estate gurus, and bidding up the price of assets. Lest we all forget the wise words of Tom Barrack, the king of real estate who cashed out right before the financial crisis in 2005, stating back then: "There's too much money chasing too few good deals, with too much debt and too few brains."
  •  Shifting more and more assets into private markets has become the new religion at Canadian public pension funds. It goes back to the days of Claude Lamoureux, Ontario Teachers' former  CEO, who started this trend, made the requisite governance changes and started hiring and compensating people properly to attract and retain talented individuals who know what they're doing in private markets. But I agree with Jim Keohane, CEO of HOOPP, a lot of pensions are taking on too much illiquidity risk, and they will get crushed when the next crisis hits.
  • Of course, CPPIB and PSP investments have a huge liquidity advantage over their counterparts in that their cash flow is positive for many more years, which means they can take on a lot of liquidity risk, especially when markets tank.
  • But right now, the environment isn't conducive to making  a lot of deals in private markets which is why Mark Wiseman and André Bourbonnais, CPPIB's senior vice-president of private investments, are going to sit tight and be very selective with the deals they enter. CPPIB's size is more of a hindrance in this environment because they need to get into bigger and bigger deals which are full of risks when other players are bidding up prices to extreme valuations.
  • As far as India, China and other BRICs, there are tremendous opportunities but huge risks in these countries. Hot money flows wreak havoc in their public markets and if you don't pick your partners carefully, good luck making money investing in their private markets.
  • In terms of compensation, I note that both Mark Wiseman and Mr. Bourbonnais both made almost the same amount in fiscal 2014 ($3.6 million and $3.5 million). I contrast this to PSP's hefty payouts for fiscal 2013 where Gordon Fyfe, PSP's CEO, made considerably more than other senior executives (all part of PSP's tricky balancing act). This shows me that CPPIB's compensation, while generous, is a lot fairer than that of PSP which has the same fiscal year. PSP is outperforming CPPIB over a four-year period but still, the difference in comp is ridiculous considering the outperformance (value added over a four year period) isn't that much better and the fact is that PSP is based in Montreal which is way cheaper than Toronto in terms of cost of living (I have to give credit to Gordon, however, he sure knows how to ensure he and his senior managers get paid extremely well. He's a master at charming his board of directors).
  • Finally, one area where CPPIB is killing PSP Investments is in plain old communication (you can even follow CPPIB on Twitter now). I embedded four articles from Canadian and U.S. sources in this comment (there are more). The pathetic coverage of PSP's results isn't just because its results come out in July when Parliament approves the annual report, it's because PSP's public relations and website stink when it comes to communication. Again, that's all Gordon's doing, he doesn't like being discussed in the media, keeps everything hush, and basically thinks the annual report suffices.
Those are my general thoughts on CPPIB's fiscal 2014 results. If you have any comments, feel free to reach out to me  at LKolivakis@gmail.com.

Below, Mark Wiseman, CEO of CPPIB, talks about the FCLT initiative and the importance of  long-term investing. Very wise man, Canadians are lucky he's running their pension plan and the federal government is wrong not to enhance the CPP for all Canadians.