Friday, May 30, 2014

Get Ready for Life After Benchmarks?

Melissa Shin of Benefits Canada reports, Get ready for a life after benchmarks:
Benchmark-oriented active managers will fall behind.

That’s what Yariv Itah, managing partner at Casey Quirk, argued at an Alternative Investment Management Association event in Toronto on Wednesday.

A paper he co-wrote, Life After Benchmarks, says clients will soon care more about outcomes, such as specific cash-flow needs, than outperforming a benchmark.

But “to get away from the benchmark, you need a lot of courage,” says Jean-Luc Gravel, executive vice-president of global equity markets at Caisse de dépôt et placement du Québec. That’s particularly the case in Canada, where we have fewer names to choose from.

Even though clients will compare your performance to the benchmark over the long term, it can be dangerous to try beating it over the short term. For instance, when Nortel comprised 35% of the TSE 300 (now the S&P/TSX Composite Index), many managers Gravel spoke to knew it was overpriced. But they refused to sell, because they’d lose their jobs if clients didn’t see the stock in the portfolio.

Gravel says the Caisse has moved away from benchmark-oriented investing globally. “You don’t want to be down 48% even if the benchmark is down 50%,” he says. “In terms of risk-adjusted returns, it’s a better approach.”

Success without benchmarks
Managers may feel lost if they can’t compare their performance to the S&P 500 or S&P/TSX 60. The solution, says Gravel, is to create your own comparisons.

His team does 10-year forecasts to determine expected returns for their chosen allocations – for equities, he’s aiming for 7.5%, but with less risk than a typical manager. Then, they tell clients, so managers are kept accountable.

Ray Carroll, CIO of Breton Hill Capital, agrees that setting expectations will calm clients clamouring for comparisons. At the outset, walk them through scenarios where your approach should perform well, and explain which risk management tools you’ll use in down times.

Carroll says running and explaining simulations is time-intensive, but worth it. For instance, one of his largest investors gave him more money during a period of underperformance thanks to such explanations. “We see you’re down,” the investor said, “but it’s in a scenario where you said you’d be down. And, we’re impressed with how you’ve applied your risk management tools.”

Prepare for the future
In a non-benchmark world, static asset allocation isn’t enough, says Itah. Managers should start allocating portfolios by risks: cash, duration, credit, equity and correlation. And instead of setting an allocation to run for three years, for instance, managers should be taking advantage of opportunities as they arise, subject to that predefined risk profile.

They should also move away from narrow mandates (e.g., large-cap value equities) and broaden their asset classes. He predicts between 2013 and 2016, Canadian plan sponsors will increase their non-benchmark strategies by 23.1% at the expense of active equity, passive and cash allocations.

To prepare, every active manager should be comfortable with derivatives, short-selling, quant modelling, FX and commodities, Itah adds. “In the future, alternative investing will be the default method of active management. Hedge funds will be mainstream.”
You can read the Casey Quirk paper, Life After Benchmarks, by clicking here. I ended up going to the Montreal luncheon yesterday which discussed the same topic. The featured speakers were:
  • Mario Therrien, Senior VP External Mandate, Caisse de dépôt et placement du Québec (moderator)
  • Yariv Itah, Managing Partner, Casey Quirk (presenter of findings)
  • Jean-Luc Gravel, Executive VP Global Equity Markets, Caisse de dépôt et placement du Québec (panelist)
  • Jacques Lussier, President, IPSOL Capital (panelist)
  • Mihail Garchev, Senior Director, PSP Investments (panelist)
The room was packed (a bit too tight when eating) and I got to see a lot of my former colleagues from the Caisse and PSP as well as other people who I was glad to catch up with. The discussion was somewhat interesting but to be frank, I wasn't particularly impressed and think there is a lot of intellectual masturbation that goes on when discussing "life after benchmarks."

Anik Lanthier, Vice-President at PSP in charge of allocating to external funds, said it best to me after the lunch: "It's all nice to talk about being benchmark agnostic but at the end of the day, the board is going to want to measure your performance relative to a benchmark. And even if they shift away from benchmarks, when a new board comes in, they will push for performance relative to benchmarks." She's bang on and still a breath of fresh air (she hasn't changed a bit in 10 years).

I also had a chance to talk to Jean-Luc Gravel after the lunch. He's a very nice and sharp guy. We talked about the importance of long-term investing. I asked him if he read Larry Fink's comments sounding the alarm on how activist investors are way too focused on short-term investing. He told me he did and agrees with most of those comments.

Jean-Luc and I also discussed CPPIB's long-term focus. I told him it's funny how the private markets group wants their performance to be evaluated over the long-run but public markets have to beat the TSX and S&P 500 every year. He told me the Caisse has moved away from short-term investing and that public markets are also evaluated over a longer investment horizon. "But if everyone starts doing this, it will arbitrage away opportunities that come our way."

Jacques Lussier talked about the importance of process over performance, a topic which far too many institutional investors ignore. In fact, at my table sitting next to me was Francois Magny of RDA Capital and Yves Martin of Akira Capital. Yves is winding down his commodity arbitrage fund and learned firsthand how hard it is to start a hedge fund in this environment. We talked about low volatility and the dumb risks pensions and bank prop desks are taking selling options.

"Volatility keeps falling because traders keep selling it to collect yield. But as vol falls, you have to sell more vol to keep collecting the same yield," Yves said. Francois Magny agreed stating that a lot of players are taking huge risks selling vol in this environment. "At one point, the big money will be made buying vol."

I told them there is too much liquidity in these markets and that point hasn't come yet. It increasingly looks like the big unwind in Q1 was just another big buying opportunity. Stocks keep surging to record highs and even though more corrections are coming, we won't see a major bear market in the near future.

Back to life after benchmarks. My former PSP colleague, Mihail Garchev, spoke eloquently about two benchmarks, one based on opportunity cost and one based on "value creation." He rightly noted that private market benchmarks are not easy to construct but most pensions funds evaluate them relative to public market benchmarks because the opportunity cost of tying up your money in an illiquid investment is investing in some equity index. But he added private equity managers are not focused on benchmarks, they are focused on value creation, which means they look at deals that make sense and try to extract value from them.

Mihail is right but he knows full well that pension fund managers take all sorts of dumb risks to beat their benchmarks, something which we both witnessed at PSP (we were working side by side) and which wasn't addressed in the Auditor General's Special Examination. Importantly, benchmarks matter because they determine compensation and thus influence investment decisions.

Go back to read my January comment on CalPERS revamping its PE portfolio, where I wrote:
Ah benchmarks, one of my favorite subjects and the one topic that makes Canada's pension aristocrats extremely nervous. It's all about the benchmarks, stupid! If you don't get the benchmarks right in private equity, real estate, infrastructure, hedge funds, stocks, bonds, commodities or whatever, then you run the risk of over-compensating pension fund managers who are gaming their benchmark to collect a big fat bonus. And as we saw with the scandal at the Caisse that the media is covering up, things don't always turn out well when pension fund managers take stupid risks, like investing in structured crap banks are dumping on them.

A few months ago, Réal Desrochers called me to work on fixing CalPERS private equity benchmark. I can't consult CalPERS or any U.S. public pension fund because I'm not a registered investment advisor with the SEC and they got all these rules down there which make it impossible for a Canadian to work for them.

Anyways, I remember telling Réal their PE benchmark is too tough to beat, the opposite problem that many Canadian funds encounter. I told him I like a spread over the S&P 500 and even though it's not perfect, over the long-run this is the way to benchmark the PE portfolio.

Andy Moysiuk, the former head of HOOPP Capital Partners and now partner at Alignvest  has his own views on benchmarks in private equity. He basically thinks they're useless and they incentivize pension fund managers to take stupid risks. He raises many excellent points but at the end of the day, I like to keep things simple which is why I like a spread over the S&P 500 or MSCI World (if the portfolio is more global).

Should the spread be 300 or 500 basis points? In a deflationary world, I would argue that many public pension funds praying for an alternatives miracle that is unlikely to happen will be lucky to get 300 basis points over the S&P 500 in their private equity portfolio over the next ten years. To their credit, CalPERS has updated their statement of investment policy for benchmarks, something all public pension funds, especially the ones in Canada should be doing (don't hold your breath!).
Finally, I saw my good friend Nicolas Papageorgiou, at the lunch yesterday. Nicolas is one smart cookie. He's a professor of finance at HEC, an expert of smart beta, and is now running a $70 million fund at HR Strategies. He asked a question where he basically expressed his skepticism on life after benchmarks, stating that it's just using different factor models but in the end, "it's basically doing the same thing that we've done in the last 30 years."

After the lunch, Nicolas told me "it's all about marketing." I couldn't agree more and it's all part of the nonsense consultants feed institutional investors so they keep shoving more money into hedge funds, private equity, real estate and infrastructure.

I don't want to be too critical. I think Yariv Itah, Managing Partner, Casey Quirk, is a very smart guy and you should all definitely read his paper, Life After Benchmarks, as it is interesting even if it's heavily biased toward hedge funds and other alternatives. It's just that you have to take all these discussions on "life after benchmarks" with a grain of salt and remember that despite what this paper claims, at the end of the day, benchmarks matter a lot!

On a closing note, most of these conferences and lunches are a total waste of time and money. I would have much preferred having lunch with Fred Lecoq on Bernard st., enjoying the beautiful weather and talking stocks, but I decided to get out of my comfort zone, put on a suit and tie and head over there. I also got to talk to Anik Lanthier, Jean-Luc Gravelle, and see many more people like Marc Amirault, Mario Therrien, Claude Perron, Eric Martin, Simon Lapierre, Ron Chesire, Bernard Augustin, Catalin Zimbresteanu, Johnny Quigley, and Denis Parisien (who is now at Razorbill Advisors). So, in the end, even though I am publicly whining, I am glad I went and thank Claude Perron for organizing it.

Once again, please take the time to subscribe and/or donate to my blog via the PayPal buttons on the top right-hand side. You can also contact me ( if you want to send me a cheque or if you're looking for a top notch investment analyst who isn't afraid to stick his neck out and tell it to you like it really is. Remember the wise words Gordon Fyfe once told me: "Leo, you're the best investment analyst I've ever worked with." Damn right I am!

Below, an old tribute to the Montreal Canadiens, made by a Habs fan for their 100th anniversary (December, 2009). The Habs got eliminated last night by the New York Rangers. It was painful to watch and I now have to adjust to life after the Habs, which totally sucks! Good show les boys, can't wait till next year. Go Habs Go!!!