Wednesday, January 25, 2017

Canada Has No Private Equity Game?

Tawfik Hammoud and Vinay Shandal of BCG recently wrote an op-ed for the Globe and Mail, Canada needs to work on its private-equity game:
When you look at who attended last week’s World Economic Forum in Davos, it’s striking how many are global investors or work for large funds – and in particular, private-equity firms.

The question Canadians should be asking themselves is, how do we ensure that Canada receives its fair share of the trillions of dollars deployed by global investment funds, including real estate, infrastructure, venture capital and private equity? How can our entrepreneurs and company owners benefit from this growth capital and the opportunities that come with it?

How can we create an investment ecosystem that gives rise to more Canadian investment firms led by top professionals?

The global investors who gathered in Davos, Switzerland, have much to be thankful for. Business is thriving and the various private asset classes’ performance keeps pumping up demand, especially relative to fixed income and public equities. Take private equity, for example: 94 per cent of investors in a recent survey count themselves satisfied with the returns, and more than 85 per cent say they intend to commit more or the same amount of capital to private equity next year. As a result, the capital flowing into private equity is unprecedented, established firms are raising record amounts of money and fund oversubscription is common.

More than 600 new private-equity funds were created last year alone and the industry is holding $1.3-trillion (U.S.) of “dry powder,” or uninvested capital, that is sitting on the sidelines waiting to be invested. While the merits and operating model of private equity can and should be debated (as they were when former private-equity man Mitt Romney ran for president in the 2012 U.S. election), there is no denying its growing importance in many economies. Carlyle Group and Kohlberg Kravis Roberts & Co. (and their portfolio companies) employ more people than any other U.S. public company outside of Wal-Mart Stores Inc.

The sector’s roaring success might also be the biggest risk to its future. There might be such a thing as too much money, after all.

A swath of new entrants is pouring into private assets, searching for yield in a world of low interest rates. Chinese, Middle Eastern and other emerging markets investors are on the rise and have quadrupled their outbound investment over the past few years. Sovereign wealth funds, pension plans, insurance companies and even some mutual funds are allocating money to the private markets and borrowing from their playbooks. So much money chasing a limited number of opportunities has pushed prices up: historically high multiples combined with lower levels of leverage are putting pressure on returns. Private-equity deal multiples, for example, have exceeded the peaks last seen in 2006-07 for larger transactions (deals above $500-million) and deals above $250-million are also flirting with these highs. But most indicators still point to a favourable outlook as long as the credit markets remain fluid and fund managers continue to create value during their ownership period.

Canadian pension funds, many of which were present at Davos, are increasingly active in this crowded field. They have invested time and money to develop direct capabilities and increasingly stronger investment teams. In many regards, they are years ahead of their peers around the world. However, outside of our pension funds and a few select local firms, Canada tends to punch under its weight. We lack the kind of developed investment ecosystems that are thriving in other countries. As an example, the United States has 24 times more private-equity funds than Canada and has raised nearly 40 times more capital over the past 10 years.

The point is broader: Canada should be attracting more foreign direct investment, including money from global investment firms. FDI in Canada has grown by just 2 per cent a year since 2005, compared with an average of 7 per cent for all OECD countries and 8 per cent for Australia. As a percentage of GDP, Canada still sits in the middle of pack of OECD countries, but 30 per cent of that investment is driven by mining and oil and gas and is heavily skewed to M&A as opposed to greenfield investment (relative to other countries).

Something doesn’t add up. Canada is a great place to put money to work. We are a country with low political risk, competitive corporate taxes, an educated and diverse labour force, liquid public markets and a real need for infrastructure investments. Yet, we are net exporters of capital: foreign investors are often not finding Canadian opportunities as attractive as they should.

For all the criticism the investment industry sometimes faces, it would be a real miss if we failed to show long-term, growth-minded investors that Canada is an attractive place to put their money to work. We want global investors writing cheques for stakes in Canadian companies, so they can help improve their productivity, invest in technology, create new jobs, and grow global champions in many industries. If investors don’t hear our compelling story, Canada and many of its companies could be left on the sidelines as they watch all this dry powder get deployed in other markets.
This is an excellent op-ed, one that I want all of you to read carefully and share with your industry contacts. The last time I saw Tawfik Hammoud of BCG is when we worked together on a consulting mandate for the Caisse on sovereign debt risks (back in 2011). He is now the global head of BCG’s Principal Investors & Private Equity practice and is based in Toronto (all of BCG's team are very nice and bright people, enjoyed working with them).

So, what's this article all about and why is it important enough to cover on my blog?  Well, I've been short Canada and the loonie since December 2013, moved all my money to the US and never looked back. I know, Canadian banks did well last year but investing in the Canadian stock market is a joke, it's basically composed of three sectors: financials, telecoms and energy.

Ok, now we're in January 2017, the Bank of Canada recently "surprised" markets (no surprise to me or my buddy running a currency hedge fund in Toronto) by stating they are on guard and ready to lower rates if the economic outlook deteriorates, sending the loonie tumbling to about 75 cents US (it now stands at 76 cents US).

You would think global investors, especially large US investors, would be taking advantage of our relatively cheap currency to pounce on Canadian public and private assets.

Unfortunately, it doesn't work that way. Canada isn't exactly a hotbed of private equity activity. Yes, our large Canadian public pensions invest in private equity, mostly through funds and co-investments and a bit of purely direct investments, but the geographic focus remains primarily in the United States, the UK, Europe and increasingly in Asia and Latin America.

Sure, we have great private equity companies in Canada like Brookfield Asset Management (BAM), our answer to Blackstone (BX), the US private equity powerhouse, but even Brookfield focuses mostly outside Canada for its largest private equity transactions.

So why? Why is Canada's private equity industry under-developed and why are global and domestic private equity powerhouses basically shunning our economy, especially now that the loonie is much cheaper than it was a few years ago?

The article above cites Canada's stable political climate, competitive corporate tax rate and diverse and highly educated workforce but I think when it comes to real entrepreneurial opportunities, Canada lags far behind the United States and other countries.

Now, we can argue that maybe Canada's large pensions should do more to invest in and even incubate more domestic private equity funds (they already do some) but the job of Canada's pension fund managers isn't to incubate domestic private equity funds or hedge funds, it's to maximize returns taking the least risk possible by investing across global public and private markets.

Only the Caisse has a dual mandate of investing part of its assets in Quebec's public and private markets and we can argue whether this is in the best interests of its beneficiaries over the long run (the Caisse will talk up its successes but I'm highly skeptical and think Quebec pensioners would have been better off if that money was invested across global markets, not Quebec).

In my opinion, the biggest problem in Canada is the culture of defeatism and government over-taxation (on individuals) and over-regulation of industries. At the risk of sounding crazy to some of you tree hugging left-wing liberals, Canada needs a Donald Trump which will cut out huge government waste and insane regulations across the financial and other industries, many of which are nothing more than a government backed oligopoly charging Canadians insane fees (look at banks, mutual funds and telcom fees and tell me we don't need a lot more competition here).

My close buddies reading this will laugh as they recently blasted me for voting Liberal in the last election. Yes, I too voted for "boy wonder" mostly because I was sick and tired of Harper's arrogance but Trudeau junior's ineptitude, inexperience and recent comments on Alberta's tar sands and ridiculous and needless cross country tour just pissed me off enough so I will be returning to my conservative economic roots during the next election even if O'Leary wins that party's leadership race (love him on Shark Tank, not so sure how he would be as our PM).

Politics aside, we need to ask ourselves very tough questions in Canada and across all provinces because it's been my contention all along that far too many Canadians are living in a Northern bubble, erroneously believing that we can afford generous social programs forever. Canadians are in for one rude awakening in the not too distant future.

What else pisses me off about Canada? Unlike the United States where the best of the best rise to the top regardless of the color their skin, gender, sexual orientation, religious beliefs and disabilities, there is a pervasive institutionalized racism that is seriously setting this country back years, if not decades (you can disagree with me but I'm not going to be politically correct to assuage your hurt feelings, Canada lacks real diversity at all levels of major public and private organizations).

So, before Canada can rightfully argue that it deserves a bigger chunk of the global private equity pie, we need to reexamine a lot of things in this country on the social, cultural and economic front, because the way I see it, we're not headed in the right direction and have not created the right conditions to attract foreign investment from top global private equity funds.

As always, these are my opinions, you have every right to disagree with me but I'm not budging one iota and I can back up everything I've written above with concrete facts, not fake news.

Below, take the time to listen once again to Ron Mock and Michael Sabia at Davos. These are two very smart and hard working pension fund leaders who expressed great points at these interviews.


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