Friday, March 31, 2017

Caisse Bets Big on Insurance and Water?

I wasn't going to blog today but I realize that I've been slacking on my coverage of the Caisse. Two weeks ago, Devin Banerjee, Scott Deveau, and Frederic Tomesco of Bloomberg reported, Caisse Joins KKR in $4.3 Billion Deal for Onex's USI Insurance:
KKR & Co. and Caisse de Depot et Placement du Quebec agreed to buy Onex Corp.’s USI Insurance Services for about $2 billion as the acquirers partner to make long-dated private equity investments.

KKR and CDPQ, Canada’s second-largest pension fund manager, will have equal ownership in the Valhalla, New York-based insurance broker, according to a statement Friday. The deal values USI at $4.3 billion including debt.

The acquirers also said they’ve established a partnership to make core private equity investments, or deals for stable companies they can hold for longer than the typical three- to five-year period in leveraged buyouts.

Private equity firms have long favored deals in insurance services, where capital expenditures and debt levels are typically low and cash flow is steady. KKR and CDPQ outbid others including buyout firms Carlyle Group LP and CVC Capital Partners for USI, according to people with knowledge of the process. Blackstone Group LP agreed last month to buy human-resources and benefits-administration platforms from broker Aon Plc for as much as $4.8 billion.

“Insurance is a defensive sector that generates a lot of cash and is relatively resilient to economic slowdowns and recessions,” Roland Lescure, CDPQ’s chief investment officer, said in a phone interview Friday. “The good thing about being a broker is that you are only an intermediary and you are not exposed to asset risk.”

Longer Ownership

KKR’s new partnership with CDPQ to make longer-hold investments reflects a wave of similar strategies by peers seeking to benefit from holdings that grow steadily and produce stable cash. Blackstone struck its first such deal in January, acquiring music-rights company SESAC Holdings, and Carlyle and CVC also have funds to make core private equity investments.

KKR co-founder Henry Kravis has lamented in the past that typical buyout fund structures don’t allow for longer ownership, calling Warren Buffett’s long-duration capabilities in Berkshire Hathaway Inc. “the perfect private equity model.”

“The goal is to look for longer-term, defensive deals -- deals for which we are prepared to accept a little bit less leverage, a little bit smaller returns, because there is less risk and a greater resilience to economic slowdowns,” Lescure said of the strategy with New York-based KKR. “There’s no defined time horizon. Yes, it’s probable that in five, seven or 10 years we will decide to sell this business and move on. But neither KKR nor we have the obligation to sell.”

Onex, Canada’s largest buyout firm, agreed to buy USI from a fund run by Goldman Sachs Group Inc. in 2012, in a transaction valued at $2.3 billion. USI has since made more than 30 acquisitions to increase its network across the U.S., according to data compiled by Bloomberg. Onex and partners made a $610 million equity investment in the initial deal, which is now valued at 3.4 times that amount, the firm said in a separate statement Friday.

KKR has a long history in the business too, leading an investor group that bought a predecessor to Willis Group Holdings Ltd. and then took the broker public in 2001. Former Willis Chief Executive Officer Joe Plumeri was hired by KKR as an adviser in 2013 to help find new deals.

USI, founded in 1994, now has more than $1 billion in annual revenue and 4,400 employees in 140 offices across the U.S., according to its website. It offers a portfolio of diversified insurance and financial services to its customers.
Sweta Singh and Matt Scuffham of Reuters reported on a major deal, KKR, Canada's Caisse to buy U.S. insurance broker USI:
Private equity firm KKR & Co LP (KKR) and Canadian pension fund Caisse de dépôt et placement du Québec announced plans on Friday to buy USI Insurance Services from Onex Corp (ONEX.TO) for $4.3 billion, including debt.

The deal is the latest in a string of mergers in the insurance market, which has not grown quickly enough to support smaller brokerages.

"It's a sector we like," Caisse Chief Investment Officer Roland Lescure said in an interview. "It's quite defensive, it has high cash-flow generation, and it's a growing sector where there is consolidation taking place."

The Caisse, Canada's second-largest public pension plan, is buying businesses to help it diversify from public equity and fixed income markets.

The pension fund, which has net assets of more than C$270 billion ($202 billion), wants to have 30 percent to 35 percent of its investments in areas such as private equity, infrastructure and real estate in the next four to five years, compared with 28 percent currently.

"At a time when there are lots of fears and questions on the potential protectionism and border adjustment tax," Lescure said, "being exposed to small and medium companies is a safer way of exposing yourself to the U.S. economy."

Valhalla, New York-based USI had net debt of about $1.82 billion as of Dec. 31 and generated 2016 earnings of $353 million before interest, taxes, depreciation and amortization.

USI provides insurance and employee benefit-related products to smaller U.S. companies. Its staff of 4,400 operates from 140 offices throughout the United States.

Canadian private equity firm Onex bought USI in December 2012 for $2.3 billion from Goldman Sachs Group Inc's private equity arm, funding $702 million of that through equity and borrowing the rest, with debt placed on the company.

The biggest deal in the insurance brokerage sector last year was the merger of Willis Group Holdings and Towers Watson. It created Willis Towers Watson Plc, a company with a $17 billion market capitalization.

USI has been active in buying small regional rivals. It has been trying to beef up USI One Advantage, an interactive platform that helps it share information with sales consultants sitting in offices around the United States.

KKR and the Caisse said they expected the deal to close by the end of the second quarter.
Canadian Underwriter also reports, Caisse de dépôt et placement du Québec to buy stake in commercial brokerage USI from Onex:
Toronto-based Onex Corp. is selling its stake in one of the world’s largest commercial brokerages, USI Insurance Services LLC, to Caisse de dépôt et placement du Québec and other buyers.

Valhalla, N.Y.-based USI placed 11th worldwide in an earlier ranking by Finaccord Ltd., of commercial brokerages. USI has 140 offices in the United States, placing coverage for property, liability, auto, excess and environmental, among others.

Montreal-based Caisse de dépôt et placement du Québec manages funds, mainly for pension and insurance plans.

Onex said Friday that Onex and its affiliates agreed to sell USI to an affiliate of New York-based private equity firm Kohlberg Kravis Roberts and Co. LP and Caisse de dépôt et placement du Québec “for an enterprise value of $4.3 billion.” The sale, which is subject to regulatory approval and other conditions, is expected to close in Q2. In its Q4 2016 financial report, Onex said it owned 89% of USI.

KKR and CDPQ will be “partners with equal ownership” of USI, CDPQ stated.

New York City-based KKR said Friday that “KKR and CDPQ, along with USI employees,” agreed to jointly acquire USI.

“CDPQ and KKR are co-leading this investment and leveraging their respective expertise in the sector to support USI’s world-class management as it pursues its strategic plan for long-term growth,” stated Christian Puscasiu, co-head, direct investments, private equity at CDPQ, in a release. “USI operates in a resilient sector characterized by stable, long-term returns and serves small and medium-sized businesses, which are the cornerstone of the U.S. economy.”

Upon completion of the transaction, the Onex Group will have received proceeds of approximately (US) $2.1 billion, including a prior distribution of $181 million in 2015,” Onex said March 17 in a release.

In a 2014 report- Global Insurance Broking: A Strategic Review of the World’s Top 150 Commercial Non-Life Insurance Brokers – London-based Finaccord ranked the top 150 brokers by estimates of commercial non-life broking revenues in 2013. USI placed 11th. Finaccord’s estimates excluded revenues from personal lines, employee benefits, wholesale insurance and reinsurance. The top three were Aon, Marsh and Willis. Eight brokerages based in Canada made the top 150. Chicago-based Hub International Ltd. – whose Canadian operations include HKMB Hub and Totten Insurance Group – placed seventh.

Other firms in which Onex has an equity investment include claims services firm York Risk Services Group of Parsippany, N.J. and Toronto-based electronics equipment maker Celestica, which was spun off from IBM Corp. in 1996.

Onex was founded in 1983 by Gerry Schwartz, currently chairman, president and CEO.
Onex made a killing off this deal, buying USI from Goldman Sachs for $2.3 billion in December 2012 and selling it to the Caisse and KKR for $4.3 billion in a little over four years.

So, what is this major deal all about? It's a large co-investment where KKR sourced the deal and presented a great opportunity to the Caisse to buy a growing US insurance broker which provides insurance and employee benefit-related products to smaller US companies.

Remember, fund investments and co-investments are an integral part of investing in private equity at Canada's mighty PE investors. They invest in funds where they pay the big fees (typically 2 & 20) and then get to co-invest alongside them on bigger deals where they pay little or no fees (the bulk of their direct investments in private equity come from co-investments).

In order to do this properly, they need to 1) select the right private equity partners where they get solid alignment of interests and 2) hire smart people in private equity who can quickly analyze co-investments to limit turnaround time and act quickly when great opportunities present themselves.

Now, as far as this deal goes, the Caisse's CIO Roland Lescure nailed it: "It's a sector we like. It's quite defensive, it has high cash-flow generation, and it's a growing sector where there is consolidation taking place."

What else? Interest rates are at historic lows and insurance companies have been struggling to generate revenues in this low rate environment. The ones that are growing, like USI, are growing through acquisition and when rates finally start creeping up, they will be well placed to generate even more revenues.

For the Caisse, this is a long-term investment which fits into its investment philosophy of investing in solid cash flow businesses across public and private markets.

What else has the Caisse been investing in lately? Earlier this month, Barbara Shecter of the National Post reported, Caisse de dépôt pumps US$700 million into GE water venture:
The Caisse de dépôt et placement du Québec is investing US$700 million for a 30 per cent stake in General Electric’s Water & Process Technologies business.

The Quebec pension giant is teaming up on the transaction with Paris-based sustainable resource management company SUEZ, which will contribute its existing industrial water business to GE Water and will own 70 per cent of the combined water treatment operation.

The transaction values the GE Water, which provides equipment, chemicals and services for the treatment of water and wastewater in 130 countries, at US$3.4 billion.

The Caisse is seeking to increase its exposure to the water sector and executives view Wednesday’s investment as a key part of that strategy to help create generate long-term returns.

“Operating in a core industry, GE Water has built a premier business with recurring revenues and a high-quality and diversified customer base,” Caisse chief executive Michael Sabia said in statement.

“This investment is therefore highly aligned with CDPQ’s long-term vision of increasing its emphasis on stable assets anchored in the real economy, alongside a world-class operator such as SUEZ.”

In a statement, the Caisse and SUEZ said growing water scarcity and the impact of global warming on the water cycle are expected to keep long-term demand strong for water treatment equipment, chemicals and services.

In addition, increasing global concerns related to industrial wastewater and its impact on the environment will make advanced treatment of water “an absolute necessity,” they said.
Water treatment plants are a big business and this deal will provide the Caisse solid returns over the long term.

You might be asking yourself what's the link between the insurance business and water treatment business. For the Caisse, it all comes down to finding stable, growing businesses with recurring revenues to pay for their members' long-dated liabilities.

And the Caisse's CEO Michael Sabia has publicly warned of market complacency, so you know they are preparing for the next downturn and these private investments with stable revenues (yields) figure prominently into their overall defensive strategy.

The same goes for the rel estate investments where the Caisse and CPPIB recently teamed up to invest in Asian logistical warehouses, a great long-term deal for Canada's largest pension funds.

Lastly, CBC News reported this week, Cost of Montreal's light-rail train project rises by $500M:
The cost of a long-awaited Montreal light-rail commuter train line is going up by half a billion dollars.

CDPQ Infra, the subsidiary of the Caisse de dépôt et placement du Québec overseeing the project, presented an update Tuesday on the work done so far.

The project, which would link downtown Montreal with the South Shore and West Island, was initially pegged at $5.5 billion. Now it's at $6 billion.

Quebec's pension fund, the Caisse de dépôt et placement du Québec, is funding the project and has committed $3 billion to building the 67-kilometre light-rail transit system (LRT).

Michael Sabia, the head of the Caisse de Depot, said he isn't worried about costs getting out of hand.

"It's deliberate decision-making. It's not costs just rising out of neglect or mismanagement — not at all," Sabia said.

Those decisions include adding three new stations in Montreal and adding more cars to take the pressure off the Metro's Orange line.

Sabia doesn't believe the heftier price tag will affect ongoing funding negotiations with the federal government.

A good investment, environmental group says

Environmental group Équiterre considers the additional costs to be a good investment.

"There's been a lack of investment in public transportation for years, so to see money being put into transportation for a project that has great impacts, we see it in a positive light," said Colleen Thorpe, Équiterre's director of education programs.

Deal with agricultural groups

The groups says it's also pleased an agreement was struck to limit urban sprawl and protect farmland around the site of the South Shore station.

The consortium behind Montreal's planned light rail project announced an agreement with local agricultural groups and municipalities to promote the use of agricultural land.

CDPQ Infra said the partnership will mean the creation of an agricultural land trust and, eventually, a park aimed at promoting the use of agricultural land.

"Through this agreement, we are laying the groundwork for a unique initiative to promote the use of the agricultural land located around the South Shore terminal station," said Macky Tall, president of CDPQ Infra.

The consortium has been criticized by some environmental groups for failing to protect agricultural land.

The first trains are expected to run by the end of 2020.
Critics abound on Montreal's light-rail transit system but as I already covered here, the public doesn't have a full understanding of who these critics are and why they're desperately trying to torpedo this project.

Moreover, I will state this one last time, greenfield projects of this scale and magnitude are always going to run into problems and cost overruns but I'd rather have the professionals at CDPQ Infra managing this project than some government bureaucrats awarding contracts to various construction companies (the Caisse assumes the risk of these cost overruns, not the Quebec government, so it's in their best interest to try to minimize them as much as possible).

Again, the people working on this project are first-rate world class professionals who know what they're doing and will deliver a great product on time and on budget. Sabia isn't worried about costs getting out of hand and neither am I (keep in mind this project is Michael Sabia's baby, he isn't micromanaging it but he's definitely present and takes an active part in the decision making).

That wraps up my overview of the Caisse's Q1 activity. Below, Bloomberg's Scott Deveau reports on the Caisse and KKR's $4.3 billion deal to buy USI from Onex. I am glad private equity has discovered Warren Buffett and this this is a great deal for KKR and the Caisse.

Second, a clip showing how Xerox helped USI lower its costs following the 2008 crisis. I embedded this for a lost reasons, to give you a sense of why USI is doing well and to show all organizations how to lower printer costs (yes, they add up fast!).

I also embedded a clip from GE Water & Process technologies going over how GE is incorporating the lessons learned from decades of water treatment experience in the Oil & Gas industry, and is now  uniquely positioned to solve produced water reuse challenges for today and tomorrow.

And using a drone video, GE captured how Anglian Water's Great Billing Water Recycling Center captures energy and valuable products using GE’s advanced anaerobic digestion and Jenbacher gas engine technologies.

You can read more on GE Water here. As you can see, water treatment is a huge business and the Caisse is very wise to invest in it.

Thursday, March 30, 2017

Ontario Teachers' Gains 4.2% in 2016

Matt Scuffham of Reuters reports, Ontario Teachers' Pension Plan sees lower 2016 rate of return:
The Ontario Teachers' Pension Plan's rate of return dropped to 4.2 percent last year from 13 percent in 2015, the fund said on Wednesday, citing unfavorable currency movements.

The results still exceeded a benchmark target of 3.5 percent for the fund, Canada's third-biggest public pension plan.

The plan, which administers pensions for 316,000 working and retired teachers in Canada's most populous province, said its net assets grew to C$175.6 billion at the end of 2016 from C$171.4 billion a year earlier.

The fund, which has investments in more than 50 countries, said currency movements had a negative impact of 280 basis points on its rate of return in 2016, compared with an 830-basis-point positive effect in 2015.

Ontario Teachers' said it was 105 percent funded as of Jan. 1, meaning it had a surplus of assets with which to meet its future pension obligations. This was the fourth year it has posted a surplus after a decade of recording annual deficits.

Chief Executive Officer Ron Mock said the fund had achieved that despite major challenges in the global economy.

"Being focused on the long-term, we continue to believe having a highly diversified portfolio is the best way to pay pensions and minimize funding volatility over time," he said.

"Last year big swings in global currencies had an impact on the short-term value of Plan assets," he added.

Ontario Teachers' pioneered a move by Canadian pension funds in the 1990s to invest directly in private companies, infrastructure and real estate internationally as an alternative to Canadian equities and government bonds.
No doubt, currency swings were a big factor behind Ontario Teachers' 2016 results. Scott Deveau of Bloomberg reports, Ontario Teachers' Posts Worst Return Since 2008 on Pound's Drop:
The Ontario Teachers’ Pension Plan posted its worst annual return since 2008 after the plunge in the British pound and other currency moves curbed investment gains.

The 4.2 percent gain for 2016 was down from 13 percent in 2015, and trailed the fund’s average annual return of 10 percent since it was founded in 1990. It was the worst performance since the financial crisis.

Ontario Teachers’ blamed the lower returns on currency moves, after the Canadian dollar gained last year against the U.S. dollar, British pound and other currencies. The loonie added 3 percent against the U.S. dollar and 23 percent against the pound, according to Bloomberg data.

"The big mover last year was the British pound," said Bjarne Graven Larsen, Ontario Teachers’ chief investment officer. "Usually we do not hedge in general. But we felt that before the referendum in the U.K. that it was a significant risk so we decided to hedge 50 percent of our significant position in the British pound."

The pension fund manager, which has investments in 37 global currencies, said its returns were 7.2 percent in local currency terms, before converting to Canadian dollars. The currency swings lowered returns by 2.8 percent, compared with currency gains of 8.3 percent in 2015.

"If you look at currency in the last three years, it has actually benefited us," Larsen said. "We don’t as a general rule hedge. We know that some years we benefit from it, some years it actually gives us a loss."

He said the fund’s exposure to the U.S. dollar also eroded returns because more of its assets are based there.

"It might be a battle between the British pound and the U.S. dollar. A larger position in the U.S. dollar but a smaller appreciation," he said.

Fund Returns

While the pension fund manager said it beat its benchmark return of 3.5 percent, the gains were less than the 7.6 percent return for the Caisse de depot et placement du Quebec and the 10 percent net return reported by the Ontario Municipal Employees Retirement System.

Ron Mock, Ontario Teachers’ chief executive officer, said in a year marred by market volatility, low rates, geopolitical uncertainty and the unexpected Brexit vote, the return of 4.2 percent last year wasn’t bad.

"We do think that the return environment going forward is not going to be the 10 or 12 percents we’ve witnessed over the last eight years," Mock told reporters in Toronto Wednesday.

"We see it as a pretty solid result and most importantly a pretty solid funding position we find ourselves in," he said, noting the plan has been fully funded for four years straight.

Fewer Currencies

As part of a broader shuffling of its portfolio, Ontario Teachers’ reduced the amount of its assets in foreign currencies to 40 percent from 60 percent of the portfolio.

"Currency, in all of the pension plans I know of, is a big issue,” Larsen said. “Some hedge. Some don’t. Half of the time, you regret your policy and half of the time you’re happy about it. There’s no easy answer."

Ontario Teachers’ said its net assets grew 2.5 percent to C$175.6 billion ($130 billion) as of Dec. 31 from C$171.4 billion in 2015.

The fund said the total value of its public and private equity investments were C$66 billion at year-end, down almost 15 percent from C$77.5 billion a year earlier. The fund said the decline was part of an effort to reduce the risk in its portfolio by lowering its exposure to equities and increasing its focus on fixed income.

To that end, the fixed-income portfolio increased to C$75.2 billion at year-end, up nearly 9 percent from C$69.1 billion the year before. The bond portfolio returned 0.8 percent.

Larsen said the portfolio was too "equity-centric" prior to that shift.

"We want more diversification in the portfolio. We want less equity risk factor. But then we’re actually buying other things that will actually yield returns. So, we’re buying more credit and we’re buying other things," he said. "It’s still the same expected return we’re going for and better diversification."
What else is Teachers doing? Andrew Willis of the Globe and Mail reports, Ontario Teachers Pension Plan favours minds over machines:
In an era when an increasing number of investors are embracing passive investments such as index funds, the Ontario Teachers’ Pension Plan is putting its faith in its people by allocating more capital to active investment strategies.

Teachers announced on Wednesday it earned a 4.2-per-cent return in 2016, performance that ranked behind peers but exceeded its benchmark and left the $175.6-billion plan with an $11.5-billion surplus.

Last year, Canadian pension plans averaged a 6.8-per-cent return, up from 5.4 per cent in 2015, according to survey from Royal Bank of Canada. Teachers’ 4.2-per-cent return exceeded the 3.5-per-cent performance of its benchmark. Over the past five years, Teachers posted a 10.5-per-cent annual return, and over 10 years, gains averaged 7.3 per cent.

Teachers chief investment officer Bjarne Graven Larsen said in a news conference on Wednesday the fund turned in “solid returns,” with short-term performance reflecting a $4.5-billion negative impact from swings in currency markets last year. Gains on currency moves added 8.3 per cent to performance in 2015, when the fund was up by 13 per cent.

Approximately 60 per cent of the Teachers portfolio is invested in non-Canadian dollar assets, and the fund invests in 37 different currencies.

To reduce risk and increase future returns, Teachers chief executive Ron Mock said the fund decreased the amount of capital it allocates to passive investments in stocks and bonds, shifting the portfolio to sectors in which the fund has in-house expertise, such as real estate, private equity and larger equity ownership in select companies. Mr. Mock said the fund’s “secret sauce” is the internal investment acumen built up over 25 years of investing.

New York-based BlackRock Inc., the world’s largest asset manager, made headlines this week by announcing plans to replace actively managed mutual funds with passive vehicles that rely on computer-driven stock picks. Mr. Graven Larsen said that while Teachers also makes use of cutting-edge technology in the investment process, the fund is increasing its focus on active management.

Mr. Mock warned that investors should not expect the 10-per-cent-plus annual returns turned in by equity markets during bull markets. He said if the fund can consistently generate 4-per-cent “real returns,” after inflation, “we will be pretty happy.”

Teachers has significant investments in Britain and Mr. Mock said the fund plans to continue investing in the region in the wake of Britain’s decision to leave the European Union, because of the country’s attractive regulatory regime and solid economic fundamentals.

As CEO at one of Canada’s largest pension plans, Mr. Mock said he is in regular contact with the federal government over the Liberals’ plans to invest in infrastructure. Former Teachers CEO Jim Leech was recently named a special adviser to the planned Canada Infrastructure Bank.

Mr. Mock said that while Teachers supports the infrastructure bank concept, considerable work needs to be done to align the relationship between private investors and federal, provincial and municipal governments before the fund commits capital. He said that while there are a handful of large Canadian infrastructure initiatives that could be launched within the next year, experience in Australia and Britain shows it can take a decade to get significant projects planned, funded and permitted, in order to start construction.

The Teachers fund has 318,000 active and retired members, including 142 pensioners who are over the age of 100.
By the way, on the newly created $35-billion Canada Infrastructure Bank, Bill Curry of the Globe and Mail reports that Ottawa just hired Metrolinx CEO, Bruce McCuaig, to advise it. Mr. McCuaig will be joining Jim Leech, the former CEO of Ontario Teachers', who was tapped last month to get this new federal infrastructure bank up and running.

I don't know but Ron Mock is right, considerable work needs to be done to get better alignment of interests and the bigger, more ambitious infrastructure projects take years to set up and complete.

In the meantime, I agree with those who think Ottawa’s plan to sell airports needs to take off right now — while the market is still hot. This is something that I'm sure Ontario Teachers' and other large Canadian pensions would invest in and help transform our airports into world class airports.

In fact, just yesterday Ron Mock told BNN that Canadians will be slow to adapt to the concept of privately-owned airports, but will eventually understand their benefit.

As far as the UK, Barbara Shecter of the National Post reports, Ontario Teachers’ Pension Plan dealmakers won’t ‘head for the hills’ as Brexit takes shape:
The Ontario Teachers’ Pension Plan is continuing to hunt for deals in United Kingdom, even as concrete steps were taken Wednesday to extricate the Britain from the European Union.

“We’re not heading for the hills by any stretch of the imagination,” chief executive Ron Mock said at a media briefing Wednesday, shortly after news broke that Britain sent a letter to the European Union that marks a significant step in its move to exit the economic partnership.

The historic breakup has not led to any bargains so far, according to chief investment officer Bjarne Graven Larsen, who noted that while currency fluctuations can sometimes make assets look cheaper, “the pricing of assets in the UK continues to go up.”

Mock said there is likely to be a period of uncertainty, but added that the pension managers are hopeful about the long-term prospects for Britain and the European Union.

The Ontario Teachers’ Pension Plan posted a 4.2 per cent return in fiscal 2016 after accounting for swings in British pound and U.S. dollar. Despite the negative impact of currency fluctuations, the plan exceeded its benchmark return of 3.5 per cent and remained fully funded for its fourth consecutive year, Teachers’ revealed Wednesday.

Net assets rose by $4.2 billion from the previous year to $175.6 billion. Beating the benchmark translated to a “value add” of $1.3 billion, the pension manager said in a statement Wednesday.

“I’m very pleased that Ontario Teachers’ remained fully funded for the fourth year in a row despite major challenges in the global economy,” said Mock, who noted that big swings in global currencies had an impact on the short-term value of the pension plan’s assets.

The fund invests in more than 50 countries with 37 global currencies, and the return on those investments in local currency was 7.2 per cent. Converting those gains back into Canadian dollars has a negative impact of 2.8 per cent. In 2015, currency gains added 8.3 per cent to returns.

At a media briefing Wednesday morning, executives told media the currency impact in 2016 would have been worse if the fund manager, which invests and administers the pensions of Ontario’s 318,000 active and retired teachers, had not hedged about half its exposure to the British pound before the surprising outcome of the Brexit vote.

While currency exposure has helped Teachers’ in the past, Mock and Graven Larsen said the exposed portion of the portfolio is being reduced to around 40 per cent from 60 per cent through a combination of asset allocation, hedging and balance sheet management.

The Ontario Teachers’ Pension Plan, which invests in stocks, bonds and real assets including real estate and infrastructure assets, has posted an average annualized return of 10.1 per cent since its inception in 1990. The five-year return is 10.5 per cent and ten-year return is 7.3 per cent. The plan was 105 per cent funded as of January 1, 2017.

More than three-quarters of the funding of members’ pensions has come from total investment income since 1990, with the remainder coming from member and government contributions.

“We make investments to pay pensions for generations,” said Graven Larsen. “Stable returns and capital preservation are essential to our ability to deliver retirement security to our members.”

Last year, Teachers’ began implementing a new strategy aimed at better integrating its asset selection approach and risk management processes. There are three strategic areas of focus: total-fund returns, value-add above benchmark returns, and volatility management.

The fund’s real assets group, which includes real estate and infrastructure, had total assets of $44.3 billion at year-end, compared to $40.6 billion a year earlier. The real estate portfolio, managed by subsidiary Cadillac Fairview, totalled $26.5 billion in net assets at year-end and returned 7.7 per cent, exceeding the 7.4 per cent benchmark. The infrastructure portfolio had $17.8 billion in assets at year-end, up from $15.7 billion a year earlier.

The total value of the plan’s public and private equity investments dropped to $66 billion at the end of 2016 from $77.5 billion a year earlier. Teachers’ said the reduction was partly due to a strategic decision to reduce total portfolio risk by lowering exposure to equities and increasing exposure to fixed income securities. The investment return in the equities portfolio was 4.8 per cent, compared to the benchmark of 4.9 per cent.

The pension plan missed the benchmark return in two areas: private capital and fixed income. Private Capital investments totalled $26.6 billion at year-end, a decrease from $28.4 billion a year earlier, while the investment return was 4.3 per cent compared to the benchmark of 5.4 per cent.

Fixed Income had $75.2 billion in assets at year-end, compared to $69.1 billion at the end of December 2015. The one-year return of 0.8 per cent was slightly below the benchmark return of one per cent.

Meanwhile, natural resources investments posted a one-year return of 8.3 per cent, above the benchmark of 6.7 per cent. The investments totalled $10.5 billion at year-end, compared to $10.2 billion a year earlier.
OTPP put out a press release, Ontario Teachers’ is fully funded for fourth consecutive year:
Ontario Teachers' Pension Plan (Ontario Teachers') today announced it was 105% funded as of January 1, 2017, its fourth consecutive year of being fully funded. Net assets rose by $4.2 billion year-over-year in 2016 to $175.6 billion. The total-fund rate of return of 4.2% exceeded the benchmark of 3.5%, resulting in $1.3 billion in value-add.

"I'm very pleased that Ontario Teachers' remained fully funded for the fourth year in a row despite major challenges in the global economy," said Ron Mock, President and Chief Executive Officer. "Being focused on the long-term, we continue to believe having a highly-diversified portfolio is the best way to pay pensions and minimize funding volatility over time. Last year big swings in global currencies had an impact on the short-term value of Plan assets."

Ontario Teachers' has investments in 37 global currencies and in more than 50 countries. In those local currencies, the return on our investments was 7.2%. Converting the return on those investments back into Canadian dollars, the currency in which pensions are paid, had a -2.8% impact on the Plan's total-fund rate of return. By contrast, currency gains added 8.3% in 2015.

Since its inception in 1990, Ontario Teachers' has achieved an average, annualized return of 10.1%. The five and ten year returns are 10.5% and 7.3% respectively. Total investment income since 1990 has accounted for more than three-quarters of the funding of members' pensions, with the remainder coming from member and government contributions.

"We make investments to pay pensions for generations. Stable returns and capital preservation are essential to our ability to deliver retirement security to our members," said Chief Investment Officer Bjarne Graven Larsen. "Our philosophy is that we will perform better than average by having a deep understanding of what is going on in the world rather than trying to make bold forecasts."

In 2016, Ontario Teachers' began implementing a new strategy aimed at better integrating its accomplished bottom-up approach to asset selection with a well-established top-down risk management process. The strategy focuses on three pillars: total-fund returns, value-add (above benchmark) returns, and volatility management.

Ontario Teachers' continues to show strong performance in pension services, according to two independent, annual studies. The plan's Quality Service Index (QSI), which measures members' service satisfaction, was 9.1 out of 10 in 2016, and the plan was ranked second, by CEM Benchmarking Inc., for pension service in its peer group and internationally.

2016 investment return highlights by asset class

The total value of the plan's public and private equity investments totaled $66.0 billion at year-end, compared with $77.5 billion at December 31, 2015. The reduction from the previous year was partly due to a strategic decision to reduce total portfolio risk by lowering exposure to equities and increasing exposure to fixed income securities. The investment return in the equities portfolio was 4.8%, in-line with a benchmark of 4.9%.

Private Capital investments totaled $26.6 billion at year-end, a slight decrease from $28.4 billion a year earlier. Private Capital's investment return was 4.3%, compared to the 5.4% benchmark.

Fixed Income had $75.2 billion in assets at year-end, compared to $69.1 billion at December 31, 2015. The one-year return of 0.8% was slightly below the benchmark return of 1.0%.

Real assets, a group that consists of real estate and infrastructure, had total assets of $44.3 billion at year-end, compared to $40.6 billion a year earlier. The real estate portfolio, managed by the plan's subsidiary Cadillac Fairview, totaled $26.5 billion in net assets at year-end and returned 7.7%, exceeding the 7.4% benchmark. The infrastructure portfolio had $17.8 billion in assets at year-end, up from $15.7 billion a year earlier. New investments and higher valuations for existing assets were partly offset by the impact of a stronger Canadian dollar. Infrastructure assets delivered a one-year return of 1.4%, outperforming the benchmark return of -2.3% (As country benchmarks are assigned to each asset class, conversion back to Canadian dollars results in a negative benchmark).

Natural Resources investments were $10.5 billion at year-end, compared to $10.2 billion at December 31, 2015. The one-year return of 8.3% was above the benchmark return of 6.7%.

About Ontario Teachers'

The Ontario Teachers' Pension Plan (Ontario Teachers') is Canada's largest single-profession pension plan, with $175.6 billion in net assets at December 31, 2016. It holds a diverse global portfolio of assets, approximately 80% of which is managed in-house, and has earned an average annualized rate of return of 10.1% since the plan's founding in 1990. Ontario Teachers' is an independent organization headquartered in Toronto. Its Asia-Pacific region office is located in Hong Kong and its Europe, Middle East & Africa region office is in London. The defined-benefit plan, which is fully funded, invests and administers the pensions of the province of Ontario's 318,000 active and retired teachers. For more information, visit and follow us on Twitter @OtppInfo.


Net Assets graph

Preliminary Funding Valuation graph

Currency Impact on Total Fund Return graph

Net Investments and Rates of Return by Asset Class chart

Link to 2016 Annual Report

Benchmarks Used to Measure Fund Performance
I am glad Teachers provided links to everything I need to cover its 2016 results. Before getting started, I highly recommend you read the Report to Members, the Report from the Chair, and this Report on Investments.

I also highly recommend you read OTPP's 2016 Annual Report and at least take the time to read the Report from the CEO (page 3), Management's Discussion & Analysis on subsequent pages and the Report from the CIO (on page 12).

I had a chance to talk to OTPP's President and CEO, Ron Mock, yesterday and we went over the 2016 results. I asked him plenty of questions and he was kind enough to answer them all and cover a lot of material.

I began with the most obvious, the impact of currency swings which is front and center in the news articles and in the Annual Report (click on image):

By now, everyone in the world knows Brexit hit Teachers' results last year and if their investment staff didn't partially (50%) hedge the Fund's exposure to the Pound Sterling prior to the Brexit vote, the results would have been even worse.

As stated in the press release, Teachers has investments in 37 global currencies and in more than 50 countries. In those local currencies, the return on our investments was 7.2%. Converting the return on those investments back into Canadian dollars, the currency in which pensions are paid, had a -2.8% impact on the Plan's total-fund rate of return. By contrast, currency gains added 8.3% in 2015.

Ron told me that in terms of asset returns, 2016 was actually better than the previous year, but when you factored in currency swings, it really detracted from the performance.

Like CPPIB, Ontario Teachers' typically doesn't hedge currencies. This means in years where the euro, yen, pound, and US dollar are up relative to the Canadian dollar, they enjoy currency gains but in years where the CAD is doing relatively better, they take a hit on currencies.

The chart below shows OTPP's currency exposure by country (click on image):

As you can see, the biggest exposure is to the US dollar ($49.6 B) which I recently discussed and stated that I'm still long despite the recent selloff, followed by the euro ($7.8 B) and then the Pound Sterling ($4.5 B).

UK investments are significant for Teachers, especially in private markets like infrastructure where they hold major stakes in airports and other investments in that country. This is why exactly one year ago, Ontario Teachers' was assessing Brexit risk very closely.

Now, after the fact, anyone could say they should have fully hedged the risk of a yes vote for Brexit and they would have looked like superstars, but that vote was very close and it was a stunner. Thank goodness they partially hedged their currency exposure but even that decision wasn't a given.

Anyway, Ron told me that Teachers' implemented a new strategy focusing on three pillars: total-fund returns, value-add (above benchmark) returns, and volatility management.

That last component -- volatility management -- was to ensure they can maintain the funded status or reduce the volatility of the funded status as much as possible. This new strategy has all sorts of implications in terms of investments, including currency exposures which they decided to limit to 40% from 60% of the portfolio through a combination of asset allocation, hedging and balance sheet management.

Why not fully hedge currency exposure just like HOOPP and OMERS do which is one big reason they both outperformed Teachers' last year? The way Ron explained it is fully hedging currency exposure adds costs and it could have serious implications on liquidity needs in the short run.

I take a more intuitive approach when thinking of currencies. I believe the US economy will continue to dominate the global economy for many more years which is why I want to be long US dollars over the long run. Moreover, I think the Canadian economy is going to run into all sorts of problems in the next few years so if you ask my opinion, Canadian pensions are better off not fully hedging their currency exposure.

Can there be unexpected negative surprises? Sure, the eurozone might blow up sending the euro even lower, but I think the best way to play currencies is not to hedge or hedge partially like Teachers did when there is significant event risk.

Anyway, if I had to bet, I'd bet Teachers, CPPIB and I believe now PSP will gain from currency exposure this year as they all don't hedge for the most part.

The important thing to note is big currency swings matter a lot to Canadian pensions that don't fully hedge currency exposure and they add or detract from net results (I wish every Canadian pension fund had a dedicated section on currency hedging and exposure in their respective annual report).

What else did Ron and I discuss? Compensation. In particular, Ron told me the new strategy had implications on compensation so he enlisted the help of the top investments officers at OTPP to draft and discuss it and then they did a survey to see if the rest of the investment staff were on board.

Ron told me everyone overwhelmingly agreed with the three pillars of the new strategy and the new compensation system, which sort of surprised me somewhat because I told him "there are always egos at pension funds who want their compensation based primarily on individual targets."

He told me it all stems from the plan's mission statement and that every employee at OTPP signed off on five core values of the organization, "humility being the first one."

So, what does this mean in practice and how does it change investment decisions in the short and long run? Ron told me that compensation "has to align with the mission statement" and it was lower last year "because value-add was lower".

And as you can see from the table below, he wasn't kidding, apart from Bjarne Graven Larsen who is the new CIO and holds the top investment job at OTPP, all other senior executives including Ron saw their total compensation go down in 2016 (click on image): 

Moreover, from now on every investment decision will take into account total fund volatility targets. "You might not see a significant change in a month, but over the next few years, it will represent a significant change," Ron said.

Are you confused? Well let me clarify. Ron agrees with Jim Keohane and Hugh O'Reilly, the best measure of a pension plan's success is its funded status, so even if they return double digit gains, add value over a benchmark, it's meaningless if the pension plan's funded status deteriorates and that should be reflected in their compensation.

Remember something I keep harping on, pensions are all about managing assets AND liabilities. If rates sink to new secular lows and liabilities skyrocket, it doesn't matter if pension assets gain, in that scenario, the increase in liabilities will more than swamp any increase in assets, so the funded status will necessarily deteriorate.

Interestingly, Ron told me OTPP was implementing something akin to Bridgewater's All-Weather approach looking at how their total portfolio would do under various growth/inflation scenarios. He said they were exposed to the "low growth/ high inflation" scenario which was the main reason they decided to reduce their equity exposure and increase their exposure to real assets.

At this point I had to bite my tongue because I'm a well-known delfationista who thinks we have yet to see secular lows on US long bond yields but I trust the folks at Teachers have done their homework and they know which economic scenario their Fund is most exposed to (to be fair, Ron put it this way: "We realized we are under-invested for this scenario").

Anyway, the critical thing to remember is the new system is looking to reduce risk while obtaining the required rate of return and everyone at Teachers is on board. "It has unleashed a level of innovation and horizontal communication to better structure all our portfolios, placing the plan's mission statement front and center." (I am paraphrasing a bit here but that's what he told me)

In terms of private markets, I asked him if it's getting tougher to find opportunities. He said yes but they have expert partners that can assist them in finding great opportunities and better managing companies and other investments like airports where one of their consultants was the previous CEO of Heathrow airport for many years.

He agreed with me that most of the direct investments at Canada's mighty PE investors come from co-investments and said it would be "naive" to think you can go it alone in private equity. I stated it would also be against the best interests of the plan's beneficiaries and he agreed.

But one thing he said that I learned from is that when a private equity fund wraps up and it comes to the end of its life, quite often the private equity partner will go to Teachers and ask it if it wants to bid on a portfolio company as part of its exit strategy. Ron told me since they sit on the board and know the company well, if they like it, they will bid on it to own it directly after the fund wraps up.

And on co-investments, Teachers typically is the lead investor, does most of the due diligence and knows the deals very well, often presenting opportunities to other LPs who are part of the syndicate on the deal. Interestingly, he added that it's a mutually beneficial partnership with all their general partners across many asset classes including private equity: "Sometimes they come to us with deals, sometimes we go to them with deals."

He added: "This is why it's critical to select the right partners who have the right culture and alignment of interests."

For example, in my last comment going over why PSP is investing in data centers,  I mentioned Ontario Teachers’ acquisition of Compass Datacenters, a wholesale data center developer it acquired in partnership with RedBird Capital Partners.

On private debt, he told me that "Teachers isn't there yet" doing some fund deals in private equity but if they were to significantly increase this activity they would opt for the same approach of CPPIB and PSP, namely, find the right talent, seed them with a platform where they own 100% of the assets.

Ron gave me a good example of how Teachers selects its private deals, citing its acquisition of OGF, France's leading funeral home company. "It has 45% of the market, is very well positioned, and we are contributing to its long-term success with our own value creation plan."

By the way, they do this for every private market investment, implement a value creation plan and then routinely benchmark themselves against it. Ron was adamant about one thing: "Long gone are the days of financial engineering, either you roll up your sleeves and drive EBITDA growth by increasing operational efficiency, or forget making money in private equity."

This is the philosophy that permeates every private market activity, including infrastructure where they have a team of engineers with airport and other expertise at their disposal and renewables where they invested with PSP in major sustainable investments, and recently announced a clean energy partnership with Anbaric, a leader in the development of clean energy transmission and microgrid projects.

That's why I was laughing when I read last night that students, teachers, and climate activists are continuing to pressure the Ontario Teachers’ Pension Plan to immediately stop investing in the destruction of their future by divesting from fossil fuels.

Apart from being ignorant of Teachers' commitment to renewable energy, it shows that a few plan members don't understand the plan's mission statement and why it's virtually impossible to divest from fossil fuels (not to mention it's not in their best interests).

Anyway, I've covered a lot, I am really tired (exhausted) so I am going to wrap it up here. I think you should all take the time to carefully read OTPP's 2016 Annual Report and this Report on Investments.

Let me end by thanking Ron Mock for taking the time to speak with me, I know he's a very busy man but I always enjoy our conversations and still firmly believe Ontario Teachers' is very lucky he's at the helm of this venerable organization. If there are any mistakes or things that need editing, I will ask Ron and his senior staff to get back to me and I will edit this comment.

Below, Ontario Teachers' Pension Plan President and CEO Ron Mock speaks about the plan’s 2016 financial results with BNN’s Paige Ellis.

I also embedded a Bloomberg interview from earlier this year where Ron discussed the challenges facing pension funds in the wake of Brexit and President Donald Trump's election. He spoke with Erik Schatzker from the World Economic Forum in Davos, Switzerland on "Bloomberg Markets".

Wednesday, March 29, 2017

PSP Investing in Data Centers?

Benefits Canada reports, PSP Investment consortium acquires U.S. data centre:
A consortium that includes the Public Sector Pension Investment Board has acquired Vantage Data Centers, a U.S.-based provider of data centre solutions.

The consortium, which also includes Digital Bridge Holdings LLC and TIAA Investments, has purchased Vantage Data Centers from technology investor Silver Lake. The terms of the private purchased were not disclosed.

Vantage Data Centers was founded in Silicon Valley, California in 2010. It has four data centres at this location, as well as a campus in Quincy, Washington.

“We are confident that Vantage is ideally positioned to successfully deploy its winning expansion strategy, and look forward to supporting the company’s . . . management team,” said Daniel Garant, executive vice-president and chief investment officer at PSP Investments. “Vantage’s leading market position, in a sector which we believe will grow significantly in the coming years, makes it an attractive investment for PSP Investments.”

Vantage will continue to be led by its president and chief executive officer Sureel Choksi and the existing management team, each of whom has made an investment in the business alongside the consortium. “We’re thrilled about the opportunities to serve our customers’ future expansion plans going forward.,” said Choksi.

“We have been fortunate to have had a great partner in Silver Lake, and are excited to partner with Digital Bridge, PSP Investments and TIAA Investments as we enter this exciting new phase of the company’s growth.”
Bill Stoller of Data Center Knowledge provides more details in his article, Digital Bridge Buys Vantage, Silicon Valley’s Largest Wholesale Data Center Firm:
Boca Raton-based Digital Bridge Holdings just cut another large notch into its already ample M&A belt, acquiring Vantage Data Centers, the largest wholesale data center landlord in Silicon Valley, a deal that has been rumored since January.

Santa Clara-based Vantage becomes the wholesale data center platform for Digital Bridge, a communications infrastructure investor that got into the data center space last year, intending to become one of the forces driving the current wave of consolidation in the market. Digital Bridge plans to invest in expanding Vantage, which is currently in Silicon Valley and Quincy, Washington, into new markets along with its existing cloud, IT services, and large enterprise customers.

The due-diligence process around the deal showed Digital Bridge that Vantage “under promised and over delivered,” Digital Bridge CEO Marc Ganzi said in an interview with Data Center Knowledge. “At the end of the day, Vantage will be able to expand if customers have confidence and want to follow Vantage into other markets to assist with future capacity needs.”

Rapidly Buying Data Centers

Digital Bridge began its data center buying spree last July with acquisition of retail colocation and managed services provider DataBank. In January 2017, DataBank announced acquisition of Salt Lake City-based C7 Data Centers, as well as two data centers located in Cleveland and Pittsburgh, considered “key interconnection assets,”, purchased from 365 Data Centers.

Vantage was purchased by a consortium, including: “Digital Bridge Holdings, LLC, a leading global communications infrastructure company, Public Sector Pension Investment Board (PSP Investments), and TIAA Investments (an affiliate of Nuveen), which made the investment on behalf of TIAA’s general account.” Financial terms of the private purchase from Silver Lake were not disclosed.

To steer Digital Bridge’s data center strategy, Ganzi brought on board Michael Foust, co-founder of the world’s largest wholesale data center provider Digital Realty Trust and its former CEO. He’s been serving as DataBank chairman and has now also been named chairman of Vantage.

In addition to data centers, Digital Bridge owns several wireless tower and communications infrastructure companies, including: Vertical Bridge, ExteNet Systems, Mexico Tower Partners, and Andean Tower Partners.

“Resetting the Shot Clock”

Sureel Choksi, Vantage president and CEO who is staying in his seat post-acquisition, told Data Center Knowledge that he felt “relieved and excited” to be teaming up with Digital Bridge and Foust after an eight-month process. He said the deal was “the ideal scenario,” since existing Vantage management, employees, and customer relationships all remain in place.

Each member of the Vantage management team has also invested in the company alongside the buyer consortium, the company said in a statement.

As the company’s former private-equity owners Silver Lake Partners were exploring their options regarding a sale of Vantage, it felt like “running out the clock” at the end of an NCAA tournament game, he said. The shot clock has now been reset.

Since 2010, Vantage has built 51MW of IT load in Santa Clara and secured expansion capacity for 93MW total. The company’s Quincy campus currently has a 6MW data center and additional land and power for expansion.

Building a Platform of Scale

According to Ganzi, in addition to building first-class facilities, the Vantage team understood the intricacies of underwriting and allocating capital wisely, things that are very important to the long-time real estate investor.

The three investors acquiring Vantage in aggregate have over $1 trillion worth of assets under management.

Ganzi previously was CEO and sole founder of Global Tower Partners, which was acquired by publicly traded wireless tower REIT American Tower Corporation (AMT) in October 2013.

“The data center space is actually in the early innings,” he told us in an interview earlier this year. “There’s still a fantastic opportunity to roll up the space and to create a platform of scale.”

His company is now well on its way to making that happen with both Choksi and Foust on board.
Lastly, PSP Investments put out this press release, Consortium of Digital Bridge, PSP Investments and TIAA Investments Acquires Vantage Data Center:
Vantage Data Centers, a leading provider of data center solutions in support of mission-critical applications, today announced it has been acquired by a consortium which includes Digital Bridge Holdings, LLC, a leading global communications infrastructure company, Public Sector Pension Investment Board (PSP Investments), and TIAA Investments (an affiliate of Nuveen), which made the investment on behalf of TIAA's general account.  Financial terms of the private purchase from Silver Lake were not disclosed.

Founded in 2010 in the heart of Silicon Valley, Vantage's customer base includes the world's leading cloud service providers and large enterprises. With four data centers on the flagship Santa Clara campus, two more under construction, and a second large-scale campus under development, Vantage has the largest wholesale data center footprint in Silicon Valley. The company has built 51 megawatts of IT load in Santa Clara and has secured expansion capacity totaling 93 megawatts of IT load. The company also owns and operates a data center campus in Quincy, Washington, including a 6 megawatt data center and additional expansion land and power in that market. Vantage is well positioned for continued growth in the industry, with plans to significantly expand its data center footprint in existing and new markets.

"Vantage is one of the highest quality businesses I have encountered in more than two decades of investing in the sector," stated Marc Ganzi, co-Founder and CEO of Digital Bridge. "This is a unique and special opportunity to invest in a company that has operational excellence, quality customers, and a current lease portfolio with long duration. It also has significant expansion capacity in Silicon Valley, perhaps the best data center market in the U.S."

Vantage will continue to be led by President & CEO Sureel Choksi and the existing management team, each of whom has made an investment in the business alongside the consortium. In connection with the transaction, Mike Foust, Senior Advisor to Digital Bridge and former CEO of Digital Realty, will join the Vantage board of directors as Chairman, and Raul Martynek of Digital Bridge will also join the board.

"We're incredibly proud of what the Vantage team has achieved by providing flexible solutions to our customers and delivering an industry-leading service experience," said Choksi. "We're thrilled about the opportunities to serve our customers' future expansion plans going forward. We have been fortunate to have had a great partner in Silver Lake, and are excited to partner with Digital Bridge, PSP Investments and TIAA Investments as we enter this exciting new phase of the company's growth."

"We are confident that Vantage is ideally positioned to successfully deploy its winning expansion strategy, and look forward to supporting the company's top tier management team," said Daniel Garant, Executive Vice President and Chief Investment Officer at PSP Investments. "Vantage's leading market position, in a sector which we believe will grow significantly in the coming years, makes it an attractive investment for PSP Investments."

"This communication infrastructure investment represents a growing and attractive asset class within TIAA's infrastructure portfolio," stated Marietta Moshiashvili, Managing Director & Head of Infrastructure Asset Management for TIAA Investments. "Partnering with the successful Vantage management team and this group of investors will strengthen the firm's expansion plans and position in the marketplace, generating what we believe will be significant value for all parties."

"Silver Lake is proud to have supported Vantage's vision and accomplishments since inception," said Greg Mondre, Managing Partner at Silver Lake. "From a standing start seven years ago, the company has become a leading wholesale data center provider, with an established platform for long-term growth."

RBC Capital Markets, LLC and DH Capital served as financial advisors, and Simpson, Thacher & Bartlett LLP acted as legal advisor to Vantage in connection with the transaction. Jones Day acted as lead M&A counsel, Kleinbard LLC acted as investment structure counsel, and Ernst and Young LLP served as accounting advisor to Digital Bridge. Davies Ward Phillips & Vineberg LLP acted as legal advisor to PSP Investments, and Arnold & Porter Kaye Scholer LLP acted as legal advisor to TIAA Investments. TD Securities together with CIT Bank, N.A., RBC Capital Markets, and SunTrust Robinson Humphrey provided debt financing commitment for the acquisition.

About Vantage Data Centers

Vantage is a leader in highly scalable, flexible and efficient data center solutions offering unique value through its commitment to exceptional customer service. Operating campuses in Silicon Valley, Calif., and Quincy, Wash., Vantage offers industry leading data center design solutions engineered to meet the unique requirements of enterprises, technology companies and service providers. Vantage's first Silicon Valley campus includes four data centers totaling 51 megawatts (MW) of critical IT load, with an additional 24MW of expansion capacity under development. In addition, Vantage is developing a second Vantage Silicon Valley campus offering an additional 69MW of capacity. Vantage also operates a 6MW data center in Quincy, Washington with plans to add four additional data centers to the campus. For more information, visit

About Digital Bridge Holdings, LLC

Founded in 2013 by Marc C. Ganzi and Ben Jenkins, Digital Bridge is focused on the ownership, investment, and active management of companies in the mobile and internet infrastructure sector. Since inception, Digital Bridge has raised over $6.5B USD of equity and debt capital used to acquire and invest in all three core pillars (data centers, towers and fiber/small cells) of mobile and internet infrastructure through six businesses, including Vantage Data Centers, DataBank, ExteNet Systems, Vertical Bridge, Andean Tower Partners, and Mexico Tower Partners. For more information, please visit

About PSP Investments

The Public Sector Pension Investment Board (PSP Investments) is one of Canada's largest pension investment managers with C$125.8 billion of net assets under management as at September 30, 2016. It manages a diversified global portfolio composed of investments in public financial markets, private equity, real estate, infrastructure, natural resources and private debt. Established in 1999, PSP Investments manages contributions to the pension funds of the federal Public Service, the Canadian Forces, the Royal Canadian Mounted Police and the Reserve Force. Headquartered in Ottawa, PSP Investments has business offices in Montréal, New York and London. For more information, visit or follow Twitter @InvestPSP.

About Nuveen

Nuveen offers a comprehensive range of outcome-focused investment solutions designed to secure the long-term financial goals of institutional and individual investors. As the investment management arm of TIAA, Nuveen has $882 billion in assets under management as of 12/31/16 and operations in 16 countries. Its affiliates offer deep expertise across a comprehensive range of traditional and alternative investments through a wide array of vehicles and customized strategies. For more information, please visit

Nuveen, formerly known as TIAA Global Asset Management, provides investment services through TIAA and its registered investment advisers. C38555

About Silver Lake

Silver Lake is the global leader in technology investing, with over $24 billion in combined assets under management and committed capital and a team of approximately 100 investment and value creation professionals located in Silicon Valley, New York, London, Hong Kong and Tokyo. Silver Lake's portfolio of investments collectively generates more than $142 billion of revenue annually and employs more than 300,000 people globally. The firm's current portfolio includes leading technology and technology-enabled businesses such as Alibaba Group, Ancestry, Broadcom Limited, Ctrip, Dell Technologies, Fanatics, Global Blue, GoDaddy, Motorola Solutions, Sabre, SolarWinds, Symantec, and WME│IMG. For more information about Silver Lake and its entire portfolio, please visit
Even though the details of this latest deal are not public, Fortune reported back in October of last year that Silver Lake Partners was looking to sell Vantage Data Centers and was hoping to value the company well in excess of $1 billion, including debt.

Despite the terms being private, I think PSP and its consortium partners just made a great deal acquiring Vantage Data Centers, a leading whole wholesale data center platform.

Over the last five years, everything in the IT space is about the rise of data analytics and cloud computing. Everyone from Amazon, Google, IBM, Microsoft, and a lot of other smaller technology players are investing heavily in data analytics and cloud computing, as are many other non tech companies, and they all need state of the art data centers.

Moreover, US businesses' burgeoning demand for data and video is fueling a revival in fiber optic services and data storage. Many technology companies have turned to vendors such as Vantage to host and maintain their servers in a bid to cut costs.

The players involved in this deal are experts in IT. Silver Lake is arguably the best private equity fund in this space and Digital Bridge Holgings is a top communications infrastructure investor.

I find it particularly interesting that Marc Ganzi, co-Founder and CEO of Digital Bridge, was previously the CEO and sole founder of Global Tower Partners, which was acquired by publicly traded wireless tower REIT American Tower Corporation (AMT) in October 2013.

So these data centers fall in between real estate, private equity and communications infrastructure. It's a very exciting, high growth area and it's a super hot sector right now with tremendous long-term potential.

In fact, Bill Stoller wrote a great article on data center REITS last November, asking whether the sky is falling, and he went over the pros and cons of investing in this space.

But this deal is private, so just like CPPIB and GIC bought a $1.6 billion US student housing portfolio along with their partner, the Scion Group, PSP invested directly in this private company to avoid market beta and paying fees to any REIT manager.

Get it? When you're the size of CPPIB and PSP, you can invest directly in great properties and private companies, avoiding fees and public market beta.

Retail investors looking to invest in data centers can do so through data center REITs but they're volatile and move with other REITs and the market (click on image):

Still, this is definitely a sector worth investing in through public or private markets like PSP and others have done.

Again, without beating the drum too loudly, this is a great deal for PSP and the consortium. It comes on the heels of other great IT deals like CPPIB acquiring GlobalLogic and Ontario Teachers’ Pension Plan's acquisition of Compass Datacenters, a wholesale data center developer it acquired in partnership with RedBird Capital Partners.

Speaking of Ontario Teachers', its 2016 results are out and I had a chance to go over them and a lot more with Ron Mock, OTPP's President and CEO, earlier today. I will go over the results and my conversation with Ron as soon as possible.

All I can say is that I definitely don't get paid enough to provide you with this information and remind all of you reading my blog posts to kindly support my work via PayPal donations or subscriptions on the top right-hand side. I thank those few who do so without me asking them.

Anyway, one last news item on PSP, it settled its lawsuit with Saba Capital over bond valuations, which is a good thing for both parties.

Below, Fortune Senior Editor Geoff Colvin interviews Emerson's CEO David Farr who talks about serving the power needs of mega data centers. A very interesting discussion which ties into the other clips.

Second, Vantage Data Centers offers the best data centers in Silicon Valley, bringing together the highest levels of customer service and support, and a customized experience to meet the highest levels of demand.

Also, take a tour of Vantage Data Center in Quincy, Washington servicing a large manufacturer and taking advantage of some of the lowest power rates in the country, with capacity to grow and expand.

Lastly, have a first look at the latest addition to the Vantage Santa Clara Data Center campus. Coming summer 2017, this new facility will bring a completely new modern wholesale data center, adding 9MW to the Vantage campus.

Once you watch these clips, you'll understand why this is a great long-term deal for PSP, its partners and its beneficiaries.

Tuesday, March 28, 2017

Hedge Funds Dying at an Alarming Rate?

Lucinda Shen of Fortune reports, Eton Park Closing Shows How Hedge Funds Are Dying at an Alarming Rate:
While doors are opening all over the White House for Goldman Sachs alumni, another one is being closed by one of its former shooting stars.

Eton Park Capital Management, helmed by Eric Mindich, is shutting down and returning its capital to investors, the hedge fund told its clients in a letter Thursday. It's a disappointing end for the hedge fund, which opened in 2004, riding on Mindich's financial pedigree and reputation as a wunderkind. At the time, Eton Park was said to be the biggest-ever hedge fund launch, with $3.5 billion in capital commitments, according to the New York Sun.

But now, its holdings, which once ballooned to $14 billion, have withered down to $7 billion, after the hedge fund made several bad stock bets, accelerating the exodus of investors who have lost faith not only in Eton Park, but also in the industry.

"Recently, a combination of industry headwinds, a difficult market environment and, importantly, our own disappointing 2016 results have challenged our ability to continue to maintain the scale and scope we believe necessary to pursue our investment program consistent with our founding principles," Mindich wrote in a letter to investors.

Mindich is not alone. The challenges he has faced are well known to the 9,893 hedge funds left in the $3 trillion industry.

Not only were markets choppy in the early months of 2016, but increasingly, investors have begun questioning whether the high fees charged by hedge funds are justified. Research, along with an experiment by legendary investor Warren Buffett, have shown that low-cost stock market index funds have generally outperformed hedge funds.

Eton Park lost 9% in 2016. Not only did Mindich's returns lag behind the S&P 500—they also underperformed the overall hedge fund industry's 5.5% return last year, according to Hedge Fund Research. Eton Park's underperformance also wasn't contained to just 2016. It beat the S&P 500 just once in the last six years, and has been relatively flat in 2017 (click on image).

It's the largest hedge fund fund closure of 2017, and points to more troubling trends for the industry now struggling to keep its customers.

In a bid to keep their clients happy, funds such as Och-Ziff Capital have hacked away at their fees, while others including Paul Tudor Jones have dealt with investor redemptions by cutting staff in recent years.

But those methods don't seem to have stymied the outflow of clients from the industry. Roughly $70.1 billion in assets were redeemed last year—the highest level since 2009.

Perhaps more alarmingly, 2016 continued on a six-year trend of fewer and fewer new hedge funds opening—and a three-year trend of more and more hedge fund closures. That's resulted in a decline in the overall number of hedge funds from their peak in 2015, with 147 fewer hedge funds in operation by the end of 2016.

In fact, 2016 had the highest level of hedge fund closures and lowest level of openings since 2008, the year of the financial crisis. And for the second year in a row, the rate of hedge fund closures outpaced that of hedge fund openings, with 1,057 hedge funds closing in 2016,while 729 hedge funds were launched, according to HFR.

So will hedge funds have another rough year in 2017? It's possible that select funds will do well, though the industry as a whole has underperformed the market every year since 2008. The rising frustration among investors over high fund fees and inconsistent returns? That's not likely to go away any time soon.
You can read more about Eton Park shutting down in Reuters, the New York Times and the Wall Street Journal. You can also read about the fund's terrible 2016 performance in Institutional Investor.

You might be thinking "so what, who cares?", it's just another hedge fund charging huge fees delivering sub-beta performance. And you're right, except in this case, Eton Park isn't just any hedge fund, it's a $7 billion well-known multi-strategy hedge fund, one of the elite hedge funds that has succumbed to an increasingly brutal market environment.

And investors are taking note. As I explained in a recent comment on No Luck in Alpha Land, fed up of paying excessive fees for mediocre returns, investors continue to squeeze hedge funds on fees or they are just abandoning them altogether.

Now, you might think it's noble of Eric Mindich to return capital to his investors realizing his fund can't deliver the goods in terms of performance but I assure you his decision is based on selfish business reasons, not altruism toward his investors.

One former hedge fund allocator put it this way:
"All these greedy guys converting to family offices so they don't have to make their investors money back... the same money that paid them all those fees they became wealthy off of. It's really sad. The only other reason is avoiding prosecution because regulators getting too close."
Got it? The number one reason a multibillion dollar hedge fund closes shop and returns money to its investors after suffering poor returns is to avoid having to make up the money it lost. The managers know their fund is so much underwater that it's extremely hard to make back the losses to surpass their high-water mark and start charging performance fees again. Without performance fees, they risk losing their top traders and it just isn't worth keeping the fund open.

For elite managers, they simply close shop, get to manage their own billions as a family office and if things go well, they can come back in a few years and open up a new fund under a new name, and start charging 2 & 20 all over again.

It's a great gig, one that most struggling hedge fund and other fund managers don't get to enjoy, but when you reach superstar status, you can pull it off.

Think about it. You're an elite hedge fund manager charging 2 & 20 on billions under management. If you don't perform well, you're still collecting a 2% management fee on billions of assets under management in good and bad years and if things go downhill, you just close up shop, convert to a family office, manage your billions and aim to open up a new fund down the road under a new name.

It's enough to drive investors crazy but most investors are stupid and they have short memories. They just look at pedigree and don't ask the tough questions that need to be asked.

Trying to capitalize on investors' frustrations, some hedge funds are taking a win-or-die approach to their fee model to lure money into their fund but I predict they will die before attaining their bogey.

Honestly, I am watching all the nonsense going in the hedge fund industry and also watching various markets closely and I'm hardly surprised that big and small hedge funds are closing shop.

No matter what you're trading, it's a very hard environment, and this is especially true if you're a huge hedge fund that needs scale to move the needle.

I just finished writing a comment on why I wouldn't read too much into the greenback's recent slide and remain long US dollars. After talking to a buddy of mine who trades currencies and manages his own hedge fund, I updated that comment to give my readers some more insights into understanding why I remain long US dollars.

But my buddy was telling me that it's increasingly harder to make money trading currencies because "ranges are tight and the algos are front-running your every move." He added: "If humans were doing what algos are doing, they'd be prosecuted, but because algos and high-frequency currency platforms supposedly add to liquidity and price discovery, nobody raises a peep."

He was even more blunt: "The only hedge funds making money in currencies in this market are those that have insider information. You see leaks going on all the time and some big funds making big bets prior to a major announcement and wonder what did they know that I don't know?"

Good point, sometimes you see major moves in currencies just prior to a major announcement and wonder who knew what and when. The F/X market is still the Wild West but regulators don't touch it because it's the number one profit center for big banks which rake retail and corporate clients on fees for each currency transaction (up to 3% for retail clients and up to 20 pips for corporate clients, and all those fees add up and go straight to banks' profits).

Anyway, whether you are a currency hedge fund, a multi-strategy hedge fund, or a Long-Short hedge fund, these are difficult times and a few well-known funds are reeling (only hedge fund quants seem to be escaping the carnage and doing relatively well, for now).

For example, Reuters reports that hedge fund Pine River Capital Management LP is losing two more partners following a difficult year that involved a restructuring and major decline in assets.

Again, these aren't your run-of-the-mill crappy hedge funds, these are well known "elite" hedge funds managing billions which are struggling and closing up shop.

And we're not even experiencing a financial crisis yet. Wait till that hits the industry and many more top players close up shop. It's a disaster and it will have knock-on effects in terms of employment on Wall Street and the Manhattan, Connecticut and London real estate markets.  

Below, CNBC's Leslie Picker reports on a letter from Eric Mindich of Eton Park Capital Management which explains why he is returning capital to investors.

Again take this letter and its contents with a shaker of salt, the decision to close up shop wasn't as difficult as it sounds. It was based on selfish business motives and I suspect over the next few years, many more 'elite' hedge fund managers will follow Mindich and close their shop. It's just that brutal for established and emerging hedge funds trying to raise assets in this environment.

Update: There were some good comments to this post on LinkedIn which you can read here.