Wednesday, June 14, 2017

PSP Investments Gains 12.8% in Fiscal 2017

Benefits Canada reports, PSP Investments posts 16.1% return:
The Public Sector Pension Investment Board earned a 16.1 per cent return (gross, not net) in its 2017 fiscal year, bringing its net assets under management to $135.6 billion.

That’s a significant increase from last year, when it earned a one per cent return, and closer to its 14.5 per cent result in 2015.

Private debt and natural resources saw the strongest returns, at 27.5 per cent and 19.5 per cent, respectively. Public markets posted a 16 per cent return, with infrastructure at 14.4 per cent and real estate at 10.8 per cent. Private equity was the only asset class that saw a negative return, at minus 3.4 per cent.

“While substantial volatility and international uncertainty remain, we continue to pursue our objective of navigating market fluctuations with a long-term investment horizon and well-diversified global footprint,” André Bourbonnais, president and chief executive officer at PSP Investments, said in a statement.

Significant real estate investments during the 2017 fiscal year included seniors’ properties in Canada, the United States and Britain. The pension fund also invested in student housing and a large office project in Britain, as well as new developments in Mexico, Colombia and China.

In terms of private equity, PSP Investments acquired significant interests in the U.S. physician services organization Team Health, global advisory firm AlixPartners, animal intelligence technology company Allflex Group, and Keter Group, which makes resin consumer products. The pension fund has also committed to acquiring Cerba Healthcare, which operates clinical pathology laboratories in Europe, before the new fiscal year ends.

Natural resources activities include new projects in Australia and the United States and expanding four existing agricultural investments.

On the infrastructure side, major investments include hydroelectric assets in New England, larger stakes in the renewable energy platform Cubico, as well as ROADIS, which owns 1,644 kilometres of roads in Brazil, Mexico, India, Spain and the United States.

When it comes to public markets, PSP Investments created an internal global equity research and investment platform that will provide sector and company-specific information.

In the past year, the pension fund also opened a European hub in London, England, and completed staffing its New York office to focus on private debt and private investment opportunities. It also created a responsible investment group and total fund portfolios to better identify opportunities and deploy capital.
PSP Investments put out a press release announcing its results, PSP Investments posts strong performance for fiscal year 2017 - Net return of 12.8% brings net assets to $135.6 billion (added emphasis is mine):
  • One-year total portfolio net return of 12.8% generated $15.2 billion of net income, net of all PSP Investments costs.
  • Five-year annualized net return of 10.6%, which is 1.2% above the policy portfolio benchmark return.
  • Ten-year net annualized return of 6.0% generated $13.7 billion of cumulative net investment gains over the return objective.
The Public Sector Pension Investment Board (PSP Investments) announced today that its net assets under management reached $135.6 billion at the end of fiscal year 2017, compared to $116.8 billion the previous year, an increase of 16.1%. The one-year total portfolio net return of 12.8% created $15.2 billion of net income, net of all PSP Investments costs. This return continues to outperform the policy portfolio benchmark which generated 11.9% return. On a gross basis, the portfolio delivered a 13.2% return, compared to a 1.0% return in 2016.

"We couldn't be prouder of our team's accomplishments in bringing back double-digit returns and contributing to delivering the pension promises to the contributors and beneficiaries who dedicated their active lives to serving Canada," said André Bourbonnais, President and Chief Executive Officer at PSP Investments. "While substantial volatility and international uncertainty remain, we continue to pursue our objective of navigating market fluctuations with a long-term investment horizon and well-diversified global footprint."

Net assets increased by $18.8 billion in fiscal year 2017, attributable to net income, net of all PSP Investments costs of $15.2 billion and net contributions of $3.6 billion. All asset classes saw strong returns, with the exception of Private Equity.

Asset Class Performance Highlights (click on image)


As of March 31, 2017:
  • Public Markets had net assets of $77.2 billion, an increase of $8.6 billion from fiscal year 2016, for a one-year return of 16.0%, compared to a benchmark of 14.9%. Despite political and economic uncertainty, gains in public equities were the strongest contributor to our absolute and relative rate of return during fiscal 2017. The largest contributor to overall performance came from the absolute return portfolio (internally and externally managed), which added close to $700 million. Going forward, PSP Investments and Public Markets will benefit from the newly created internal Global Equity Research and Investment platform, which will provide sector and company-specific research. The group also created a new absolute return strategy within Public Markets. Through the Global Investment Partnerships Portfolio, the group aims to establish itself as a key partner for all co-investments, structured and opportunistic transactions in both traditional public markets and non-traditional space between public and private markets.
  • Real Estate had $20.6 billion in net assets, up by $0.2 billion from the previous fiscal year, resulting in a 10.8% one-year return versus 6.2% for the benchmark. In fiscal year 2017, the group completed new acquisitions in multi-residential properties in Canada and in industrial and retail assets in the U.S., while it disposed of non-strategic properties in Canada, the U.S., Europe and Australia. Real Estate continued to position Revera Inc., our seniors' retirement and healthcare platform, as a major operator of seniors' communities in Canada, the U.S. and the UK. Real Estate expanded the London Student Housing portfolio with Greystar UK and continued to grow our pan-European platform, SEGRO European Logistics Partnership (SELP), increasing the portfolio from 124 to 135 buildings through the acquisition of 14 assets for a purchase price of €265 million (CAD389 million), and the completion of eight developments at a further cost of €49 million (CAD72 million). SELP also successfully issued a €500 million (CAD720 million) unsecured bond listed on the Irish Stock Exchange. Real Estate also funded large, ongoing mixed-use and multi-family developments in the U.S., a large office development at 22 Bishopgate in London, as well as ongoing and new developments in Mexico, Colombia and China. The group established representation at our London office in order to better manage its total European portfolio of CAD$5.92 billion of net assets, build new relationships and originate new investment opportunities.
  • Private Equity had net assets of $15.9 billion, $3.4 billion more than in fiscal year 2016, for a one-year return of (3.4) %, compared to a benchmark return of 9.3%. The group significantly expanded its global network of investment partnerships with like-minded investors, including traditional private equity funds. Private Equity also made new direct investments in the consumer and healthcare sectors, including the acquisition of significant interests in Team Health, a leading U.S. physician services organization; global advisory firm AlixPartners; Allflex Group, a global leader in animal intelligence and monitoring technologies for livestock, pets, fish and other species; and Keter Group, the world's largest maker of quality resin consumer products. The group also committed prior to year-end to acquire Cerba Healthcare, a leading European operator of clinical pathology laboratories and continued to build its presence in London with the hiring of a team of experienced and dedicated investment professionals.
  • Infrastructure had $11.1 billion in net assets, a $2.4 billion increase from the prior fiscal year, leading to a 14.4% one-year return, relative to the benchmark return of 5.2%. Our Infrastructure group deployed $2.6 billion in fiscal year 2017, including the acquisition of a portfolio of hydroelectric assets in New England, an additional interest in our Cubico renewable energy platform and 33% of Vantage Data Centers, in collaboration with external partners and also with our CIO group, and Private Equity and Real Estate asset classes. Moreover, with the completion of the split of Isolux Infrastructure Netherlands B.V. and Grupo Isolux Corsan, PSP Investments is now the sole shareholder of Isolux Infrastructure. Renamed ROADIS, it has a portfolio of 1,644 km of roads across nine concessions located in Brazil, India, Mexico, Spain and the U.S. and will serve as our new global road investment platform. Infrastructure also committed to four funds which invest in a wide variety of sectors and niche markets. The group established senior representation at PSP Investments' London office in order to extend our global reach for asset management, managing partner relationships and developing investment opportunities.
  • Natural Resources had net assets of $3.7 billion, an increase of $1.2 billion from the previous fiscal year, for a one-year return of 19.5% versus the 5.3% benchmark. Income was driven by strong cash flows and valuation gains, primarily in timber and agriculture. Natural Resources also made five new investments in the U.S. and Australia and expanded four existing agricultural platforms. Net assets under management grew by $1.2 billion on a year-over-year basis, resulting primarily from $729 million in net deployments and valuation gains. Long-standing investments in timber continued to account for most investment income and assets under management.
  • Private Debt funded net assets of $4.4 billion, up from $640 million the previous year, resulting in a 27.5% one-year return, compared to a benchmark of 12.4%. In fiscal year 2017, Private Debt committed across 30 transactions, including investments in first and second lien term loans, unitranche term loans, secured and unsecured bonds and a credit fund. Among them was a US$125 million (CAD 163 million) commitment to a Unitranche Term Loan in support of Advent's acquisition of Quala, North America's largest independent provider of tank trailer cleaning, ISO container depot services and IBC cleaning, testing and reconditioning services. Private Debt also facilitated our CIO group's commitment to a senior equity investment in Information Resources, Inc., a point-of-sale and marketing data aggregator for consumer packaged goods, over-the-counter healthcare companies and retailers in the U.S. and internationally. Private Debt portfolio diversification continued to improve in terms of geography, industry, equity sponsors and asset type. The group committed to the international expansion of PSP Investments by hiring four investment professionals in our London office.
PSP Investments' total cost ratio was 70.5 cents per $100 of average net investment assets in fiscal year 2017, compared to 63.0 cents in fiscal year 2016. The higher total cost ratio is part of our Vision 2021, to deliver better sustainable investment returns for our sponsors. It was due to higher operating expenses—mainly attributable to increased headcount required to deliver on our strategic plan objectives and the opening of two international offices— and a rise in management fees.

Other Corporate Highlights

Additional accomplishments during fiscal 2017:
  • Created a dedicated Responsible Investment group and expanded our in-house capacity to identify and monitor environmental, social and governance (ESG) factors in investment decision-making. Our inaugural Responsible Investment Report can be consulted here.
  • Expanded our global footprint and reinforced the One PSP investment approach by completing the staffing of our New York office and opening a European hub in London. These new offices will pursue private investment and private debt opportunities and improve access to local knowledge and market insights.
  • Increased operational agility. Through its Public Markets group, PSP Investments created a centralized equity research platform to perform sector and stock analysis on a global basis. It directly feeds all internal active public equity mandates and provides sector expertise and support to all asset classes.
  • Continued the implementation of a flexible total fund approach that allows investment teams to take advantage of opportunities that do not fit current asset classes. With the oversight of the Investment Committee, we created our Total Fund portfolios, which help optimize our ability to identify opportunities, deploy capital and improve the risk-return profile of the total fund. We also established a CIO group to seek greater total fund perspective and implemented a new compensation system aligned with total fund views.
  • Consolidated our approach to diversity and inclusion practices. We see diversity as a key success factor and we are enabling our increasingly diverse workforce to reach their full potential and, as a team, to successfully deliver on PSP Investments' corporate business strategy, Vision 2021. The number of women in senior roles increased from 18.2% in 2015 to 30% in 2016, compared to a national availability rate of 27.4%. As a percentage of our workforce, members of visible minority groups increased from 15.4% in 2015 to 16.6% in 2016. Representation of group members within PSP Investments is consistent with the market availability rate of 14.8%.
"We believe that attracting a talented, high-performing workforce and building relationships with the strongest institutional partners worldwide is translating directly into results in our investments," Mr. Bourbonnais said. "Our vision is to be a leading global institutional investor that puts the interests of the contributors and beneficiaries at the heart of everything we do. I am proud of the progress that our employees and partners have made to bring this vision to life."

For more information on PSP Investments' fiscal year 2017 performance, visit http://www.investpsp.com/en/index.html.

About PSP Investments

The Public Sector Pension Investment Board (PSP Investments) is one of Canada's largest pension investment managers with $135.6 billion of net assets under management as of March 31, 2017. 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 net 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 its principal business office in Montréal and offices in New York and London, their European hub. For more information, visit www.investpsp.com or follow us on Twitter @InvestPSP.
Let me begin by thanking my contact in Ottawa for bringing PSP's results to my attention early Wednesday morning. In past years, PSP typically released its results to the public a month after they were tabled at Parliament, so I wasn't expecting them to be available so soon.

Anyway, let me delve right into my analysis and begin by stating these are impressive results. It's not just the headline figure, what most impressed me was the ramp-up of the Private Debt asset class, and of course the results this group delivered in such a short amount of time (operations began in late 2015).

At a CFA luncheon earlier this year, PSP's President and CEO, André Bourbonnais, stated that PSP is trailing its peers in Private Debt and is a late comer to this asset class. Well, I think it's safe to say that certainly isn't the case any longer.

Led by David Scudellari, Senior Vice President, Head of Principal Debt and Credit Investments, out of PSP's New York office, this group has been very busy deploying capital in high yield, leverage loans, and direct lending.

In London, PSP seeded a credit platform late last year which I'm sure has ramped up its operations. The platform, created by David Allen‘s AlbaCore Capital, will focus on private and public credit markets where there are inefficiencies in pricing, including high yield, leveraged loans and direct lending. At the time, PSP said it may deploy more capital in partnership with AlbaCore for specific deal opportunities.

Now, I don't know if Private Debt can continue to deliver an exceptional performance of 27% ++ every single year. In fact, I think it's wise to temper our enthusiasm on credit markets and private debt going forward, but clearly this is a great asset class which will grow over time and offer PSP a significant source of value added for many more years.

How did PSP ramp up its operations in Private Debt so quickly? It has the right governance which allows it to compensate people appropriately and it created these credit platforms to deploy significant capital very quickly, paying fewer fees than farming it out to traditional private equity funds that are active in this space.

As stated above, all asset classes had strong returns with exception of Private Equity. I have long warned investors these are treacherous times for private equity. If you look at results from various large US and Canadian pensions in the last year, you will see returns on private equity have come down considerably.

Still, large Canadian pensions are doing better than their US counterparts in private equity and as you will read below, there are legacy issues which explain why PSP's Private Equity team underperformed its benchmark in fiscal 2017.

There are a lot of structural factors that explain why times are tough in private equity. A wall of capital from all over the world is chasing private equity, deals are pricey, the cost of capital is cheap, strategics are flush with cash and they are competing directly with private equity firms.

In fact, you can say the same thing is happening in other private markets like infrastructure and even real estate. As more and more global funds increase their allocation to private markets, deals are getting pricier and the risk premium over public markets is coming down.

At the International Pension Confrence of Montreal on Monday, André Bourbonnais said pensions and other institutional investors are under-estimating the risks of infrastructure investments, seeing them as a substitute for bonds, but neglecting the high valuations and regulatory risks of these investments.

He also noted that following Brexit, PSP slowed its activities in infrastructure and real estate in the UK, and even sold some assets (real estate) but it remains committed to investing in that country and recently opened a London office and sees it as its European growth hub. 

Still, looking at the results above, both Real Estate and Infrasructure delivered great returns and both handily beat their benchmark, adding significant net income to PSP's overall portfolio. 

In past years, I would scutinize the benchmarks in all asset classes, but suffice it to say that even if the benchmarks in Private Debt, Real Estate and Infrastructure were much tougher to beat, the results are still very impressive in these asset classes and they would likely still beat tougher benchmarks.

In Public Markets, where it's a lot tougher beating benchmarks, the results are equally impressive for fiscal year 2017, gaining 110 basis points over the benchmark (16% vs 14.9%).  The press release states the largest contributor to overall performance came from the absolute return portfolio (internally and externally managed), which added close to $700 million.

It is worth noting that PSP allocates to a handful of top hedge funds (like Bridgewater and company) and it has also developed a significant internal alpha team covering bonds, stocks, commodities, and currencies and anything in between (like PIPEs, etc.).

This internal alpha team also co-invests with external partners on transactions where it can take bigger opportunistic positions internally. This is basically piggybacking off of external managers when they see a great idea worth taking a risk on. This is on top of generating their own alpha ideas internally ( a smart way of leveraging their public market partnerships).

Anyway, fiscal year 2017 was a great year for PSP Investments. Just look at the financial highlights which speak for themselves (click on image):


I highly recommend you take the time to dig deeper and read the complete annual report available here.

I just finished a very brief chat with PSP's CEO André Bourbonnais as he was waiting to head through airport security to catch a flight. Here are the points we covered in our brief conversation:
  • On Private Debt, André noted PSP began operations in late 2015. "We got the timing right, and we hired the right people to oversee these operations." He was referring to David Scudellari in New York and Oliver Duff in London.
  • The quality of the underwriting in these credit operations is excellent and they have been able to deploy capital fairly easily without relying on getting it back.
  • André told me Private Debt will grow to 7% of the total portfolio over the next 3 to 4 years.
  • In Private Equity which was the only asset class that underperformed its benchmark, André said there is "transformational change" going on there where PSP is exclusively focusing on partnerships and co-investments (ie. the CPPIB approach which André knows well and has served that fund very well over the years). He told me that Private Equity also had some "legacy investments" it needed to deal with in FY 2017 (ie. they took writedowns on some purely direct deals that were there from the previous team). 
  • He said that they invested in 15 new funds and 10 direct co-investment deals (to lower overall fees). In roughly two years, PSP will see major benefits to this new approach in Private Equity focusing exclusively on fund investments and co-investments to lower fees. I totally agree with this approach in Private Equity.
  • Lastly, in terms of risks, André repeated what he said at the conference on Monday, namely, he is worried about "complacency in the market" where people mistakenly believe this is the new normal and underestimate geopolitical and other risks lurking out there.
That was all the time André Bourbonnais could allocate to me and it was plenty as he answered my main concerns. At this time, I had to leave in the afternoon for a long physio appointment, which is why I was late to post this comment as I wanted to get back to read it properly before posting it.

The key takeaway I got from my conversation with André is that there is a major shift going on in Private Equity to focus exclusively on fund investments and co-investments. The reason that group underperformed its benchmark this year was that they needed to write down some "legacy investments" in their portfolio which were purely direct investments from the previous group that most likely turned out to be bad investments (didn't get more details but that's what it sounded like).

Again, this new Private Equity  strategy is in line with what CPPIB has done in PE for years, namely, fund investments and co-investments with no purely direct investments. It is a bit more costly but in my opinion, this is the fiduciary right thing to do in private equity and it's in the best interests of contributors and beneficiaries.

[Note: After reading my comment, André Bourbonnais sent me a subsequent email stating: "The slight nuance I would bring is that we will not exclusively focus on funds and co-investments in PE but it will definitely be the cornerstone of our strategy for this asset class".]

I wanted to ask André Bourbonnais more questions on the new absolute return group within Public Markets, the four infrastructure funds they invested in, some "legacy" private market benchmarks, currency hedging policy and how compensation has changed. 

Unfortunately, it takes time to properly go over everything and time is something he just didn't have today as he's traveling. The job of a CEO at CPPIB or PSP is very hectic, especially when the annual reports come out, so I am glad I covered some important points and thank him for calling me.

Once more, I highly recommend you take the time to dig deeper and read PSP's complete annual report available here. At a minum, take the time to read the Chair's Report and the President's Report.

Below, as I customarily do, you can go over PSP's total direct compensation from page 69 of the Annual Report (click on image):

I would urge you to go over the details of how compensation is determined. Of course the compensation is excellent but it's in line with PSP's large Canadian peer group and it is based primarily on long-term results like all of Canada's large public pensions.

More important than total compensation, I think people need to understand that André Bourbonnais and his senior team have done a great job turning this shop around, being far more transparent, stressing the importance of effective communication, and focusing on a long-term strategy that diversifies across public and private markets all over the world.

I will also mention the move to diversify the workforce in upper management and all levels of the organization is extremely important for a lot of reasons. PSP's workforce should reflect that of the Public Service, Canadian Armed Forces, Royal Canadian Mounted Police, and the Reserve Force.

I fundamentally believe PSP and other large Canadian public pensions should always strive to diversify their workforce at all levels to gain the benefits that come from hiring smart people with different life experiences and perspectives.

Let me end this comment by once again thanking André Bourbonnais for taking a few precious minutes to answer my questions. I congratulate PSP and all its employees for delivering great results in fiscal 2017. Keep up the great work and always strive to be better.

Below, André Bourbonnais, President and CEO at PSP Investments, explains why his firm has chosen London as its European hub, despite the UK's decision to leave the European Union. He speaks on "Bloomberg Markets. Listen closely to his comments.

I also embedded a panel discussion on assessing the shifting dynamics of the LP/ GP relationship from earlier this year featuring Guthrie Stewart, Global Head of Private Investments at PSP Investments. Great discussion, well worth listening to, but I want you to focus on what Guthrie Stewart said about the PE portfolio he inherited at PSP.

Lastly, Guthrie Stewart discusses the importance of co-investing and the shifting dynamics in the LP/GP relationship at SuperReturn International 2017 in Berlin. Listen to his comments, he's spot on. 



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