Friday, July 28, 2017

The Silence of the VIX?

Earlier this week, Saqib Iqbal Ahmed of Reuters reported, Volatility plunge sends VIX index to 23-year low:
Strong earnings boosted U.S. stocks on Tuesday, driving the S&P 500 to a record high while also sending a popular options-based gauge of expected price volatility down to a more than 23-year low.

The CBOE volatility index, better known as the VIX and the most widely followed barometer of expected near-term stock market volatility, fell to 9.04 intraday on Tuesday, its lowest since December, 1993, before rebounding to close at 9.43.

The VIX is derived from the price of S&P 500 index options. A low VIX reading typically indicates a bullish outlook for stocks.

The volatility index, whose long-term average level is around 20, has been extremely subdued this year as a surging stock market has chilled demand for options that provide protection against price declines, driving down the index itself.

The index has now closed below 10 for the ninth straight day, its longest such streak ever.

Market experts peg the relative tranquility to factors including a generally upbeat macroeconomic backdrop and the lack of any big events that could stoke volatility.

And the sense of calm is not restricted to the equity markets. Merrill Lynch’s gauge of one-month U.S. Treasury market volatility was at 46.9963, a record low.

To be sure, some traders in the options market have taken advantage of subdued levels of volatility to load up on contracts that profit from a pick-up in stock gyrations.

“Over the past few days, we’ve seen a tremendous amount of options activity in VIX,” Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors in New York, said in a research note. “These trades all have a common theme – investors expect volatility to move higher after the summer.”

On Friday, more than a million VIX options contracts traded in one go. The trader makes money as long as the VIX is between 12 and 35 at the October expiry.

There's been a lot of talk about the mystery trader who made a massive bet that the stock market will go crazy by October. Is it Soros, Druckenmiller, or Dalio?

I have no idea but this mystery trader isn't the only one thinking along these lines. Jennifer Ablan of Reuters reports, Gundlach's DoubleLine purchased five-month put options on S&P 500:
Jeffrey Gundlach's DoubleLine Capital purchased some five-month put options on the Standard & Poor's 500 Index a couple days ago as the CBOE Volatility Index .VIX fell to its lowest since December 1993.

"We lost money the first day we put on the trade, but now we are doing great. This is like free money," Gundlach, who is known on Wall Street as the Bond King, said in a telephone interview on Thursday. "We are in a seasonally weak period for stocks, but more importantly, we think the VIX was really, really low. So the S&P puts are going long volatility."

The CBOE Volatility Index, better known as the VIX and the most widely followed barometer of expected near-term stock market volatility, on Thursday spiked above 11 for the first time since July 11 while its true range, a measure of internal swings, shot to its highest since June 29.

"Now we wished we had done more," said Gundlach, the chief executive officer at DoubleLine, which oversees $110 billion in assets under management. The put options on the S&P 500 translate into "going long volatility. The price is ridiculously low" on VIX, Gundlach said.

Gundlach said he still has exposure to gold and predicted gold prices would rise because "gold looks cheap compared to markets that have rallied a lot, including bitcoin and including Amazon (AMZN.O)."

Late Thursday, Amazon shares came under selling pressure, dropping more than 4 percent before paring losses, as the company reported a 77 percent slump in quarterly profit.
So, is Gundlach right? Is the price of the VIX "ridiculously low"? Well, only time will tell because if this market continues to rally going into year-end, the price of volatility will remain subdued longer than Gundlach and that mystery trader can remain solvent (tongue in cheek play on the old expression "markets can stay irrational longer than you can stay solvent").

Have a look at the daily chart of the iPath. S&P 500 VIX Short-Term Futures ETN (VXX):

Notice how it has been declining over the last year and when it spikes, it's unable to stay above its 50-day moving average?

Now, let's look at a longer-term weekly chart going back five years (click on image):

Notice the pronounced decline over the last year and its inability to get and stay over its 10-week moving average?

Yeah, so what? All this technical analysis mumbo jumbo, what does it mean in practice? What it means is that while Gundlack and others might be right to go long volatility in the short run, it's far from certain they will make money if markets don't explode this fall.

The reality is those funds that have been shorting volatility have thus far been making off like bandits. Sure, they can go broke if volatility spikes and stays high, but so far, they've been right.

Still, some pretty smart money managers like Baupost's Seth Klarman have been warning investors to beware of those shorting volatility. Klarman has been raising cash to pounce on opportunities that will arise if markets get clobbered, and he's not alone.

Howard Marks, another one of the most respected value investors out there, warned his clients to move into lower-risk investments to protect against future losses:
"Given my view of the environment, the only reason to be aggressive today is because defensive investing implies low prospective returns. But the question is whether pursuing high expected returns through aggressiveness can be counted on to be rewarded," Marks wrote in the investor letter Wednesday. "If the answer is no, as I believe, then this is a time for caution."
This is sound advice but earlier this week, I had an exchange with Ross Kasarda, Director of Risk Management at the Virginia Retirement System which I will share with you below. He was responding to Seth Klarman's letter (click on image):

In short, there are legitimate concerns out there because all asset classes are overvalued, but there is so much liquidity out there that another risk is risk assets continue melting up quietly and everyone starts chasing returns higher and higher or risk underperforming their benchmark.

[Note: I say "risk assets" because I don't want to just focus on stocks. There are growing concerns that credit markets are in a heap of trouble as “covenant-lite” loans – risky instruments issued by junk-rated borrowers, with few protections for creditors – set an all-time record at the end of the second quarter.]

And if risk assets continue melting up, volatility will remain subdued for a lot longer. This is a problem because low volatility is already wreaking havoc on global macro gods and the calmness is also killing investment banks in Europe and elsewhere.

The irony is that the implosion of market volatility coincides with the big, fat ETF beta bubble I've been warning of. The $3 $4 trillion dollar shift in investing is giving many unsuspecting retail clients a false sense of security

Back in June, I asked whether ETFs are driving markets higher. You bet they are along with central banks expanding their balance sheets and corporations buying back shares at a record pace.

But the rise of ETFs has also spelled the death knell for market volatility. I discussed the technical factors as to why in my comment on hedge fund quants taking over the world:
One final note on ETFs and the VIX (or fear) index. As mentioned in this article, the rise of ETFs is impacting the volatility index through hedging activities:

Deshpande and other derivatives market experts say speculators are to a large extent just selling VIX futures to the issuers of exchange-traded products (ETPs) who need protection against volatility.

With the S&P 500 stock index near a record high, demand for these is quite strong.

For instance, money flows into the iPath S&P 500 VIX Short-Term Futures ETN (VXX), the most heavily traded long volatility ETP, are the strongest in three years, according to data from Lipper. In turn, that's creating a steady demand for VIX futures that the hedge funds are only too happy to supply.

"Strong inflows into long VIX ETPs means the issuers of these products have to go and buy VIX futures," Rocky Fishman, equity derivatives strategist at Deutsche Bank.

Even in the absence of those inflows, the way these ETP products work means that as market volatility declines it requires these product issuers to buy more VIX futures contracts.

It is in response to this strong demand for VIX futures that speculators have ramped up the selling of VIX futures. Essentially, these funds are acting as liquidity providers, not making outright bets.
In fact, back in April, Alex Rosenberg of CNBC reported, The rise of ETFs may be a cause of record-low volatility:
If the capital markets had to be characterized by one quality this year, it would be the low level of volatility. And if changes in investor behavior had to be characterized by one quality, it would be the rise of passive investing.

So are the two trends related?

Some experts, such as Sandler O'Neill research analyst Richard Repetto, see a connection.

"There's no one resounding answer to [why we've seen] this low volatility," Repetto, who covers the brokers and exchanges, said Tuesday on CNBC"s "Trading Nation." But the growth of assets in exchange-traded funds, which largely track indexes, "has had some impact."

Repetto pointed out that the first quarter of 2017 was the least volatile quarter for the S&P 500 in decades — which is just one among a host of stats showing how anomalous the lack of market movement has been.

Interestingly, this general decline in volatility has come in an environment in which it is not uncommon to see big volatility spikes in reaction to surprising events such as the U.K. vote to exit the European Union or Donald Trump's election.

The fact that the low level of realized volatility (which is distinct from, but largely explains, the low level of expected future volatility portrayed by the VIX) comes amid potentially anxiety-making world events leaves Repetto reaching for market structure-based causes.

"My explanation is that [high-frequency trading] and the growth of ETF assets are reducing volatility," Repetto wrote in a recent research note.

There may be something to this, acknowledged Seddik Meziani, professor of finance at Montclair State University's Feliciano School of Business.

"To a large extent, I disagree that low volatility is being caused by ETFs," Meziani, the author of three books about exchange-traded funds, told CNBC in a Thursday phone interview.

That said, "I would go so far as to say that it's exacerbated by this new tool. I would grant that maybe volatility wouldn't reach these highs and lows as easily if ETFs weren't around" given that "now you can express your sentiment toward the economy a little more easily."

Meziani's last point hints at a famous puzzle in finance. Why, academics such as Robert Shiller, have asked, are markets so much more volatile than the underlying economy?

"It has often been objected in popular discussions that stock price index are too 'volatile', i.e., that the movements in stock price indexes could not realistically be attributed to any objective new information, since movements in the indexes are 'too big' relative to actual subsequent movements in dividends," is how Shiller summed up the problem in a widely cited 1980 paper. And this was before stocks crashed in October 1987 for no apparent reason whatsoever.

When considered within this framework, it seems that fretting over the decline in volatility may be a bit silly — akin to demanding that a chef explain why a once-inedible dish no longer scorches the taste buds.

"If there is excess volatility due to non-fundamental reasons, eliminating it will result in lower volatility and more efficient markets," Stefano Giglio, associate professor of finance at the University of Chicago's Booth School at Business, wrote to CNBC on Monday.

"If market participants and arbitrageurs are able to eliminate some of the excess price fluctuations that are generated by deviations from fundamental values, this is certainly better for investors," Giglio added.

To be sure, it's far from obvious that a decline in volatility is good for investors.

As Ian Dew-Becker, assistant professor of finance at Northwestern's Kellogg school, pointed out in an email, it's hard to prove that equity volatility has indeed been higher than economic volatility.

On top of that, the recent decline in stock market volatility has come amid an "extremely stable" period for economic growth, which means that whether fundamental and actual volatility "have gotten closer to each other is a separate question that I don't know the answer to."

Finally, while reduced volatility lowers the risk of buying at a poor price, it also reduces the opportunity to buy at a great one.

Still, for the average investor who is more interested in seeing their money grow alongside the economy than in snatching up incredible bargains, the decline of volatility is probably a boon.

And the fact that one of the causes of this lower volatility may be their vehicle for doing so cheaply may be the icing on the cake.
I believe the rise of ETFs is contributing to record low volatility, along with central banks and other factors. This will mean that active managers who have been shunned over the last few years will come back in vogue (read Hegel to understand why).

While I am on the topic of market volatility, yesterday I swun by the offices of OpenMind Capital here in Montreal to visit its two principals, Karl Gauvin and Paul Turcotte (click on image):

You can read about them here. They are both extremely bright and they know their vol regimes extremely well. In fact, they even have a picture of vol regimes in their office (click on image):

I even met Karl's son, Simon, who was busy programming things while listening to music on his headphone (very nice young man).

Anyway, you don't know much about OpenMind Capital but I know enough to tell you that you should meet with them. They are not a hedge fund and don't charge hedge fund fees. They are smart alpha managers who have worked on great low vol strategies which you can read about here

Paul Turcotte previously worked at the Caisse, has a Ph.D. in physics from University of Montreal and is probably one of the nicest guys you will meet in finance (probably because he didn't study finance). When I tell you he knows his stuff, I am understating it.

Both Karl and Paul really know their stuff and I would ask investors reading this comment to contact Karl at so he can send you a recent presentation he made on retirement decumaltion strategies (click on image):

So, if they're so smart, why aren't they managing multi-millions yet? My answer to this is these guys are super smart, they're not marketing types at all and they are brutally honest with investors to the point where some might get scared away needlessly. The other problem is they have had issues labelling their strategies to satisfy certain potential investors (I told them yesterday to scrap L/S and stick to the  low vol label). Anyway, if you meet them, you will appreciate what I'm writing above.

Lastly, last Friday I sent my distribution list my top three macro conviction trades going into year-end and posted them on LinkedIn. They are listed below:
  1. Long US long bonds (TLT) is my highest conviction trade going into year-end, stay long & strong, US economy is slowing, bad economic data on the horizon.
  2. My other macro conviction trade is that the USD (UUP) will bottom soon and rally going into year-end. Start nibbling.
  3. My third and last macro conviction trade is to underweight/ short oil (USO), energy (XLE) and metals and mining (XME) as the global economy slows. Sell commodity indexes and currencies too.
I've embedded all three charts below and yes, all three trades are related and predicated on my view that the US economy is slowing and the global economy will follow suit (click on image):

Note, these charts are from last week and since then US longs bonds and the USD have dropped and oil and energy shares have rallied so you have plenty of time to jump on my macro trades and make great risk-adjusted returns going into year-end. Gundlach loves S&P puts and gold but I prefer US Treasurys (I believe they are a steal at these levels and will prove to be the ultimate diversifier).

I'm convinced the USD downtrend is being exacerbated by CTAs but when it reverses, it will be violent. This will send energy and commodity prices lower and no, I don't believe the fundamentals justify the euro or Canadian dollar (aka, the loonie) at these levels (if you do, you're smoking some good Canadian legalized pot).

Anyway, hope you enjoyed this comment, I'm taking a little break and will be back on Wednesday. Pay attention to US economic data next week, I believe it will be weak, offering support to my macro trades.

Please remember that I put a lot of time and effort writing this blog to provide you with great insights on markets and pensions so I do appreciate those that take the time to subcribe and donate via PayPal on the right-hand side. If you have never subscribed or donated, please take the time to do so.

Below, Richard Repetto of Sandler O’Neill discusses the causes of low volatility with Brian Sullivan (April 2017). A very interesting discussion on the causes of low vol.

And JPMorgan quant, Marko Kolanovic, may have dropped the whole market with report comparing today's risks to 1987. Take the time to listen to Kolanovic, I don't agree with all his recommendations (I'm short financials and energy) but he really knows his stuff and it does feel a bit like 87.

Third, Alberto Gallo, head of global macro strategies at Algebris U.K., discusses how the Federal Reserve plays into U.S. dollar strength and the effect that has on markets. He speaks with Bloomberg's Mark Barton on "Bloomberg Surveillance." Great discussion, listen to his views on using the US dollar as the new fear gauge.

Lastly, how come they don't make movies like this anymore? When it's all said and done, a lot of traders and funds shorting volatility will be wiped, screaming like the lambs that haunted Clarice.

Thursday, July 27, 2017

La Caisse's Big Stake in Wind Power?

Canada News Wire reports, La Caisse acquires a 17.3% interest in Boralex Inc.:
Boralex Inc. ("Boralex" or the "Company") (TSX: BLX) announced today that Caisse de dépôt et placement du Québec ("la Caisse") has acquired all of the Class A common shares of Boralex held by Cascades Inc. representing 17.3% of the outstanding shares for the amount of $287.5 million.

As part of the transaction, the Company and la Caisse have agreed to explore partnership opportunities with respect to investing in future projects developed by Boralex that are in line with its growth strategy.

"We wish to thank Cascades for its support since Boralex was founded in 1995. Bernard Lemaire's vision has allowed Boralex to become a leader in the Canadian renewable energy industry and France's largest independent producer of onshore wind power. Boralex is pleased to welcome la Caisse as a new major shareholder in a transaction that will benefit the company as well as its shareholders," said Alain Rhéaume, Chairman of the Board of Directors of Boralex.

"To have la Caisse come in as principal shareholder reflects the trust it puts in the business model and know-how of Boralex. We intend to work with la Caisse to develop growth opportunities through its financial capabilities, expertise and international network," said Patrick Lemaire, President and Chief Executive Officer of Boralex.

"This stake in Boralex is an opportunity for us to invest in both a promising sector and high-quality assets, many of which are in Québec. In addition to sharing our long-term vision, Boralex's ability to innovate and strong operating capacity ensure the reliability of its installations and contribute to its development. It has played an important role in the growth of this Québec-based company, both here and in global markets," added Macky Tall, Executive Vice-President, Infrastructure, at la Caisse.

The transaction completed today strengthens la Caisse's position as one of the largest private investors in North America's wind power sector.

La Caisse will appoint two independent directors to Boralex's Board of Directors and will have pre-emptive rights with respect to future issuances of shares, subject to customary exceptions.

About Boralex

Boralex develops, builds and operates renewable energy power facilities in Canada, France and the United States. A leader in the Canadian market and France's largest independent producer of onshore wind power, the Corporation is recognized for its solid experience in optimizing its asset base in four power generation types — wind, hydroelectric, thermal and solar. Boralex ensures sustained growth by leveraging the expertise and diversification developed over the past 25 years. Boralex's shares and convertible debentures are listed on the Toronto Stock Exchange under the ticker symbols BLX and BLX.DB.A, respectively. More information is available at or

About Caisse de dépôt et placement du Québec

Caisse de dépôt et placement du Québec (CDPQ) is a long-term institutional investor that manages funds primarily for public and parapublic pension and insurance plans. As at December 31, 2016, it held $270.7 billion in net assets. As one of Canada's leading institutional fund managers, CDPQ invests globally in major financial markets, private equity, infrastructure, real estate and private credit. For more information, visit, follow us on Twitter @LaCDPQ or consult our Facebook or LinkedIn pages.

Forward-looking statements

Certain statements contained in this news release may constitute forward-looking statements which involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.

Forward-looking statements are based on certain factors and assumptions, and there can be no assurance that such assumptions will prove to be correct. Readers are cautioned that forward-looking statements included in this news release are not guarantees of future performance, and are also cautioned not to place undue reliance on forward-looking statements which involve known and unknown material risks and uncertainties that may cause our actual results, performance or achievements to be materially different from any anticipated results, performance or achievements expressed or implied in such forward-looking statements. These statements speak only as of the date of this news release. Boralex undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be expressly required by applicable securities law.

SOURCE Caisse de dépôt et placement du Québec

For further information: Media (Boralex): Julie Lajoye, Advisor, Public Affairs and Communications, Boralex Inc., Office: 514 985-1327, Cell: 514 623-4197,; Investor Relations (Boralex): Marc Jasmin, Investor Relations, Boralex Inc., 514 284-9868,; Media (Caisse de dépôt et placement du Québec): Jean-Benoît Houde, Senior Advisor, Media Relations, 514 847-2571,
The above is basically the press release la Caisse put out here. At this writing, shares of Boralex (BLX.TO) are up close to 5%, near their 52-week high (click on image):

This is a great deal for all parties. Boralex gets a solid partner which will help the company grow and la Caisse not only cements its position as one of the largest private investors in North America's wind power sector, but it also fulfills part of its dual mandate which includes promoting Quebec-based businesses.

There was a time when I was skeptical of la Caisse's big investments in wind farms, but I was wrong. These investments are profitable and they are great long-term investments which is why they're part of the infrastructure portfolio.

Last month, I discussed how PSP is pushing further into renewables, acquiring a 10% stake in US-based Pattern Energy Group as part of a series of transactions aimed at supporting a major expansion of the renewable energy company.

Renewables are the future of energy and whatever skeptics think (and I was one of them), these companies are profitable and investing in them is investing in a long-term renewable energy future.

Below, the 25 years of Boralex which traces the company's origins and milestones till 2015. Quite impressive and to think of the potential in the next 25 years with a solid partner like la Caisse by its side.

Tuesday, July 25, 2017

OMERS Unloading UK Assets?

Simon Jessop of Reuters reports, Canadian pension funds sell Britain’s High Speed 1 rail link:
Two leading Canadian pension funds have agreed to sell their stakes in Britain’s High Speed 1 (HS1) rail project to a consortium of funds including HICL Infrastructure and South Korea’s National Pension Service.

The deal valued HS1 at more than 3 billion pounds (US$3.9 billion), two sources said. British investor HICL Infrastructure said it would pay about 320 million pounds for its 30 percent stake, giving an indicative equity value of 915 million pounds.

The South Korean pension fund would also take a 30 percent stake in the consortium, with Equitix Investment Management funds holding the remaining 35 percent.

Infrastructure is an increasingly attractive asset class for investors looking for stable, long-term yields and the involvement of South Korea’s public pension plan reflects growing interest by Asian buyers in prime European assets.

The deal was struck with Borealis Infrastructure, the infrastructure investment manager of the Ontario Municipal Employees Retirement System (OMERS), and Ontario Teachers’ Pension Plan, which have held their stake since 2010.

HS1 operates the 109-kilometre (68-mile) high-speed rail line connecting London St Pancras International station with the Channel Tunnel, under a 30-year concession signed in 2010.

Seven years ago Borealis and Ontario Teachers’ paid 2.1 billion pounds to operate Britain’s only high speed railway, beating rivals including Eurotunnel, Morgan Stanley and Allianz.

“We are confident that HS1 will continue to prosper under its new ownership, while Ontario Teachers’ remain committed to the U.K. as an attractive destination for future investment,” Jo Taylor, senior managing director of Ontario Teachers’, said.

Operators pay index-linked access charges to HS1, partly regulated and partly depending on the number of trains. They include Eurostar and Southeastern Trains, which operates domestic high-speed services.

In the 12 months ending March 2017, HS1 made a loss of 94 million pounds.

Update: Borealis and Ontario Teachers’ announced late last year that they were contemplating the sale of HS1 after receiving investment inquiries from third parties.
HS1 wasn't the only UK asset OMERS sold. The Canadian Press reports, Four years ago OMERS bought Civica for $635 million, today it sold it for $1.72 billion:
OMERS Private Equity has signed a deal to sell software company Civica to investment manager Partners Group for 1.055 billion pounds or roughly $1.72 billion.

The private equity arm of Ontario pension fund acquired Civica in 2013 when it was valued at 390 million pounds, or about $635,000,000.

Civica provides business software to both government organizations and the private sector in highly regulated sectors around the world.

OMERS manages investments on behalf of 470,000 members from city governments, school boards, emergency services and local agencies across Ontario.
Not bad, OMERS PE bought a software company in 2013 and sold it four years later for almost triple the cost of acquisition. This is how serious money is made in private equity.

Who did OMERS buy this company from? I suspect it was bought from one of its private equity partners. OMERS invested in the fund and when the fund matured, there was an auction to sell Civica and OMERS Private Equity bought it (I could be wrong, maybe OMERS PE independently sourced this deal but I doubt it).

Who did they sell it to? Reuters reports that Swiss asset manager Partners Group bought Civica for $1.3 billion:
Swiss asset manager Partners Group has agreed to buy Civica from OMERS Private Equity in a deal valuing the U.K.-based software firm at around 1 billion pounds ($1.30 billion), the companies said on Monday.

OMERS Private Equity, part of Canadian pension fund OMERS, acquired Civica in 2013 from 3i for 390 million pounds, according to Thomson Reuters LPC data.

Sky News reported on July 13 that Japan's NEC was interested in buying Civica for 900 million pounds. Other possible buyers included private equity firms BC Partners and Berkshire Partners, as well as Partners Group.

OMERS hired Goldman Sachs to explore a potential sale of Civica Group in November 2016.
What is Partners Group going to do with Civica? They will try to add value to sell it for a higher mutiple down the road.

OMERS has been quite active lately. Reuters reports that it is in talks to sell Teranet for $3 billion:
Canadian pension plan Ontario Municipal Employees Retirement System has been talking with major U.S. and Canadian private equity firms about selling land registry company Teranet in a deal that could fetch about $3 billion, according to people familiar with the situation.

Carlyle Group (CG.O) and KKR & Co (KKR.N) are among several buyout firms that have held discussions with Borealis Infrastructure Management, an investment division of OMERS that owns Teranet, the people said on condition of anonymity, since the talks were private.

In 2008, Borealis acquired then-publicly listed Teranet Income Fund for about $1.5 billion. Teranet Income Fund was spun off by the Ontario government in 2003.

Toronto-based Teranet, which has exclusive rights to offer electronic land registration services in Ontario and Manitoba, collects a fee every time a home in Canada's most populous province and its Western neighbor changes hands or is registered.

It also offers housing data services. Its Teranet-National Bank house price index, a collaboration with Canada's sixth biggest bank, is a closely tracked economic indicator.

OMERS, Carlyle and KKR all declined to comment.

There is no certainty that a deal will materialize, the sources said, adding that OMERS could also choose to keep the asset. It was also not immediately clear if OMERS is running a formal sales process involving investment banks.

Teranet has benefited from the boom in Canada's housing market, the people said. Canadian housing market prices soared over the past decade, with Ontario in particular seeing strong demand from foreign buyers. For example, Toronto prices rose 29.3 per cent in the year to June 30, and have more than doubled since 2009.

The move by OMERS to consider offloading Teranet suggests that the pension fund believes it may be time to sell and take the returns when the market might be close to the top.

In April, the province of Ontario said it would introduce a property tax for foreign buyers in order to cool Toronto's housing market. Concerns of a housing bubble have drawn warnings from both the Bank of Canada and the International Monetary Fund. While prices continue to rise, sales figures in Toronto have dipped in recent weeks.

Teranet's cash flow stream makes it attractive for private equity buyers, who are looking for steady returns over long-term investment horizons.
My advice to OMERS: Unload Teranet as soon as possible especially if you can get $3 billion for it.

That's all from me, if you have anything to add, feel free to email me at

Below, an older interview with OMERS's CIO Satish Rai on Bloomberg Canada (November, 2016). I like this interview and OMERS should be doing more public interviews with him and others (don't be lazy, you're public pensions and need to communicate more effectively and more often).

Monday, July 24, 2017

PSP Investments Moving Into Asia?

Barbara Shecter of the National Post reports, PSP Investments seeking Asia base but London remains key hub despite Brexit fears:
Canada’s Public Sector Pension Investment Board is establishing a base in Asia to pursue deals in private debt and equity, real estate, and infrastructure, mirroring a strategy already deployed in London.

The office, to be located in either Hong Kong or Singapore, will complement a London hub that is to be expanded by as much as 50 per cent in spite of the looming prospect of Brexit, André Bourbonnais, chief executive of PSP Investments, told the Financial Post.

“We’re looking very actively to have a presence either in Hong Kong or Singapore,” he said, adding that both the Asia base and the expansion of the London office to as many as 45 people will be in place by the end of the current fiscal year in March.

“London is and will remain a key financial market,” Bourbonnais said, noting that British politicians have recently soothed Brexit fears with reassurances that bankers and dealmakers from other parts of the European Union will be allowed to stay if and when Britain exits the EU.

While some banks have pulled staff, it’s mostly been back and middle office employees, Bourbonnais said.

“People that are client-facing will remain there,” he said, adding that London continues to be a draw for top deal-making and financial talent.

“The talent pool that’s available is so much larger than (those willing to locate in) Canada, let alone Montreal,” Bourbonnais said.

In a wide-ranging interview, he said the geographic expansion at PSP Investments will be complemented by a continued focus on breaking down barriers within the pension management firm to find investments that benefit the portfolio as a whole.

Those aims were at the top of his list in March of 2015 when he took the top job at PSP, which invests funds for the pension funds of Canada’s public service, the Canadian Armed forces and reserves, and the Royal Canadian Mounted Police.

Another priority was to establish private debt as a new asset class at the pension investment manager, which had $135.6 billion in assets under management on March 31, the end of its most recent reporting period.

“In this environment, it’s a very good asset class, as evidenced by the $4 billion or so that we’ve been able to deploy,” Bourbonnais said, adding that the new business also led PSP Investments to establish an office in New York.

Prior to taking his current job, Bourbonnais was global head of private investments at the much larger Canada Pension Plan Investment Board, a job he says influenced his vision for the public sector pension manager he now runs.

The CPP Fund has more than $300 billion in assets, and deals are sourced from CPPIB’s seven international business hubs in locations including London, New York, and Hong Kong.

In addition to the geographic coverage, Bourbonnais says he was also influenced by his former employer’s focus on the total portfolio, a strategy he introduced at PSP Investments.

“The place had been built in a very entrepreneurial fashion where… nobody was really looking at the total fund,” he said. “One of the big objectives I had was to break those silos and force people to work together at the beginning, but now it’s becoming much more spontaneous and natural for them to do it.”

He said the more co-operative strategy was evident in a deal struck in March to acquire Vantage Data Centres with partners Digital Bridge Holdings LLC and TIAA Investments.

“We couldn’t quite figure out if it was private equity, if it was infrastructure, if it was real estate, so we stopped the debate, we put all three groups together, and we did that transaction with our partners,” Bourbonnais said, adding that other prospective transactions now in the pipeline would combine dealmakers from private debt and equity, and real estate and infrastructure.

“We’ve created a structure where a group of people including myself are looking at … (transactions) that don’t quite fit nicely in one asset class but are beneficial to the total fund,” he said.

“We really foster collaboration between asset classes and (are) really making sure people work together and are rewarded for it.”

PSP’s one-year total portfolio net return of 12.8 per cent generated $15.2 billion of income in fiscal 2017, net of all investment costs. Gross portfolio return stood at 13.2 per cent, compared to a one per cent return in fiscal 2016.
I missed this article which came out at the end of June but it doesn't surprise me. In fact, when I recently examined whether pension funds are displacing private equity funds, I wrote this:
So, are pension funds displacing private equity funds? Yes and no. Where they can compete effectively, they will and this is most notable in Canada where large public pensions have the right governance which allows them to hire industry experts and pay them properly.

But in the buyout world, large private equity funds reign supreme, and there's not a pension in the world that will ever displace them from their bread and butter. It won't ever happen, ever, and the reason is simple, when there's a major deal on the table, the first phone calls bankers make is to Schwarzman et al., not the CEO of a major pension fund.

In other words, while Canada's large pensions can compete with private equity funds in private debt, ramping up their operations in the US and Europe and pretty soon Asia, they will never compete with private equity titans on major deals and still need them to generate returns in the traditional buyout space where they invest and co-invest with top private equity funds.

But there is no question that large Canadian pensions are increasingly muscling into private debt an they are delivering stellar results in this area which was once dominated by top PE funds. Just look at the results of CPPIB and PSP Investments in fiscal 2017 to underscore this point.
PSP is basically catching up to CPPIB, moving into Asia and taking a total portfolio approach. You need boots on the ground to find the right partners and deals, especially in Asia.

The good news is Asian private equity has found something good about the region's aging population, and private equity can take off in this region. There is no doubt PSP, CPPIB and other large Canadian pensions will team up with the right partners to gain access to these deals.

Apart from investments into funds and co-investments alongside them to lower fees, PSP will look to set up private debt operations in Asia and this too can be profitable if they have the right team originating these debt deals.

This is all positive and part of PSP's strategic long-term plan. Once operations are set up and they gain prominence in the region, it will add geographic diversification in a region with real long-term growth potential.

Will there be bumps along the way? You bet. You can execute the best strategy, hire the best team and still suffer setbacks along the way, especially in Asia where private markets are opaque, often dominated by a handful of wealthy families.

Still, over the long run, this move will pay off in spades and PSP needs to move into Asia now to capitalize when markets there get whacked and opportunities in private markets arise.

One last note on PSP. I've been getting emails from a few people asking me about where its former CIO, Daniel Garant, went. I have no clue, none whatsoever. Institutional Investor recently published an article stating he abruptly resigned, which may or may not be true.

Rumors have swirled that he will be replacing Roland Lescure at the Caisse where they will groom him to take over Michael Sabia's job. I also heard rumors that he will join Gordon Fyfe and Jim Pittman at bcIMC where he will assume the role of CIO.

So far, these are nothing but rumors, nothing has been announced anywhere. Mr. Garant is a big boy, he can take care of himself and I'm certain he will land on his feet (they all do). I've never spoken to the man nor am I privy to his future plans. Just because this blog is called "Pension Pulse", doesn't mean I know everything going on at Canada's large pensions (trust me, I don't want to know everything).

Below, from the Milken Institute conference, a panel discussion on the coming US infrastructure boom featuring PSP's CEO André Bourbonnais and Michael Burke, Chairman and CEO at AECOM.

Thursday, July 20, 2017

HOOPP Warns of the Next Crisis?

At the end of June, The Healthcare of Ontario Pension Plan (HOOPP) put out an article, Senior Poverty: The Next Crisis?:
HOOPP is launching a series of articles to deepen the conversation around retirement security and to bring awareness around the benefits of defined benefit (DB) pension plans.

In the first article, we discuss how an increasing number of Canadians are heading into their senior years financially ill-equipped to adequately support themselves when their working lives end. A stark illustration of this has been set out in a slew of new statistics and studies that show poverty among seniors is on the rise once again after nearly two decades of decline.

Two key shifts have contributed to the rise of senior poverty in Canada:
  • Canadians are living longer than ever before
  • The number of seniors is growing at a faster rate than any other segment of the population, with those over 85 leading the way
In our first paper, we provide highlights from a growing body of statistics and research on senior poverty in Canada and explain why workplace savings plans must play a role in generating a healthy and stable income in retirement.
You should all take the time to read this report here. It is excellent and I applaud HOOPP for having the foresight for launching a series of articles to deepen the conversation around retirement security and to bring awareness around the benefits of defined benefit (DB) pension plans.

When it comes to communication, I give HOOPP an A++ and they deserve it. Not only are they the best pension plan in the world along with Ontario Teachers' and a handful of others, but they are taking the looming retirement crisis very seriously and by writing these articles, they are enhancing the policy discussion around retirement and rising senior poverty.

This report focuses on Canada, which arguably has the best defined-benefit plans in the world. The situation in other countries including the United States is far worse, all part of the $400 trillion pension time bomb.

I'm very conservative in my economic views but I fundamentally believe that a well-functioning democracy has three main pillars:
  1. Universal healthcare which provides access to great healthcare for every citizen, rich or poor
  2. Great public education for everyone, especially the poor who need it
  3. A solid retirement system that ensures hard-working people can retire in dignity and security no matter what happens in the bloody stock market
I've said this plenty of times on my blog, good pension policy is good economic policy over the long run.

Again, take the time to read HOOPP's short report here, it is superb. A few things that I will bring to your attention. First, CPP is not a pension plan (click on image):

Here, I agree, CPP is not the solution to Canada's retirement crisis, at least not yet. However, if it were up to me, I would significantly enhance CPP far more than what the federal and provincial governments did to make sure every Canadian can retire in dignity and security.

The truth is Canadians are poor savers, many are buying houses they can't afford and will regret it big time down the road, and they are financially illiterate. Even smart Canadians who save their money don't really know what to do with their money, and others are taking out huge mortgages to buy a nice house because "house prices never go down" (yeah, right).

There is a nice man is Vancouver, a retired securities lawyer who is quite astute and reads my blog religiously. Unlike others, he has significant savings and understands options strategies and markets.

He asked me for advice and what I trade. I showed him how to go on to make daily and weekly charts of various stocks and how I get ideas of which stocks are worth looking at using information from what top funds are buying and selling and what are the top gainers in the market.

But I told him, I start out with my macro views to guide my trading and they haven't changed in a long time. I still fear global deflation lies straight ahead (the global retirement crisis and rising senior poverty will only exacerbate it).

And I didn't sugarcoat it. I told him I track and trade many biotech stocks, take huge risks and have endured 80%++ drawdown in my personal account, made it all back and more. I told him flat out, trading stocks is a full-time job and it's extremely stressful but if you want, follow my ideas on Stocktwits and roll the dice if you like any of them:

In fact, here is my latest Stocktwits post on biotechs (click on image):

But I also told him if I was retired and had substantial savings, half my money would be in US long bonds (TLT) and the other half in dividend paying stocks like Bell (BCE.TO), Enbridge (ENB.TO) and Bank of Nova Scotia (BNS.TO), which is the only Canadian bank that actively manages its mortgage risk.

In other words, if you already have a nice retirement nest egg, it's not about capital expansion, it's about capital preservation and being able to sleep well at night.

And let me share another Stocktwits post that I posted on Friday afternoon on US long bonds (TLT) which is my highest conviction trade going into year-end (click on image):

Now, this individual is savvy about options and he wanted to know more about my friends at OpenMind Capital, so I put him in touch with them as they can explain their options strategies far better than I can.

Most retired Canadians are not in his position and don't have his knowledge of markets and options. We cannot expect people to manage their own money in these brutal markets where even macro gods are struggling.

These markets are brutal, I know, I trade them and often see big quantitative sharks raping clueless retail investors. I don't like using the word "rape" but that is what it is. I would love to take you into the real stock trading world where ruthless market makers and quants take out all the stops so they can load up on shares and make off like bandits.

It's brutal, trust me, and unless you've traded, you just don't know how brutal it really is.

And this leads me to my other point, we can't expect Joe and Jane Smith to trade these markets or even to retire by picking "safe" ETFs and dividend stocks. We need to provide them with a defined-benefit pension, something they can count on for the rest of their lives.

I firmly believe in large, well-governed public defined-benefit plans that pool investment and longevity risks, lower costs by managing the bulk of assets internally and invest all over the world across public and private markets and invest with the top hedge funds and private equity funds all over the world.

Period. This is my gold standard but as I also stated in my comment on the pension prescription, large public pensions need to adopt a shared-risk model:
The biggest problem with pensions these days are stakeholders with inflexible views. Unions that don't want to share the risk of their plan, governments that shirk their responsibility in topping out these public pensions and making the required contributions, pension funds with poor governance and unrealistic investment targets, and powerful private equity and hedge funds that refuse to cut their fees in order to contribute to solving this crisis.

From a social and moral view, I truly believe that a case can be made to a group of elite private equity and hedge fund managers that they need to cut their fees in half and be part of the pension solution. In return, public pensions can perhaps allocate more assets to them over a longer period, provided alignment of interests and performance are maintained.

I don't know, I've been thinking long and hard of a pension prescription which will go a long way into solving a looming crisis that is only going to get worse. There are no easy solutions but in my mind, we absolutely need to bolster defined-benefit plans and avoid defined-contribution plans, and make sure we get the governance and risk-sharing right. And to do this, everyone needs to be committed to the best interests of the plan, including unions, governments and alternative investment managers.
Interestingly, in its report, HOOPP recommends five best practices from the DB space that policymakers can look to for making progress in pension coverage right now (click on image):

Take the time to read the entire report here, it is brief and to the point and these recommendations can be used everywhere, not just in Canada.

Below, HOOPP's President & CEO Jim Keohane discusses Healthcare of Ontario Pension Plan’s overall pension plan performance and explains how the Plan’s funded status, which stands at 122%, acts as a cushion for the Fund.

If only all Canadians had access to this plan, there would be no looming retirement crisis.

Update: After reading my comment, the retired securities lawyer from Vancouver sent me two comments (added emphasis is mine):
  1. While I fully accept everything they, and you, say on the issue, there is a part of me that bristles at a moral problem that goes untouched. Specifically, a portion, probably relatively small, of the population had the means to ensure adequate pension assets, or at least ensure a better outcome than they have achieved, but failed to do so due to spending habits that would have kept Depression-era babies up at night. One need only look at the awesome increase in Canadian debt levels over the last 30 years to see that baby boomers brought forward spending at the expense of retirement savings. I believe strongly in protecting those who really had no chance to protect themselves, and most no doubt fall into this category. For the rest, fixing and preventing the problem in the future begins with acknowledging the role of reckless spending patterns, a lesson it appears the millennial generation might have learned from their profligate parents.
  2. Regarding defined benefit plans and the recent bankruptcy of Sears Canada, I have always been puzzled that legislation does not rank pensioners claims in first place, even ahead of CRA. We have reams of idiotic securities laws that are designed to protect the investing public because the investing public is judged to lack the sophistication to protect itself. Yet employees, many of whom aren’t even as sophisticated as the lowly investing public, are left to fend for themselves. Essentially, the pension promises made to them are substantively “securities” even if not technically. The holders of the pension promise have no way to protect themselves, unlike the holder of a bond. It’s a moral outrage that we let banks step in front of pensioners. Indeed, even CRA is in a better position to protect itself than pensioners and should therefore rank behind. Plus, there’s the economic point you and HOOP have made: a pensioner made whole is probably much more likely to generate economic activity than a bank made whole. Unless I’m missing a compelling counter-point, public policy considerations cry out for pension claims to rank in first place.
I thank him for sharing this and his comments only reinforce my view that corporations shouldn't be in the pension business, something I discussed in my comment on how GE botched its pension math:
I envision a future where all corporations get out of the pension business to focus only on their core business and retirement will be handled by the federal and state (provincial) governments using large, well-governed public pension plans. There will be resistance to such change but it's the only way forward and it makes good pension and economic sense to do this.

One thing is for sure, the status quo isn't working and is leaving too many Americans exposed to pension poverty. It's not just GE's botched pension math that worries me, it's that of the entire country where too many public and private pensions are chronically underfunded.
Think about it, why are corporations in the pension business at all? Many US corporations are grossly underfunded and the situation isn't that much better in Canada (with a few exceptions).

Wednesday, July 19, 2017

bcIMC Gains 12.4% in Fiscal 2017

Canada News Wire reports, bcIMC Reports 12.4% Annual Return For Fiscal 2017:
The British Columbia Investment Management Corporation (bcIMC) today announced an annual combined pension return, net of costs, of 12.4 per cent for the fiscal year ended March 31, 2017, versus a combined market benchmark of 11.7 per cent. This generated $680 million in added value for bcIMC's pension plan clients.

Infrastructure, private equity, real estate, and renewable resources outperformed for the calendar (error: fiscal) year and delivered above-benchmark returns. Tactical decisions to underweight fixed income in favour of public equities provided value-added returns. A key contributor was the outperformance of global equities relative to their benchmark. In a low return environment for fixed income, the decision to underweight nominal bonds added value and was further enhanced by outperformance relative to the benchmark. Strong performance in illiquid asset investments also provided value-add.

"I am proud of the bcIMC team and the strategic investment decisions they made to generate $680 million in additional value, as well as deploying new capital into long-term investments. This is a significant contribution to securing our clients' financial futures," said Gordon J. Fyfe, bcIMC's Chief Executive Officer and Chief Investment Officer. "Although annual returns provide us with a short-term perspective, it is the longer term that matters. Over the twenty-year period, we have exceeded their actuarial return requirements and have added $7.7 billion in cumulative value add."

Fiscal 2017 Highlights
  • Committed $9.9 billion to illiquid assets — infrastructure, mortgages, private equity, and real estate
  • Established QuadReal Property Group, a real estate asset and property manager 100 per cent owned by bcIMC
  • Transitioned $2.8 billion of externally managed public equity funds to bcIMC
  • Raised $750 million in debt financing for our real estate program
  • Expanded the team by 74 and added expertise in asset management, data governance, derivatives, illiquid assets, portfolio management, quantitative analysis, and tax
"We are required to work in our clients' best financial interests, and it influences our strategies, asset selection, and operations," said Fyfe. "bcIMC's new investment model emphasizes a greater degree of active management over indexing strategies, and creating new and diversified sources of market return and active return to increase the probability of meeting our clients' actuarial rate of return."

bcIMC's operating costs were 24.2 cents per $100 of net assets under management; compared to 23.7 cents in fiscal 2016. Costs incurred on our behalf by third parties and netted against investment returns are not included in operating costs. Our strategy refocuses bcIMC to become an in-house asset manager that uses sophisticated investment strategies and tools. By increasing the percentage of assets managed by bcIMC's investment professionals, we will transition from a reliance on third parties to a more cost-effective model of managing illiquid assets.

In fiscal 2017, bcIMC increased our managed net assets to $135.5 billion, an increase of $13.6 billion from the previous year. bcIMC's asset mix as at March 31, 2017 was as follows: Public Equities (48.3 per cent or $65.5 billion); Fixed Income (19.2 per cent or $26.0 billion); Real Estate (13.5 per cent or $18.2 billion); Infrastructure (8.1 per cent or $11.0 billion); Private Equity (5.8 per cent or $7.8 billion); Mortgages (2.1 per cent or $2.9 billion); Other Strategies–All Weather (1.5 per cent or $2.1 billion); and Renewable Resources (1.5 per cent or $2.0 billion). bcIMC's 2016–2017 Annual Report is available on our website at

About bcIMC

With $135.5 billion of managed assets, British Columbia Investment Management Corporation (bcIMC) is a leading provider of investment management services to British Columbia's public sector. We generate the investment returns that help our institutional clients build a financially secure future. With our global outlook, we seek investment opportunities that convert savings into productive capital that will meet our clients' risk/return requirements over time. We offer investment options across a range of asset classes: fixed income; mortgages; public and private equity; real estate; infrastructure; and renewable resources.
At last, we get bcIMC's results so we can close out the year in terms of reporting the performance of all of Canada's large public pensions.

You should note there is only one blogger in the world who properly covers the results of large Canadian pensions. Let's briefly recap the performance of Canada's large pensions:
And now we see bcIMC gained 12.4% in fiscal 2017 (fiscal year ends March 31st). While the results are in line with those of CPPIB and PSP, it's important to note that bcIMC is relatively underweight private market asset classes relative to the former two and its large peer group (it's also important to note that no two pensions are the same, so making comparisons is trickier than just looking at headline results).

But with the arrival of Gordon Fyfe three years ago, the focus has shifted to private markets in a meaningful way. In fiscal 2017, bcIMC committed $9.9 billion to illiquid assets — infrastructure, mortgages, private equity, and real estate. That is a huge shift into private markets.

In order to do this properly, Gordon hired Jim Pittman, formerly of PSP, to be the SVP of Private Equity at bcIMC. Lincoln Webb is the SVP of Infrastructure and Renewable Resources and Dean Atkins is the SVP Mortgage and Real Estate Investments. Together, these three indivduals are responsible for private market investments.

Now, I want you all to take the time to read bcIMC's Annual Report for 2016-2017 which is avaliable here. You can begin by reading the Chair's Message and then the Report from the CEO/ CIO. The entire Annual Report is well written and contains most of the pertinent information for my analysis below.

First, let me begin with the table below from page 3 of the Annual Report which shows a profile of assets under management as of the end of March (click on image):

When I look at this table above, I see the weighting in Private Equity (5.8%) is well below its peer group. Jim Pittman is going to be in charge of ramping up operations in this asset class and his team was very busy in fiscal 2017.

Second, the table below from page 15 of the Annual Report provides a summary of returns by asset class for bcIMC's combined clients (click on image):

As you can see by looking at one-year results, the bulk of the outperformance in fiscal 2017 came from Fixed Income, Mortgages, Global Public Equity, Private Equity and Infrastructure. Real Estate and Renewable Resources also outperformed in fiscal 2017. Lastly, the All Weather strategy (Bridgewater) also outperformed in fiscal 2017, earning 14.3%, well above its benchmark of 9.8%.

I will let you read the notes of each asset class in the Annual Report, but I note below the activities in Private Equity and Infrastructure which are described on pages 20 and 21 of the Annual Report (click on images):

The results for fiscal 2017 are excellent and it's important to note all asset classes contributed to these results (public and private) but going forward, it's clear the focus will primarily be on private markets to deliver the added-value and attain and surpass the actuarial target rate of return over the long run.

Below, as I customarily do when I go over results of large Canadian pensions, I provide you with the summary compensation table of bcIMC's five senior officers (click on image):

As always, keep in mind that compensation is based on long-term results, something Gordon Fyfe rightly emphasized in his Report from the CEO/ CIO. Gordon also mentioned this in his message:
In 2016—2017 we saw the retirement of Paul Flanagan, who led our fixed income & foreign exchange department for the past 11 years. We wish him all the best in this new chapter of his life. Chris Beauchemin, who has been with bcIMC since 1989, stepped into the position as acting senior vice president, fixed income & foreign exchange. Jim Pittman joined and leads our private equity department and Lawrence Davis also joined to lead our finance department.
One final note on compensation at bcIMC. A friend of mine who worked at BC Hydro told me that public sector compensation in British Columbia is "abysmal". He also told me "Gordon is going to have a hard time convincing his board and the government apparatchiks that they need to improve comp at bcIMC'.

I told him not to underestimate Gordon and the truth is bcIMC needs to improve its compensation at all levels for all sorts of reasons, chief among them is they need to attract and retain qualified people to do all sorts of sophisticated strategies across public and private markets. You need to pay for skill and this is in the best interests of bcIMC's contributors and beneficiaries.

Lastly, I did reach out to Gordon to gain more insights on bcIMC but his assistant Maria told me he's away on business (the old Gordon would have called me right away no matter where he was).

I was also happy to hear that my old colleague from PSP, Mihail Garchev, landed on his feet and is now working at bcIMC doing very similar work that he was doing at PSP.

I hope that Gordon, Mihail and Jim (Pittman) are all doing well and congratulate all of bcIMC's employees for a great fiscal year. Keep up the great work.

One last critical point, just like AIMCo, bcIMC flies too low under the radar and needs to significantly improve its communication. The leaders at both these large public pensions are smart and articulate, there is simply no good reason as to why they shun the media and don't give interviews to Bloomberg and other media just like their counterparts out east regularly do.

Proper communication is pension governance 101. PSP's CEO, André Bourbonnais, was absolutely right when he said: "If you don't take control of your brand and communication, someone else will." I wholeheartedly agree and I'm glad PSP is more active on social media, more present in traditional media and more engaged with its community.

On that note, a lot of people in British Columbia are struggling as wildfires rage in that province, wreaking havoc on communities and displacing thousands from their home. Below, a recent report from the CBC's The National. The Globe and Mail posted an article on the extent of the devastation and how you can help here.

Tuesday, July 18, 2017

CalPERS Goes Canadian in Private Equity?

Robin Respaut of Reuters reports, CalPERS says considering making own private equity investments:
The California Public Employees' Retirement System (CalPERS) on Monday said it was considering making direct investments in private companies, a potential major shift in strategy that would be the first such action by a U.S. public pension fund.

The change, discussed at a meeting of CalPERS board in Monterey, would be closely watched by other U.S. public pensions as they look to improve returns on their investments, in part by cutting fees.

The $323 billion pension fund, the largest in the country and a trend setter, has been under increasing pressure to achieve returns closer to the fund's assumed rate of return of 7 percent by 2020.

In the fiscal year ended June 30, private equity investment returned 13.9 percent, the second best performer behind public equities, or stock portfolio. The asset class helped to boost the fund's total year-end returns to 11.2 percent, exceeding expectations for the first time since 2014.

Private equity has been CalPERS' best performing asset class in the past two decades and accounts for about $26 billion of its portfolio. But CalPERS mainly invests in private equity funds and has been criticized for accepting the high fees and limited disclosures typically associated with the asset class.

The shift in strategy, if adopted, is likely to require a considerable investment in staff and expertise in the years ahead to handle the strategic shift.

CalPERS Chief Investment Officer Ted Eliopoulos told Reuters he would recommend CalPERS "explore setting up a separate vehicle" for direct investments and expand the current co-investment program.

Eliopoulos suggested CalPERS focus on opportunities that do not compete with its current private equity investments, such as owning companies for longer than 10 years, and investing in technology and life science companies.

"CalPERS has a unique opportunity to be a leader in the co-investment space," Sandra Horbach, U.S. buyouts co-head at The Carlyle Group, told the board on Monday.

CalPERS' massive size would make it a formidable player and allow the fund to dictate some investment terms, Horbach said.

Most U.S.-based funds shy away from such investments, while Canadian pension funds are considered leaders in the strategy.

By its own account, CalPERS has developed somewhat of a negative image among private equity firms as being difficult to work with and slow to make decisions, John Cole, CalPERS investment director, told the board at Monday's meeting.

A number of funds "have told us that we have become too unpredictable to do business with, and many larger general partners are cutting back the amounts that they are willing to allocate to us in their new funds", Cole said.
So, CalPERS is going Canadian, or at least attempting to by exploring the creation of a separate vehicle for direct investments and co-investments with top private equity funds.

The key passage in the article above is this:
"The shift in strategy, if adopted, is likely to require a considerable investment in staff and expertise in the years ahead to handle the strategic shift"
Why? Because in order to attract and retain qualified individuals to do direct lending (private debt), purely direct investing and co-invest with top private equity funds, they need to compensate these individuals properly or else this venture will be a failure.

This is why CalPERS' CIO Ted Eliopoulos told Reuters he would recommend CalPERS "explore setting up a separate vehicle" for direct investments and expand the current co-investment program.

Unlike Canada's large pensions, CalPERS doesn't have the governance to pay people to come to its pension fund to engage in these direct investing activities and therefore needs to create a separate vehicle to pay them properly.

Canada's large public pensions have the right governance to pay people properly to bring these activities in-house but they too have seeded specialized platforms when they need the expertise of people they cannot pay internally.

But the difference is Canada's large public pensions are way ahead of the game, having developed their fund investments and co-investments and entering private debt in a huge way.

Go read a comment I posted last week on whether pension funds are displacing private equity, where I wrote this:
So, are pension funds displacing private equity funds? Yes and no. Where they can compete effectively, they will and this is most notable in Canada where large public pensions have the right governance which allows them to higher industry experts and pay them properly.

But in the buyout world, large private equity funds reign supreme, and there's not a pension in the world that will ever displace them from their bread and butter. It won't ever happen, ever, and the reason is simple, when there's a major deal on the table, the first phone calls bankers make is to Schwarzman et al., not the CEO of a major pension fund.

In other words, while Canada's large pensions can compete with private equity funds in private debt, ramping up their operations in the US and Europe and pretty soon Asia, they will never compete with private equity titans on major deals and still need them to generate returns in the traditional buyout space where they invest and co-invest with top private equity funds.

But there is no question that large Canadian pensions are increasingly muscling into private debt an they are delivering stellar results in this area which was once dominated by top PE funds. Just look at the resuts of CPPIB and PSP Investments in fiscal 2017 to underscore this point.

Is private debt foolproof and the pinnacle of all asset classes? Of course not. I worry about public an private debt as the US and global economy slow over the next year but if the principals at large Canadian pensions can still originate great deals, they will be able to weather the storm ahead.
I have no worries that the individuals doing private debt at PSP and CPPIB know what they're doing, I am a little more worried about how CalPERS is going to engage in direct lending, direct investments, and co-investments.

Can it be done? Of course, it can. Should it be done? You bet as long as they get the governance right. If not, it will be doomed from the get-go.

Below, I embedded all three parts of the CalPERS' Investment Committee (June 19, 2017). Listen carefully as CalPERS' CIO Ted Eliopoulos attacks critics of their private equity program, stating that CalPERS is way ahead of its peers when it comes to transparency of fee disclosure (Part 1).