CPPIB Gains 8.9% in Fiscal 2019

Today, the Canada Pension Plan Investment Board (CPPIB) reported impressive results for fiscal year 2019. It achieved a 10-year and five-year annualized net nominal returns of 11.1% and 10.7%, respectively. The Fund returned 8.9% net of all costs:

“CPPIB continues to deliver strong absolute and relative returns, and our robust 10-year performance demonstrates our long-term contribution to the sustainability of the CPP,” says Mark Machin, President & Chief Executive Officer, CPPIB. “We have gradually built a diversified, global investment platform and focused on executing our multi-year strategy – these are key drivers of our financial performance and our future success.”

Fiscal 2019 brought on a range of market conditions, including a public equity market downturn in December, which was bookended by rising equity markets at the beginning and end of the period. CPPIB’s portfolio management strategy benefits from ascending public equity markets, while alternative assets and our private investments can help to moderate the impact of significant market drops, even as they produce growth over longer periods.

“The role of diversification came through clearly this year, and we were encouraged to see nearly all investment departments contributed positively to our results. CPPIB’s investment teams also took advantage of our international reach and competitive strengths to pursue select transactions as well as explore new areas of growth,” Mr. Machin added.

I had a chance to talk to Mark Machin and you can read highlights of our conversation at the end after reading my quick analysis of CPPIB's fiscal 2019 results.

Let's first look at the Fund's long-term results:

As shown above, over the last 5 and 10 years, CPPIB has gained 10.7% and 11.1% annualized respectively, and 8.9% and 9.2% annualized real returns over these periods. This is well above the long-term 3.9% real rate of return assumed for CPPIB's Reference Portfolio in the 27th Actuarial Report.

Clearly, over the long run, the shift into global private markets is working for CPPIB as it has helped the organization deliver on its mandate.

Now, let's delve right into the portfolio performance by asset class:

All asset classes except for emerging-market equities contributed to the positive performance but the biggest contributors to the overall performance in fiscal 2019 were Foreign Private Equities, gaining 18%, followed by Infrastructure (+14%), Emerging Private Equities (11.8%), and Credit Investments (+8.7%).

Next, have a look at the change in CPPIB's asset mix over the last fiscal year:

In line with their active management strategy, Public Equities were reduced from 38.8% to 33.2% over the last fiscal year while Private Equities increased from 20.3% to 23.7% and Credit Investments were up from 6.3% to 9.1%.

It's also worth noting that external debt issuance increased from 6.7% to 7.9% of total assets over the last fiscal year as the Fund capitalized on its AAA credit rating to issue more debt to invest in renewable energy and other private market investments all over the world.

CPPIB's Reference Portfolio

It's worth taking some time to read page 56 of the Annual Report and CPPIB's Statement of Investment Objectives, Policies, Return Expectations and Risk Management for the Investment Portfolio of the Canada Pension Plan, which is available here to understand the Reference Portfolio.

As shown below, the CPPIB's Reference Portfolio for base CPP returned 6.6% in fiscal 2019 and for additional CPP, it gained 7%:

The key thing to understand is CPPIB's Reference Portfolio for base CPP or additional CPP isn't easy to beat, it's made up of 85% Global public large/mid-cap equity (including Canada and emerging markets) and 15% Canadian Federal and Provincial Governments Nominal Bonds.

This is a tough benchmark to beat on any given year so outperforming this Reference Portfolio over 1, 5 and 10 years is extremely impressive.

Conference Call with Mark Machin and Michel Leduc

Late this afternoon, I had a chance to speak with Mark Machin and Michel Leduc. I thank both of them for taking some time to speak with me on such short notice.

Below, I provide highlights from our conversation:

• Mark began by stating he was very pleased with the overall performance of 8.9% in fiscal 2019. Amazingly, he told me the Fund was up 8.3% in calendar year 2018, which shocked him (and me) given how poorly equities performed in the last quarter of the year. "I asked to check the numbers a few times but they were accurate."
• He told me that Foreign Private Equities, Infrastructure, Emerging Private Equities and Private Credit were all stellar performers. 
• In Infrastructure, he said valuations helped as assets got marked up (lots of demand for quality assets) and since they got into direct infrastructure investing early on (gave me an example of Transelec, an investment in Chile they got into back in 2006), they benefitted from the increased valuations.
• Private credit expanded its activities and is doing very well. Mark told me he reorganized investment activities earlier in the fiscal year to put all credit into one portfolio (headed by John Graham).
• Two areas that didn't go well in fiscal 2019 were external hedge funds and the internal quant investing based on factor investing. Mark told me that Poul Winslow, Senior Managing Director & Global Head of Capital Markets and Factor Investing, remarked that in October "all hedge fund strategies underperformed at the same time," which is rare, and factor investing has been struggling for a long time. Still, CPPIB is committed to its external and internal absolute return platforms as they keep sourcing uncorrelated alpha, both liquid and illiquid (Note: Given Harvard's stance on hedge funds, this is a very wise decision).
• On leverage, Mark told me they target a level of risk (85% equities) to maximize returns investing in a broad portfolio so when needed, they do increase their balance sheet but are very careful "never to jeopardize their AAA credit rating."
• On private equity valuations being inflated, Mark told me they have internal and external auditors reviewing their valuations and "more often than not, we are told we are too conservative in our valuations." (Michel Leduc later told me to look at page 86 of the Annual Report to see details on their accounting policies).
• We then got into an interesting conversation on China. Mark told me China 1) offers high returns to diversify into an uncorrelated market and 2) it's still a relatively inefficient market driven mostly by retail investor sentiment. "This allows fundamental investors to find alpha."
• When I asked him about private equity in China, he told me he spent 22 years of his life there, has cultivated deep relationships with the managers who are "people of the highest integrity."
• In terms of the biggest concern going forward, he was unequivocal, "US-China relations" and not just on the trade front which has obvious repercussions on the global economy. "There is a general recognition that the US is trying to contain China and China is reacting to this." 
• He said he wasn't optimistic that a trade deal is on the horizon any time soon and this will likely become a long, drawn-out affair which will impact global growth. "Central banks will respond with more monetary stimulus, keeping rates lower for a lot longer."
• Lastly, when I asked him if there were concerns about investing in China, a communist country, he reiterated that growth will be coming from there and that there were inefficiencies in the major indexes that did not reflect the country's deep capital markets and this future and even current growth. Michel Leduc added: "The biggest risk with China is the risk of omission."

I agree which is why I totally understand CPPIB's shift to emerging markets. Mark spoke very highly of Suyi Kim and her team and told me it was her (not him which is what I thought) that opened their Hong Kong office in 2007.

For all details, read CPPIB's full press release and the entire fiscal 2019 Annual Report which is available here.

Once again, I thank Mark Machin and Michel Leduc for taking the time to speak to me.

Below, Mark Machin, president and CEO of the Canada Pension Plan Investment Board, discusses the plan's investment strategy and why he's worried about the rise of geopolitical tensions with Bloomberg BNN's Amanda Lang.