Are Canada's Large Pensions Really Putting Their Clients First?
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This is an excellent short Q&A with David Morhart, EVP Corporate & investor Relations at BCI.
David is in charge of many relations including BCI;s clients:
[Note: Why does BCI manage BC Hydro’s pension plan assets but CDPQ doesn't manage Hydro Quebec's pension plan?].
There are a few more similar Q&As with BCI's leaders in the corporate annual report which I found very insightful and useful.
When I spoke with BCI's CEO Gordon Fyfe last summer covering their 2021 results and more, I remember telling him and Gwen-Ann Chittenden, VP Corporate Stakeholder Engagement, that I really like those short Q&As with BCI's leaders interspersed in the annual report and wish other Canadian pension funds did the exact same thing.
Gordon told me back then: "it was Gwen-Ann's idea," and I said great idea, make video clips of these Q&As for clients and stakeholders.
Many of you don't know but I am an expert on pension governance and even did a huge report for the Treasury Board of Canada on the governance of the federal public service pension plan back in 2007.
Huge report, it made the folks at Treasury Board in charge of pensions look bad so they paid me (eventually) and shelved it permanently.
In there, I discussed oversight, investments, communications, funding and other elements of good governance using the very best governance from all over the world.
And when it comes to top governance, the Canada model is great in terms of compensation, less than stellar when it comes to some elements like communication and transparency.
I should qualify this a bit.
Canada's biggest and best pension fund, CPP Investments, sets the bar in terms of communication and transparency but even they can take it up a notch and learn from global peers like Norway's NBIM.
And when it comes to communication, I'm in touch with many senior VPs from our pension funds and there is more that needs to be done to take communications to the next level.
Like what? Like leveraging off YouTube and social media platforms as much as possible to so clients and stakeholders can really understand what the internal teams are doing.
I'm talking short but insightful Q&As with not only investment leaders but also Risk, Finance, IT and other leaders.
That gets me back to David Morhart's Q&A above.
In a recent comment of mine going over IMCo's optimal asset mix during these uncertain times, I stated the following:
[...] it's important to note that IMCO is like CDPQ, BCI and AIMCo in that it has many clients with different asset mixes to reflect their liabilities and risk tolerance. Clients choose their asset mix based on their risk tolerance and return expectations.
OTPP, OMERS and HOOPP and large pension plans which manage assets and liabilities and since they don't have many clients (OTPP only has one basically), they can set the asset mix and match assets with liabilities to reduce funding risks.
The critical thing to remember is IMCO, AIMCo, BCI and CDPQ can only recommend an asset mix to a client, they cannot impose it.
My own personal view is this is stupid but clients like to work with their own actuaries who recommend an asset mix based on their liabilities profile.
I get it but the reason I think it's stupid is pension funds have investment experts who are paid millions to manage assets so their clients should trust them implicitly to also recommend the best asset mix for them.
But clients want to "own" their asset mix, whatever that means, but it has all sorts of governance issues attached to it, like who is exactly responsible for recommending an asset mix and what if they're completely off, costing clients a lot of lost performance.
Under Leo Kolivakis's super governance rules, I would force clients to publish the asset mix they recommended over last 5 or 10 years and then compare their performance with the asset mix recommended by AIMCo, IMCO, BCI and CDPQ.
And in both cases, I'd force them to publish who is responsible for deciding the final asset mix.
Remember, most of the returns at any pension fund or any institutional investor are determined by the asset mix.
Last week, I got an email from La Presse reporter André Dubuc asking me my thoughts on why CDPQ lost 5.6% in 2022 while OMERS gained 4.2% and OTPP gained 4%.
To his credit, Mr. Dubuc took the time to really listen to me where I went over the asset mix of these organizations and I explained unlike CDPQ, OTPP and OMERS manage assets and liabilities and control their asset mix for their clients.
This is why OMERS and OTPP have more invested in Private Markets than CDPQ and OTPP also invests in commodities which added its performance last year.
It is critically important to understand that AIMCo, BCI, CDPQ, IMCO, PSP and CPP Investments are asset managers who do not control the asset mix, they can make recommendations (not CPPIB) but in the end, it's the clients who tell them where to invest the assets in terms of how much in Public Equities, Fixed Income, Private Equity, Real Estate, Infrastructure and Natural Resources.
So, it's the clients who bear the ultimate responsibility of their asset mix and performance because they control their asset mix.
Teachers', OMERS, and HOOPP control both the assets and liabilities and are responsible for their asset mix, not their clients.
In this way, Teachers', OMERS and HOOPP have more control over the risks they take and where they take them over what period (they manage assets and liabilities and are managing risks more closely).
In bad times, where both stocks and bonds get hit like last year, this works to their advantage relative to their large asset manager peers.
Conversely, when stocks and bonds are on fire, asset managers typically outperform their large pension plan peers who manage assets and liabilities (typically, not always).
What else? Mr. Dubuc asked me about CDPQ's exposure to private debt and why I stated their Fixed Income benchmark doesn't reflect the risks they take there.
First, he asked me about duration and why they were more longer duration in sovereign fixed income than their peers like OTPP and OMERS, and I explained it's an asset mix call mostly which clients are responsible for.
But in terms of Private Debt, I did say they are loading up (over $45 billion over last two years) and this has undertones of the ABCP crisis all over again.
I told him back in 2003-2007, CDPQ was loading up on ABCP to handily beat their T-bills benchmark and nobody said a word until it blew up in their face.
"As long as everyone made money and beat their benchmark, they stayed silent to collect their big bonus."
Now, CDPQ didn't just discover Private Debt and they're not alone, everyone is doing it except for Teachers' which is getting ready to begin its private debt operations in London.
I don't have a problem with CDPQ doing private debt as long as they underwrite their loans and are transparent about exactly how much is junior versus senior loans.
When I covered OMERS' 2022 results, I asked Blake Hutcheson, OMERS CEO,and Jonathan Simmons, their CFO and CSO, how much of their private debt is junior loans and Jonathan responded:
"Our overall allocation to credit is 21%, I don't have at tip of my fingers how much is private but Ann (DeRabbie) will get that to you (Ann told me it’s 11.6%) but what I can tell you is we are not invested in junior debt in private credit, it doesn't meet our risk appetite. We do lending in real estate and it might happen there but frankly we are so far up the capital stack, that's very remote. In the same way, our private lending to businesses is in those with high quality earnings and decent moats around their businesses. Our teams are very careful not to get seduced by "shiny new objects". We are very disciplined and we underwrite al our private loans. Blake also added: "We are not deploying capital in funds doing junior debt lending, we underwrite our loans, we understand the businesses we invest in and default rates are very low. We are trying to get great risk-adjusted yields of 10% over ten years. Most portfolios out there don't have a Bruce Power providing 31% of the power to Ontario. Now, some of businesses can get hit hard from a recession but we are pruning them back over the last 2-3 years. In real estate, we will get hit by cap rate rises, we did raise a billion dollars, some markets will be better than others, some sectors will fare better than others and our development assets are great. We have liquidity to take advantage of dislocations as they arise"
And private debt makes me very nervous because I remain bearish and think we are heading into a global economic depression of sorts.
We might avoid the worst of it this year but it's coming, that much I'm sure of, and we are seeing layoffs pile up and it will ultimately show up in the jobs figures.
And when unemployment starts mounting and inflation pressures persist, it's called stagflation and if it lasts a long time, all major pension plans offering inflation indexation are in deep trouble because it will impact public and private markets.
And it will impact private debt too even if it's short-term variable rates adjusted for inflation if you don't know who is underwriting the debt and the standards they are using to do so.
BCI is getting big into private debt.
Last May, Daniel Garant, EVP & Global Head of Public Markets at BCI, talked about doubling the allocation to private debt, the shifts in the portfolio and the focus on active management.
Last month, Bloomberg carried a story about how British Columbia’s investment manager is piling into private credit:
(Bloomberg) -- British Columbia Investment Management Corp. deployed a record amount of cash in private credit last year after banks pulled back from lending.
The investment manager had C$8.4 billion ($6.3 billion) in private debt as of March 31, the most since it first began investing in the asset class five years ago, its head of public markets, Daniel Garant, said in an interview.
The asset manager oversaw C$211.1 billion ($158.3 billion) as of March 31, the end of its last fiscal year and the last time it published returns.
“Borrowers wanted certainty” and found that in private debt markets, Garant said.
In 2022, private lenders stepped in to back multibillion-dollar acquisitions when banks grew reluctant to provide financing after the Federal Reserve resumed rate increases in March.
Wall Street banks reined in lending after they took losses on big-ticket deals deals they’d agreed to underwrite before the rate increases — including Elon Musk’s $44 billion acquisition of Twitter and the $16.5 billion buyout of Citrix Systems.
The pension fund, which invests on behalf of British Columbia’s public sector, returned 7.4% for the year ended March, boosted by its holdings in infrastructure, private equity and real estate.
Again, this is fine and dandy as long as the risks they're taking in private debt are properly reflected in the benchmarks they use in Fixed Income (and there are plenty of risks).
If not, their clients will end up paying them for risks they're taking to easily beat their fixed income benchmarks and this is wrong on many levels, not to mention it's a governance issue.
What about the board of directors at these large pensions? Aren't they ultimately responsible for the risks these pension fund managers take and how much they're being compensated?
Yes and no, in my opinion, we assume too much from these boards and I would implore clients to work closely with their actuaries and other independent consultants to really understand the risks pension fund managers are taking across public and private markets.
For example, when it comes to Private Debt, CPP Investments is the leader by far, they bought out Antares Capital years ago, they know exactly what they're underwriting in their portfolio and are very careful to make sure there are no junior loans in their private debt portfolios.
This is why IMCO invested $500 million with Antares Capital and I believe BCI did the same thing although this isn't public for whatever reason (it should be).
I would urge more pension funds to invest with Antares Capital if trying to expand their private debt portfolio for the simple reason that they're really good and the folks at CPP Investments watch over them like hawks.
What else? When it comes to putting clients first, I'm for more transparency and a lot more communication.
As I stated above, Canada's large pension funds and plans need to take it up a notch in terms of communication, have a dedicated YouTube channel and populate it with meaningful videos featuring Q&As with leaders across their investment, risk. IT and finance groups.
For example, a Q&A with Samir Dhrolia, senior managing director, global derivatives, trading and indexing portfolio management at BCI to discuss the benefits of their innovative centralized trading platform.
I've got plenty more great ideas to improve the governance at Canada's large pension funds, plenty more that will truly make us the envy of the world.Lastly, when it comes to amazing video clips, I want to see more of Jim Pittman, BCI's EVP and Head of Private Equity and Blake Hutcheson, OMERS' CEO.
Once again, below the 2022 video clip of the year featuring Blake Hutcheson and Jim Pittman for those of you who didn't see it yet. Enjoy, these are the types of insights I love.
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