CPP Investments' CIO on Why They Are Cutting Back on Emerging Markets

Sarah Rundell of Top1000Funds reports on why CPP Investments CIO Ed Cass says they are cutting back on emerging markets:

CPP Investments, the C$675.1 billion asset manager for the Canada Pension Plan, has already hit its reduced long-term strategic exposure to emerging markets of 16 per cent in a quick paring back of the allocation from 2023 levels when emerging markets accounted for 22 per cent of assets under management. 

Edwin Cass, chief investment officer at CPP Investments tells Top1000funds.com that although the investor still believes there is both an opportunity to diversify and generate alpha in emerging markets because of inefficiencies, that window of opportunity is narrowing.

“This is changing over time due to a number of factors, including geopolitical risk and improving market efficiency,” he says.

On one hand, deglobalisation can be positive for emerging market investors because it adds to diversification by decoupling relationships between various trading blocs, he explains. However, geopolitical risk is the “flip side” to deglobalisation and brings real complexity.

“We need to understand the impact that deglobalisation and regional trading blocs will have on sectors and specific assets within the countries we invest in. Due diligence and appropriate investor protections become even more important.”

Successful emerging market securities selection during the past several years has been a source of alpha, and he says CPP Investments has found the strongest returns in emerging market infrastructure, notably through investments in toll roads. For example, the asset manager owns toll roads in Mexico, Chile, Indonesia and India that Cass says “are performing well.”

The energy transition also continues to present opportunities. Investments include renewable energy providers, such as Renew Power in India, and Auren Energia, one of Brazil’s largest platforms for renewable energy and energy trading.

However, more expensive active management in emerging markets is important because these markets are less efficient. And successfully navigating the risks is an intense process that relies on an in-country presence resting heavily on “boots on the ground” to stay close to political and regulatory developments and monitor any impact to existing assets.

CPP Investments has opened emerging market offices in Mumbai and São Paulo to allow it to “do its homework,” better understand the businesses it invests in; the environment in which they operate and sensitivity to local risks. Cass explains that offices in emerging markets also allows CPP Investments which manages assets both internally and with external partners to position itself to partner with the best regional and national firms.

“We also spend time building relationships with governments to understand the regulatory environment in the countries where we invest. These local and regional factors are incorporated into our organisation-wide integrated risk framework, which covers a wider variety of investment risks and includes various types of stress tests on our portfolios.”

“Our presence in the regions where we invest combined with our company-wide focus on building relationships with governments and monitoring regulatory changes also enables us to mitigate issues as they arise.”

CPP invests across 56 countries with more than 320 investment partners. Just over 50 per cent of investments are in North America.

If I read this right, CPP Investments is going to start trimming its massive exposure to emerging markets which stood at 16% for base CPP (bulk of assets) and 11% for enhanced CPP (all figures from F2024 Annual Report):

Most of the exposure in emerging markets is in passive global equity indexes which you can find here and below (click to enlarge):

CPP Investments also has made meaningful investments in infrastructure in India but the bulk of the assets are passive exposures to emerging market equity indexes.

Ed Cass cites two reasons for cutting back exposure: geopolitical risk and increased market efficiency (ie security selection is becoming tougher there).

He doesn't get into details on how much they plan to cut, we will have to monitor that in every subsequent annual report.

He does state that these markets provided meaningful alpha for the Fund over the last several years but provides very little detail on how much alpha was produced there:

Successful emerging market securities selection during the past several years has been a source of alpha, and he says CPP Investments has found the strongest returns in emerging market infrastructure, notably through investments in toll roads. For example, the asset manager owns toll roads in Mexico, Chile, Indonesia and India that Cass says “are performing well.”

He states they need to understand deglobalization and the risks and opportunities that brings and they have boots on the ground in key areas to build relationships and monitor government regulations.

My thinking? It all comes down to US interest rates, the lower they go, the more exposure you want to risk assets including emerging markets.

Conversely, the higher they go, the less exposure you want to emerging markets and other riskier assets.

Interestingly, as US rates normalize, the trend in emerging market equities is lower:

 

Of course, I'm oversimplifying but that's how these funds think in terms of Risk On/ Risk Off and it makes a lot of sense because higher US rates go, less risk you need to take (just buy more long-dated US Treasuries and hold to maturity).

There's another risk in emerging markets and we saw it last year as CDPQ got embroiled in a large bribing scandal in India where three former executives there were accused of taking part in bribing scheme to bribe Indian government officials by US regulators. 

I can assure you that this rattled the boards of the Maple Eight and many board members raised concerns about investments in India and other emerging markets.

At the end of the day, governance, rule of law and a stable regulatory framework are critical to making large investments in private markets and some countries are a lot more advanced than others in that regard.

In my opinion, this might require a rethink in emerging markets on whether you want to be a direct owner of a platform there or indirect owner of assets through funds even if you pay fees.

On a related topic, CPP Investments and  and MGRV, a leading Korean rental housing provider, recently announced a KRW 500 billion (C$500 million) joint venture to develop rental housing projects in Korea:

CPP Investments will hold 95% of the venture and MGRV will own the remaining 5%.

The joint venture, CPP Investments’ first direct investment in the residential sector in Korea, aims to develop properties in key corridors of Seoul, close to major business districts and leading universities. CPP Investments has committed up to KRW 133 billion (C$133 million) to the joint venture’s seed projects located within Seoul.

“This joint venture offers an excellent opportunity to enter the residential sector in Korea and meet the strong demand for high-quality rental housing in the greater Seoul area where half of Korea’s population resides,” said Sophie van Oosterom, Managing Director, Head of Real Estate at CPP Investments. “We are pleased to work alongside an experienced local partner like MGRV to enter this market segment, which we believe can generate attractive long-term returns for the CPP Fund.”

MGRV CEO Cho Kang-tae said, “this strategic partnership marks a significant step in demonstrating the high growth potential of the Korean rental housing market and MGRV’s competitive operational capabilities on a global scale,” adding, “we will continue to drive the ecosystem innovation in the market by expanding community-centered properties.”

Rental housing market is huge everywhere nowadays, including in Korea. This is a smart long-term investment.

Below, Bloomberg Daybreak Asia podcast explores where opportunities lie in emerging markets with Rahul Chadha, Founder and Chief Investment Officer at Shikhara Investment Management. Plus, a look at how the week's US eco data will play into the Fed's policy path with Rob Haworth, Senior Investment Strategist at US Bank Wealth Management.

Next, Commerce secretary nominee Howard Lutnick was asked about the potential impacts of tariffs at a hearing on Wednesday. Lutnick, who appeared to suggest tariffs could come in phases, pointed to border issues with Canada and Mexico as a ‘short term’ issue. Lutnick cited both fentanyl and undocumented migrants as areas of concern for the Trump administration but did not provide details about his assertions beyond calling for an end of movement of fentanyl into the US.

Lastly, watch FOMC Chair Jerome Powell's presser from earlier today after the Fed kept rates unchanged.

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