Thursday, March 21, 2019

Canadian Pensions Embrace New Technologies?

Earlier this week, the Caisse put out a press release, CDPQ Expands Its Artificial Intelligence Offering:
Caisse de dépôt et placement du Québec (CDPQ) has announced the creation of a fund dedicated to Québec businesses with a proven track record in artificial intelligence. Funded with a $250-million envelope, the CDPQ–AI Fund aims to ramp up growth in businesses whose product offerings are based on the development of AI, and to accelerate the commercialization of artificial intelligence solutions.

This fund, managed by CDPQ’s Venture Capital and Technology team, will serve technology companies that have developed demonstrably sound business models and shown a capacity for continued strong growth. They will need to have a well-established management team as well as a dedicated team with AI experience.

Over the years, CDPQ has invested in many venture capital firms (1) that target artificial intelligence companies in the startup phase. The CDPQ-AI Fund’s objectives include supporting the development of the most promising businesses to emerge from these funds, once they have reached their growth phase.

Note that in 2018 this co-investment strategy, combined with a CDPQ-sponsored venture capital fund, has resulted in CDPQ making direct investments in AI businesses, such as Hopper (fund: BrightSpark), TrackTik (fund: iNovia), or even Breather (fund: Real Ventures). The CDPQ-AI Fund will be used for new transactions of this kind.

In addition to this new fund for growing technology companies, CDPQ has recently announced a series of initiatives and partnerships targeting young AI companies in the startup phase.

CDPQ, in collaboration with Mila – Quebec Artificial Intelligence Institute, created Espace CDPQ | Axe IA to house nine startups from innovative sectors. They will also have access to Mila’s academic resources and advice, coaching and a network of experts from la Caisse and Espace CDPQ, to accelerate the commercialization of their AI solutions. Furthermore, CDPQ will soon have a laboratory, on Mila’s premises, that it can make available to certain businesses in the portfolio that have clearly defined AI integration programs.

Espace CDPQ, a CDPQ subsidiary, is also a founding partner of the Creative Destruction Lab Montréal which, through its extensive academic and business networks, is driving the development of AI technology companies with strong growth potential.

It should also be noted that NextAI, an innovation program designed to create artificial intelligence companies and commercialize technologies, is a new Espace CDPQ collaborator. Active in both Montréal and Toronto, NextAI accelerates and develops businesses in the seed capital and startup phases. NextAI works with teams that are commercializing research on AI and are interested in building global businesses.

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1 iNovia, Real Ventures, BrightSpark, White Star Capital, Relay Ventures, Georgian Parners, RV Orbit, Luge Capital, InnovExport, Anges Québec Capital, CTI Life Sciences and Lumira Ventures.
The CDPQ–AI Fund is a new fund but from an experienced team which has a track record investing in many venture capital firms that target AI companies in the startup phase.

Some of these companies have been very successful. For example, the Caisse booked a huge gain when Montreal's Lightspeed IPOed, a rare Canadian IPO success story:
When Dax Dasilva rang the opening bell at the Toronto Stock Exchange on Friday morning, the company he founded 14 years ago, Montreal-based Lightspeed POS, was officially worth almost $1.4 billion.

By the end of the day, as shares (TSX:LSPD) that were sold at an initial public offering price of $16 rose to $18.90, was worth more than $1.65 billion.

It was one of the 10 largest tech IPOs in the history of the Toronto Stock Exchange — and may be the largest ever by a Montreal-based tech company.

“A couple of years ago, people would have said, you’re not going to get American-level valuations, or interest, or volume on the Toronto Stock Exchange, and hopefully we’ll show that that’s just not true,” Dasilva said. “We’ve been able to attract as many American investors as Canadian investors by going public, and also by going public in Canada.”

The IPO raised more than $240 million for the company, which develops point-of-sale software for small and medium-sized retailers and restaurants.

Originally, the company had sought to raise $200 million through the share sale, with shares valued at between $13 and $15. Dasilva said the increased price was the result of “overwhelming demand.”

IPOs are uncommon among Canadian venture-backed companies. Promising firms are often acquired by larger players before they get to the point where they can go public.

“It’s rare that you are able to be in this position, we were lucky because we had long-term Canadian-based investors,” Dasilva said. Montreal-based venture capital firm “iNovia, the Caisse de dépôt, Investissement Québec and myself are the biggest shareholders, so keeping the company independent and keeping it Canadian and headquartered in Montreal, being a tech anchor in this province, that was important to everybody that’s involved.”

Around one-fifth of the company was sold to investors through the IPO. Dasilva remains in control, with the majority of voting shares.

Now, instead of being acquired, Lightspeed plans to start doing more acquisitions as it looks to become a global brand.

“We bought five companies, in the U.S., in Canada and in Europe, and we want to continue to do that and build the company globally,” Dasilva said. “So, rather than having a mindset of being an acquisition target, which is often the case of a VC-backed company, because VCs would like their return, we were able to graduate from the VCs, to long-term holders like the Caisse, and pursue this vision of being a public company.”

Lightspeed had revenue of $57 million during its 2018 fiscal year, which ended on March 31, 2018. It had an operating loss of $21.922 million.

Dasilva said he sees Lightspeed consolidating its market.

“Our market is very fragmented with lots of different, smaller players that are selling to the same set of customers, retail and restaurant SMEs,” Dasilva said.

Currently, Lightspeed has 47,000 customers in 100 countries. But, Dasilva said, there are 47 million businesses around the world in its target market.

Being public will help his company sell to more of those businesses, he said.

“We’ll have greater visibility, we’ll be able to do strategic (mergers and acquisitions), we’ll be able to grow globally,” he said. “We’re going to invest in developers, we’re going to invest in our go-to-market teams. There’s an enormous opportunity to capture more of these 47 million potential customers that could be Lightspeed customers, globally. This kind of event, where you raise this amount of capital, gives you the funding you need to apply to a model that’s already working.”
Remember the name Lightspeed POS (ticker symbol: LSPD.TO). Its shares were up 5% today to close at $21.50 and the company is run by a great entrepreneur, Dax Dasilva, a man with a clear long-term vision who is looking to be the acquirer, not the acquiree.

Why is the Caisse investing in Quebec tech startups? First, unlike other large Canadian pensions, the Caisse has a dual mandate which includes investing in Quebec's economy in public and private markets. It even has a private equity team dedicated to Quebec private companies.

Second, as demonstrated above, the Caisse's venture capital investments are risky but they can be enormously profitable.

Third, I refer you to an article by Don Wilcox I read last month on Real Estate News Exchange, Tech likely Canada’s saviour if recession hits: Morassutti:
If executives arrived at Tuesday’s RealCapital conference in Toronto with concerns about a downturn, CBRE’s Paul Morassutti likely put a bit more spring into their steps.

His annual state-of-the-economy presentation focused on Canada’s booming tech sector, and how innovation could be an economic — and commercial real estate — saviour when recession arrives.

“Some say a recession is looming, sounds ominous,” he said during a keynote address. “This morning, we’re going to explain why there may be less to fear in the Canadian commercial real estate market than many would have you believe. We will also discuss why we believe Canada’s most valuable resource has nothing to do with energy, minerals or anything else that comes from the ground.

“In real estate, identifying areas of growth is fundamental. Increasingly, the areas of growth in Canada are all about technology and our growing knowledge economy. Technology is the catalyst, change agent and king-maker and its impact is rippling through every sector of our market.”

Canada well-positioned if recession hits

Morassutti, CBRE’s vice-chairman of valuation and advisory services, said the rising interest rate environment, combined with historically high global debt, will undoubtedly lead to a reckoning. However, he said economies positioned to benefit from new technologies and lifestyle trends should weather the worst of whatever storms are coming.

He noted the innovation sector extends well beyond what many people think of as traditional “technology” into virtually every aspect of Canadians’ lives.

“Tech has become so ubiquitous across Canadian industries the true impact the tech sector has on Canada’s economy has been understated. CBRE research estimates that for every tech employee hired at a tech firm between 2012 and 2017, there were three more tech employees hired by non-tech firms.

“Loblaws for example, a grocer, employs almost a thousand people in its AI digital division.

“When you look at it this way, Canada’s tech sector is exceptionally diverse and has a multiplying effect on the economy. But even more important is the rate of growth. Over the past 10 years, tech has grown at more than 2.5 times the pace of the energy sector and three times the overall economy.”

Support for innovation from both the private sector and governments has made Canada a true leader in technology and innovation — and that is driving many of the commercial real estate trends today across the country. He pointed out Canada was the first country to create a national artificial intelligence strategy, and the creation of incubators such as MARS district in Toronto opened the door for innovators to become established and grow.

Toronto a “global tech powerhouse”

“In 2017, Toronto produced more tech jobs than San Fran, Seattle and Washington, D.C. combined,” he said. “Toronto has emerged as the undisputed tech capital of Canada and is a global tech powerhouse and it is no coincidence that our downtown office vacancy rate now sits at a 26-year low.

“In Ottawa, tech companies are now the biggest (private sector) tenants, second only to the federal government, occupying more space than the accounting and legal sectors combined.”

Toronto’s office development pipeline of 10 million square feet under construction is 58 per cent pre-leased. Twenty per cent of that is tech sector space, despite the sector historically accounting for only four per cent of total occupancy. Microsoft is moving into the downtown core, taking a landmark 132,000-square-foot lease at the new CIBC Square.

“Tech companies anchoring new buildings is something we have virtually never seen before,” he said.

That expansion is occurring across the GTA and surrounding areas.

“Waterloo region and Toronto form the second-largest tech cluster in North America. This corridor, dubbed Silicon Valley North, encompasses 15,000 tech companies, 200,000 tech workers, and over 5,0o0 tech startups and 16 universities and colleges and is a testament to our tech strength.”

Vancouver and Montreal have also taken great strides, and other Canadian cities have been creating niches for themselves.

He said the good news doesn’t stop there. Canadian immigration policies are welcoming thousands of international students into our universities and colleges, and highly skilled workers into the labour force.

“Capital follows talent, and capital-backed talent produces innovation that will define the future,” he said.

Industrial sector also benefits

Tech is also having a major impact in another outperforming sector of CRE, the industrial market. The impact of e-commerce is driving demand for logistics, and pushing rents higher.

“It is not a stretch to say that we have never seen a better market than the 2018 industrial market. The lowest availability we have ever tracked. Rising rents. In some market, rising dramatically,” Morassutti said.

And while markets like Toronto, Vancouver, Montreal and even Calgary get much of the attention, this trend isn’t focused in a few large centres.

“Demand has outstripped supply for the last 10 years and the new supply pipeline is still low relative to fundamentals.

“Once again, technology is the driver here. The ongoing shift to e-commence remains the primary tailwind. Here in Toronto it represents roughly 85 per cent of all occupier demand and there is more of it to come.”

But, what happens if, or when, the economy begins to slow down?

“All of that sounds great but it raises an obvious question: If tech is having an outsized impact on our market, how durable is that demand? And what happens when we hit a slowdown?”

Apple investors lost $70 billion in value in one day recently, tech stocks have fallen from historic highs, privacy concerns abound and increasing government regulation is in the offing in many sectors.

“Are we in a tech bubble?”

Morassutti also raised the spectre of declining venture capital for startups and rapidly expanding firms.

“Are we in a tech bubble?” He asked, proceeding then to address the possible fallout.

Morassutti said we live in a very different world from two decades ago when the first dot-com crash caused severe economic upheaval. He agreed there will be a “scaling back” of demand, but he does not see the same kind of traumatic impact.

“Fears of a dot-com-style crash appear to be unfounded. First of all, the extremes are not the same. The last dot-com crash was based mainly on hot air and hype.

“As (futurist) David Houle says, tech continues to push into new areas of our lives at a rate that most of us just can’t fathom.

“We can debate current-day tech valuations, even with the decline it may still be overvalued. But when you consider where tech is going; cyber security, health care, fintech, clean energy, proptech, it becomes clear that if anything they are just getting started and the ecosystems around them are not going anywhere.

“Despite softening economic conditions fundamentals at the property level remain incredibly strong. Technological change, and tech business growth and tech talent are the dominant factors driving demand.”
Canada can’t become “complacent”

In keeping with his upbeat presentation, Morassutti said there are many reasons to take heart.

“Real estate is cyclical, always has been and that hasn’t changed,” he said. “We should be aware of those cyclical factors just as we should be aware that our fundamentals as we enter this slowdown are, on average, as good as they have ever been. That is cyclical as well.”

But Canada’s diverse population, safe banking structure, high standing in international “freedom” rankings, and world-leading tech sectors are all huge positives.

“The biggest challenge we have is that this is a race with no end, and there is no room for complacency because we are competing with everyone,” he said.

“Rather than obsess over when the next downturn will hit, I take comfort in knowing the Canadian market is well positioned not only to weather it, but to continue to flourish.”
I don't share Morassutti's enthusiasm for the Canadian economy, think our day of reckoning will come and it won't be pretty, but he raises many excellent points and makes me think long and hard about  the tech sector as a creator of jobs and its ability to mitigate the impact of a recession.

Importantly, if CBRE research estimates are correct and for every tech employee hired at a tech firm between 2012 and 2017, there were three more tech employees hired by non-tech firms, then that definitely argues for the Caisse and others to invest in emerging technology companies.

And others are investing in them, including OTPP, CPPIB and OMERS which last month tapped ex-CPPIB exec Mark Shulgan to lead new growth-equity strategy:
OMERS appointed Mark Shulgan to head the Canadian pension fund’s new growth-equity platform, PE Hub Canada has learned.

OMERS announced Shulgan’s hire as a managing director in September, though at the time did not mention the new strategy.

He will now run OMERS Growth Equity, recently set up for long-term investing in high-growth companies committed to innovation in sectors like healthcare and tech, according to OMERS’ site.

The platform’s strategy is to partner with entrepreneurs as a minority investor, deploying equity of $50 million to $250 million and taking board seats.

Previously, Shulgan was a senior portfolio manager in Canada Pension Plan Investment Board’s thematic investing group.

He co-founded the CPPIB group, an investor in private and public companies in North America and Asia, a decade ago.

Before then, Shulgan spent nearly three years as a vice president at Fortress Investment Group.

Shulgan could not be immediately reached for comment.

OMERS Growth Equity represents a third division of OMERS Private Equity, filling a space between the PE group and OMERS Ventures, both of them pioneers of in-house direct investing by a major pension fund.
You'll recall when I covered OMERS's 2018 results, I discussed how OMERS Ventures hired Michael Yang and opened two offices in Silicon Valley and San Francisco as part of an expansion aimed at investing in US startups.

It looks like Mark Shulgan is going to invest in late-stage tech companies that need financing and OMERS will be taking a minority stake in them.

Not sure if his focus is on the US or Canadian market but unlike the Caisse, OMERS, CPPIB and OTPP don't have to invest in Ontario or Canada, their focus is squarely on finding the best investments all over the world.

Still, as the article above states:
“In 2017, Toronto produced more tech jobs than San Fran, Seattle and Washington, D.C. combined,” he said. “Toronto has emerged as the undisputed tech capital of Canada and is a global tech powerhouse and it is no coincidence that our downtown office vacancy rate now sits at a 26-year low.

“In Ottawa, tech companies are now the biggest (private sector) tenants, second only to the federal government, occupying more space than the accounting and legal sectors combined.”
All this to say, there's no reason to ignore Canadian tech companies, especially if they're successful and growing fast (like Lightspeed POS).

Is Venture Capital easy? Of course not, it's exceedingly difficult, need I remind you of what Sequoia Capital's Doug Leone told me back in 2004 right before I managed to persuade him to take a meeting with Gordon Fyfe and Derek Murphy: "My best advice to your pension fund is don't get into venture capital, you will lose your shirt!".

But these big pensions would be foolish to ignore this space altogether, especially if they can partner up with the right VC firms to identify the next key growth areas and growth companies. It is far from easy but it's definitely an exciting area to invest in.

Below, former OMERS CEO Michael Nobrega, chair of the Ontario Centres of Excellence, joined BNN Bloomberg's Amanda Lang from the OCE Discovery 2018 conference with his take on Canada's current competitiveness, stating Canadian pensions should invest in tech startups. Listen carefully to what he said (in May, 2018).

Next, Jim Orlando, managing director at OMERS Ventures, came out with his 2019 Canadian tech predictions that include a warning. He says the most recent wave of tech innovation may be coming to an end. Orlando also talked about the importance of artificial intelligence and why he predicts a rise in bitcoin. Not sure about bitcoin but agree with him on entering a period of tech malaise and that AI is where you want to be.

Lastly, Dax Dasilva, founder and CEO of Montreal software firm and Caisse-backed Lightspeed POS, recently joined BNN Bloomberg as they begin their first day of trading on the Canadian public markets. Like I said above, keep tracking this company, it has a great future ahead of it.


Wednesday, March 20, 2019

CPPIB Hitting Another Level?

Valerie Jones of Rigzone reports, Williams, CPPIB to Form $3.8B Shale Gas JV:
Williams and Canada Pension Plan Investment Board (CPPIB) have entered into an agreement to create a $3.8 billion joint venture which will expand CPPIB’s exposure in the North American natural gas market.

CPPIB will invest $1.34 billion into the joint venture, which will give it 35 percent ownership. The joint venture will include Williams’ owned Ohio Valley Midstream system and its newly fully-owned Utica East Ohio (UEO) Midstream system.

“This joint venture will provide CPPIB additional exposure to the attractive North American natural gas market, aligning with our growing focus on energy transition,” Avik Dey, managing director, Head of Energy and Resources for CPPIB,” said in a company statement. “The joint venture complements our recent investment in Encino Acquisition Partners, an anchor customer on UEO and other Williams gathering assets. Through these unique operations in highly attractive basins, we will further our strategy to establish U.S. midstream exposure alongside highly regarded and experienced operating partners such as Williams.”

Williams’ CEO Alan Armstrong believes the joint venture will advance an “already strong position in the Northeast.”

CPPIB’s investment in the joint venture is expected to occur in the second or third quarter of 2019.
JWN also reports, Williams and Canada Pension Plan Investment Board forming US$3.8B Marcellus/Utica joint venture:
The Canada Pension Plan Investment Board has formed a US$3.8-billion joint venture with Tulsa-based Williams Co. to optimize its midstream operations in the western Marcellus and Utica Basins.

CPPIB will invest approximately $1.34 billion to acquire a 35 percent stake in Williams' Ohio Valley and Utica East Ohio midstream systems.

Concurrent with signing the agreement , Williams purchased the remaining 38 percent stake in Utica East Ohio from Momentum Midstream.

Williams will retain 65 percent ownership of both systems and will operate the combined business on behalf of the joint venture with CPPIB.

The deal is expected to close in the second or third quarter of 2019.
On Monday, CPPIB put out a press release, Williams and Canada Pension Plan Investment Board to form a US$3.8 Billion Strategic Joint Venture Partnership in the Marcellus/Utica Basins:
  • Strategic partnership between Williams and CPPIB to support ongoing growth and Northeast region optimization
  • Williams consolidates 100% interest in Utica East Ohio Midstream (“UEO”) and assumes operatorship
  • Williams expects to receive approximately $1.34 billion in exchange for a 35% interest in a combined UEO-Ohio Valley Midstream (“OVM”) joint venture, providing Williams with a net of approximately $600 million, after transaction fees and paying for the UEO interest, allowing for debt reduction and funding of Williams’ attractive growth capital in the region
  • Enables synergies from common UEO-OVM operatorship
Tulsa, Okla./Toronto, Canada - March 18, 2019 - Williams (NYSE: WMB) today announced a series of transactions that will establish a new platform for the optimization of its midstream operations in the western Marcellus and Utica basins through a long-term partnership with Canada Pension Plan Investment Board (CPPIB).

Williams and CPPIB have entered into a definitive agreement to establish a US$3.8 billion joint venture that will include Williams’ 100 percent owned Ohio Valley Midstream system (“OVM”) and 100 percent of Utica East Ohio Midstream system (“UEO”). CPPIB will invest approximately $1.34 billion (subject to closing adjustments) for a 35 percent ownership stake in the joint venture. Williams will retain 65 percent ownership, will operate the combined business, and will consolidate the financial results of the joint venture in Williams’ financial statements.

Concurrent with signing the agreement with CPPIB to purchase a 35 percent interest in the joint venture, Williams purchased the remaining 38 percent stake in UEO from Momentum Midstream and will take over operatorship. The UEO acquisition was signed and closed today. UEO is involved primarily in the processing and fractionation of natural gas and natural gas liquids in the Utica Shale play in eastern Ohio.

Williams expects synergies through common ownership by combining UEO and OVM to create a more efficient platform for capital spending in the region, resulting in reduced operating and maintenance expenses and creating enhanced capabilities and benefits for producers in the area.

“Acquiring the remaining interest in UEO and forming a partnership with CPPIB continues to advance our already strong position in the Northeast,” said Alan Armstrong, president and chief executive officer of Williams. “These transactions create a platform for continued optimization and growth, provide deleveraging, reduce capital spending on processing and fractionation capacity for OVM, and unlock further synergies through combined operatorship of the systems.”

“This joint venture will provide CPPIB additional exposure to the attractive North American natural gas market, aligning with our growing focus on energy transition,” said Avik Dey, Managing Director, Head of Energy & Resources, CPPIB. “The joint venture complements our recent investment in Encino Acquisition Partners, an anchor customer on UEO and other Williams gathering assets. Through these unique operations in highly attractive basins, we will further our strategy to establish U.S. midstream exposure alongside highly regarded and experienced operating partners such as Williams. We look forward to expanding this new joint venture over time.”

“We’ve seen first-hand the focus of the UEO employees on delivering safe, environmentally compliant and reliable results, and we are excited to welcome these employees to Williams,” said Micheal Dunn, chief operating officer of Williams. “Williams looks forward to helping Encino and CPPIB maximize their important investment in the basin through safe, reliable and cost-efficient services.”

The cash proceeds to Williams from the purchase by CPPIB of its 35 percent interest in the joint venture will be used to offset the purchase price of the UEO acquisition, with the balance of proceeds used to fund Williams’ extensive portfolio of attractive growth capital and for debt reduction.

Closing of CPPIB’s investment in the joint venture, which is expected to occur in the second or third quarter of 2019, is subject only to customary closing conditions, including regulatory approvals.

Williams plans to provide updated 2019 financial guidance with its first-quarter 2019 earnings release.

The joint venture excludes Williams’ ownership interests in Flint Gathering, Cardinal Gathering, Marcellus South Gathering, Laurel Mountain Midstream and Blue Racer Midstream.

For the combined transactions, Morgan Stanley and CIBC Capital Markets acted as financial advisors to Williams. Gibson Dunn served as legal counsel to Williams.

About Williams

Williams (NYSE: WMB) is a premier provider of large-scale infrastructure connecting U.S. natural gas and natural gas products to growing demand for cleaner fuel and feedstocks. Headquartered in Tulsa, Oklahoma, Williams is an industry-leading, investment grade C-Corp with operations across the natural gas value chain including gathering, processing, interstate transportation and storage of natural gas and natural gas liquids. With major positions in top U.S. supply basins, Williams owns and operates more than 30,000 miles of pipelines system wide – including Transco, the nation’s largest volume and fastest growing pipeline – providing natural gas for clean-power generation, heating and industrial use. Williams’ operations handle approximately 30 percent of U.S. natural gas. www.williams.com.

About Canada Pension Plan Investment Board

Canada Pension Plan Investment Board (CPPIB) is a professional investment management organization that invests the funds not needed by the Canada Pension Plan (CPP) to pay current benefits in the best interests of 20 million contributors and beneficiaries. In order to build a diversified portfolio, CPPIB invests in public equities, private equities, real estate, infrastructure and fixed income instruments. Headquartered in Toronto, with offices in Hong Kong, London, Luxembourg, Mumbai, New York City, São Paulo and Sydney, CPPIB is governed and managed independently of the Canada Pension Plan and at arm's length from governments. At December 31, 2018, the CPP Fund totalled C$368.5 billion. For more information about CPPIB, please visit www.cppib.com or follow us on LinkedInFacebook or Twitter.
This is a huge deal even by CPPIB's standards, one that will provide it with more exposure to the North American natural gas market.

CPPIB will invest approximately $1.34 billion to acquire a 35 percent stake in Williams' Ohio Valley and Utica East Ohio midstream systems. Williams will retain 65 percent ownership, will operate the combined business, and will consolidate the financial results of the joint venture in Williams’ financial statements.

When doing a deal of this size, you want to first find the right partner, second take a minority stake in the joint venture and third have the partner own the majority stake and continue to operate the business.

Avik Dey, Managing Director, Head of Energy & Resources at CPPIB and his team structured this deal and they should be commended for this mammoth undertaking. I can't begin to imagine the amount of due diligence required to enter into this joint venture.

For its part, Williams (WMB) gets a nice infusion of cash to expand its operations and a great long-term partner with an extensive global network which comes in handy should it decide to eventually sell these assets down the road.

Judging by its stock performance, investors like this deal a lot and if the stock price breaks above $30 a share, it could be headed for a new high (click on image):


Alright, I'm being optimistic and it will help if natural gas prices pick up from here like they did in Q4 2018 (click on image):


Anyway, this is a long-term deal, one that will benefit CPPIB and Williams.

In another major deal, Reuters reports, CPPIB, Ontario Teachers’ join $3.3 bln offer for Inmarsat:
Inmarsat Plc said on Tuesday it has received a cash takeover offer from a private equity-led consortium, a deal that would value the British satellite company at about US$3.3 billion and take it private.

The consortium, which includes U.K.-based Apax Partners, U.S.-based Warburg Pincus and Canada Pension Plan Investment Board (CPPIB), offered US$7.21 per share on January 31 and the proposal remains under discussion, Inmarsat said in a statement.

The US$7.21 (543 pence) per share offer is at a premium of about 24 percent to Inmarsat’s Tuesday close of 437.8 pence on the London Stock Exchange. The offer price represented a premium of about 47 percent when the proposal was made on January. 31.

The company said it is not certain the discussions will lead to a formal offer.

Ontario Teachers’ Pension Plan Board would also be supporting the proposal as part of the consortium, Inmarsat said.

The group is required to make a formal offer by April 16, the FTSE 250 company said. The offer values Inmarsat at US$3.3 billion, according to Refinitiv Eikon data.

An external representative for Warburg Pincus declined to comment. Apax and CPPIB did not respond to requests for comment.

Last year, U.S. satellite group EchoStar Corp walked away from discussions to acquire Inmarsat after it rejected a US$3.25 billion cash and stock offer.

A takeover of the company could be closely scrutinized by the British government because of the satellite company’s position as a strategic asset.

Founded in 1979, Inmarsat was set up by the International Maritime Organization as a way for ships to stay in communication with shore and make emergency calls.

The company sees a growing opportunity to supply in-flight broadband services to commercial aircraft, having partnered with Japan’s Panasonic Avionics in September last year.
If it passes regulatory approval, this will be one of the biggest PIPE deals since CPPIB and GIG took Ultimate Software private in a deal led by Hellman & Friedman.

What else? Greg Zochodne of the National Post reports, How CPPIB is tapping ‘alternative data’ to refine its investment processes:
There was a time when the Canada Pension Plan Investment Board didn’t even make “alternative” investments. Now, Canada’s biggest pension fund says it is sifting through “alternative” forms of data to try to improve its investment decisions.

CPPIB has assembled what it calls a “data-driven edge” team, a small group of investors and data scientists that are experimenting with different kinds of information in making longer-term investment decisions, says Deborah Orida, senior managing director and global head of active equities at CPPIB.

“As we look to enhance that decision-making, one of the things that we’ve been focused on for the last couple of years is being able to use not only the traditional financial data that we get from the traditional sources like Bloomberg in making our investment decisions, but also the increasing volume of alternative data that is available,” Orida told the Financial Post in a phone interview from Hong Kong.

One example of how it is already putting alternative data to use that Orida provided was the fund’s recent analysis of a pair of real-estate companies, one public and one private, for which CPPIB used a public registry of realtors in the U.S. to study their movements between firms. The data would be one piece of a bigger puzzle that the fund would be trying to solve in order to make its investment decisions.

“But by looking at this additional source of data, and being able to analyze that trend, we could gain insights about what was attracting agents to different companies,” Orida said.

It’s unlikely CPPIB is the only Canadian pension fund tapping into emerging forms of data either.

The Ontario Teachers’ Pension Plan recently posted a job opening for a director of analytics platforms, the duties for which include maintaining “industry knowledge on data science, machine learning, data engineering, alternative data, data visualization and other relevant Advanced Analytics topics.”

Teachers’ posting said the director would be leading a team of five to 15 employees.

CPPIB, which invests the funds of the Canada Pension Plan, is also diving deeper into new innovation-related ideas and technologies.

The fund recently advertised that it was looking to hire a director of innovation to help test out “emerging concepts and ideas” and expand CPPIB’s advanced analytics capabilities.

Along the same lines, CPPIB said recently that it was seeking a head of data and advanced analytics, billed as “a transformative role.”

CPPIB says the two jobs are new ones, as the fund tries to ensure that its talent and technology keep pace with its growth.

The price for all this remains to be seen; CPPIB will reveal its costs in an upcoming annual report.

But while CPPIB already has certain advantages over other investors — such as the steady flow of contributions and a much longer-term outlook — it’s always looking to make decisions on the basis of the best-available information, Orida said.

Reams of data can also be used to feed various artificial intelligence technologies, and Orida said that CPPIB does employ machine-learning in its research. The example she gave for this was their thematic investing group researching automobility, such as trends around consumers moving from buying cars to buying rides off an app instead, or the evolution towards electric and autonomous vehicles.

Orida said the existing research had taken a more regional approach, but CPPIB, a global investor, had wondered if it made more sense to analyze the adoption trends based on certain characteristics, such as density or wealth. The fund used a machine-learning algorithm to group cities around the various attributes, which is insight it could also apply across its portfolio.

“So for example,” Orida said, “when you think about that evolution of moving from buying a car as a capital investment to consuming rides as a service, that’s going to impact how we think about long-term projections for toll roads, for airports that make a lot of their money from parking revenue, in our infrastructure team.”

Again, however, alternative data is not the be-all-end-all for CPPIB, as Orida noted when it came to their research of real-estate companies. The fund was not using the analysis alone to make an investment decision; rather, it was trying to respond to a question humans were asking and supplementing its other work.

“Ultimately, our investment decisions are still captured in making a financial forecast about a company and then discounting the cash flows back to figure out what price we would pay for it,” Orida said. “But when you’re forecasting those cash flows, the more information you could have about the industry trends and how they might impact the future of that company, my own view is that the better investment decision that you’ll make.”
Indeed, I agree with Deborah Orida, when making significant investment decisions, it's best to use all the available data including alternative data sources.

A former colleague of mine, Derek Hulley, who is now the Director, Data Science at Sun Life, went back to school in his forties to complete a Masters of Science in Predictive Analytics (Data Analytics) from Northwestern University while he was working (he already had a CFA and Masters of Science in Finance/ Economics).

Derek is a big-time data geek and one of the smartest and nicest modelers and data scientists I know. He has incredible experience in finance and shared this with me:
"All organizations have silos and it's up to data scientists like me to work to connect the dots. The problem is if you don't get executive sponsorship, you get a lot of pushback from IT and others who perceive you as a threat, not as an asset. It's incredibly frustrating and this is why many talented data scientists leave an organization because they don't have the upper level support they need to carry out their functions."
Well said from a guy who has seen a lot in his career. Here he is proudly displaying his certificate from Sun Life after winning some predict modeling competition in 2017:


When it comes to making money in markets, everyone wants "edge", hedge funds pay big bucks for "edge" and they will go at lengths to buy the best and most expensive alternative and traditional data for this edge so why shouldn't CPPIB, OTPP and others do the exact same thing?

I'm a big believer in data but my intellectual mentor at McGill University was a political philosopher, Charles Taylor, and my philosophy is simple: you can have access to all the data in the world but if you can't connect the dots across geographies, sectors, asset classes, etc., your data is pretty much useless and your investment decisions will suffer the consequences. That's why I'm more of a macro guy.

An example? I don't know, how about this, how will tight monetary and fiscal policy in China and a crackdown on capital flight impact the residential real estate markets in developed nations? This is just an example, not what is going on right now, but you need people at these large pension shops who can sit down with the guys and gals in Public and Private Equities, Fixed Income, Infrastructure, Real Estate and other teams to connect the dots.

And trust me, having worked at these large pensions, there is a lot of work that needs to be done to share information across business lines (some are much better at it than others but nobody has perfected it).

Another example? Well, the 2008 financial crisis. A lot of people couldn't believe it but some of us were very worried about the record issuance of CDO-squared and cubed and the rise and fall of esoteric credit structures and all that counterparty risk. Nobody could have predicted the scale of that crisis but some of us were definitely warning about the system reaching an important inflection point long before 2008 came around.

I'm bringing this up because data sources are all about managing risks and here I'm referring to downside risks. There are a lot of moving parts at these huge pension funds and it typically falls on the Risk groups to manage the risks of these moving parts, hopefully warning senior managers long before something blows up and contagion spreads across all asset classes.

Anyway, CPPIB, OTPP and others are right to focus on data. Today I read another interesting article on how OPTrust is staying ahead of the curve on artificial intelligence:
At a time when making money in the markets is increasingly difficult, technology can provide an edge, says James Davis, chief investment officer at the OPSEU Pension Trust.

“You need to have an edge, and the edge historically has been relationships and information asymmetry,” Davis says. “Now you’re going to need an edge in the technology space to be able to identify the kinds of themes or the kinds of relationships that you, before this technology existed, would never have been able to identify.”

The OPTrust’s focus on innovation allowed it to beat stiff international competition to take home an award for innovation in institutional investments at the 2019 volatility and risk premia awards.
I will let you read the rest of the article here and I'm lookng forward to seeing James Davis in Toronto next week where he will take part in a panel discussion with Marlene Puffer, President and CEO of CN Investment Division, Jean Michel, CIO of IMCO and Francois Bourdon, CIO of Fiera Capital. They will be discussing the top challenges and opportunities facing pension investors in 2019 and beyond (see details here).

Lastly, Vinicy Chan of Bloomberg reports, Canada's biggest pension fund considers opening its first office in China:
Canada Pension Plan Investment Board, which manages around $368.5 billion (US$277 billion), is considering opening its first office in China as it seeks greater exposure to the world’s second-largest economy.

Canada’s largest pension fund investor could open an office in Beijing as soon as next year, Hong Kong-based head of Asia Pacific Suyi Kim said in an interview this month. Staff there would then work closely with CPPIB’s 130 employees in Hong Kong, which have helped to invest $42 billion in Greater China so far, she said.

“As we’re also growing our portfolio in China, which is around 10 per cent of our total fund, it makes a lot of sense for us to consider expanding our footprint there,” said Kim, adding that one of the firm’s key investment themes is China’s rising middle class and its burgeoning consumer consumption story.

CPPIB has already invested US$4 billion in a China logistics venture with Australia’s Goodman Group as e-commerce rises, creating the need for more large-scale storage facilities. It also owns shares in Alibaba Group Holding Ltd., Meituan Dianping, Midea Group Co. and Tencent Holdings Ltd., plus it has invested in funds run by Citic Capital, FountainVest and Hillhouse Capital.

CPPIB can invest in those private-equity firms’ buyout funds, giving it the opportunity to look at deals alongside them, or make direct investments in its own right, Kim said. The pension fund expects its total net assets will grow to $800 billion by 2030.

Kim, 46, who built CPPIB’s Hong Kong office from scratch, is “mindful” of the growing competition from buyout firms and deep-pocketed tech companies in pursuing deals. “Having a lot of capital isn’t our competitive advantage here, our competitive advantage is having high quality talent and strong partnerships,” she said.


The fund’s China push comes as CPPIB aims to improve its track record of gender diversity globally. It made a commitment to hire equally by gender by 2020 and 47 per cent of new hires last year were women, Kim said.

The Toronto-based company’s senior management team is currently 35 per cent female, while there are seven women on its 11-person board. That compares with a 16.4 per cent female board representation for companies listed on the Toronto Stock Exchange.

Prior to joining CPPIB in 2007, Kim worked at Ontario Teachers’ Pension Plan and Carlyle Group LP, where she never had a female boss. “When I started at Carlyle Asia buyout fund in 2002 at the Seoul office, I was the only female professional,” Kim said. “There was no other female working in private equity in the country at the time.”

While that’s changed in the years since, Kim says gender bias is still quite common in the region.

“When I go to a business presentation with my team, the counter party very often would look at another male, thinking he must be my boss,” the Stanford Business School graduate said. “As I start to introduce myself and talk about CPPIB’s expertise as well as what my team has done, their faces change.”
Hah! I can just picture the faces of these Asian counterparties which are mostly men when they realize she's the boss and is doing a great job expanding CPPIB's imprint in China and the rest of Asia.

Below, Mark Machin, president and CEO of the Canada Pension Plan Investment Board, joins BNN Bloomberg to discuss his current market strategy and his outlook for the global economy. He also states the Fund is looking to grow China exposure despite trade uncertainty with US.

I've said this before, Mark is a great leader and he and the rest of the team at CPPIB are doing an outstanding job bringing Canada's pension fund to another level altogether.

Tuesday, March 19, 2019

PSP, QuadReal Invest in London's Cherry Park?

PSP Investments put out a press release yesterday, Unibail-Rodamco-Westfield forms partnership with PSP Investments and QuadReal for a €750Mn (£670Mn) Private Rented Sector scheme in London:
Unibail-Rodamco-Westfield announces today that it has signed a conditional agreement with a wholly owned subsidiary of the Canadian public pension fund the “Public Sector Pension Investment Board” (PSP Investments) and global real estate company QuadReal Property Group (QuadReal), to form the “Cherry Park Partnership”. The Partnership will deliver the development and management of a €750Mn (£670Mn) Private Rented Sector (PRS) residential scheme, adjacent to Westfield Stratford City in London. It will be one of London’s largest single-site PRS schemes.

PSP Investments and QuadReal will each take a 37.5% share in the Cherry Park Partnership, while Unibail-Rodamco-Westfield will retain a 25% share and be appointed as the development and asset manager.

Olivier Bossard, Group Chief Development Officer, Unibail-Rodamco-Westfield, said: “This new residential quarter in the heart of Stratford City is an example of the Group’s strategy to significantly increase the densification of exceptional and highly connected retail destinations by adding offices, residential, hotels and other uses, where relevant. With the Cherry Park Partnership, we are leveraging our unique know-how and joining with strategic capital partners to reinvent city districts.”

Stéphane Jalbert, Managing Director Europe and Asia Pacific, Real Estate, PSP Investments, added: “London’s residential sector is chronically undersupplied and Cherry Park supports PSP’s broader long-term sectorial strategy to develop professionally managed residential assets alongside best-in-class investment partners. Once completed, this will be one of central London’s largest residential rental schemes and will offer future residents an incredible level of connectivity in an exciting and unique mixed-use location.”

Jay Kwan, Head of Europe, International Real Estate, QuadReal, said: ”This Partnership fits squarely into our investment strategy to densify successful retail destinations alongside world-class development and operating partners. We are excited to launch this new relationship with Unibail-Rodamco-Westfield whilst extending our long-standing and successful relationship with PSP.”

Construction work is set to start in Q2 2019, with a phased completion and a delivery expected post 2023. The Cherry Park Development will feature approximately 1,200 new homes benefitting from a suite of amenities including a residents’ gym, swimming pool, workspace and high-quality public areas.

Completion of the formation of the Cherry Park Partnership is subject to customary conditions precedent.
Unibail-Rodamco-Westfield also put out a press release on this deal:
On March 18, 2019, Unibail-Rodamco-Westfield announced the signing of a conditional agreement with a subsidiary of the Canadian public pension fund PSP Investments and global real estate company QuadReal Property Group, to form the "Cherry Park Partnership".

The Partnership will deliver a €750 Mn (£670 Mn) Private Rented Sector (PRS) residential scheme, adjacent to one of the Group’s London flagship destinations, Westfield Stratford City. It will be one of London's largest single-site PRS schemes. Construction work is set to start in Q2 2019, with a phased completion and a delivery expected post 2023. The Cherry Park Development will feature approximately 1,200 new homes benefitting from a suite of amenities including a residents' gym, swimming pool, workspace and high-quality public areas.

This new residential quarter in the heart of Stratford City is an example of Unibail-Rodamco-Westfield’s strategy to significantly increase the densification of exceptional and highly connected retail destinations by adding offices, residential, hotels and other uses, where relevant. With the Cherry Park Partnership, we are leveraging our unique know-how and joining with strategic capital partners to reinvent city districts.

Learn more about mixed-used projects and our vision of urban development in the URW 2018 Report.
Last week, I discussed BCI's record $7 billion partnership with RBC Global Asset Management and Quadreal Property Group, BCI's real estate subsidiary.

I explained why the deal made sense for everyone, allowing BCI to geographically diversify its real estate holdings outside Canada.

This week we find out BCI's QuadReal and PSP signed a deal with Unibail-Rodamco-Westfield to deliver a €750 Mn (£670 Mn) Private Rented Sector (PRS) residential scheme, one of London's largest single-site PRS schemes.

It's not by accident that PSP and QuadReal teamed up on this deal. Gordon Fyfe, BCI's President and CEO, and Neil Cunningham, PSP's President and CEO, go back years as Neil was the Head of PSP's Real Estate under Gordon's watch.

Neil is an expert in commercial real estate and he has a solid team backing him up at PSP. Gordon set up QuadReal back in 2016, shortly after joining BCI, and that company is headed by Dennis Lopez, a seasoned real estate investment professional with over 30 years of industry experience in real estate acquisition, development, M&A, financing and investment trusts, and someone who has worked in the Americas, Asia and Europe (note his international experience).

Mr. Lopez relies on Jonathan Dubois-Phillips, QuadReal's President of International Real Estate, to focus on the management and expansion of the company’s international assets. Mr. Dubois-Phillips was formerly a Managing Director of Nomura International, one of Asia’s largest Investment Banks, and also worked in a senior role with Lehman Brothers in the Global Real Estate Group where he invested on behalf of the bank and its private equity funds across Asia, as well as in Europe and North America.

Jay Kwan, Head of Europe, International Real Estate at QuadReal reports to Mr. Dubois-Phillips, and this partnership with PSP and Unibail-Rodamco-Westfield to build  London's largest single-site PRS schemes fits perfectly in PSP's and QuadReal's multi-family portfolios.

Interestingly, institutional involvement in the UK's private rented residential property only recently took off due to a long-standing fear of rent control and other reputational concerns related to the ownership of rented residential. Since 1990, the percentage of UK housing stock in the private rented sector has grown from 9% to 19% but mostly due to the growth in the private “Buy to Let” investor.

It's also worth noting that PSP and QuadReal's partner on this deal, Unibail-Rodamco-Westfield, is Europe’s largest property firm and it specializes in shopping centers (click on image):


This shift to a residential (with some retail) is something new for this firm as far as I can tell, but given its track record of success, I wouldn't bet against this deal.

Now, you might be asking, why are these two large Canadian public pensions investing in a huge project in London with all the uncertainty surrounding Brexit?

My answer to this is they're obviously looking way beyond Brexit and no matter what happens, this is a great long-term project.

Brexit or no Brexit, London is the financial capital of Europe and it will remain so. As more and more people will move to live in London, property prices are going to continue going through the roof and young adults and older pensioners will opt to rent (touches on rising inequality theme), so this is a great project over the long run.

Moreover, with the British pound well off its 5-year high relative to the Canadian dollar, and some saying to keep selling it versus the CAD (I don't agree), now is as good a time as ever to take currency risk to invest in this London project (click on image):


If a favorable Brexit deal is struck, these assets will increase in value significantly.

Right now, it looks unlikely the UK will leave the EU on the 29th of March and all indications are that Prime Minister Theresa May is going to ask for a delay.

The situation is one big mess and the EU can't seem to give the UK too much leeway or else its members will reject any deal.

Still, Brexit or no Brexit, London will thrive as a cosmopolitan global city and that's why PSP and BCI's QuadReal invested in this multi-million-pound project.

Interestingly, exactly one month ago, CPPIB signed a partnership with La Française and its shareholder CMNE to develop Grand Paris investment vehicle:
La Française and Canada Pension Plan Investment Board (CPPIB) announce the signing of a strategic partnership for the launch of a real estate investment and development vehicle: Société Foncière et Immobilière du Grand Paris. The joint venture between CPPIB (80%) and Caisse Fédérale du Crédit Mutuel Nord Europe (CMNE) (20%), La Française’s shareholder, will invest in major real estate projects linked to the Grand Paris infrastructure in the Greater Paris area.

Paris, February 15, 2019 - With over C$368 billion in assets under management worldwide, CPPIB continues to expand its investment program and has formed a joint venture with CMNE, La Française’s majority shareholder, to focus on Grand Paris related real estate projects – one of the most significant and prestigious regeneration projects in Europe. The parties will initially allocate €387.5 million in equity to the venture.

With €19 billion in real estate assets under management and over 40 years of investment experience, La Française has seized the real estate investment and community development opportunities offered by the Grand Paris Express transit project over the past several years. Early on, and in order to capture substantial value, the group has positioned itself on several strategic locations that are part of a broader urban regeneration initiative and close to hubs that will be serviced by the Grand Paris Express.

La Française’s expertise and longstanding reputation have enabled Société Foncière et Immobilière du Grand Paris, managed by Guillaume Pasquier, Head of Real Estate Business Development Grand Paris Project, and Anne Génot, CIO, Grand Paris and European Real Estate Business Development Director, to secure two flagship projects: Saint-Denis-Pleyel (mixed use) and Villejuif-Gustave Roussy (office buildings).

“This new partnership in France with a leading real estate manager and investor like La Française and its parent company CMNE allows us to invest in a strategically important development in Paris,” says Andrea Orlandi, Managing Director, Head of Europe, Real Estate Investments at CPPIB. “Through this partnership, we will target regeneration and infrastructure-led investments, and we expect the Grand Paris Express to significantly transform the Greater Paris market over the next decade and beyond. We look forward to growing the venture anchored by the significant development opportunities in Paris and its Grand Paris Express project.”

The joint venture will look to grow the partnership through additional development projects beyond Saint-Denis-Pleyel and Villejuif-Gustave Roussy that are consistent with its overall investment strategy.

“This partnership with a leading institutional investor will enable La Française, with the support of its shareholder, CMNE, to step up its real estate business development and participate, along with other public and private stakeholders, in making Paris a “Global City,” concludes Xavier Lépine, Chairman of La Française Group.
I guess CPPIB isn't too perturbed by Les Gilets Jaunes and the ongoing protests in Paris, they're taking a very long view on this city and rightly so.

I mention this because an astute reader of my blog who is long European shares relative to US sent me a tweet from Callum Thomas, Head of Research at Top Down Charts:



His reasoning is everyone is so bearish on Europe that any good news will propel these stocks higher, much higher, and he may be right but I don't rely on mean reversion to make money in these markets.

Below, Unibail-Rodamco-Westfield's CFO, Jaap Tonckens, spoke to CNBC in August after the firm  reported a jump in first-half profits. Very sharp guy, listen to what he says about retailers bucking the trend and doing well.

Next, following the successful acquisition of Westfield Corporation by Unibail-Rodamco, the new Group has been listed on the 5th June 2018 on Euronext Amsterdam and Euronext Paris. The new Group opened the trading day in both Euronext marketplaces. Christophe Cuvillier, CEO of Unibail-Rodamco-Westfield, opens the trading day in Paris and discusses the merger.

Next, BBC's Newsnight discusses why Brexit has thrown the UK into a constitutional crisis and BB's political correspondent Jonathan Blake explains why it now looks unlikely that the UK will leave the EU on the 29th of March. Like I said, anyway you slice it, Brexit is a complete mess!

Lastly, since I'm talking about real estate, take the time to watch this interview (in French) with the President of Ivanhoé Cambridge, Natalie Palladitcheff, on Gérald Filion's show:



Very impressive lady who along with Daniel Fournier is in charge of one of the most important institutional real estate portfolios in the world.

I was particularly struck by the demographics statistics she cited on India (half the population is younger than 25) and Mexico which explains why the Caisse and others are investing heavily in these emerging markets (but the bulk remains in developed markets).




Monday, March 18, 2019

Wisconsin's Big Public Pension Cheese?

Elizabeth Bauer wrote a comment for Forbes, 'Go North, Young Man,' To The Wisconsin Public Pension System:
To parapharase Horace Greeley in his Manifest Destiny exhortation, but for those seeking out well-funded public pension plans, it's time to go north -- northwards from Illinois, that is, to the greener pastures of the Wisconsin Retirement System.

Let's start with some charts:  first, the funded ratio.  (This and the following charts come from data extracted from PublicPlansData.org, which includes the years 2001 through 2017, as well as the Wisconsin 2017 actuarial report.  For Illinois, the three major public plans for with the state bears funding responsibility are combined and, where applicable, weighted averages calculated; for Wisconsin, the WRS already includes the three categories of state employees, teachers, and university employees, as well as most municipal employees except for those of Milwaukee city and county.)


Yes, that's correct.  The Wisconsin funded ratio hovers at or just barely below 100% for this entire period.  What's more, regular readers will recall that in my analysis of Chicago's main pension plan, I did the math to demonstrate that even if the city had made the contributions as calculated by its actuaries during this time frame, they would have been insufficient to have kept the plan funded, and even so, would have increased dramatically.  Is Wisconsin keeping its plan funded only by means of unsustainably-increasing contributions?  Let's compare (click on image):


To be sure, the scale required for Illinois' contributions makes interpreting Wisconsin's contributions difficult.  For reference, Illinois' contributions increased from $1.4 billion in 2001 to $7.6 billion in 2017, a 450% increase.  Wisconsin's contributions increased from $411 million to $1.0 billion in the same time frame, an increase of 150%.

The Public Plans Data site also provides payroll data, which means we can view change over time in the contributions as a percentage of total payroll.  That's easier seen as a table (click on image).


Finally, the Wisconsin actuaries are not hoodwinking us by means of artificially-high valuation interest rates; during this time period, the weighted-average Illinois discount rate dropped from 8.5% to 7.3% (it is now somewhat lower in the plans' most recent valuations), and the Wisconsin plan's rate was consistently lower, from 8.0% to 7.2%.  (Remember that lower discount rates result in higher liabilities and relatively lower funded ratios.)

So what is the secret sauce to Wisconsin's full funding?

A small piece of the puzzle is the much-restrained growth in benefits during this timeframe:


The much larger piece of the explanation, though, is this:  Wisconsin's public pension system, unique among not just public pensions but among any defined benefit pension in the United States, is designed to share risks between participants and the state, through two key mechanisms.

First, the contribution each year is recalculated as needed to keep the plan properly funded, and that contribution equally split between workers and the state.

Second, unlike Illinois' retirees, who are guaranteed a 3% benefit increase each year, no matter what, Wisconsin's cost-of-living adjustments are dependent on favorable investment returns, and, far more crucially, retirees' benefits are similarly reduced in down years. The gains and losses are smoothed on a five-year basis to reduce the impact any given year, but, despite fears by many retirement experts that, when it comes down to it, plan administrators would chicken out on benefit reductions, in Wisconsin, these benefit reductions really have been applied just as consistently as the benefit increases. What's more, the adjustments take into account not just investment returns but also mortality improvements and other plan experience/assumption impacts.

(For more information, see "Wisconsin's fully funded pension system is one of a kind" from 2016 at the Milwaukee Journal-Sentinel as well as Mary Pat Campbell's analysis on her blog last summer; also, note that the Wisconsin actuarial valuation, as do all plans valued in accordance with actuarial standards of practice, already assumes future improvements in life expectancy over time; benefit adjustments reflect the degree to which actual mortality matches this expected improvement over time.)

Of course, the increasing plan contributions during this time frame, from 4.1% to 7.3% of pay, suggest that it's not all magic.  And as the Journal-Sentinel reports, lawmakers succumbed to the temptation to boost benefits in 1999, and, as Campbell reports, they then resorted to a Pension Obligation Bond and its "beat the stock market" gamble, to fill a budget hole, which, again per the J-S, has worked out in their favor.

Nonetheless, in my article earlier this week on the Aspen Institute's report on non-employer retirement plans, I wrote that they sought the "holy grail of retirement policy" -- risk pooling as a replacement for the risk protection that employer-sponsored retirement plans had formerly provided. If we want to analyze prospects of risk pooling, collective defined contribution, defined ambition -- however we wish to label this sort of plan, there is no better place to start than the Wisconsin Retirement System.
There's no doubt about it, while I'm very worried about most US public pension plans, Wisconsin Retirement System isn't one of them.

Why? As the author states above, they have adopted a shared-risk model, including key elements which have led to the success of Canada's pension titans like conditional inflation protection.

Are they the only one? Apparently not. If you read the comments to this article here, you will read this comment from Keith Brainard:
The Wisconsin Retirement System is a terrific pension plan, but is not unique in sharing risk between employers and employees. In addition to Wisconsin and South Dakota, many other public pension plans also contain risk-sharing arrangements. These arrangements are described in this recent paper: https://bit.ly/2T51HMa and in this short video: https://bit.ly/2F3M8iG
And this one from Doug Fiddler:
See also the South Dakota Retirement System. Very similar concept but different mechanics. Fixed contribution rates (split 50/50 member/employer) and variable benefits (mostly through COLA like Wisconsin) designed to keep plan 100% funded at current assumed 6.5% discount. Full details in winning paper from SOA Retirement Section’s Retirement 20/20 contest at https://www.soa.org/sections/retirement/retirement-landing/

There are some states striving to do what’s right for all stakeholders. They just don’t get the amount of press that plans in crisis get.
Fair point, reporters love to report doom & gloom on state pensions -- and to be sure, most are in dire shape -- but some are doing just fine, having adopted a shared-risk model similar to the ones Canada's successful large public have adopted so they can achieve fully funded status.

Remember, pension plans are all about matching assets with liabilities. You can have the best investment managers in the world but if liabilities start soaring, mainly because rates keep declining, then your pension plan is going to be in trouble.

In terms of investments, the Wisconsin Retirement System's assets are maanged by the State of Wisconsin Investment Board, and by all accounts, they're doing an decent job investing in the Core Fund and the Variable Fund (click on image):


I say decent, not spectacular, because, over a long period, it has basically matched the benchmark, but not added significant added value over the benchmark (it's basically all beta).

What is noteworthy, however, is the SWIB manages 62% of the assets in-house, saving the system over $400 million over the past 10 years (click on image):


I also like how transparent SWIB is in terms of its investments. You can see the full list for calendar year 2017 here, including investment partnerships. It also has public records on board meetings but no videos like CalPERS and CalSTRS.

Anyway, the reason it's important to bring up the Wisconsin Retirement System is that it (and others like South Dakota) are obviously doing something right in terms of maintaining their fully funded status and that something right is adopting a shared risk model.

In an era where defined-benefit (DB) plans are being attacked all over the United States, I think this is the standard all states should aspire to, not the silly things Kentucky and other states are doing or trying to do by cutting DB plans to replace them with cheaper defined-contribution (DC) plans (cheaper is a matter of debate when you add all the long-term costs and DC is definitely not better than DB).

Below, Michael Williamson, the former Executive Director of the State of Wisconsin Investment Board, gave an excellent speech at the Milwaukee Rotary Club in August 2017 before he retired. Listen carefully to what he says about their exceptional funded status, the shared risk model and more.

I also embedded another clip where Michael Williamson and others at SWIB discussed why they chose Citisoft for their technological needs.

Lastly, let me share with you my favorite thing about Milwaukee. Giannis Antetokounmpo, aka the Greek Freak, recorded a career-high 52 points on Sunday (including a career-half-high 35 points in the 2nd half), with 16 rebounds and 7 assists as the 76ers defeated the Bucks in Milwaukee by a final score of 130-125. They lost the game but that dunk over Ben Simmons was priceless!

Update: After reading this comment, Gordon  Hamlin sent me this on WRS's discount rate:
I noticed in your column about Wisconsin that you are relying on the Public Plans Database. Unfortunately, it has Wisconsin's discount rate wrong.  See page 148 of the 2017 CAFR.  http://etf.wi.gov/about/2017-cafr.pdf  WRS uses a discount of 7.2% for active employees and a discount of 5% for retirees, resulting in a blended rate of 5.5%.  I believe that this is unique among American pension plans, and I have brought this error to the attention of the folks at Boston College.  I guess the correction fell through the cracks.
I thank Godon for sharing this information with my readers.



Friday, March 15, 2019

More Bad News For Active Managers?

Fred Imbert of CNBC reports, Dow rises more than 100 points, S&P 500 posts best weekly gain since November:
Stocks posted strong weekly gains, led by tech shares, as investors cheered renewed optimism on the U.S.-China trade front on Friday.

The Dow Jones Industrial Average climbed 138.93 points to 25,848.87 as Boeing shares turned around to close 1.5 percent higher. Boeing’s turnaround was sparked by a report saying the company planned to roll out a software upgrade for its 737 Max aircraft. The stock had been under pressure all week after an Ethiopian Airlines flight using a 737 Max plane crashed on Sunday, which prompted several countries to ground flights involving the plane.

Gains in the tech and consumer discretionary sectors pushed the S&P 500 up 0.5 percent to 2,822.48. Tech shares also bolstered the Nasdaq Composite, which climbed 0.8 percent to 7,688.53.

The S&P 500 and Nasdaq Composite both rose at least 2.9 percent, though the laggard Dow gained only 1.7 percent amid Boeing’s troubles. The S&P 500 also posted its biggest one-week gain since November.

Stocks have been on a tear this year, with the three major indexes rising more than 10 percent each in 2019.

“Coming off the lows in December, we thought that was a volatility event. We thought we could get back to those all-time highs by about late March to early April,” said Craig Callahan, president at Icon Funds. Valuations “still backs up that view.”

This week’s gains were largely led by tech shares, as the sector surged 4.9 percent. The tech sector also became the best-performer of 2019. Nvidia was the best-performing stock in the sector, rising more than 12 percent while fellow semiconductor stocks like Broadcom and Lam Research also rose sharply this week.

Semiconductor shares rose broadly on Friday, as the VanEck Vectors Semiconductor ETF (SMH) climbed 2.7 percent. Broadcom shares led the gains, rising more than 8 percent after the company reported better-than-expected quarterly earnings.

“There’s less of a reason to sell; it’s more of a reason to just sit tight and see which way things go,” said Michael Katz, managing partner at Seven Points Capital. “Everybody is looking for a dip that’s not really coming.”

“Barring any macroeconomic news, any North Korea-related news, any negative news coming out of the China trade deal, I think the momentum is still just holding,” Katz said. “At the same time, [the market] is getting up there.”

Chinese Vice Premier Liu He spoke via telephone with U.S. Treasury Secretary Steven Mnuchin and U.S. Trade Representative Robert Lighthizer, Xinhua news agency reported Friday. The report, according to The South China Morning Post, said: “The two sides have further made concrete progress on the text of the trade agreement between the two sides.”

The news comes after CNBC reported Thursday that Chinese negotiators suggest combining a state visit to the U.S. with the signing of a trade deal. Beijing wants a deal to be fully ironed out before President Xi Jinping meets with U.S. President Donald Trump.

“US-China trade negotiations will likely reach a temporary deal, transforming future negotiations into a framework to monitor China’s compliance with trade and intellectual property policies,” Alberto Gallo, head of macro strategies at Algebris Investments, wrote in a note. He added, however, that “binary events” like this “may not translate into tail risks.”

AT&T shares rose 1.3 percent after Raymond James upgraded the telecommunications giant to outperform from market perform, citing an attractive valuation relative to rival Verizon. “We believe that the combination of positive earnings growth and delivering over the course of the year will being investors back to AT&T,” analyst Frank Louthan said in a note.

Ulta Beauty surged 8.3 percent on the back of better-than-expected quarterly earnings. The company’s same-store sales also rose 9.4 percent, topping an estimate of 7.9 percent.

Tesla shares fell 5 percent after investors were left disappointed with the unveiling of the Model Y, the car company’s latest electric vehicle.
Bob Pisani of CNBC also reports, Now that the market has broken through key resistance, here’s what’s next:
The S&P 500 closed up 2.9 percent for the week, its best so far this year. It’s now at the highest level since early October, after breaking through key resistance levels near 2815, where it failed several times.

The S&P is now less than 4 percent from the old historic closing high (2,930 on September 20).

Key observations:

1) Traders increasingly believe global central banks have their backs.

2) With the CBOE Volatility Index at 12, its lowest level since October, strategies driven by volatility would likely add to stock exposure.

3) Bond yields continue to drop, remaining near the lows of the year. The new-high list this week was littered with interest-rate sensitive stocks (utilities, REITs) that rally when rates remain low.

4) Quadruple witching (quarterly expiration of index options and futures, and stock options and futures) has added a lot of volume this week and likely contributed to the upside rally. But the question is whether the expiration exhaust near term demand. The S&P 500 tends to be lower in the week after quadruple witching.

5) Europe (and the U.K.) have outperformed the U.S. this month. There are some hopes for a bottom in the recent poor economic data.

6) Downward earnings revisions are slowing to a crawl. The rate of downward earnings revision for the first quarter was intense from January into mid-February, slowed in the next several weeks and has essentially stopped this week. First-quarter earnings are now expected to be down 1.5 percent for the S&P 500, according to Refinitiv. If it stays in that range, there is a good chance earnings will be positive for the first quarter (companies tend to beat analyst estimates), and we will avoid an earnings “recession,” at least one that began in the first quarter.

7) The key to a further rally: positive comments on global growth. The two key names next week are Micron and Federal Express, which are both scheduled to report earnings. Both had big drops last quarter and saw lower earnings estimates on concerns over China and (for Micron) increasing competition.
I agree, the key to a further rally is signs of global growth which is why I'm tracking Global M-PMIs and other manufacturing indexes and emerging market stocks (EEM) very closely (click on images):



As you can see, Global M-PMIs are still deteriorating for developed markets but improving for emerging markets. The Emerging Markets ETF just broke above its 50-week moving average which is good news for global growth, as long as it continues. And with the Fed out of the way for now, it should continue.

Nevertheless, looking at the Purchasing Managers Indexes, you see there is weakness in some developed markets (Eurozone, Japan) and the US and UK are decelerating. Among the BRICS, India and Brazil are doing well but Russia and China are weak (click on image):

What we don't know is whether all those rate hikes over the last two years are finally catching up to the real economy, and if so, how extensive the damage will be.

That's why everyone is looking for a confirmation that global growth is picking up, it will give investors a sigh of relief.

It's too early to tell but one thing which is encouraging is the absence of inflation, allowing bond yields to go lower and long bond prices (TLT) to go higher (click on image):


In turn, lower bond yields have helped push the S&P 500 (SPY) higher (click on image):


The breakout in stocks has been nothing short of spectacular which is why at the beginning of the month, I said don't discount the possibility of another bubble, especially if the Fed stays on the sidelines longer than anticipated.

Sure, stocks have entered March madness, it will be volatile especially after quadruple witching, but if stocks keep grinding higher, it could cause all sorts of problems for active fund managers who trail the S&P 500 for the ninth year in a row:
It’s the triumph of indexing: Fund managers continue to trail their benchmarks.

Active managers who claim that they would do better during periods of heightened volatility are going to have to find another argument.

This week, S&P Dow Jones Indices released its annual report on how actively managed funds performed against their benchmarks. The conclusion is that active managers continue to show dismal performance against their passive benchmarks. For the ninth consecutive year, the majority (64.49 percent) of large-cap funds lagged the S&P 500 last year (click on image).

 “The figures highlight that heightened market volatility does not necessarily result in better relative performance for active investing,” the report said.

“What’s different about 2018 was the fourth quarter volatility,” Aye M. Soe, a managing director at S&P and one of the authors of the report, told CNBC. “Active managers claimed that they would outperform during volatility, and it didn’t happen.”

The study will bolster the claims of many financial advisors, who say that investing in low-cost, passive funds remains the soundest long-term investment.

This is not a one-year phenomenon. S&P has been doing this study for 16 years, and the long-term results only strengthen the claims for index investing. Indeed, while a fund manager may outperform for a year or two, the outperformance does not persist. After 10 years, 85 percent of large cap funds underperformed the S&P 500, and after 15 years, nearly 92 percent are trailing the index (click on image).


Long-term, the numbers were not much better in other categories like small-cap stocks or fixed income: “Over long-term horizons, 80 percent or more of active managers across all categories underperformed their respective benchmarks,” the report concluded.

Looking at managers’ overall record last year versus the broader S&P 1500 Composite, 2018 was the fourth-worst year for stock managers since 2001 (click on image).


Critically, the study adjusts for “survivorship bias.” Many funds are liquidated because of poor performance, so the survivors give the appearance the overall group is doing better than it really is.

“The disappearance of funds remains meaningful,” the report notes. Over 15 years, 57 percent of domestic equity funds and 52 percent of all fixed income funds were merged or liquidated.
Unless we see a prolonged bear market, and even then, I just don't see what is going to change US active managers' fortunes.

Picking stocks is a very, very, very difficult game. Very few managers have a long-term stellar track record, and if stocks continue melting up, a lot of active managers worried about career risk are going to jump on the bandwagon or risk underperforming for another year.

Let me end with some US stock market data.

Have a look at the how the S&P sectors performed this week, courtesy of barchart (click on image):


As you can see, all the major sectors were up this week with Technology (XLK), Healthcare (XLV), Energy (XLE) and Financials (XLF) leading the way. Industrials (XLI) were the weakest sector but that was because of Boeing (BA) which got hit hard this week following concerns with its 737 Max planes.

And here are the top-performing US stocks for this past week, courtesy of barchart (click on image):


Once again, small cap biotechs led the way, with incredible action on some of these stocks, like  Atossa Genetics (ATOS) which was up over 300% yesterday and down 50% today but still managed to clinch top spot for the week following an FDA special approval for its breast cancer drug Endoxifen.

Also, here are the top large cap stocks year-to-date, courtesy of barchart (click on image):


No wonder active managers are having a very hard time beating the S&P 500 and why most large global asset allocators are indexing their large cap US exposure.

Below, CNBC's Rick Santelli and David Bailin, Chief Investment Officer at Citi Private Bank discuss the future path of the markets. I agree with Santelli, if rates keep going lower for bad reasons, it will hit stocks hard.

Second, Chief U.S. Economist at J.P. Morgan Michael Feroli discusses why he believe the Fed will not raise interest rates this year. Again, if yields keep going lower for all the wrong reasons, the Fed might cut rates this year.

Third, is a Fed rate cut looming, and what does that say about the economy? With CNBC's Melissa Lee and the Fast Money traders, Steve Grasso, Brian Kelly, Steve Chiavarone and Guy Adami.

Lastly, ECRI's Lakshman Achuthan builds his bearish case on a chart of falling semiconductor shipment demand. If he's right, get ready for a second half global slowdown.