CPPIB Hedging For Choppy Markets?

John Greenwood of the National Post reports, Choppy markets hit Canada Pension Plan:

The Canada Pension Plan Investment Board ended the first quarter with a loss on invested assets of $1.7-billion, or 1.3%, amid tumbling equity markets and rising concern around European sovereign debt.

However, the negative investment result was offset by $3.8-billion of member contributions, allowing Canada’s second biggest pension fund manager to post a modest $2.1-billion bottom line gain compared with the previous quarter.

That brought total assets under administration to $129.7-billion for the three months ended June 30, an increase of 1.7%.

“This was a challenging quarter for public equity markets around the world, many of which experienced double-digit declines,” said David Denison, chief executive of the CPP Investment Board.

Since April of 2009 when the financial crisis began to abate the CPPIB has chalked up a string of successful quarters so the latest result raises further questions about the strength of the global recovery.

The CPPIB has about 54% of its assets invested in public equities, 32% in fixed income and the remainder in what it calls “inflation sensitive assets.”

Because of its heavy exposure to stocks, the fund hammered by the downturn in May and June.

“Public equity markets were all down on a global basis,” Mr. Denison said in an interview.

The fund was also affected by continuing uncertainty in credit markets, and Mr. Denison predicted that will continue.

“Credit markets are far from stable and what we’ve seen over the past 12 or 18 months periods where they firm up and it’s a little easier for us as an investor to... access financing, and then we see periods where the credit markets become quite unstable again, and that’s what we’re pointing out. When it’s unpredictable how firm those credit markets will be, it makes it quite challenging to do the kind of private investing that we do.”

On a positive note, because of its size the CPPIB has better access to credit than many of its competitors especially in commercial real estate, which allowed the fund to take advantage of several major opportunities in the United States and Britain.

“We are very pleased with the progress we have made [in commercial real estate],” Mr. Denison said. “We are happy that after looking for five years at properties in Manhattan, countless properties, we just completed two very good transactions in the last quarter, and we think there will be more to come. In the U.S. market generally, we think prices have settled at a level that makes sense to us.”

And prices could go even lower over the next 24 months as property owners seek to refinance their mortgages.

“Inevitably we think there are going to be some sales, quite a volume of sales,” he said. “We think there will be attractive transactions over the next 24 months, not just here [but in United Kingdom and Europe as well].”

Another investing area the CPPIB is involved in is lending to companies, known as private debt.

As even blue-chip companies found it more difficult to access credit in the wake of the financial crisis, the CPPIB has been quietly approaching potential borrowers and has so far invested $2.2-billion in private debt deals.

“We are focused on good, solid [corporate borrowers],” Mr. Denison said, adding that the money might be needed for anything from refinancing existing debt to making new acquisitions.

“We are at a stage in the credit cycle where we think we get quite well compensated for providing that financing,” he said.

Bloomberg provides more details on why Mr. Denison sees "good pricing" for Manhattan real estate:
Canada Pension Plan Investment Board Chief Executive Officer David Denison said he expects to complete more commercial real estate transactions after the fund made its first investment in the Manhattan market.

Canada’s second-biggest manager of retirement funds agreed in May to buy a 45 percent stake in 1221 Avenue of the Americas from SL Green Realty Corp. for about $576 million including debt. It also worked with SL Green to buy a 45 percent stake in 600 Lexington Ave. for about $87 million.

“We’ve looked at Manhattan for five years; I’ve lost track of how many building opportunities we’ve looked at,” Denison said today in a telephone interview. “We’ve never felt that the pricing was sensible for that market. Now we’re starting to see some very good pricing in Manhattan.”

Denison, whose pension fund today posted a 1.3 percent decline on investments in the fiscal first quarter, said the outlook for real estate transactions is “quite good” for the next year to 18 months.

Canada Pension Plan Investment Board also said it will continue investing in emerging markets, such as India, China and Brazil.

“We see that as an important area of focus for our fund,” Denison said. “They’re important markets for us to be involved with, learning, putting some capital to work.”

The investment board lost C$1.7 billion ($1.63 billion) in the quarter ended June 30, the Toronto-based manager said today in a statement. A drop in government stimulus efforts and higher “concern about economic conditions in Europe” led to declines in global stock markets, the fund said. Canada’s benchmark Standard & Poor’s/TSX Composite Index declined 6.2 percent in the quarter.

Credit Markets

Denison said challenges in international credit markets will hamper the manager’s ability to complete private-asset transactions.

Canada Pension last month offered A$3.47 billion ($3.2 billion) for Intoll Group, an Australian toll-road operator. The fund and Onex Corp. also agreed last month to buy auto parts firm Tomkins Plc. for about $4.5 billion.

The fund, which includes investment earnings and contributions not needed to pay current pensions, had C$129.7 billion in assets at the end of June. That’s up from C$127.6 billion at the end of March. The fund, which manages pensions for 17 million people in Canada, returned 15 percent last fiscal year.

And Janet McFarland of the Globe & Mail reports, CPPIB gets into the lending business:

When Canada Pension Plan Investment Board chief executive officer David Denison saw credit drying up in 2008, he decided to try a new investment strategy: Becoming a lender.

In the 18 months since first dipping a toe into the financing market, the $130-billion pension giant has become a large provider of private debt financing to large companies, increasing its lending portfolio to $2.2-billion and creating an internal team to manage the business.

Mr. Denison said CPPIB decided the high borrowing costs being charged by lenders during the financial downturn presented an attractive incentive to get into the same line of business. And with ample cash rolling in from Canada Pension Plan members, the CPPIB isn’t facing any cash or credit constraints of its own.

“In an environment where financing is generally difficult to come by, that’s a very good opportunity for us to be a provider of debt financing to companies,” Mr. Denison said in an interview Wednesday.

The shift means CPPIB is plugging a hole left by traditional lenders who have been shying away from deal financings or are demanding tougher terms for their participation. A deal last November – where CPPIB provided financing for a leveraged buyout of Northrop Grumman Corp.’s TASC division by General Atlantic LLC and Kohlberg Kravis Roberts & Co. – was hailed as a sign the acquisitions market was again open to buyout firms after a two-year hiatus.

While there were times in the past when providers of financing were earning little, Mr. Denison said the situation has reversed for lenders.

“If you go back to 2007 or early 2008, that was perhaps the most compelling example where providing debt, on a risk-adjusted return basis, you were not getting paid,” he said. “Right now, providing debt on a risk-adjusted basis, we think that the spreads are very good – compelling, quite frankly.”

Deals so far have been spread across the energy, power, chemical, industrial, health care and aerospace industries, and include term loans, high-yield bonds, mezzanine and other types of debt financing.

Most of the CPPIB’s activity has been in North America and Europe. Deals include a $150-million loan last year to Montreal-based Osisko Mining Corp., as well as the Northrup Grumman loan.

Mr. Denison said there is no target for the size of CPPIB’s private debt portfolio, but the lending will continue as long as current credit conditions persist.

“When the credit conditions aren’t as good, we’re not going to be investing. We don’t feel compelled to put capital into that area of the market.”

A turnaround isn’t likely to come soon, however.

Mr. Denison predicts credit issues will be constrained for the rest of CPPIB’s fiscal year, which ends next March 31. One result is that the fund’s own private equity purchases remain difficult to complete.

Many of CPPIB’s biggest deals are done with partners or with larger investment groups, and those players are still finding it difficult to get financing for deals, he said.

“Where we’re acting with partners, their business models aren’t the same as ours, and they don’t have the same ability to look at transactions in quite the way we do,” Mr. Denison said. “And many of our transactions are going to be with partners.”

The fund reported Wednesday that it posted a 1.3-per-cent investment loss in its fiscal first quarter ended June 30, owing to a decline in global stock markets.

The value of the fund’s assets rose to $129.7-billion from $127.6-billion, however, thanks to $3.8-billion in new contributions from plan members, which offset a $1.7-billion loss on investments.

The losses came as the S&P/TSX composite index fell 6.2 per cent in the three-month period, while the S&P 500 index fell 11.9 per cent. Equities represent about 54 per cent of the CPPIB’s investment portfolio.

A recent pension fund survey by Morneau Sobeco found pension funds averaged a loss of 3.4 per cent in the quarter ended June 30, ending a rally that started in the second quarter last year.

Interestingly, more pension funds are getting into the lending business. Reuters reports that Mexican private pension funds are on track to more than double their investment in private equity this year after placing roughly $460 million with real estate and debt funds this month:

The 14 pension funds, known as Afores, may allocate 8 percent of their roughly $100 billion in assets to "capital development certificates," or CKDs, which regulators conceived last year as a way for the Afores to make private equity bets.

The Afores purchased about $1 billion worth of the new certificates through a handful of deals in 2009, but dozens of private equity projects are being considered as the pension funds seek to boost returns.

In August alone, Mexican airport magnate Fernando Chico Pardo raised $200 million to finance his private equity fund, Promecap, while AMB Property Corp launched a real estate fund with $260 million of pension cash.

Promecap will use the bulk of its money to soak up risky corporate debt and other distressed financial assets, while AMB is expected to bankroll warehouses, distribution hubs, and other industrial real estate.

Mexican President Felipe Calderon wants the Afores to give a capital injection to roads, ports and other infrastructure projects while meeting the growing needs of an aging population.

About 65 percent of Afore holdings are in ultra-safe government debt that cannot deliver the long-term returns that officials hope to see.

The search for higher yields continues, and pensions are responding by getting more into property and debt investments, filling a market gap that exists as credit markets remain in a fragile state and banks focus more on trading than lending.

I hope Warren Buffett is right, betting on inflation, because if Gary Shilling's prediction comes true, and chronic deflation hits us, then a lot of pension funds are going to suffer devastating losses (watch interview below).