Surprising Strength of Canada's Pension Funds?
Deep in the financial crisis, a Canadian pension fund entrusted with the nest eggs of 17 million workers bet a chunk of that money on Internet phone service Skype, venturing well outside its tradition of long-term, conservative investing.
The investment, made by Canada Pension Plan Investment Board(CPPIB) in partnership with private equity, more than tripled in less than two years and marks the clearest sign to date that Canada's once-staid pension funds have become a huge new force in a globalized market.
Between them, CPPIB and four other big Canadian players control over half a trillion dollars in assets, about the size of the total Swiss economy and more than the $410 billion managed by the Chinese sovereign wealth fund China Investment Corp.
The Canadian investments are large-scale and diversified, with an emphasis on real estate, natural resources and infrastructure projects such as bridges, tunnels and roads.
Large, aggressive and patient, they are pushing into a financing vacuum that neither cash-strapped governments nor private equity alone can fill. Their growing power is a challenge to the world's biggest sovereign wealth funds and it is enabling the Canadians to take on the occasional role of activist investor.
"These are really talented dealmakers now; they're very savvy. It's just not to be confused with some sleepy funds sitting on money. That's not who these folks are," said Scott Petepiece, a New York-based M&A partner at law firm Shearman & Sterling LLP.
"They've become really significant players in the M&A market in the U.S.," he added. "It's a very different world in that respect than it was 20 years ago. ... They're somehow involved in almost every significant 'take-private' deal that happens."
The model - under which funds are run like a business rather than a government agency - was pioneered by Ontario Teachers' Pension Plan in the 1990s. Its approach proved so successful that other Canadian fund managers soon embraced it, recruiting CEOs with experience at the top ranks of Canadian finance, government and business.
"Ten years ago ... we weren't in the inner circle. Central bankers spoke to the banks," said Jim Leech, the chief executive of Ontario Teachers, who came to pension plans after careers in the military and business. "Well, now central bankers speak to the banks and the sovereign wealth funds and the pension plans."
The other factor in the funds' favor is a financial market malaise that resulted in a treasure trove of assets up for sale at a discount.
"For institutions like ours or others who have financial flexibility, these are actually great markets," said Michael Sabia, CEO of Quebec's Caisse de depot et placement. Sabia, one of the French-speaking province's best-known business leaders, previously headed Canada's biggest telecom company, BCE Inc, and helped privatize Canadian National Railway.
In an era of debt-laden cities, states and countries, there is no shortage of parties seeking investors for a highway, office tower or pipeline.
"When governments hit the wall, the opportunities do arise. And they arise particularly in the infrastructure space," said Michael Nobrega, chief executive of OMERS, which manages the funds of Ontario municipal workers.
In fact, pension plans and Chinese sovereign wealth funds are among the few players left with the liquidity to invest big, and the pension funds often have the edge.
"My experience is that they're the preferred players," said John Ilkiw, a pension expert with Paros Consulting and former senior vice president at the CPPIB.
"The larger funds in the world, they would say: 'Here is our short list of people to approach first to be co-investors in this deal,' and right on the top of the list would be GIC out of Singapore, the China fund, Ontario Teachers, probably the Caisse and certainly the CPPIB," Ilkiw said.
The Canadian funds could become even more powerful in the next couple of years. The CPPIB expects to have net assets of C$275 billion by 2020 and over C$1 trillion by 2050.
But nothing lasts forever, and soon they will have to beat off competition from sovereign funds from emerging economies that are racing to build Canadian-caliber investing expertise.
U.S. pension funds are also becoming more aggressive and are looking to the Canadians to model similar investment strategies. If the global economy continues to recover in the aftermath of the financial crisis, there will be fewer fire sales and the danger of overpaying will increase.
For now, however, the Canadians are riding high. While hyperbole has it that half of Manhattan is owned by Chinese investors, Canadian pension funds' purchase of an array of attractive investments around the world has largely remained under the radar.
London's Heathrow Airport, toll roads in Chile, real estate from Manhattan to Sao Paulo, gas pipelines in the United States, water treatment plants in Britain, timberlands in Australia - all are fully or partially owned by pension plans of Canada's teachers, city workers and citizens.
"The UK government is trying to form an infrastructure fund that all the pension plans will contribute to and all they keep saying is: 'How come it's Ontario Teachers that comes in here and buys our water, buys our high-speed rail, buys our airports, buys our gas distribution systems, and you guys, the UK pension funds, don't do anything?'" said Leech of Ontario Teachers.
In deals such as those, the Canadians have a big advantage over China Investment Corp (CIC) and Government of Singapore Investment Corp (GIC), which holds an estimated $300 billion: the perception of political independence.
That is especially true of CIC, given sensitivities about Chinese control of assets considered "strategic" in the West.
The political neutrality of a Canadian buyer - compared with say, a sovereign wealth fund from China or the Middle East - also enhances the appeal of pension plans as European governments look to sell assets.
"They are friendly buyers from a political perspective for these governments, ... a bunch of Ontario Teachers is quite a benign group," said a senior banker at a major Wall Street firm.
The long-term horizon of Canada's pension funds is also preferred by foreign governments and strategic bidders looking to partner up on real estate or infrastructure, the banker noted. "Governments don't like what is considered to be critical infrastructure being bought and sold every 5 to 10 years, it's disruptive," he said.
A second reason for the Canadian inroads is the expertise of the fund's investment teams. CPPIB, Caisse and OMERS have as many as 800 each on staff to find attractive investments, put together bid proposals and close the deals.
In contrast, U.S. funds tend to farm out sometimes huge amounts of capital to external managers because they lack the in-house talent to deploy the money.
"When you have our scale and our advantages, it becomes very efficient to manage it in-house," said Mark Wiseman, executive vice-president, investments, at CPPIB. He cites costs that are "10 to 15 percent" of what it would cost to outsource any given investment to third-party fund managers or investment bankers.
That makes the big Canadian funds more like private-sector teams than stodgy public ones, observers say.
"OMERS, Teachers, CPPIB - they've all developed internal teams that are as good as anybody around the world in terms of assessing a project, pricing it, doing risk analysis," said Keith Ambachtsheer, a pension scholar and adviser on pension design and governance.
But expertise and deep pockets don't mean Canada's top pension funds want to go it alone. Increasingly they are teaming with other funds to leverage their size in so-called club deals that may vault them even higher up the list of dealmakers.
A prime example is the bid to acquire Canada's largest stock market operator by the country's top banks and pension funds - including Caisse, the CPPIB, Ontario Teachers and the Alberta Investment Management Corp, known as AimCo.
The pension funds have been very clear that their investment alongside the banks makes good business sense, and they insist they were not motivated by opposition to a rival proposal from the London Stock Exchange.
FORGED IN CRISIS
The growing dominance of Canadian pension funds arose from the convergence of the global financial crisis and the funds' own disappointing investment returns, which made it hard for them to meet promised benefits while facing a rapidly aging workforce.
One by one, they radically shifted their strategy from investing in public markets - mostly Canadian stocks and bonds - to private investments in global markets, taking large stakes in public companies, private projects and state enterprises in need of capital.
The 2008 financial crisis offered new opportunities. Liquidity was in short supply, banks faced a capital crunch, and pension plans were among the few with no one knocking at their door.
"You have to remember the markets hit a low in March of 2009. Pension plans in general were a different kind of animal because we could bring some stability to the place, to the system," recalled Leech of Ontario Teachers.
CPPIB's Wiseman, a former protege to Leech, nods to the financial crisis as "a nice confluence of events."
"During the financial crisis, the certainty of assets was a material advantage for us vis-a-vis most other capital markets participants, and we were able to enter into transactions, essentially to be a provider of liquidity at a benefit to us - and cost to those we were providing it to - where liquidity was very dear."
In 2010, working with Onex Corp, the CPPIB was involved in the largest private equity deal of the year, the C$5.0 billion ($4.91 billion) leveraged buyout of Tomkins Plc, a British maker of car parts, industrial hoses and bathtubs.
The year before it had a hand in three of the top five private-equity deals, including the largest leveraged buyout, the $4 billion acquisition of IMS Health Inc a provider of prescription drug sales data.
If Canada's pension plans sound proud to have made the inner circle of global power players, they are.
"I had Australians around here the other week. Pick the week, pick the nationality, whether it's Korean, or Singapore. Singapore has been here a few times. Abu Dhabi was here a few weeks ago. Every week there is somebody coming through here saying, 'How do you guys do such and such?'," Leech said.
"When statistics are published that show we earn 10 percent over 20 years and that for the past 10 years we've been the highest absolute return in the world and the highest value added return, people pay attention," he said.
In 2010, the latest year for which figures are available, Ontario Teachers' had a rate of return of 14.3 percent. That compared with returns of 9.8 percent for a benchmark that tracks standard indexes for Canadian and foreign markets in proportion to the fund's asset-mix policy
Two questions will dominate the future: Where will the pension plans invest next, and who might stand in their way?
"Real estate and infrastructure ... those are areas where there is likely to be fire sales occurring by governments, so it is going to provide tremendous opportunity for people who have the liquidity and the cash to step in and buy things at a discount to what they are really worth," said David Service, director of investment consulting at Towers Watson.
Service points to the United States and its struggling cities and states as opportunities, along with Europe. Both have aging infrastructure and a dearth of cash. He also sees opportunities in developing markets.
"That's a whole different kind of project, obviously. It's a much higher risk but potentially higher reward project. Those are going to be there in a big way as well," Service said.
Caisse's Sabia is also likely to look toward building infrastructure in both Europe and emerging markets to match his fund's existing strength in real estate.
"I think we are going to see an interesting wave of infrastructure opportunities in Europe. Why? Because governments have got massive fiscal problems," he said.
At AimCo, the youngest of Canada's major new pension fund administrators, Chief Executive Leo de Bever sees opportunity in complicated fire sales of government assets.
"There are lots of opportunities that will come from the fact that a lot of financing was done by European banks into developing economies, and that is drying up because of all the problems in Europe," said De Bever.
At OMERS, Nobrega looks to Western Europe, where the debt crisis has sidelined competitors, and western Canada, where natural resources from oil to potash are fueling growth.
The CPPIB, which teamed up with a consortium led by Silver Lake to buy its Skype stake for $1.9 billion in September 2009 and then sold it last May for $8.5 billion, is likely to look beyond infrastructure and real estate. With a new office in Hong Kong, its sights are turning to Asia.
"We have about two dozen people in Hong Kong, close to four dozen in our London office. You will continue to see us evolve globally," said Wiseman. "And I think you'll see us continue to hone our skills and our abilities to do complex skills (deals) that play back into those comparative advantages, so we can execute on deals that others can't.
"We never like to lose money, but given our scale ... we can do two or three or four or five Skypes, and if all it takes is a couple of them to work out, we'll do well in the end," he said.
Wiseman would not comment on market speculation that the CPPIB was looking at a potential deal with private equity funds to bid for Internet giant Yahoo Inc.
As proud as they are of their success to date, Canada's big pension funds know others are trying to emulate their strategy, whether by pooling resources and rewriting governance, as in New York City or Britain, or building internal staff to compete on the knowledge side, as in Singapore and China.
"It used to be we had a five-year lead on people. And now we have much shorter leads on people and people can replicate quickly," Leech said. "We've got to stay ahead of the curve."
Ambachtsheer, the adviser on pension design, said the attempt to emulate Canadian success is well under way around the world.
"It is not just Canada anymore," he said ticking off Denmark, Sweden, the Netherlands, Australia, Korea, Brazil and China as nations trying hard to revamp pension traditions and regulations to build a more efficient model.
"There is no secret. We know what the formula is, what you have to do. But to actually implement it turns out to be very challenging. There are lots of barriers to getting it right."
OMERS' Nobrega agreed. He thinks the Canadian headstart in expertise and reputation will keep them the preferred partner for a while to come.
"I think the last thing is that people know we can close a deal," Nobrega said.
Beyond the hoopla, this is a good article because it makes a powerful statement on defined-benefit plans, which in my opinion are way better than defined-contribution plans. They can pool resources, lower fees, take activities internally and invest in top managers around the world in both public and private markets.
And having worked as a senior investment analyst at two of the largest Canadian pension funds - the Caisse and PSP Investments - I know exactly why Canadian pension funds are doing so well. It all boils down to governance. Governments and funds looking to emulate the success of Canadian pension funds should take the time to study the governance model of the Canada Pension Plan Investment Board. Other funds have similar governance which is why they are successful.
Importantly, if you do not pay your pension fund managers properly, appoint independent and qualified board of directors, and align their interests with those of all stakeholders, you will never compete with Canadian pension funds.
Having said that, I do not want to get carried away and tell you Canadian pension fund managers walk on water. They don't. They've made plenty of big mistakes. Earlier this week, I wrote about Goldman's New York story and how the Caisse sold real estate debt at bargain basement prices. Other funds have made big mistakes too and governance is something you have to continuously strive to make better.
Also, the article fails to mention the best defined-benefit pension plan in Canada, the Healthcare of Ontario Pension Plan (HOOPP), which is fully funded, doesn't invest in hedge funds or mega buyout funds, but has managed to deliver the best risk-adjusted returns over the last 10 years, trouncing their peers and remaining fully funded.
And while Canadian pension funds are strong, the Dutch and Nordic pension funds are just as strong, if not better. ABP is a global force to be reckon with. The same with PGGM. Sweden has excellent pension funds. And many US pension funds are competing just fine. One of my favorites is a small public fund in Missouri, MOSERS, run by a great guy called Rick Dahl. I have yet to comment on them (Rick is low key and humble), but they can teach Canadian funds a thing or two on proper governance, especially in terms of transparency and communication (they are the best in this regard).
Below, Bloomberg's Nicole Itano reports on gambling in Italy, the country's third-biggest industry, which is worth 76.1 billion euros annually, according to anti-mafia association Libera. The mafia is now the biggest bank in Italy and it's a shame Italians (and Greeks) are turning to gambling as a pension backup. That's what decades of corruption does. Greece and Italy should study and implement the Canadian pension fund model and so should others around the world.