Caisse Gains 12% in 2014

Ross Marowits of the Canadian Press reports, Caisse de dépôt sees softer stock market ahead after generating 12% return in 2014:
The years-long bull run on equity markets that helped the Caisse de dépôt et placement du Québec generate a 12% return in 2014 is running out of steam and will require careful watching going forward, CEO Michael Sabia said Wednesday.

“We’re certainly not calling for a big correction…but it’s going to be increasingly difficult to replicate the kind of returns that we’ve seen everywhere basically since 2009,” Sabia told reporters in discussing the Quebec pension fund manager’s 2014 results.

That means the Caisse must continue to invest defensively in high quality assets, including real estate and infrastructure that have generated strong returns, he said.

Chief investment officer Roland Lescure said the double-digit returns of the past four to five years will end.

“In the next five years we should expect single-digit returns with double-digit volatility and that requires quality, quality, quality, but also the ability to be opportunistic.”

The large institutional investor said its assets as of Dec. 31, 2014, were $225.9 billion, even though investment return slowed slightly from 13.1% in 2013.

All three of the Caisse’s major asset classes experienced gains, led by equities which had a nearly 14% return as assets rose to $106.9 billion. Inflation-sensitive investments had an 11 per cent return, while fixed-income investments increased 8.4%.

Sabia described the Caisse’s performance as “solid,” considering currency fluctuations, low interest rates and falling oil prices near year-end.

“Despite the volatility, we showed our resilience. We have stayed the course and that’s what counts.”

Its real estate division, Ivanhoe Cambridge, completed a record number of transactions in 2014 as shifted focused from hotels to multi-residential and logistics properties. It made acquisitions valued at $5.1 billion and sold properties worth $8.6 billion, including 21 hotels.

The division generated $2.1 billion of net investments in 2014 as its assets grew to $22.9 billion.

The Caisse’s infrastructure portfolio has more than doubled in four years to $10.1 billion, including $1.3 billion invested in 2014, when it enjoyed a 13.2% annual return.

Sabia expects new investments will more than double the infrastructure portfolio again in the next few years as the Caisse creates a new subsidiary that will fund and build projects in Quebec and chase opportunities in the United States and elsewhere abroad.

“It is probably fair to say our No. 1 global priority is to substantially expand our infrastructure presence in the United States, where we think the needs are great,” he said.

The Caisse invested $2.5 billion in Quebec companies last year and more than $11 billion over four years, pushing its assets in the province to $60 billion.

However, it shifted five per cent of its Canadian exposure to other markets to capitalize on global growth. More than 47% of its investments are outside the country.

Meanwhile, Sabia said the Caisse continues to have faith in two troubled Quebec companies — SNC-Lavalin (TSX:SNC) which faces bribery and corruption charges, and Bombardier (TSX:BBD.B) which is seeking new liquidity.

Sabia said SNC-Lavalin has made big ethics changes and is not the same company it was a few years ago. The Caisse has maintained its level of investment in the embattled engineering firm at about 10%.

The Caisse also took advantage of Bombardier’s recent nearly $1-billion equity offering to increase its $271-million stake in the airplane and rail equipment manufacturer, but didn’t say by how much.
Nicolas Van Praet of the Globe and Mail also reports, Caisse eyes ‘substantial infrastructure opportunities’ in the U.S.:
Caisse de dépôt et placement du Québec has already helped Canadian investors become the single largest foreign buyer of U.S. commercial real estate since 2010.

Now, the Caisse has its eye on another big bet south of the border: infrastructure, from airports to bridges.

Canada’s second-largest pension fund is aiming to double its current $10-billion infrastructure portfolio over four years and believes a significant portion of that growth will come from the United States.

“We think there are very, very substantial infrastructure opportunities in the United States,” chief executive Michael Sabia told reporters in discussing the pension fund’s 12-per-cent return for 2014. “In geographic terms, this would be priority one.”

As part of a transformative deal announced last month with Quebec giving the Caisse new powers to develop major infrastructure projects in the province, the pension fund is carving out a new subsidiary to handle such investments. It hopes to parlay the Quebec model, based on easing the financial load on government, to other parts of the world.

The Caisse has slowly been ramping up its infrastructure exposure in the U.S. Recent investments include a $600-million commitment for a roughly 30-per-cent stake in electricity supplier Indianopolis Power & Light Co. It also holds a 16-per-cent interest in U.S. petroleum pipeline Colonial and is said to be among a group being solicited to bid for natural gas pipeline operator Southern Star Central Corp.

But, ever searching for investments that generate long-term stable cash-flow, it wants more.

“There is a significant demand and need for infrastructure investment in the U.S., in particular in the transport sector,” said Macky Tall, who leads the Caisse’s infrastructure business. “Many roads and bridges are in need of being repaired and renewed.”

Despite the historic reluctance of the U.S. government to open up the country’s physical assets to private investors such as the Caisse, President Barack Obama’s administration has recently shown more openness in light of the strained finances of many state governments. As U.S. Transportation Secretary Anthony Fox said last year in announcing the Build America Investment Initiative: “The reality is we have trillions of dollars internationally on the sidelines that are not being put to work.”

Mr. Sabia has been executing a strategy of boosting investments in tangible assets such as real estate and infrastructure while focusing on public equities it sees as high-quality and less risk. The aim is to generate even and predictable results at a time when equity markets remain erratic and low yields are expected to continue in bond markets.

Last year’s 12-per-cent return was powered by strong gains in U.S. stock holdings. The Caisse’s global equity portfolio in particular, which invests in large-cap companies, returned 18.5 per cent as those multinationals tapped into growth in the U.S. consumer market and the economy in general.

Asked if public equity markets are overheated, Mr. Sabia noted that efforts companies have made on cost-cutting have fuelled an improvement in corporate profits of late. He said that can’t continue forever and that companies will need to generate revenue growth eventually.

“We’re not calling for a big correction in the markets,” Mr. Sabia said. “Our sense of this is, yeah the elastic is stretched pretty tight. And we’re very conscious of that. That doesn’t lead us to believe things are going to snap tomorrow. But we’re very vigilant about it.”

With a stake of about 10 per cent, the Caisse remains a major investor in SNC-Lavalin Group Inc. Mr. Sabia said the pension fund continues to back the engineering company’s efforts to win new business and put its ethics scandal behind it, even in light of new corruption charges laid by the RCMP last week.

“The fact that we haven’t changed our position, I think, speaks clearly about what we think about the current situation,” Mr. Sabia said.

Returns over the past four years under Mr. Sabia’s watch have totalled 9.6 per cent. His five-year term as CEO was extended in 2013.
Third, Ben Dummett of the Wall Street Journal reports gains in U.S. stocks helped the Caisse generate a 12% return:
Canada’s second-largest pension fund said it generated a 12% return last year, led by gains in U.S. stocks, eclipsing the fund’s internal benchmark by a small margin.

But Caisse de dépôt et placement du Québec isn’t convinced the strong run in U.S. equities will continue this year, citing stretched valuations.

The Quebec pension fund said net assets totaled 225.9 billion Canadian dollars ($180.8 billion) at the end of December, up from about C$200 billion at the end of 2013. That placed the fund, which manages pension money for much of Quebec’s workforce, behind CPP Investment Board, which had C$238.8 billion of assets under management at the end of December.

Caisse’s 12% return also edged out a 11.4% gain in the fund’s benchmark. Canadian pension funds typically measure themselves against an in-house index to reflect the diversity of public and private asset classes in which they invest.

The latest results come as the fund has moved away from investments that mirror benchmark indexes in favor of focusing more on concentrated portfolios of public and private holdings that are meant to generate steady returns. The goal is to reduce the fund’s exposure to market volatility while take better advantage of global economic growth.

“A big part of the strategy…is to be able to outperform on the downside,” something Caisse hasn’t managed well historically, Chief Executive Michael Sabia said in a phone interview.

Caisse’s public and private-equity holdings generated the biggest return among its investments, gaining 13.9% compared with 12% for the benchmark. Within that group, U.S. equities fared the best, posting a 24% return as major U.S. stock indexes rose amid growing confidence in the U.S. economy.

The weaker Canadian dollar measured against its U.S. counterpart would have also helped boost the pension fund’s U.S. equity returns after converting the U.S. dollar gains back into Canadian currency.

But the fund is more leery of the outlook for U.S. equities since stock valuations relative to corporate earnings growth are near record highs.

“The market is suddenly more vulnerable than it has been,” Roland Lescure, the fund’s chief investment officer, said in the same phone interview.

Caisse also splits its assets among fixed income and so-called inflation-sensitive investments, including real estate, infrastructure and real return bonds. The fixed-income portfolio performed largely in line with its index, but inflation-sensitive investments led by infrastructure holdings underperformed.

Infrastructure holdings, which appeal to pension funds because of the steady income they generate, also lagged behind Caisse’s benchmark over the last four years.

Caisse said its infrastructure return for 2014 exceeded its long-term target. The pension fund measures its infrastructure holdings against a benchmark of 60 public securities even though many of its infrastructure holdings aren’t listed on a stock exchange, making an accurate comparison more difficult.

According to the fund, 75% of the index’s four-year return stemmed from rising equity markets, while dividend income generated by the index-member companies accounted for 25% of the benchmark’s return.

“The Caisse will continue to make significant investments in infrastructure, particularly in Québec, the United States and in growth markets,” the pension fund said in a statement. “This asset class is central to its investment strategy, especially in an environment of low interest rates and greater volatility in the equity markets.”
Finally, Scott Deveau of Bloomberg reports, Caisse's Sabia Says Stock Markets Will `Run Out of Gas':
The double-digit gains global stock markets have experienced in the past few years can’t continue much longer, and more modest gains are in store, said Michael Sabia, the head of Canada’s second-largest pension fund.

“It’s going to run out of gas,” said Sabia, chief executive of the Caisse de Depot et placement du Quebec, in an interview in Montreal.

The Caisse has benefited from the run-up in stock prices, in particular in the U.S., coming out of the recession. The Montreal-based pension fund posted an overall return of 12 percent in 2014 on its investments, fueled by an increase in its equities portfolio. Over the past five years, its overall return on its investments has averaged 10.4 percent annually.

Sabia said a more realistic annual return would be in the single digits once the public equity markets cool, although he cautioned he didn’t know when that will be.

The bulk of gains in corporate profitability, in particular among U.S. multinationals, have come from cost cuts, he said. Companies will have to boost sales too, for the Standard & Poor’s 500 Index to continue rising.

The Caisse isn’t forecasting a massive correction. Instead, single-digit returns are a more likely scenario, he said. The fund had C$225.9 billion ($182 billion) in total assets at the end of 2014, compared with C$200 billion a year earlier.

Quebec Retirement

The pension fund, which oversees the retirement savings of those living in Quebec, is a prominent investor in infrastructure, real estate, public and private equity worldwide. The fund is looking to diversify its portfolio globally and will pursue opportunities in the U.S., Australia, and Mexico, Sabia said. It will also be exploring some opportunities in India and Europe.

The Caisse has shifted about 5 percent of its exposure in Canada to other markets in the past four years and currently has about about C$117 billion, or 47 percent of its investments, outside of the country. That’s up from C$72 billion in 2010.

Sabia also took the opportunity to defend two embattled Quebec companies the Caisse is currently invested in: SNC-Lavalin Group Inc. and Bombardier Inc.

The Caisse is SNC-Lavalin’s largest shareholder with about 10 percent of its outstanding common shares. SNC-Lavalin was charged last week with attempted bribery and fraud related to construction projects in Libya and said it would vigorously defend itself against the charges, which it said involved employees who left “long ago.”

Governance Changes

SNC-Lavalin has made great strides in corporate governance as it moves to distance itself from a scandal over improper payments that led to the departure of its former CEO Pierre Duhaime three years ago, Sabia said. The Caisse has not altered its investment in SNC-Lavalin after the last charges and supports the board’s efforts to improve its governance.

“The SNC-Lavalin today is not the SNC-Lavalin of five or six years ago,” he said.

Bombardier issued C$938 million in new equity last week to help cover the cost overruns of its CSeries jet program. The Caisse participated nominally in the raise, just a “top up” of its existing investment, Sabia said.

It will also consider investing in whatever debt offering the company might consider, he said.

“They managed to do a pretty big equity offering. Given that and whatever debt they’re going to do, they’re going to come out of this period with a dramatically changed balance sheet,” Sabia said. “I think the runway is there for them.”
You can gain more insights on the Caisse's 2014 results by going directly on their website here. In particular, the Caisse provides fact sheets on the following broad asset classes:
Keep in mind that unlike other major Canadian pension funds, the Caisse has a dual mandate to promote economic activity in Quebec as well as maximizing returns for its depositors.

In fact, the recent deal to handle Quebec's infrastructure needs is part of this dual mandate. Some have criticized the deal, questioning whether the Caisse can make money on public transit, but this very well might be a model they can export elsewhere, especially in the United States where CBS 60 Minutes reports infrastructure is falling apart.

Whether or not the Caisse will be successful in exporting this infrastructure model to the United States remains to be seen but if you follow the wise advice of Nobel laureate Michael Spence on why the world needs better public investments, public pensions investing in infrastructure could very well be the answer to a growing and disturbing jobs crisis plaguing the developed world.

As far as the overall results, they were definitely solid, with all portfolios contributing to the overall net investment of $23.77 billion (click on image below):

Of course, what really matters is value-added over benchmarks. After all, this is why we pay Canadian pension fund managers big bucks (some a lot more than others). 

In fact, in its press release, the Caisse states in no uncertain terms:
"[its] investment strategy centers on an absolute return approach in which investment portfolios are built on strong convictions, irrespective of benchmark indices. These indices are only used ex post, to measure the portfolios’ performance. The approach is based on active management and rigorous, fundamental analysis of potential investments."
I've already discussed life after benchmarks at the Caisse. So how did their active management stack up? For the overall portfolio, the 12% return edged out the fund's benchmark which delivered an 11.4% gain, adding 60 basis points of value-added last year (do not know the four year figure).

Below, I provide you with the highlights of the three main broad asset classes with a breakdown of individual portfolios (click on each image to read the highlights):

Fixed Income:



Some quick points to consider just looking at these highlights:
  • Declining rates helped the Fixed Income group generate strong returns in 2014 but clearly the value-added is waning. In 2014, Fixed Income returned 8.4%, 10 basis points under its benchmark which gained 8.5%. Over the past four years, the results are better, with Fixed Income gaining 5.6%, 70 basis points over its benchmark which gained 4.9%. Real estate debt was the best performing portfolio in Fixed Income over the last year and four years but on a dollar basis, its not significant enough to add to the overall gains in Fixed Income.
  • There were solid gains in Inflation-Sensitive assets but notice that both Real Estate and Infrastructure underperformed their respective benchmarks in 2014 and the last four years, which means there was no value-added from these asset classes. The returns of Infrastructure are particularly bad relative to its benchmark but in my opinion, this reflects a problem with the benchmark of Infrastructure as there is way too much beta and perhaps too high of an additional spread to reflect the illiquid nature and leverage used in these assets. More details on the Caisse's benchmarks are available on page 20 of the 2013 Annual Report (the 2014 Annual Report will be available in April).
  • In Equities, Private Equity also slightly underperformed its benchmark over the last year and last four years, but again this reflects strong gains in public equities and perhaps the spread to adjust for leverage and illiquidity. U.S Equity led the gains in Equities in 2014 but the Caisse indexes this portfolio (following the 2008 crisis) so there was no value-added there, it's strictly beta. However, there were strong gains in the Global Quality Equity as well as Canadian Equity portfolios relative to their benchmarks in 2014 and over the last four years, contributing to the overall value-added.
If you read this, you might be confused. The Caisse's strategy is to shift more of its assets into real estate, private equity and infrastructure and yet there is no value-added there, which is troubling if you just read the headline figures without digging deeper into what makes up the benchmarks of these private market asset classes.

The irony, of course, is that the Caisse is increasingly shifting assets in private markets but most of the value-added over its benchmarks is coming from public markets, especially public equities.

But this is to be expected when stock markets are surging higher. And as a friend of mine reminded me: "It about time they produced value-added in Public Equities. For years, they were underperforming and so they came up with this Global Quality Equity portfolio to create value."

Also, keep in mind private markets are generating solid returns and as I recently noted in my comment on why Canadian pensions are snapping up real estate:
... in my opinion the Caisse's real estate division, Ivanhoé Cambridge, is by far the best real estate investment management outfit in Canada. There are excellent teams elsewhere too, like PSP Investments, but Ivanhoe has done a tremendous job investing directly in real estate and they have been very selective, even in the United States where they really scrutinize their deals carefully and aren't shy of walking away if the deal is too pricey.

Below, Michael Sabia, CEO of the Caisse, discusses the Caisse's 2014 results with TVA's Pierre Bruneau (in French). Michael also appeared on RDI Économie last night where he was interviewed by Gérald Filion. You can view that interview here and you can read Filion's blog comment here (in French).

Also, some food for thought for the Caisse's real estate team. A new report from Zillow shows that rents across the U.S. are increasing, and not just in the expected regions of New York City, San Francisco and Boston. Overall, rents increased 3.3% year-over-year as of January. But many cities outpaced that, including Kansas City, which saw rent grow more than double the national average, jumping 8.5% year-over-year. St. Louis saw rent increase by 4.5% over the same period. Rents in Detroit grew by 5.0% and rents in Cleveland grew by 4.2%.

Zillow CEO Spencer Rascoff explains the U.S. rental market following the housing crisis: "All of a sudden, there were 5 million new renters and the rental stock didn't increase." People can't afford new homes so pensions should be focusing on multi-family commercial real estate and not just in prime markets. The Caisse is already betting big on multi-family real estate.