Caisse Going Direct in Private Equity?

Joshua Franklin of Reuters reports, Canadian pension fund CDPQ wants to be its own private equity investor:
Caisse de depot et placement du Quebec (CDPQ), one of Canada’s biggest public pension funds, has relied on private equity firms to invest in leveraged corporate buyouts. Now it is building its own investing team to depend less on buyout firms as middle men.

Private equity firms buy companies only to sell them a few years down the line for a profit. Their reputation as costcutters eyeing a speedier exit makes some companies more open to consider an investment from a longer-term investor such as CDPQ instead.

“These are interesting (opportunities) because typically these entrepreneurs or corporates didn’t want to partner with standard private equity firms,” Stephane Etroy, CDPQ’s head of private equity, said in an interview.

In recent years, large pension and sovereign wealth funds have teamed up with private equity firms to co-invest in corporate takeovers, in a bid to earn a greater share of profits and reduce their fees. However, private equity firms offer these co-investment opportunities only to their fund investors, known as limited partners.

Investing without the involvement of a private equity firm is still rare, making up only 62 of more than 300 direct deals carried out in 2017 by investors who were not private equity firms, according to the Boston Consulting Group. The majority of these direct deals were co-investments.

CDPQ, which manages almost C$300 billion ($229.2 billion) for retirees in Quebec, now makes two-thirds of private equity investments without the use of external managers.

To be sure, investor demand to get into private equity funds is still outstripping supply, resulting in record fundraising for the industry in 2017.

The resources required for such deals, ranging from sourcing opportunities to industry expertise, mean the option is open only to larger players like blue-chip pension funds and sovereign wealth funds.

“When you think about going direct without sponsors, for us it’s probably more the exception than the rule,” said Simon Marc, head of private equity at PSP Investments, another Canadian pension fund.

“We will do that in situations, typically with entrepreneurs or families, where people are looking for long-term capital and they want to stay away from traditional private equity-type capital,” he added.

CDPQ has much bigger plans for solo investing. The fund is looking to boost its headcount in Singapore - one of its three private equity offices along with London and New York - to more than ten in order to “have critical mass” for direct investing.

“We are looking to hire professionals coming from private equity firms,” Etroy said.
It's been a busy Monday for me trading and tracking public markets but this article is making a big splash on LinkedIn and around the industry so I wanted to address it.

Let me first begin with my bias which is that I'm not too keen on private equity these days so whether or not the Caisse goes purely direct, all it does is extend the maturity of its private investments and maybe allows them to ride out the traditional PE cycle (they still need to value these investments once a year using public and private comparables).

More importantly, unlike infrastructure where the Caisse is doing pioneering work developing a greenfield project with private industry, it's almost impossible, if not impossible, to compete with the big private equity giants in terms of sourcing the best deals from all over the world.

As I've stated plenty of times, the Caisse, CPPIB, OTPP, OMERS and other large Canadian pensions can hire some excellent private equity talent and even pay them competitively but no matter how good they are, they simply can't compete with their counterparts at Apollo, Apax, KKR, Blackstone, TPG, BC Partners, CVC Partners, Permira, Silver Lake and other top private equity funds.

It's nice to have delusions of grandeur but at the end of the day, I remind you of a private conversation I had with CPPIB's former CEO, Mark Wiseman, where I asked him flat out why not do more purely direct deals in private equity and he responded: "I'd love to hire David Bonderman but I can't afford him or other top talent in PE, so in this asset class we will continue doing our fund investments and increasing our co-investments to lower our overall fees."

It's critically important to note that for all the hoopla of taking on private equity funds using their long investment horizon as an advantage, which it is, the fact remains Canada's large pensions will never compete with the large PE funds head on and still desperately need them to make their allocations and return targets in this asset class.

Sure, Canada's large pensions are doing some one-off purely direct private equity deals here and there but this is the exception, not the norm.

What they are all doing is hiring talented individuals like Stephane Etroy featured at the top of this post to do more co-investments, a form of direct investing where the limited partner pays no fees. Canada's large pensions need to hire smart people to evaluate co-investment opportunities as they arise and have a small turnaround time to invest quickly and efficiently.

Another form of direct private equity investments comes when the life of a private equity fund runs out and the fund auctions off a portfolio company to its limited partners (investors) who then take the company on to its books.

But make no mistake, in order to co-invest and have access to these auctions, limited partners still need to invest in private equity funds and pay them big fees.

This is why this passage from the article above is highly misleading:
"CDPQ, which manages almost $300 billion (US$229.2 billion) for retirees in Quebec, now makes two-thirds of private equity investments without the use of external managers."
Really? I know for a FACT that these figures consist primarily of co-investments and auctions which make up two-thirds of the Caisse's private equity investments, so it's simply not true these investments "are without the use of external managers."

You read that passage and think "wow, the Caisse is sourcing two-thirds of its private equity investments” which is completely and utterly false.

Again, don't get me wrong, I'm sure Stephane Etroy is a smart guy and he's going to continue hiring smart people at the Caisse's private equity group. They may even increase their purely direct investments but these deals will be marginal in terms of the overall private equity portfolio.

At the end of the day, whether it's the Caisse or OMERS or ANYONE else, the bulk of private equity investments will be made into fund investments to gain access to co-investments and lower the overall fees. This is in the best interest of Canada's large pensions and their stakeholders.

So, forgive me, I don't want to rain on Stephane Etroy's parade, I actually wish him and his team success in independently sourcing some great private equity deals, but count me as a perennial skeptic when I read that Canada's large pensions are going to compete with PE giants head on.

Bonne chance (good luck) with that approach even if you have some structural advantages (like a longer investment horizon).

Let me end on a sobering note, something which really bugs me about the trigger-happy media in Quebec.

Last week, Francis Vailles of La Presse published an article in French basically lambasting the Caisse and its CEO for increasing the compensation of its employees. The article states that in 2017, total compensation which includes health benefits and long-term bonuses increased by $121 million or 24%.

My reaction? SO WHAT??? Mr. Vailles and the rest of the socialist presstitutes in Quebec should stop publishing sloppy articles on the Caisse and PSP and realize that Canada's pension fund industry is highly competitive and the competition for top talent is fierce.

Importantly, you can't hire civil servants to manage a multi-billion portfolio across public and private markets, you need to pay to hire top talent in order to invest and co-invest with top private equity funds and to do direct deals in infrastructure.

The reality is the Caisse for many years was lagging its large Canadian peers in terms of compensation. When I left the Caisse to go work at PSP in 2003, I got a significant boost in my overall compensation and since Michael Sabia came to power, he has restored order and rectified huge inequities between compensation at the Caisse relative to its largest peers.

And once again, keep in mind that compensation at the Caisse, CPPIB, OMERS, Teachers', PSP and other large Canadian pensions is based first and foremost on long-term performance. Also, when you're opening up offices in London, New York and elsewhere to attract qualified individuals, you need to pay them in local currency and be competitive with the local market.

If you want monkeys running your multi-billion dollar pension funds, pay them monkey salaries and bonuses but be ready to live with the long-term consequences of such shortsighted decisions.

The people working at the Caisse and other large Canadian pension funds have enough stress trying to make money in these crazy markets, they don't need to be criticized for doing their job and getting paid what they rightfully deserve.

If Francis Vailles and other reporters think they can do a better job, by all means, go for it. That experiment failed under the Caisse when Michel Nadeau was running investments and bullying people to pay them peanut salaries and bonuses.

The investment management industry is no different than other industries, you basically get what you pay for, so instead of criticizing pay increases at the Caisse, Mr. Vailles and his fellow reporters here in Quebec should first do their homework and really understand what's behind the increase in compensation.

That's where I come in. I'm a stickler for transparency and paying for real performance, not beating some bogus benchmark over many years.

I used to have hedge fund managers come to me touting their great performance and once I was done grilling them, they shriveled up like little turtles (call it the Leo Kolivakis cold shower process, the more arrogant you are, the greater pleasure I take in totally obliterating you).

Speaking of humility, I do NOT have a monopoly of wisdom and know everything about everything in public and private markets so if you think I'm an idiot and would like to privately lambast me, by all means, feel free to email me at and share your thoughts which I will post here if you want me to.

Below, CNBC contributor Kenny Polcari of O'Neil Securiites and Kevin Caron of Washington Crossing Advisors discuss what is fueling today's stock market losses.

Also Nancy Tengler, Heartland Financial chief investment officer, and David Sowerby, Ancora portfolio manager, discuss Monday's market action.

If you want to understand why Canada's large pensions have been increasingly their allocations to private equity, real estate and infrastructure over the last ten years, shunning public markets, it's because they can't stomach the crazy volatility and prefer to exploit inefficiencies in private markets.

Lastly,  I note that my Long Twitter (TWTR) / Short Facebook (FB) pairs trade finally kicked in this year but I'm not gleeful as I see more pain ahead for these markets which is why I hedge my US equity positions with US long bonds (TLT). Still, there will be bounces and if you're trading these markets, be alert and be nimble, which means sweep the table when you're up.