BCI Gains 9% in Fiscal 2018

The British Columbia Investment Management Corporation (BCI) announced its fiscal year results for 2017-18 yesterday, BCI Reports 9.0% Annual Return For Fiscal 2018:
The British Columbia Investment Management Corporation (BCI) today announced an annual combined pension return, net of costs, of 9.0 per cent for the fiscal year ended March 31, 2018, versus a combined market benchmark of 7.4 per cent. This generated $1.9 billion in added value for BCI’s pension plan clients.

A key contributor was the outperformance of global equities relative to their benchmark. Strong performance in illiquid asset investments also provided value-add — infrastructure, private equity, and renewable resources outperformed for the calendar year and delivered above-benchmark returns.

As pension plans have long-term financial obligations, BCI focuses on generating long-term client wealth while protecting the value of the funds. Returns are important — for every $100 a pension plan member receives in retirement benefits, on average $75 is provided by BCI’s investment activity. Over the five-year period, the annualized return was 9.9 per cent against a benchmark of 8.7 per cent, adding $5.8 billion in value. For the 10-year period, the annualized return was 7.4 per cent against a benchmark of 6.8 per cent. BCI added $6.6 billion in value over this period.

BCI began our transformation of the investment strategy and business model in 2015. Now three years into the transition from a more passive investment model, that was historically able to generate the necessary returns, to an active in-house model with a greater probability of sustained long-term performance, the shift is positioning us to continue to deliver meaningful financial futures for our clients over the longer term.

“BCI has a proud history of investing for British Columbia’s public sector,” said Gordon J. Fyfe, BCI’s Chief Executive Officer and Chief Investment Officer. “Our transformation to an active in-house asset manager, diversifying globally and with a focus on illiquid investments, ensures that we continue to provide the returns our clients need.”

Fiscal 2018 Highlights
  • Committed $11.5 billion to illiquid assets — infrastructure, mortgages, private equity, real estate, and renewable resources. Notable direct investments included: Hayfin Capital Management LLP, Refresco Group N.V., Nova Transportadora do Sudeste (NTS), and Endeavour Energy.
  • Increased internally managed assets to 73.3 per cent from 63.5 per cent the previous year.
  • Launched quantitative active funds for Canadian and global securities.
  • Continued the transfer of property and asset management of real estate investments from BCI’s former external property managers to QuadReal Property Group.
  • Expanded the team to a total of 413 employees and added expertise in portfolio management, asset management, risk management, information technology, investment operations, and finance.
BCI’s operating costs were 29.6 cents per $100 of net assets under management; compared to 24.2 cents in fiscal 2017. Costs incurred on our behalf by third parties and netted against investment returns are not included in operating costs. By increasing the percentage of assets managed by BCI’s investment professionals, we are transitioning from a reliance on third parties to a more cost-effective model of managing our clients’ illiquid assets. We realize the benefits of the transformation to an in-house asset manager using sophisticated investment strategies and tools, and BCI continues to build our global reputation as world-class investment manager — increasing our access to high-quality opportunities.

In fiscal 2018, BCI increased managed net assets to $145.6 billion, an increase of $10.1 billion from the previous year. BCI’s asset mix as at March 31, 2018 was as follows: Public Equities (44.3 per cent or $64.6 billion); Fixed Income (21.8 per cent or $31.7 billion); Real Estate (14.4 per cent or $21.0 billion); Infrastructure (8.0 per cent or $11.6 billion); Private Equity (7.1 per cent or $10.3 billion); Mortgages (2.5 per cent or $3.6 billion); Renewable Resources (1.8 per cent or $2.6 billion); and Other Strategies (0.1 per cent or $0.2 billion). BCI’s 2017–2018 Corporate Annual Report is available on our website at www.bci.ca.
I would love to bring you news articles on BCI's fiscal year results but as you can see here, there are none as of now excpt for this from Benefits Canada which appeared late today.

Anyway, let me turn my attention to BCI's fiscal year results. The first thing you need to do is download and carefully read BCI's Corporate Annual Report 2017-18 which is available here.

The annual report is excellent and provides all the necessary information. I also like BCI's new website which is infinitely better than the old one (about time they revamped it) and is easy to navigate. You can find everything you're looking for including pictures and bios of the executive management team.

I strongly urge everyone to at the very least read the message from the Chair, Peter Milburn, which is on pages 4-5 of the annual report.  Then read the CEO/ CIO's report which is on pages 6-8.

I note the following from BCI's Chair Peter Milburn:
Today, about 66 per cent of our clients’ assets are invested in fixed income and public equites and we are operating in markets with different conditions. Over the last three years, expected returns for fixed income have declined by 0.4 per cent and 1.2 per cent for public equities. As we can no longer generate the returns from the public markets with the same confidence, our clients are increasing their exposure to private markets. And to support our clients’ asset mix allocations, BCI is transitioning to an active asset management model.

By comparison, an active asset management model is more dependent on skills and expertise than a passive investment model. As an active manager, our investment professionals’ focus shifts to identifying inefficiencies and value creation opportunities within the public and private markets. In-house investment research, sector knowledge and risk analysis, combined with an agile and decisive team, allows BCI to use their scale to our clients’ advantage by taking bigger equity positions in stable companies, negotiating better terms with business partners, moving swiftly in bidding and closing on transactions, and offering our clients more sophisticated investment vehicles such as derivatives.

Our new investment approach requires a different skill set and talent. And for BCI to attract and retain the required expertise, we need a framework and compensation structure that aligns with, and supports, an active asset management approach. This led the board to review BCI’s compensation framework to ensure that we are competitive and can attract the best talent within the industry.
Why is this important? 66% of BCI's assets are still in public markets and they're telling you they are not going to generate the required long-term returns there so they need to focus their attention on private markets but to do this properly, they need to hire and retain people with this skill set, so they needed to review their compensation scheme to make it more competitive.

Mr. Milburn also stated that this year the board completed the review of compensation that began in 2015, right after Gordon Fyfe joined as the new CEO/ CIO. This tells me Gordon stipulated that a comprehensive review of the compensation needed to take place for him to accept this position.

In his CEO/ CIO report, Gordon notes the following:
With the foundation of our strategy now firmly established, we are beginning to see the results of the change to our investment strategy and business model. This year we increased our internal asset management to 73.3 per cent compared to 63.5 per cent from the previous year.

By using our competitive advantages as a sophisticated, agile investor with large amounts of capital we are increasing our access to high-quality opportunities. We continue to build strategic partnerships and be more innovative and entrepreneurial when negotiating transactions, setting the terms of these deals while aligning the investment interests of BCI, our investment partners, our portfolio companies, and our clients.

This year we committed $11.5 billion in the illiquid markets — expanding our direct investments and increasing our global exposure. With a more global outlook, we are putting our clients’ capital to work with stable and reliable companies that operate in sectors that we believe to be growing and evolving.

BCI’s private equity program committed more than $3.4 billion in new capital around the world this year. Our team is taking advantage of our new strategy and business model by strengthening existing partnerships and building new ones, giving us better access to high-quality deals. Key transactions for the year included: Hayfin Capital Management LLP, a leading private credit asset manager; a pharmaceuticals manufacturer; and we announced our intention to acquire a significant stake in Refresco Group N.V., a beverage and bottling company, which completed in April 2018.

Our infrastructure program committed $1.5 billion in new capital. The team continues to focus on regulated assets that provide stable cash flow and opportunity for capital appreciation. We directly invested in Nova Transportadora do Sudeste (NTS), a wholesale gas transmission business in Brazil; and Endeavour Energy, the second largest regulated electricity distributor in New South Wales, Australia. Within the infrastructure program, direct investment comprised 82 per cent of the total portfolio at year-end.

QuadReal Property Group, BCI’s real estate company 100 per cent owned by clients, continued internalizing our assets from previous third-party managers. They have assembled world-class real estate expertise with over 860 investment and property professionals solely focused on managing, expanding, and diversifying our clients’ global real estate portfolio. QuadReal committed $2.7 billion to international real estate opportunities this year.

The core focus for new development is in industrial, high-density residential, office, and retail properties in major urban centres. Similar to our other direct investments, BCI maintains strategic oversight of QuadReal and is not involved in the day-to-day operations.

A large percentage of our assets under management will remain in public markets — fixed income and public equities — and we are transforming our approach and model here as well. The public markets team is shifting to appropriate strategies that target cost-effective indexing in liquid public equities, while deploying active management in less-efficient markets.

Our public markets team transformed the High Yield Bond Fund into the Corporate Bond Fund. The expanded mandate will include U.S. investment-grade bonds, provide access to new market opportunities, and add much greater capacity and liquidity.

We also established the Principal Credit Fund which aims to generate higher returns than traditional bonds and take advantage of more illiquid segments of the global credit market. This fund officially launched April 2018.
The focus is clearly on ramping up direct investments in  private markets which include co-investments in private equity, but BCI is also shaking things up in public markets which is headed by Daniel Garant, PSP's former CIO.

Now, let's take a look at returns by asset classes for the combined pension plan clients from page 17 of the annual report (click on image):

As you can see, in private markets, there were strong returns in Private Equity (20% vs 17.8% benchmark),  Renewable Resources (15.7% vs 7% benchmark). Global Real Estate (10.7% vs 7% benchmark) and Infrastructure (10.2% vs 7% benchmark).

In public markets, there were big gains in Global Public Equities (11.6% vs 10.1% benchmark) and Emerging Markets which gained 17.9% but underperformed the benchmark by 290 basis points.

So clearly, most of the value-add came in private markets and this is where the focus has been on since Gordon joined the organization.

As far as benchmarks, BCI provides this chart below (click on image):

In Real Estate, Natural Resources and Infrastructure they use 7% which is a bit more than CPI+ 4% (6.3%) but in Private Equity the benchmark return was 17.8% over the fiscal year and 18% over the five last fiscal years and that a lot more than MSCI AC World + 2%.

BCI needs to do a much better job explaining its private market benchmarks because the one they use for Private Equity seems very high to me (it seems to be a mix between MSCI Emerging Markets and MSCI AC World +2%).

I mention this because roughly 20% of BCI's Private Equity portfolio is in emerging markets (click on image):

As you can see, the returns in Private Equity over a one-year (19.9% vs 17.5% benchmark) and five-year (19.5% vs 17.8% benchmark) period are very strong. [Note: There is a bit of confusion here because these figures don't correspond exactly to those on page 17 of the annual report but they're close enough...BCI needs to check].

Everyone should carefully read this passage on Private Equity (click on image):

I note the following:
During 2017, we committed approximately $2.5 billion to 13 new fund investments with external managers that we consider to be strategic partners. We continue to focus on strategic relationships and partners, in identified sectors, that will provide us with strong returns and potential co-investment opportunities. We divested 20 fund investments that no longer aligned with our program strategy.

Focusing on our strategy, we committed approximately $950 million to new co-investments. Notable transactions included: Hayfin Capital Management LLP, a leading private credit asset manager; a pharmaceuticals manufacturer; and we announced our intention to acquire a significant stake in Refresco Group N.V., a beverage and bottling company — the transaction closed in April 2018. As an active investment manager, our focus continues to be on increasing our co-investment opportunities and transitioning to more in-house asset management.
Jim Pittman, the head of Private Equity who joined BCI after leaving PSP, is doing a great job building up fund investments and co-investments. If BCI is going to scale into private equity and do it intelligently, it needs to capitalize on co-investment opportunities to lower overall fees.

All in all, it was a solid year for BCI. Its fiscal year results aren't as strong as CPPIB's (11.6%) or PSP's (9.8%) which have the same fiscal year-end (March 31st) but that can be explained by the fact that both CPPIB and (to a bit lesser extent) PSP have a much more developed private markets program.

In terms of compensation, the summary table below from page 44 of the annual report provides details for senior managers (click on image):

A full discussion of compensation begins on page 38 of the annual report and I suggest you read that section very carefully.

As always, compensation is based on overall results and a five-year average. Gordon Fyfe received $3 million in total compensation which is in line with his peer group. You will also notice he made a lot more than the rest of the senior managers.

Now, to be fair, Gordon took a big pay cut to join BCI and he is the CEO and CIO of the fund so it's understandable to a point that he receives the highest compensation but still, it should be flatter at the upper level and that's based on what I've seen at other large pensions.

It also doesn't help heal BCI's toxic work environment when dismissed employees and ones still working there see such big increases in compensation no matter how justified they are. BCI has a serious morale problem and as my friend who lived in Vancouver keeps telling me: "Victoria is a very small place, everyone knows everyone there so chances are you're going to run into people who used to work at BCI."

Interestingly, BCI doesn't disclose a full compensation report like other B.C. Crown Corporations.  It used to and you used to be able to look up the data on the Vancouver's Sun website here. The latest year data is available is from 2014, and the top paid employees were all from bcIMC now called BCI.

Lastly, take the time to read BCI's Responsible Investing Report here. As I stated when I compared BCI to OPTrust on climate change, I think there is a lot of nonsense being spread out there in terms of BCI's investments in fossils fuels and I do not believe BCI or any other Canadian pension should divest from this industry (also see, The Death of Fossil Fuels? Really?).

Below, an older 2013 Fireside chat with Gordon Fyfe, then president and CEO of PSP. Gordon, it's time you did another chat on BCI and let us know what's going there. Enjoy the rest of your summer.