CPPIB to Double its Allocation to China?

Jennifer Thompson of the Financial Times reports, Canada’s CPPIB plans to double China asset allocation:
The Canada Pension Plan Investment Board plans to more than double the proportion of assets it allocates to China in the next seven years as one of the world’s biggest pension schemes looks to tap fast-growing emerging markets for greater returns.

The C$367bn (US$280bn) CPPIB plans to allocate up to 20 per cent of its assets to China by 2025, up from the 7.6 per cent of its portfolio it currently has invested in the world’s second-biggest economy, it said.

Overall, it plans to allocate up to 30 per cent of assets to emerging markets over the same period, compared to 15 per cent currently.

The Toronto-based board chose Hong Kong as the location of its first international office in 2008 and currently has C$28bn invested in mainland China.

In common with other Canadian pension funds, CPPIB is known for being a proponent of “direct” investment, where it bypasses intermediaries to make deals or buyouts. Last month it announced a deal to partner with Longfor Group, a Hong Kong-listed Chinese property developer, to develop rental housing programmes in the country. Other investments include a stake in Raffles City, a commercial real estate development in Shanghai.

It also has about US$3bn invested in Chinese equities due to its participation in China’s Qualified Foreign Institutional Investor programme, which allows foreign institutional investors to buy securities listed on stock exchanges in Shanghai and Shenzhen.

Mark Machin, CPPIB’s chief executive, spent more than 20 years in Asia, primarily working for Goldman Sachs. He was vice-chairman of Asia ex-Japan for the US bank before joining CPPIB in 2012 as the group’s first president for Asia. He took over the top job in 2016.

The Canadian retirement system is regarded as one of the best in the world because of a high rate of contributions from both employees and companies, the independent governance of the funds themselves and their willingness to experiment.

CPPIB was formed more than 20 years ago to build a reserve fund to support the Canada Pension Plan, the country’s largest retirement fund to which every person working in Canada must contribute. It has 20m contributors and beneficiaries.

Emerging equities were the top performer in the group’s most recent set of full-year results for the 12 months to March. However, even the CPPIB is not immune from economic pressures, warning of potentially lower future returns as it reported a net annual return of 11.6 per cent.

The CPPIB recently announced plans to become the first pension fund in the world to issue a green bond, saying the move would give it additional funding “as it increases its holdings in renewables and energy efficient buildings as world demand gradually transitions in favour of such investible assets.”
I thank Suzanne Bishopric for bringing this article to my attention.

As I told Suzanne, CPPIB talks a lot about China and certain emerging markets (India and Brazil) but the truth is it's under-allocated to these markets and the bulk of its investments remain in the US and other developed nations (click on image):

Still, you will hear Mark Machin often state that China and other emerging markets are growing fast and they represent an increasing portion of world GDP, so over the long run, it makes sense to open offices in Asia and work with partners there and find good investments across public and private markets.

Now, those of you who read my blog know I'm not particularly bullish on emerging market stocks (EEM) or bonds (EMB). In fact, I've been bearish on them for a long time.

As you can see, they both have been clobbered this year as trade tensions, Fed rate hikes and the higher US dollar have all hit them hard and they risk getting hit some more if these trends continue:

Add to this that emerging market currencies are getting destroyed and you wonder just how bad can it get.

So what gives? Are the folks at CPPIB stupid? Why invest in emerging markets and set goals to double allocations to China?

The easy answer to this is the folks at CPPIB aren't swing trading, they are using any weakness in China and other emerging markets to increase their stakes there across public and private markets and benefit from long-term secular growth.

And that's the key here. Public and private markets and a long investment horizon. Read some of my recent comments on CPPIB, like how it went on a huge buying spree and closing huge deals to understand the approach the fund is taking over the long run.

Importantly, CPPIB wants to leverage off the same model that has served it so well in developed countries -- namely, partnering up with world-class investment managers across public and private markets -- in emerging markets and China.

The hitch is China is still a communist country which operates at its own pace and there is no real rule of law or transparency. This is why it's critically important to partner with the right partners who know the market well and are politically connected.

It's also worth noting CPPIB is helping China fix its pension system but I remain skeptical because China will never be able to have the governance or transparency and independence that CPPIB has.

But does it make sense to invest in China and other emerging markets, especially now that their economies are fragile and external debt crises threaten them?

It depends on which emerging market we are talking about. As I stated above, CPPIB will focus primarily on China, India, and Brazil.

I'll share something else with you. If a crisis develops and all hell breaks loose in China and other emerging markets, that is the best time for CPPIB to be putting money to work on deals.

That's why it's critically important to be building the right partnerships now, not later. Pensions need to pounce on opportunities as they arise.

By the way, the same thing with developed markets. Why do you think allocations to private equity are soaring again this year and there is more dry powder than ever in the industry?

Everyone is preparing for the next downturn, they want to commit to private equity before the crisis hits so they can capitalize when these funds buy assets on the cheap.

It's that simple and yet a lot of critics of private equity still don't get it.

Of course, with all that money flowing into private equity, the industry is bracing for a downturn and valuations with public markets are converging as valuations are being bid up.

Anyway, this model can work in China and other emerging markets as long as you find the right partners to co-invest with on large transactions. And CPPIB has the right partners there like Longfor Properties which it invested $800 million with earlier this year.

Below, the Financial Post’s Barbara Shecter speaks with Mark Machin, CEO of Canada Pension Plan Investment Board, on their bond program and lessons from China’s aging population.