CPPIB's CEO Warns of Lower Returns?

Geoff Zochodne of the National Post reports, Brace for lower returns amid this ‘sluggish’ global economy, says Canada Pension Plan’s investing head:
The head of the Canada Pension Plan Investment Board said Thursday that investors are likely to see weaker returns in the future amid a “pretty sluggish period” that has struck most global economies.

“I think we’re going to see much lower return on assets going forward than we have since the global financial crisis and the recovery,” said Mark Machin, president and chief executive officer of the CPPIB, in an interview with the Financial Post. “So I would see returns coming down around the world.”

The CPPIB reported on Thursday net assets of $368.5 billion for its quarter ended Dec. 31, up $200 million from the end of the previous quarter. The pension fund also said its investment portfolio posted a net return of 1.1 per cent for the three months, which included the period of volatility that struck the markets in late 2018.

“It was a solid quarter given a pretty weak market environment,” Machin said. “The fact that our portfolio held up pretty well during that shows that diversification works.”

The pension fund also reported its investment portfolio notched 10-year and five-year annualized returns of 10 per cent and 11 per cent, net of all its costs.

CPPIB announced a number of investments during the quarter, including paying $670 million with a partner for a controlling stake in a hydro-power company in Brazil, which was one of the few countries “desynchronized” from the global economic slowdown, Machin said.

The complex situations involving Canada, China and the United States are contributing to those growth issues, Machin said, although he remained optimistic about a resolution.

“It’s a very significant drag on global growth right now,” he added. “Because uncertainty holds people back from making investments in their businesses, and may hold people back from hiring people, and it holds people back from taking risk in their business.”

CPPIB invests the funds of the Canada Pension Plan, and the board began receiving additional CPP contributions in January, when measures to bolster the plan kicked in.

The pension fund also isssued its first Euro-dominated green bond last month, a €1-billion sale of 10-year fixed-rate notes. CPPIB said the issuance “will enable us to invest further in eligible assets such as renewables, water, and real estate projects, and to diversify the Fund’s investor base.”

January’s issuance follows CPPIB’s first-ever green-bond sale last June, which the board said was a first for pension funds.

“I would imagine we’ll continue to use that market,” Machin said Thursday.

CPPIB signed an agreement during its third quarter, alongside the Ontario Teachers’ Pension Plan, to buy 49 per cent of a 309-kilometre toll road in Mexico for an initial $314 million. The fund said there is also the possibility of a second investment of up to $218 million in the road.

CPPIB already owns 40 per cent of the privately-leased section of Highway 407, another toll road that runs 108 kilometres from Burlington, Ont. in the west to Pickering, Ont. in the east.

SNC-Lavalin Group Inc. and a subsidiary of Spanish infrastructure company Ferrovial S.A. own 16.77 per cent and 42.23 per cent, respectively.

However, SNC-Lavalin said last August that it had hired CIBC Capital Markets and RBC Capital Markets as financial advisors to help the company with a possible sale of 6.76 per cent of the 407, which would reduce its stake to around 10 per cent.

Since then, shares of SNC-Lavalin have dropped more than 35 per cent, with the company recently cutting its earnings forecast and being pulled into a political firestorm tied to the company’s lingering corruption and fraud charges.

Machin declined to comment Thursday on whether or not CPPIB would be interested in the stake in the 407 floated by SNC-Lavalin.

“We’re happy investors in the 407,” Machin said.
Matt Scuffham of Reuters also reports, Canada Pension Plan CEO Machin warns of lower returns:
Canada Pension Plan Investment Board (CPPIB) Chief Executive Mark Machin said on Thursday he anticipates significantly lower returns on assets over the “next several years” as the global economy slows.

Canada’s biggest public pension fund reported a net return of 1.1 percent in the third quarter of its fiscal year to Dec. 31, which Machin said represented a “resilient” performance in the face of declines in global equity markets.

“We’re going to see much more modest returns going forward across the board,” he said in an interview. “We’re seeing a significant slowing of economies across the world.”

Machin said he expected lower returns across all asset classes due to both economic challenges and competition for assets driving valuations higher.

“I think it’s going to be much more challenging for the next few years,” he said. “Whether it’s a public or private asset it’s going to be a similar story. There’s a large amount of capital in the world competing for assets at the same time.”

The CPPIB, which manages Canada’s national pension fund and invests on behalf of 20 million Canadians, has diversified to become one of the world’s biggest investors in infrastructure, real estate and private equity to reduce its reliance on volatile global stock markets and low-yielding government bonds.

Machin said diversification left the fund well-placed to grow despite the challenging market backdrop.

The CPPIB said its net assets totaled C$368.5 billion ($278 billion) on Dec. 31, 2018, compared with C$368.3 billion three months earlier. For the nine months to Dec. 31, the CPPIB posted a net return of 3.6 percent.

Canadian pension plans, on average, lost 3.5 percent on their investments in the quarter to Dec. 31, according to a report by RBC Investor & Treasury Services last week, which blamed global political and economic uncertainty for the losses.
Benefits Canada also reports, CPPIB ekes out 1.1% return during challenging fiscal Q3:
The Canada Pension Plan Investment Board grew its net assets by $0.2 billion during its third fiscal quarter, pushing overall assets up to $368.5 billion, off a 1.1 per cent return.

“Broad declines in global public equity markets created a challenging investment environment during the quarter,” said Mark Machin, president and chief executive officer of the CPPIB, in a press release. “However, our net income increased during the downturn, underscoring the fund’s resiliency and ability to weather difficult conditions,

“Portfolio diversification across a wide range of private assets helped moderate public-market headwinds, especially in December. The fund also benefitted from its global investment footprint, as many major foreign currencies strengthened against the depreciating Canadian dollar, leading to investment gains,” he added.

Investment highlights for the quarter included a $945 million allocation to GLP Japan Development Partners III, a Japan-focused logistics real estate venture; the purchase of a controlling stake in Brazilian hydro generation company Companhia Energética de São Paulo; and an agreement with Banco Bilbao Vizcaya Argentaria to transfer a portfolio of credit rights with an aggregate outstanding principal balance of about 1,490 million euros.

The CPPIB also shed some assets, including its 45 per cent stake in the the Warner building in Washington, D.C., for US$47 million.

In other highlights for the quarter, the CPPIB issued its first euro-denominated green bond in January 2019. As well, in December 2018, the fund established a policy to vote against the chair of the board committee responsible for director nominations at investee public companies if no women were on their board of directors.

The CPPIB also noted it will begin to release financial results for the CPP base and CPP additional components separately, as well as those for the total aggregate CPP fund, at the end of its fiscal year.
That last part is interesting and if you read CPPIB's press release going over its third quarter fiscal 2019 results, you'll note this part on enhanced CPP contributions:
Starting in January 2019, CPPIB began to receive and invest the first additional CPP contribution amounts, which immediately benefit from the Fund’s global network, expertise, investment strategies and risk governance framework. CPPIB will report on the performance of the combined total Fund, as well as the base CPP and additional CPP components, in our news release and annual report at the end of this fiscal year.
That's great news. We will get to see how CPP and enhanced CPP are doing from now on.

I went over CPPIB's fiscal 2019 Q3 results carefully since last quarter was very rough. The fact that CPPIB eked out a 1.1% gain last quarter when most Canadian pensions lost 3.5% is due to two things:
  1. CPPIB has a much heavier weighting to private markets (private equity, real estate, infrastructure) than most Canadian pensions and that helped cushion the blow from the selloff in public markets. 
  2. And CPPIB invests all over the world and doesn't hedge its currency risk. In quarters and years where the Canadian dollar underperforms other currencies, especially the US dollar, CPPIB and other large Canadian pensions that don't hedge currency risk take advantage of extra currency gains.
I can easily illustrate the second point (click on image):

This is simply a one-year daily chart of the Canadian dollar ETF (FXC). During the fourth quarter of last year, CPPIB's fiscal Q3, oil got slammed hard and so did the Canadian dollar.

It's the first point, however, which is critical to understand. It's really important to note that while CPPIB will generally underperform in a raging bull market, its heavy weighting in private markets all over the world allows it to outperform during a bear market in stocks.

You can see this by looking at CPPIB's asset mix below (click on image):

As shown, 32% is in Public Equities (mostly US and foreign), 24% in Private Equities (again, almost all US, developed markets and 3% in Emerging Markets), and 25% in Real Assets which is made up of Real Estate (13%), Infrastructure (9%), Energy and Resources (2.3%) and Power and Renewables (only a 1.4% weighting but CPPIB's Green Team is ramping up and expanding very fast!).

When you add Government Bonds (22%) and Credit (9%), you see that Public Equities aren't going to roil the overall portfolio in any meaningful way, even during a bad quarter, because there are plenty of shock absorbers to deal with increased downside volatility.

No doubt, if it gets really bad and contagion spreads to other asset classes, it will impact the overall portfolio. I think Mark Machin's warning of lower returns ahead in both public and private markets is spot on, he understands the structural issues impacting both markets.

Lastly, I typically don't go over CPPIB's quarterly results because they're meaningless to me. I prefer looking at the one year and more importantly, five and ten-year results. And on this front, 10% and 11% annualized is absolutely great but Mark Machin is already warning you, those returns will come down over the next ten years.

Still, CPPIB is well-positioned to weather the storm ahead, which isn't something I can say about many other pensions.

Below, take the time once again to listen to Mark Machin, chief executive officer at the Canada Pension Plan Investment Board, as he spoke with Bloomberg's Erik Schatzker at Davos. Listen to him allude to the public versus private markets battle and why many pensions aren't prepared for the coming dislocations which will force them to sell public and private assets at the wrong time.