Trans-Canada Capital Ready For Take Off?
Air Canada, the pension fund for Canada’s flagship carrier, is preparing to manage external assets in a bid to let other pension funds and institutions tap into its top decile performance and 65-strong expert internal team, currently managing 80 per cent of the C$21 billion portfolio. The pension fund’s investment staff have transferred to a new entity, Trans-Canada Capital (TCC), now readying its legal, compliance and best practice pillars for take-off.Someone sent me this article late last night and I thank him for sharing it with me.
It’s a new approach designed to boost assets and grow Air Canada’s internal expertise as the closed fund carries on its own de-risking journey.
“We have been in gradual de-risking phase for many years. Managing external client assets is a new business line for the company and will help maintain and grow the team which is interesting from Air Canada’s point of view,” says Vincent Morin president, pension investments at TCC.
The final phase of the process involves transferring assets held under Air Canada’s pension master trust to a limited partner fund structure from which Air Canada’s pension fund will buy units, also offered to third party clients. TCC hasn’t begun a marketing push yet, but six investors have already shown interest, one of whom has just committed to investing in the fund’s internally managed C$1 billion multi-strategy hedge fund.
“As well as continuing with great returns for the pension fund, if someone wants to chip in and invest alongside us in any of our portfolios, they can now access the exact same strategy that has put Air Canada pension plans in surplus,” says Morin who won’t put a figure on the size of external assets TCC hopes to manage until the structure is right, but hazards it could hit C$10 billion in 10 years.
It’s a remarkable transformation from when Morin and his senior vice-president Nelson Lam, who heads up equity and alternatives, joined the fund 10 years ago. A time when tight budgetary constraints due to Air Canada’s rocky finances and $4.2 billion pension fund deficit (when the fund’s AUM was only C$10 billion – there is now a C$2 billion surplus) left them working off laptops with a skeleton, mostly part-time, staff.
They set about replacing the wholly outsourced 60:40 portfolio with an active liability-driven strategy that aims to hedge 100 per cent of the fund’s interest rate risk (in sight, but not completed yet) and uses leverage to enable an allocation of up to 140 per cent. The 40 per cent allocation to risk assets comes via a reduced public equity exposure, and a diversifying allocation to private markets, hedge funds and recently added liquid alternatives.
One of the biggest changes was the introduction of derivatives. Less liquid than the US market, finding bank counterparties in Canada’s derivatives market was tough – as was convincing the board to authorise trading swaps, says Morin. “We now have ISDA’s with 24 different counter parties.”
Last year TCC reduced its public equity allocation from 20 per cent to 10 per cent in favour of a new allocation to liquid alternatives. Comprising emerging market debt, high yield bonds and listed infrastructure, the allocation diversifies away from equity but also allows TCC the liquidity to be fleet-of-foot in times of crisis. Although the fund has traded liquid alternatives on a tactical basis before, it has never been in the fund’s strategic allocation where it now accounts for 5 per cent.
TCC will use some leverage to obtain exposure in liquid alternatives, explains Morin.
“We can use derivatives in emerging market debt and bonds to access the market. Alternatives, including liquid alternatives, can be expensive and using derivatives is a cost-effect way to access them.”
TCC will also use active management to improve returns, but only in niche corners of the liquid alts space where Morin and Lam believe there is enough value to make it cost effective compared to the fees of accessing the beta of the asset class.
“The challenge here is that using derivatives involves mark-to-market. In this way liquid alternatives are like equity, but they have a less risky profile because these asset classes are mostly bonds,” says Morin.
As for the 20 per cent allocation to private markets, the mantra is dynamic and opportunistic. The allocation focuses on real estate, private equity, private debt and infrastructure but has no sub asset class divisions, allowing capital to move freely between the four allocations. For example, TCC moved out of its chunky allocation to US real estate debt as the sub-prime crisis unravelled to later re-invest in US real estate funds, from which it then made capital commitments to European real estate following ECB chief Draghi’s assurances on the euro in 2012.
“We can move around the private market asset classes according to the environment and opportunities the market is giving us,” says Lam.
In another example, they point to how the recently boosted private debt allocation will allow the fund to get its capital back faster than it can in private equity – a good thing in today’s market.
“If the market goes down, we can have a return of capital, or coupon, that will allow us to reinvest in distressed assets in the next crisis. We try to be dynamic but it’s hard because selling an asset in this market leaves too much money on the table. It’s great to be able to invest tactically wherever possible,” says Morin.
TCC’s strategy in private markets is currently defined by small ticket sizes (typically around C$50 million compared to C$200 million in the past) in response to high valuations. In another sign of their wary eye on compressed spreads and low risk premiums, they haven’t deployed to core real estate or developed market infrastructure for a couple of years.
“We want to reserve our cash for an opportune time to invest,” says Lam. “We’ll wait until there are distressed sellers.”
In public equity the fund accesses the beta of the portfolio as cheaply as possible using futures or total return swaps. Alpha comes mostly via a portable alpha strategy in niche, long short equity strategies run externally to actively harvest additional value.
“In current markets it’s hard to outperform in large cap, but some sub-asset classes or sectors are proving less efficient so we move tactically where we believe we can add value,” says Lam. It’s part of a $2 billion fund of hedge funds portfolio with 11 managers diversified across strategies including credit, CTA, volatility, global macro, event-driven and emerging market debt.
It’s no surprise that TCC’s first client, a Canadian fund in the retail space which Morin and Lam decline to name at this stage, has chosen to chip in to TCC’s internal hedge fund allocation. In an asset class where Morin says “size matters” the multi-strategy allocation stands at C$1 billion with a sharpe ratio of over one. It’s guiding pension fund culture is a particular source of attraction, whereby a longer-term view (with up to two, three or four-year positions) is combined with daily and weekly trades.
“When we say longer term there is a caveat,” says Lam. “We are still in the hedge fund industry and the multi-strategy that we manage does have very short-term exposures where we come in and out in a day. However, we differentiate ourselves by also having longer term positions. We think these positions can add tremendous value to the portfolio.”
The fund uses over 60 managers across public equity, private markets (it also runs a co-investment program within private markets) and hedge funds. Rules of engagement include insisting managers have skin in the game.
“In all the funds we invest in, we want the investment managers to personally invest to a significant degree,” says Lam. If it’s a theme they like they “aren’t shy” of putting in large commitments that can stretch to $200 million.
“If we put in a higher ticket size, we obtain a seat on the limited partner advisory committee. This ensures we get a lot of attention, co-investment rights, fee rebate and preferential terms.”
TCC’s bargaining power is also bolstered by the fund’s ability to swiftly make decisions on deploying capital. Any deal involves internal analysis and external consultants, but the decision rests with the investment committee, chaired by Morin, which meets twice a week, and more frequently if needed.
“We can give a quick yes or no. We’ve made deals within three days in the past and our external managers really appreciate this,” says Lam.
Please note I reached out to Vincent Morin and Nelson Lam earlier today and Vincent did get back to me but he is not available to discuss this week (I did get to chat briefly with Nelson, see below).
So what is Trans-Canada Capital all about? On its website, you can read more about TCC:
Trans-Canada Capital Inc. (TCC) is a registered investment management firm with over $20 billion of assets under management.Below, you can see TCC's strengths:
Our mission is to add value for our clients on a consistent basis by using sophisticated and innovative investment strategies in a risk conscious framework.
Who We Are
Since 2009, TCC’s investment team has been managing the assets of Air Canada’s Canadian pension plans, consisting of over $20 billion of assets in aggregate today. Air Canada is one of the largest corporate pension plan sponsors in Canada and administers eight Canadian defined benefit pension plans.
TCC is a newly-created subsidiary of Air Canada. Formerly operating as a division of Air Canada, the team is now composed of over 60 investment professionals based in Montréal, Canada.
TCC’s team of investment professionals has extensive expertise in managing and trading fixed income securities and derivatives, from front to middle to back office, with an emphasis on portfolio construction and risk management in a liability-driven context.
What We Do
TCC offers world-class investment strategies and innovative risk management solutions to meet the needs of the most demanding institutional investors.
Our successful track record over the past 10 years has placed Air Canada’s Canadian pensions plans in an enviable financial position. The top quartile returns delivered by TCC’s investment team have been a major factor in the financial turnaround of Air Canada’s Canadian pension plans, in which a $4.2 billion solvency deficit was eliminated and replaced by a surplus of over $2 billion as of today.
Over the years, TCC has developed unique skills in managing pension assets with a specific expertise covering the following investment categories:
Building on this valuable experience, TCC is now proud to offer its unique expertise to third-party institutional investors, including pension plans, foundations and endowment funds.
- Canadian fixed income
- Hedge funds
- Alternative investments (real estate, infrastructure, private equity, private debt, etc.)
Also, according to its website: "TCC is now proud to offer its unique expertise to third-party institutional investors, including pension plans, foundations and endowment funds."
So why is Air Canada Pension now offering its expertise to third-party institutional investors? Put simply, the story of how Air Canada turned its pension around is nothing short of spectacular and now that this pension is fully funded and in de-risking mode, the people in charge of it went to see Air Canada's senior management and sold them on the idea of selling their pension expertise to third-party institutional investors.
Readers of this blog know that most corporations are winding down any existing defined benefit plan to replace them with "cheaper" (and lousier) defined contribution plans.
Back in September, I critically examined whether the DB model has failed, criticizing the head of defined benefit solutions at Sun Life for writing a self-serving op-ed claiming so.
Let me repeat, I am a firm believer of well-governed defined benefit plans that responsibly share the risk of their pension among all stakeholders, including retired members (via conditional inflation protection).
I'm not a bleeding hard liberal who comes at this from a social democratic point of view. Instead, I come to this conclusion from a somewhat right-wing, conservative point of view where I strongly believe good retirement policy bolsters well governed DB pensions and this is what is in the best long-term interest of the economy.
In short, Canada's large, well governed public pensions are the envy of the world, they truly are global trendsetters and more and more countries are taking a closer look at them trying to emulate them.
A few of the senior managers at Trans-Canada Capital have either worked at large Canadian public pensions or consulted them.
For example, Marc-André Soublière, TCC's SVP Fixed Income and Derivatives, worked with me at PSP Investments prior to joining Air Canada Pension. I can speak about him because I worked with him and know he's one of the best global macro traders in Canada.
I'm not trying to flatter him and he's not the only great macro trader I've worked with -- Simon Lamy who formerly worked at the Caisse as a VP Fixed Income is another great trader who is now running his own money -- but Marc-André knows how to a) take a macro view and b) structure it properly using derivatives to get the best risk-adjusted returns.
Just like HOOPP and OTPP after which it is structured, TCC is a highly sophisticated derivatives shop where the front, middle and back offices work closely together to structure their trades in an internal multi-strategy hedge fund which has consistently added value over the long run.
TCC also invests in external hedge funds and private equity funds. That responsibility falls under Nelson Lam, SVP Equity and Alternative Investments.
I don't know much about Nelson except that he's a very nice guy who really knows his subject matter and takes alignment of interests very seriously.
Reading what TCC is doing with their liquid alternatives portfolio really piqued my interest as I kind of agree with James McMullan, head of corporate credit for Caisse de Depot et Placement du Quebec, corners of private debt are very frothy as underwriting standards are being eroded fast.
TCC rightly takes an opportunistic approach in liquid alternatives and uses some leverage (up to 140% gross exposure) to take advantage of opportunities as they arise.
[Update: Late today, Nelson Lam called me and we briefly chatted about the products they are offering. Nelson told me they are registered with the AMF and other regulators. The internal multi-strategy fund headed by Marc-André Soublière and overseen by the investment committee is being marketed locally and internationally.
Nelson also told me that they are also offering a funds of funds for hedge funds and a funds of funds investing across private markets (real estate, PE, private debt and infrastructure) which is unique and has performed exceptionally well (net IRR of 15% since inception). All these funds of funds are priced at very competitive rates (he told me "a lot lower than 1 and 10").
The liquid alternatives portfolio is more opportunistic and will complement this portfolio.]
As far as TCC's leader, Vincent Morin, I have not met him yet but have also heard and read great things about him.
Vincent is routinely featured on CIO's Power 100 list, he took over the top job at Air Canada Pension from Jean Michel who is now the CIO at IMCO. He has extensive consulting experience and brings over 20 years of experience managing pension plans, including portfolio management, risk and asset/liability management and establishing funding and investment policies.
What is interesting is how Jean Michel and Vincent Morin after him adopted/ continued a liability-driven approach to managing Air Canada's Pension. It’s this rigorous focus on risk which differentiates them from other asset managers which tend to focus more on taking risks at whatever cost, with little to no consideration to downside risks and funded status risk.
I can tell you that prior to Jean Michel, the fellow running Air Canada Pension was simply investing with external asset managers and didn't focus on risks or costs which is why that pension fell into a deep deficit when the crisis hit. I'm not sharing this to put this guy down, it's simply the truth and he wasn't the only one taking this risky approach (back then, Air Canada Pension had way too much beta in its portfolio and the results were disastrous).
Anyway, I am glad Trans-Canada Capital got the green light for take off, that speaks volumes of Air Canada's C-Suite and board of directors and it demonstrates the confidence they have in this team, and it is a team of hard-working dedicated professionals.
The only slight criticism I will level at them is when I look at the senior team, it lacks diversity, not just gender diversity but ethnic diversity. I'm not saying this was purposely done but when you're looking to raise assets, optics matter and if I'm thinking this, you can bet others are thinking the exact same thing.
Lastly, last September, Jean Francois Paquin, TCC's VP Asset Allocation, came over to my condo with his young son to pick up my huge collection of economics/ finance books. I was preparing for extensive and much needed renovations and my now wife rightly accused me of being a hoarder and gave me an ultimatum: "It's either the books or me, you choose".
I wisely chose her over my finance and philosophy books which I sold to The Word bookstore (my wife still can't believe I got money for my used books and that my philosophy books all together were worth significantly more than my finance books which individually cost me a fortune over many years).
Anyway, the folks at TCC have a great collection of finance books courtesy of yours truly but what most impressed me about Jean Francois Paquin was how well mannered and well raised his son was and how he helped his father load up a mini van full of books. Good kid with good values and that tells me a lot about his parents too.
I can say the same about the rest of the team at TCC, they have the right values and culture which is why the turnover rate has been very low there (according to Nelson, apart from Jean Michel, there hasn't been any major turnover there).
One last important note. Nelson Lam told me they are open to managing pensions (not just corporate but also public pensions), endowments and foundations looking to better manage their assets and liabilities.
If you are interested, feel free to contact Vincent Morin (firstname.lastname@example.org) or Nelson Lam (email@example.com) to obtain more information on how TCC can help you manage your pension risk.
Below, a clip for Marc-André Soublière where influential bond investor Jeffrey Gundlach, the CEO of $150 billion DoubleLine Capital, sees a scenario where US stocks get crushed in the next recession — and likely won't recover for quite some time to come.
There's a lot I can cover here and criticize Gundlach but take the time to watch this with a very critical eye, it's definitely worth watching and he gives great food for thought.
I sent this clip over to Fred Lecoq, another former PSP colleague of mine who wryly replied: "Yes, Captain Obvious. What is the point saying that? The only thing I want to know is when to get out” (Fred later admitted he didn’t watch the interview, only reacted to the headline).
Another astute blog reader of mine noted the following: "Gundlach is an amazing promoter, partly because nobody recognizes that that is central to his present persona."