AIMCo's 2019 Annual Report

Last week, AIMCo released its 2019 Annual Report:
Taking the long view is instinct at AIMCo. Investing on behalf of Albertans requires us to seek opportunities that will ensure a secure and prosperous future. It calls for patience and ingenuity. And a belief in what we do, and why we do it.

Over the last decade, AIMCo has earned $66.2 billion in net investment returns on behalf of its pension, endowment and government funds clients.

Our 2019 Annual Report details our calendar-year and long-term investment performance, assets under management, team member accomplishments, redevelopment of a real estate asset, responsible investing progress, risk management initiatives and more.

Please note, we report our performance based on the 2019 calendar year, while our financials use the fiscal year ending March 31, 2020 in line with our shareholder, the Government of Alberta.

It is a privilege to be Alberta’s investment manager — now and for the long run.
You can download the 2019 Annual Report here. I read it today and thought it would be useful going over it.

Keep in mind, I have already covered AIMCo's 2019 results back in April and you can view that comment here.

Unfortunately, the Annual Report comes out later because it has to be approved by Alberta's Parliament.

In an ideal world, every large Canadian pension would release its annual report at the same time as it releases its results. That's the right thing to do from a pension governance point of view but there are political considerations for some large funds which is extremely annoying for people like me who like to cover their results properly.

Anyway, I'm going to keep it as brief as possible, focusing on the sections that are important. Again, I covered a lot of AIMCo's results here when I went over them with its CIO, Dale MacMaster.

Let me go straight to Kevin Uebelein's message on page 8 where he states:
It is perhaps somewhat of a relief to step away momentarily from the realities of 2020 — a global pandemic, an oil-price war, market uncertainty — and reflect on 2019.

Reflections on the past year include a moment of nostalgia for more normal times, but also a real sense of pride and accomplishment from an AIMCo perspective. AIMCo had a busy and remarkable year, one that strengthened us in a way that will serve us well as we confront the challenges of today and the future.

By almost any metric you can use, this was the busiest investment year of AIMCo’s existence. Whether one measures volume of transactions, scope of our strategies or geographic coverage — we were at or near all-time highs in 2019. This activity reflects an ongoing maturity of our capabilities that will serve clients not just now, but for the long run.

Despite all of AIMCo’s asset classes earning strong absolute returns in 2019, our performance fell below benchmark. While we have bested the benchmark in ten of the past twelve years, we acknowledge that in the short term we have not met our clients’ expectations. I am urging the team to maintain a balance of motivation and patience as we look to improve upon our performance.

While our investment team focused on building our clients’ portfolios, 2019 brought change that impacted our organization in monumental ways. In March, the Government of Alberta passed pension reform legislation that triggered a tremendous amount of work to adjust our ecosystem. I cannot stress enough how impressed I am by the leadership, coordination, organization and flat-out hard work that occurred to accomplish this task. As we worked closely with our pension fund clients through these changes, there was an inevitable outcome — a strengthened understanding of their objectives and challenges. That is something that we must not lose sight of in the weeks, months and years to come.

The fall brought additional legislative changes. A new government made substantive changes to the effects of the legislation passed in spring, impacting three of our pension clients and our relationships with them. Word also came that AIMCo would eventually be serving three new clients with assets in aggregate of $30 billion. Much has been said and written, in public and in private, about these decisions. At AIMCo, we must focus on the fact that the changes signal a belief in what we do and in our vision of enriching the lives of Albertans by building prosperity, security and opportunity across generations. I want our clients, old and new, to know that we are committed to helping them meet their goals, and we truly believe that in Alberta, we are stronger together.

By year-end, our Edmonton-based team was reunited under one roof, after years of having our workforce split between two buildings. Our new home is extremely well-suited to meet our long-term needs and will go a long way in support of our efforts to continue building a culture of collaboration and innovation with the ability to attract top talent. Many hands and minds contributed to the design and development of the new office space and the logistics of moving hundreds of employees with only minimal disruption to their work. This task was achieved on time and under budget and I am grateful to all who made this such a success.

From an organizational perspective, the developments of 2019 shone a bright light on the team we are building. Circumstances required us to be agile — to complete important and complex tasks in short order. What I am mindful of, is the need to focus on the long term. While that is our mantra when it comes to investing on behalf of our clients, it also holds true with regard to the culture we are building at AIMCo. To that end, we will continue our work in that area, building off of initiatives like our coaching program and our new tool that measures employee engagement on a more regular basis, as opposed to annually.

Before we turn our focus back to the challenges of the present, I want to thank the team at AIMCo for their hard work and to express our appreciation to our Board of Directors for their support and guidance. And finally, to our clients, we are eager to meet your expectations, to support your goals and to develop stronger relationships, built for the long run.
On page 24, there is a Q&A with AIMCo's CIO, Dale MacMaster, on the 2019 investment performance and his expectations for 2020:
How would you characterize 2019 for investors?

Balanced fund investors enjoyed one of the best years in decades. Most of the equity markets were up well into the double digits, so overall it was a good year for our clients.

The markets were driven higher through the year by central bank liquidity and a couple of hurdles being cleared — the U.S. – China trade issue and a conclusion on Brexit.

Yield curves, which had been slightly inverted, normalized somewhat. One thing that was a bit unusual on the markets was that stocks and bonds both moved higher. They are typically negatively correlated so that was a bonus for a lot of investors.

For Alberta in particular, the energy sector ended the year on a pretty good note as well, with some positive news about pipelines and higher commodity prices.

You could not have gone wrong investing last year, which is kind of amazing considering we were 10 or 11 years into a bull market and coming out of the global credit crisis. To get this kind of result is a little surprising but, again, great for our clients.

How did AIMCo investments perform?

A double-digit return for our total portfolio is something we always like to see. But we did have several asset classes that were below their benchmarks, putting us not exactly where we want to be. The important thing to remember is that our clients are long-term investors. We can certainly feel good about the value we have added to their portfolios over a longer time horizon.

What were some of the highlights from a performance perspective?

We saw several of our asset classes post good returns above their benchmarks — Fixed Income and Money Markets, Private Debt & Loan, Infrastructure & Renewable Resources.

Fixed income portfolios generally benefited from the global trend of lower rates, while private credit continued generating attractive returns with all-in yields much higher than public sovereign debt even in the lower risk spectrum we are invested in. As for our infrastructure-related portfolios, falling interest rates for rate-sensitive infrastructure sectors and increasingly better growth expectations contributed to a strong rebound in valuations.

Where were some of the challenges?

On the public equities side, it was a challenging environment for active managers. The market was very narrow, and what I mean by that is there were fewer stocks and fewer sectors that outperformed the benchmark. That concentration of markets really shows when you consider that the five biggest stocks on the S&P 500 — Apple, Microsoft, Google, Facebook and Amazon — represented more than 16% of the financial market. So, even though the markets were up, growth outperformed value which can be difficult for value investors like us.

Another interesting place to look is in our illiquid asset classes. When we saw the numbers come in from 2018 — double digit returns for Private Equity, Infrastructure and Real Estate — we were quick to warn clients that those numbers were likely to dip in 2019, and that’s exactly what happened. Still, we had a lot of positive things happening in those asset classes through the year that we believe will be fruitful in the long-term.

What are your expectations for 2020?

Well, they have certainly changed from what they were in early January.

By the end of 2019, the U.S. economy had moderate growth and the lowest unemployment rate in decades. Europe, China and many key emerging markets were also witnessing stable growth and low inflation. Moreover, market volatility stood at the lowest across asset classes in recent years. But there were some challenges as well. The lack of market breadth and elevated valuations left the equity markets vulnerable to a potential market drawdown. Another area of concern was the diminishing income from the fixed income markets as policy interest rates came down all around the world and, consequently, the reduced diversification cushion from those markets. On balance, however, the macro environment at the onset of 2020 looked mildly positive across public and unlisted markets globally.

The outlook worsened early in 2020 as the coronavirus (COVID-19) hit the global economy. China was hit first, which ultimately led to disrupted global supply chains, followed by most major developed economies. Social distancing measures and lockdowns led to a sudden and severe economic shock. There was also a geopolitical struggle between Russia and Saudi Arabia that resulted in an oil price war. Global demand went into freefall and investment and market volatility increased to levels previously unseen. Most global markets experienced severe drawdowns during the first quarter with the S&P 500 equity index going from all-time highs to multi-year lows in what turned out to be the fastest descent into a bear market in history. Many market participants were forced to de-risk while at the same time deal with a situation where no asset class provided protection. Central banks and policymakers, having learned lessons from the Global Financial Crisis, swiftly implemented unprecedented measures to support market liquidity and cashflows for both households and corporations.

While the outlook remains uncertain in a post-COVID-19 world, with markets repricing sharply, AIMCo remains committed to identifying attractive long-term investment themes required to effectively manage well-diversified portfolios for our clients.
That last passage is in line with what Dale told the Standing Committee on the Alberta Heritage Savings Trust Fund (see my last comment for details).

Anyway, have a look at AIMCo's asset mix as of the end of 2019:

Keep in mind, AIMCo has many clients with different liabilities and asset mixes (see details on page 22).

According to the Annual Report:
The Balanced Funds combine asset allocation and active investment management to earn higher returns. Diversification plays an important role in maintaining a level of portfolio risk that is appropriate to the client, as these funds can traditionally include relatively more aggressive investment strategies, which are implemented in a risk management framework.
In aggregate, AIMCo funds achieved a net return of 10.6% in 2019. AIMCo’s Balanced Fund clients, many of which capitalize on AIMCo’s full suite of investment capabilities, earned a net return of 11.8%, while Government & Specialty Funds earned a net return of 4.8%.

As shown above, AIMCo funds underperformed their benchmark by 50 basis points last year and as shown below, the Balanced Funds underperformed their benchmark by 70 basis points (11.8% vs 12.5%):

The table above is on page 27 of the Annual Report and it is the most detailed performance table.

The most telling thing for me was in Private Equities, only returning 3.8% versus a benchmark return of 8.2%.

First of all the benchmark AIMCo uses for PE has changed over the years from the S&P 500 to the new benchmark: Total CPI 1 Month Lagged + 650 bps (5-year rolling average).

There are issues with all PE benchmarks but using an absolute return one like this based on inflation plus a 650 bps premium seems wrong to me. It's basically an easy benchmark for PE funds to beat as they typically have a hurdle rate of 7-8% before charging carried interest.

This is why most pensions use the S&P 500 or MSCI Global and a premium to reflect illiquidity risk but that benchmark comes with its own issues.

Anyway, when I spoke to Dale MacMaster back in April, he told me the PE strategy shifted five years ago and they are still ramping up fund investments and co-investments "which is why our program is more volatile than more mature PE programs of our peers, we still have J-curve effects."

AIMCo's PE program is only $3 billion and growing. Dale told me in private equity, they focus on middle market funds where they can be a more influential/ larger partner. However, he did admit that middle market funds have more operational and key man risks and require more due diligence since they lack the size and depth of larger funds. ("we make sure carry is distributed across the organization”).

The fact that AIMCo hasn't developed its PE program to full maturity yet is one big reason why it can't be firing on all cylinders like its larger peers which have developed their PE portfolio over the years.

And now that the volatility strategy (VOLTS) has been scrapped, there will be more pressure on other asset classes like PE, private debt, real estate and infrastructure to generate more of the value add going forward.

However, both Dale and Kevin were careful yesterday at the hearing and stated  they're not going to take more risks elsewhere to make up for the $2.1 billion loss in VOLTS.

In all likelihood, 2020 will be a very tough year for AIMCo even if equities bounce back and end the year strong. I can see problems arising in Alberta office space, for example, just like PSP mentioned in its annual report, and there will be writedowns taken in retail real estate as well.

There may be other write-downs as well in some energy investments but AIMCo and other pensions invest for the long run, so write-downs in any given year aren't necessarily a bad thing (they can write these assets back up when the cycle turns up).

I will leave it up to you to read the details of each asset class in the 2019 Annual Report.

I end with the summary compensation of AIMCo's senior executives for 2019 on page 76 of the Annual Report:

Remember, it is based on four-year annualized results and over the last four years, AIMCo Aggregate Fund has outperformed its benchmark by 50 basis points (7% vs 6.5%, details on page 27).

Below, Kevin Uebelein, chief executive officer at Alberta Investment Management Corporation, talks about how one of Canada's largest pension funds is managing the shockwaves from COVID-19 (March, 20202).