Total Fund Management Part 2: What Nobody Told You About Long-Term Investing

Today, Mihail Garchev, former Vice President and Head of Total Fund Management at BCI, and I bring you the second installment of our seven part series on integrated Total Fund Management for pensions (added emphasis is mine; lightly edited some parts to make them more readable) :

This comment is a synopsis of the original video presentation by Mihail Garchev, former VP and Head of Total Fund Management at BCI, and hosted by Leo Kolivakis, publisher of Pension Pulse. Parts of this synopsis have been presented on this blog last week (see first installment here).

The purpose of the series

One might think that this series is about TFM. But it is not. Well, not entirely, at least. TFM is a means to an end—and this end goal is to advance further the structure of the Canadian pension model. And re-imagine it as the Canadian model, version 2.0. This topic will be at the center of the discussion in the final Episode 7. It is much bigger than TFM itself, but one cannot do it without understanding the basics of TFM. TFM has a central role in helping the CEO and the CIO and their board of directors to accomplish a change and manage the Canadian Model 2.0 in the future.

But before talking about the structural role, one needs to understand the functional role of TFM.

Episodes 1-4 build an understanding of this functional role. Episode 5 will further illustrate different aspects of TFM decision-making through several case studies related to central TFM functions such as rebalancing, leverage, liquidity, balance sheet, and risk mitigation TFM decisions.

Then, in Episode 6, we will talk about moving from a framework and a process to actual implementation and capability.

And finally, we will get to the end goal of our series, where we will be talking about the Canadian Model 2.0 and the critical role of TFM.

Key takeaways from Episode 1 last week

Last Thursday, we discussed that Canadian funds might be at a critical point of the organizational maturity because of size and scale, complexity, among other issues. The efficiency of Canadian funds, the much touted "economies of scale," and by extension, the Canadian model itself as it stands today, might be facing its biggest challenges.
From this perspective, TFM's goal is to restore the economies of scale by pursuing second-order efficiencies. We called these "economies of scope" These efficiencies occur because one uses an optimal top-down view to evaluate and adjust what may seem optimal on a standalone basis for the asset classes or operations. Some examples of such second-order efficiencies include reducing overlaps and associated costs and removing unintended bets and consequences, which is a hidden cost. Also, ensuring an optimal flow of capital and liquidity and that asset classes and Total Fund both function optimally and Total Fund is not subsidizing, in a way, the asset classes. Lastly, TFM complements and augments other functions, such as risk, performance, reporting, and communication.

Client maturity and external environment are additional reasons for an increased Total Fund focus. In many cases, the pension plans' maturity leads to an increased sensitivity to negative outcomes due to the interaction of net cash outflows and market downturns. As such, it becomes increasingly important to manage the short and medium-term returns better and avoid adverse outcomes in a lower expected return environment going forward. Being efficient matters even more because cost becomes an increasing part of the overall return.

We have also witnessed an extraordinary environment of significant structural changes, disruption, pandemic, ESG, and various policies and regulations. Thus, selectivity would be an essential part of portfolio management. Just buying beta might not be enough anymore.

Finally, it might also be a question of survival for the pension model itself. With increased competition and the commoditization of strategies and low cost, sometimes even zero cost for some strategies, it becomes increasingly important for the pension fund managers to remain relevant. As much as clients might be captive, they could also influence organizational restructuring and investment strategy via the board of directors and even opt-out in some instances.

Another aspect is the ability of TFM to enable the flow of capital and optimal functioning of the four pillars of the total portfolio: public markets, liquidity, private markets, and liabilities. In this part of the episode, we talked about being able to differentiate what optimal means for public markets and what it means for private markets and be explicit about it, not only in the narrative but also in measurement and accountability. And finally, this is also true for any liquidity, leverage, balance sheet decisions, which might seem optimal for the asset classes or what we call local optimality. Still, they might not necessarily be optimal for the Total Fund, or what we call global optimality.

Our final point in Episode 1 was that ultimately, what matters are outcomes. For a typical pension plan, key outcomes are wealth to pay benefits, contribution rate stability, inflation adjustment, and liquidity. Outcomes could be achieved by designing a preferred mix based on asset classes and their long-term assumptions and hoping that these assumptions will realize. Or one should not be concerned about the asset mix as an essential belief, but rather, establish the required outcomes and tolerance levels around them and have this as an objective and as a policy portfolio. Then, continuously evaluate the best short and medium-term returns, their probability and confidence levels, and build a portfolio based on this. At any time, whatever the current asset mix is, it will have the highest probability of keeping outcomes intact.

After this much needed brief recap from the previous episode, let us delve right into Episode 2.

Episode 2: What nobody told you about long-term investing

As a disclaimer, the views expressed in this episode represent a generalized framework for understanding some of the aspects of long-term investing. Organizations may have particular circumstances, such as structure, accounting, valuation, or actuarial practices, among others, which may support, negate or mitigate the general conclusions presented in this episode. Let us start with the favorite part of any story, the conflict.

The conflict

There is a widely held belief that short-termism is both pervasive and detrimental.

Meanwhile, long-term investing is considered comparatively rare yet virtuous. However, the case against short-termism is not clear cut. There seems to be this fixation on the horizon, be it short or long. What if it not about the horizon but something else? Could it be that we collectively might be mislabeling something for something else? Could this something be wealth maximization? There are often these truisms that are frequently cited but maybe because of the message being passed along so many times, these concepts are taken for granted in their absolute value, without necessarily understanding the details and perhaps, the particular circumstances which lead to the headline staple. Examples of such statements would be that real estate is an inflation-hedging asset (sometimes, but it depends on the rent resets, among other things, and actually, often it might not be). Or that infrastructure (and more generally, private assets) has a liquidity premium (if anything, it has a liquidity discount because most of the private infrastructure transactions are closed at a 40-60 percent premium to the regulatory cost of capital). I am sure everybody has their favorite list of these staples, as one book called them, "investment fables."

It is a widely accepted belief that as the investment horizon increases, the investment approach and the information it draws on should shift from price drivers to value drivers. This is a correct statement. Almost.

The problem with it is that it is taken in its absolute. Even worse, practitioners may assume their discrete cut-off on what is long and what is medium and short-term. If one asks the question, the bulk of the answers would be something like 10-15 years is long-term, 5-7 years is medium term, and 0-1 year, or so, is short term. Based on this plausible distribution, an investment thesis might posit that it is a 10-15-year strategy; it is long-term investing. Hence, it should focus on the long-term value drives, whichever way these are specified.

Time relativity – What would have Albert Einstein have to say?

A simple analysis brings a striking revelation to this seemingly obvious conclusion. As illustrated in the presentation, it turns out that at the 15- to 20-year horizon, the three drivers of terminal wealth, prices, cash flows, and reinvestment contribute equally to the end wealth. At the 5-year horizon, prices contribute 70% of the end wealth. Only at a horizon of 40 years and beyond, cash flows and reinvestment (value drivers) overwhelm prices, as prices contribute only to the vicinity of 10% to terminal wealth. As such, a nagging question remains, "How long is the long-term, and can one neglect how prices change?"

Could time be relative, and not in the Albert Einstein notion of it (or maybe it is, after all)? Should we forget about these notions of short or long or horizon in general? It is not about how long one holds the asset. It is about what one does with the assets, meanwhile. After all, could all this be about maximizing terminal wealth, and time is not only relative but irrelevant?

Given that it might all be about wealth maximization, the question is: "How one maximizes wealth?" There are two parts to it. The first part is the returns. One needs to produce inflation-adjusted cash flows in the first place (growth). Then, reinvest either new capital or capital from dispositions, cash flows or divert cash flows from other assets and reinvested the capital and cash flows at the best returns currently available at the appropriate horizon. The third aspect is to avoid negative returns. Finally, the cost is always a part of the return, so one needs to minimize any direct cost or hidden or unwarranted exposures and costs.

There is also the liquidity side. And from a liquidity perspective, one needs to have unencumbered liquidity when required. And "unencumbered" is an important word, as sometimes, even government bonds are taken for granted in the various liquidity. But if you think about it, in a real liquidity crunch where cash is king, nobody wants any assets, no matter what the price of these assets is. Everybody really just wants cash. Unless the central bank has an explicit and tested mechanism to provide this ultimate liquidity, any assumption might be wrong, especially if there is a moral hazard involved. And as you know, politicians may make surprising, even illogical decisions at times. So, having unencumbered liquidity is essential. Also, crystalizing losses or selling assets at the worst time impacts terminal wealth. As such, these are some of the key elements to maximize wealth.

The seven wealth maximization commandments

Zooming out of the lengthy narrative, these are the seven wealth maximization commandments: (i) maximize cash flows; (ii) explicitly manage inflation risk (cash flows and returns need to be real; otherwise, it is just mental accounting); (iii) reinvested at the best current returns; (iv) avoid negative returns; (v) minimize direct or hidden costs; (vi) always have enough liquidity; (vii) do not sell assets unless the reason for this is to reinvest in the best current returns.

While today's presentation's key focus is (iii) reinvested at the best current returns, it is worth briefly illustrating the importance of cash flows and avoiding negative returns to the terminal wealth. We already discussed at length the issue of efficiency and costs in Episode 1.
Wealth maximization and cash flows

An interesting question is how one maximizes cash flows? It turns out that private assets are the perfect vehicle to maximize cash flows. The presentation provides an example of the US mid-market buyout value creation versus the comparable industry and highlights that most of the value-added, outside the effect of leverage, is achieved via the revenue, sales and cash flow channels of value creation. The presentation also brings back the discussion on the four pillars of the total portfolio. The point is that the optimal private portfolio might be different from a public one. The difference comes from the objective function to maximize economic value added given cash flows, business model and business model risks, permanent capital impairment, quality of partners, network strength, and expertise to manage businesses. 

One can maximize the economic value-added because one controls business plans, management, costs, management incentives, strategic synergies, acquisitions, and dispositions. Such actions are much more challenging to put in place at public companies. However, many aspects of the ESG revolution and the increased focus by asset owners, in many ways, might lead to similar positive developments for the sustainability of the businesses at even more engaging levels. There is a fundamental reason why private markets have a place in the portfolio, and to no small extent, notwithstanding other essential considerations, it is value creation (maximizing cash flows). There might also be a similar approach to the public markets portfolio, albeit maybe at the expense of growth, or a barbell approach to jointly maximize cash flows and compensate for growth considering both public and private markets together.

Wealth maximization and the upside of the downside

(It seems it is difficult to escape from the Upside Down movie analogy from Episode 1). Another critical aspect of wealth maximization (we will talk about it more in the next episodes) is avoiding negative and adverse outcomes. The presentation makes the point via the cruel math that avoiding adverse outcomes matters more than upside growth.

Depending on the tug-of-war between upside growth and limiting adverse outcomes, in a simplified example, the presentation illustrates that the impact on terminal wealth could be material (30% more wealth due to downside protection).

The point, however, is to move away for a moment from any narrow tail risk or risk mitigation mindset but to think about this aspect from a decision-making perspective. How to evaluate potential upside growth (be it cash flows or reinvestment, which is related to the short-and medium expected returns) versus the cost of avoiding adverse outcomes and its "multiplier" (the cruel math, if you wish) as an equivalent upside growth exposure? In a simple dilemma: I can grow cash flows through corporate actions at 6%, have short-and medium-term returns of 5%, and the cost of protection is 3%? How to evaluate this decision. Is there such a decision-making framework and process in the first place? 

The key risks to outcomes checklist

The seven wealth maximization commandments ultimately lead to the question of what the key risks to outcomes are. If you recall, in the "Upside Down" section of Episode 1, we defined an alternative way to construct a portfolio based on outcomes rather than asset classes. These outcomes were the level of wealth, intergenerational fairness (contribution rate risk), inflation (cost-of-living adjustment), and liquidity (to pay benefits at all times).
Drawing from the seven wealth commandments, we then put forward a checklist of the critical risks to sustainability (strategic risk). And these are the strategic risks to outcomes:

  • Are we producing enough real cash flows? Where should we be producing these cash flows, public or private assets? What are the risks to these cash flows? 
  • Are we reinvesting at the best returns? What are our short, medium-term expected returns? Should we sell assets and reinvest, or divert cash flows from other assets to reinvest in these other assets? 
  • What are our short, medium-term expected returns? Are these less than the impact of drawdowns? What is the cost to mitigate drawdowns? How does this interact with structural risk mitigation, which is embedded in the plan design (this is a topic to come; take it for granted, for now)? Are there any hidden costs, overlaps, and exposures? Are we considering the global optimality versus what is optimal for the asset classes? 
  • Should we lever and which asset should we lever? Should we increase or decrease and deploy liquidity in the asset classes? Should we rebalance? 
  • Which is the optimal balance sheet given current market conditions?

These are all questions on your checklist when discussing risks to outcomes and wealth, which is one of the most significant outcomes. Of course, together with inflation and liquidity.

Meet your new favorite curve – The term structure of expected returns

(There has been so much pain from the yield curve anyway). The answer to many of these questions, how to manage these risks, and how to make decisions about them, ends up with the ability to formulate expected returns. Expected returns at the short and medium-term horizon and extend them up to the long-term horizon and in a consistent manner. Of course, what is the level of confidence in these expected returns because they are not certain. We call these expected returns the "term structure of expected returns," similar to the familiar concept from rates and yields. As a fast-forward, and to have a central tenet— the term structure of expected returns is central to many TFM decision.

The tug-of-war – Required and achievable expected returns

It is not just about any returns. It is about the required returns versus the achievable returns. Borrowing from Episode 1 and the distinction we made there about the difference between Asset Allocation and TFM, the required returns are associated with the long-term investment policy.

What assets to own, and what are the long-term expected returns for these assets and their yields? On the contrary, the achievable returns are the asset management view. Not what assets to own, but when to own them and how to own them. And when to own them is associated with the current pricing and the short and medium-term expected returns for these assets. The immediate point of reference emerges with the discussion at the beginning of Episode 2, where it was demonstrated that prices and reinvestment (another way of saying short and medium-term returns) contribute equally, together with cash flows to terminal wealth at the 10-15-year horizon, and 70% at the 5-year horizon. Outside the cash flow generation risk, which is a topic on its own, and we briefly touched on it in the private market example earlier, managing price risk and managing reinvestment are the critical risks to wealth to manage.

There are two aspects to this. First, the long-term expected returns might never be realized. We hope and pray the long-term expected returns we have put in our original asset mix would lead to the outcomes that we have calculated using these expected return assumptions. As such, there is a need to continually evaluate the long-term expected returns, even more so in a challenging external environment like today (impact of disruptions, themes, social and environmental issues, to name a few, and to link to Episode 1).

The second risk is if the required returns are higher than the achievable returns. This return gap causes asset value erosion due to the compounding of losses, with large, one-off losses or a series of small losses for more extended periods. These instances both need to be always assessed in conjunction with the specific liability profile and the embedded structural risk mitigation in the plan design (actuarial smoothing, use of surplus, among others). These are the critical risks to wealth maximization outside the cash flow generation risk itself.

Hibernation – While you were sleeping… Liability happens

When talking about long-term investing, there is a tempting analogy to compare it to hibernation. So long-term investing is not like going to sleep and waking up ten years later. And everything will be fine because someone might wake up to a rude awakening.

While you were sleeping... Liabilities happen, markets happen, and life happens.

The presentation further illustrates the fact that in the absence of any liability (or generally, any cash flows), long-term expected returns matching the required time horizon are a sufficient objective.

Of course, this is provided one is right about the long-term returns in the first place, which might be a heroic assumption to start with. Long-term returns are indeed the only thing that one needs to look at as the short term does not matter. Thus, the long-term investing thesis can disregard the short term.

However, in the presence of liabilities, the long term represents a series of short terms. Or what this introduces is a path-dependence.

As such, the long-term expected returns, instead, matching the required time horizon, are no longer a sufficient objective. One cannot just go to sleep or go into hibernation and wake up 10 or 20 years later. And as long as one has guessed (and prayed hard) for the long-term expected returns, it will all be okay. No, you will not be okay. As mentioned earlier, it might be a rude awakening. So, liabilities indeed happen. The presentation further provides a stylized example of these impacts on a portfolio to conclude that assets must be liquidated to cover the payments when asset returns are less than the required returns. And with that, the future required return rises. If this happens often enough, and by large enough amounts, the problem spirals. These dynamics are exacerbated when portfolios have net cash outflows, and particularly in volatile market environments (recall Episode 1's discussion on TFM and client maturity and external environment again). 

Liabilities happen… Markets happen…

Not only do liabilities happen but markets happen as well. Even the heroic assumption of being right about the long-term expected returns could not meet the objectives. As such, it requires managing the required versus the achievable return gap. A 2% gap between required and achievable returns results in a 40% probability of zero assets over a 40-year horizon for a typical pension fund portfolio. And it is a certain 100% loss for a 4% gap over the same horizon.

Well, not only liability and markets happen, but life happens as well. The presentation further transforms the stylized example into a real case study on the required versus achievable returns gap's impact using CalPERS's experience. Some key conclusions based on the case studies are:

  • Long-term sustainability requires ensuring the achievable returns are equal or higher than the required returns, and there is sufficient liquidity to meet the liabilities at all times.
  • Long-term expected returns alone are not sufficient to guarantee the end-wealth objective's sustainability, even if achieved. Long term is a series of short terms which need to be managed.
  • This requires path-dependent management of the gap between required and achievable returns to manage asset value erosion, complemented by active management and liquidity management.
This concludes the synopsis of Episode 2: What nobody told you about long-term investing.

This is what nobody told you about long-term investing (we should stop calling it this, really; ask Albert Einstein):

  • Long-term investing is not only about the horizon. But it is actually about wealth maximization. 
  • Prices, cash flows, and reinvestment drive wealth maximization. They contribute equally at the 15 to 20-year time horizon. 
  • In the presence of liability, the long term is a series of short terms. Long-term expected returns alone are not sufficient to guarantee the end-wealth objective's sustainability, even if achieved. 
  • The path of the short terms needs to be managed. It requires a path-dependent allocation to manage the gap between required and achievable expected returns and reinvest at the best current returns possible, minimizing drawdowns and efficient portfolio maintenance.

Equipped with the insights from Episode 1 and 2, next week, we will link back to TFM and how these conclusions build the foundation of the TFM framework. 

Let me begin by thanking Mihail for another outstanding comment.

I took the liberty of slightly editing some things only to make it clearer but the content is truly exceptional and he covers the material extremely well, laying the foundations for his upcoming comments.

I'd like to emphasize once again that the material Mihail and I are bringing to you cannot be found in textbooks, at your favorite consultants, or anywhere else.

It can only be produced by someone like Mihail who has extensive knowledge and experience and a true passion for the material and a gift for explaining it in the simplest terms.

This isn't easy stuff, it took me a few reads and watching the clip Mihail worked on (embedded below) to really grab the concepts and I gather it will take many of you a few reads too

But like he says, TFM, not because it's easy, because it's hard.

There is a beauty in complexity, especially when you think about modern Canadian pensions which operate like different lines of businesses. Independent on one level but integrated businesses on the most important level.

Speaking of the Canadian Model 2.0, Mihail shared with me his thoughts on funds which have organized themselves around an LDI strategy like HOOPP, or OPTrust with its MDI (member-driven investing), as being two pensions that are probably more total fund-oriented than anyone:

This is because the explicit LDI/MDI approach inevitably forces you into a deliberate and unavoidable total fund thinking and decision-making. As much as other organizations would strive to introduce a TFM approach, it might be an uphill battle if they do not change the mindset and the investment and operations structure and decision-making. It is not that it needs to be an LDI or MDI to be a total fund approach - these approaches may have already or will face their own challenges at some point. There are many roads to the proverbial “Rome,” but what probably needs to change is the structure, and with it, the mindset and culture. This is what I was alluding to as the TFM’s structural rather than functional role, and the idea around the Canadian Model 2.0
I agree but even though large pension funds don't manage liabilities, they too need to be cognizant of all this.

There's a reason why CPP Investments keeps harping on "total fund approach" in its annual report. Geoffrey Rubin, Senior Managing Director and Chief Investment Strategist and Ed Cass, the new first-ever CIO, both have a hell of a job managing the complexity of all the different investment departments in regards to how they impact the total fund (CPP Investments can use a guy like Mihail).

The same goes for all other CIOs at major Canadian pensions, they need to think about tapping these second-order efficiencies Mihail is talking about.

Anyway, I don't want to deeply analyze the second episode but Mihail is right, TFM is about maximizing wealth and the best way pensions can do this is through private markets where they can formulate a value creation plan and realize it over a number of years.

In private markets, however, execution risk needs to be controlled. Think about my earlier discussion this week on CalPERS wanting more private equity.

As I stated, and Mihail clearly shows, more private equity isn't going to save CalPERS' funded status which continues to deteriorate (only a better plan design will do that).

Moreover, in private equity, the approach matters a lot. 

Following my CalPERS comment, very wise former Canadian pension fund manager shared some observations and insights after reading this comment: 

How do we know co-investing is enhancing the return of a private equity portfolio?  Is there any instance where for example the direct/co investment 5 and 10 year track record is compared with the fund only track record?  I am unaware of any institution ever disclosing this. Lots of unsupported claims and assertions, but mostly on the theory that reducing effective fund fees in blending the outcomes of co-investment somehow creates better overall returns. 

Reducing effective fees through direct investment comes at the cost of the substantial risk of adverse selection, and undoing some of the diversification decisions that the funds themselves think through very carefully.  I have no doubt there are co-investment wins, but there are losses too. Rarely do we hear about the losses, although the anecdotes suggest to me some pretty outsized losses are piling up, and there is way more unrealized rather than realized track record at this point in pretty much any institution that has scaled up this activity in recent years.

Many institutions have not been co-investing for that long, but for those that have for all we know they would have been better off with the funds on their own. Absent disclosure, comments that this approach is in fact working are simply anecdotal. 

Sometimes you do get what you pay for, that is the task and goal of managing fees, not reducing them in isolation. Further there are illiquidity implications. There has been good and creative development of the secondary markets over many years such that the fund interests can achieve some enhanced liquidity when the need arises.  The ability to sell down co-investments, especially where the company performance is questionable, trips up various co-invest agreement terms and makes for a much more bespoke secondary market, if any exists at all for a specific asset.

I support the idea of co-investment but the accountability for this should be completely transparent, at least in the fullness of time.  Otherwise there are misleading signals to the pension market about what strategies to employ.  In an era of up risking due to low bond returns, these signals are resulting in increased private equity allocations which seem to now include co-investment as a necessary component.  The cost and governance implications of building in-house capability is considerable. As usual, the idea is fine but I fully expect that the execution can bring, or more likely already has brought unintended consequence.  Which may actually be reduced returns, and at the least even greater illiquidity on increasingly levered balance sheets.  
That prompted this response from me:
I agree with you that they need to disclose more on co-investment portfolios. On that, BCI has explicitly stated their co-investment portfolio is outperforming their fund investments one and others have told me the same. Is it because they’re not paying fees on co-investments? 

One thing Ben Meng told me before he left, CalPERS can’t expand its private equity portfolio through funds alone, it would force the to allocate to third and fourth quartile funds and defeats the purpose.
 And he replied:
Yes, I have heard the statements about performance butt when you dig, it is usually "since we changed out strategy in 2015" or "under the watch of the present leader/team", or "including the secondaries deals which we view as direct investments", or "before non-core activities" and so on. 

It is possible that there has been good performance in recent years, all with mark to market, but the current state is lagging in showing that it is typically risky deals that get syndicated. It would actually be a very simple thing to disclose, but the implications that the direct activities detracted from value would be really hard to explain. I am ok with the lack of transparency to the point of protecting long term capability. But the other side of the coin is insufficient data to actually rationally advocate for a strategy, which is what you would expect for any other asset class.

Doing third and fourth quartile funds is probably better than doing third and fourth quartile co-investments. But we don't know about the quartile breaks for any co-investment programs, so it is all just talk and wishful thinking.

I personally think that pensions taking on more illiquity through privates and more leverage at the total fund level will be the downfall of the pension system, and that will manifest quicker than people expect. Bit by bit, the old prudent man/woman fiduciary rules of play are being discarded in the quest for returns so that employers and members can avoid the full cost of excessive pension arrangements.  I love risk, but rightsizing portfolios is the way to control it, and privates or all types should be way less than the current advocates suggest.  Liquidity is way undervalued.
On Tuesday, I covered Ontario Teachers' deal with Lightyear Capital where they acquired wealth management firm Allworth Financial from Parthenon Capital.
I mentioned that I learned that several years ago, Ontario Teachers' Private Capital did a detailed attribution analysis on all their private equity deals and here's how they ranked them by profitability from worst to best:
  • Fund investments were the worst because carry and management fees ate up most of the returns
  • Minority syndication (a lower form of co-investments where you get a some slice of a deal, say 5%) were second worst because these deals are typically done in bad vintage years when deal activity is high and GPs are looking to unload investments.
  • Teachers' purely direct deals were the second most profitable deals but they weren't plentiful.
  • And the most profitable deals by far were jointly sponsored co-investments (50/50) where Teachers' and their partners sourced and underwrote deals jointly, reducing fee drag. For example, Teachers' deals in Dematic (with AEA Investors) and CPG International (with Ares), both returned roughly 8x the money. These are phenomenal deals.

What is critical to understand is Ontario Teachers', just like CPP Investments, has a specialized PE staff doing jointly sponsored co-investments which is where they get their best bang for their pension buck.

And as was explained to me, not all co-investments are profitable, especially not minority co-investments which are considered direct deals but are really nothing more than syndication where GPs unload small stakes to smaller LPs who can't do jointly sponsored co-investments (and sometimes to larger LPs).

Again, what does this have to do with Total Fund Management? Execution risk or the risk of not realizing on your value creation plan is critically important and ties in to what Mihail discusses on maximizing wealth via private markets.

What else? Mihail discusses the importance of mitigating downside risk and I think he makes a great case.

Remember, pensions are all about managing assets and liabilities but in doing so, they want to minimize downside risk to mitigate extreme volatility and large swings in their funded status and contribution rates.

Take two individuals, Joe and Bob. Joe likes growth stocks, keeps investing everything in the Nasdaq-100 (QQQ). Bob is more safe, likes a balanced 60/40 portfolio and invests only in high dividend blue chip stocks.

Since 2009, Joe's portfolio (100% Nasdaq) has outperformed Bob's but with a lot more volatility. Joe had many sleepless nights, worried sick about his investments. Bob just stuck to his plan and slowly but surely accumulated wealth and didn't suffer the drawdowns Joe did. His portfolio hasn't outperformed Joe's but he sleeps well at night knowing he has more than enough to cover his retirements needs.

Well, lately, with bond yields at zero, even Bob is starting to worry about his retirement but the point I'm making is achieving the same end result doesn't mean experiencing the same journey, investment outcomes are very path dependent. 

Like Mihail states, liabilities, markets and life happen and they can all influence the terminal wealth creation. 

Think about the pandemic and its long-term impact on segments of real estate, infrastructure and private equity. We still don't know the long-term effects of this pandemic.

Lastly, I told Mihail about something very wise OTPP’s former CEO Jim Leech once told me: "Pension deficits are path dependent, the starting point matters."

If you're a chronically underfunded US public pension with a 7% target, you need to take excessive risk to make your target rate-of-return and more than likely, you will never achieve it (taxpayers and governments will need to bail you out).

Alright, let me stop there, adding some of my thoughts but I want you all to please take the time to view Mihail's longer presentation below where he delves into the subject matter and offers excellent insights.

Once again, on behalf of everyone reading this comment, let me thank Mihail Garchev for the incredible work he has done putting this series together. It truly is outstanding.

Below, Episode 2 of the seven-episode series "Introduction to Integrated Total Fund Management" presented to you by Mihail Garchev, former VP and Head of Total Fund Management of BCI.