PSP's CIO on ExpandingTheir Total Portfolio Approach
In just 20 years the Canadian fund PSP Investments has grown to more than $200 billion. As it enters its next five year strategy, Amanda White spoke to CIO Eduard van Gelderen about the next phase of portfolio management and the development of its total portfolio approach including assessing and allocating investments on a sector basis.
In the past five years a big focus at PSP Investments has been developing the total fund portfolio approach including the team and decision making, and CIO Eduard van Gelderen says this meant the portfolio fared well during the market volatility of the past 18 months.
“When the uncertainty started the most important thing was that we didn’t panic,” he says. “We had a controlled way of looking at our portfolio on the public and private side of investments and didn’t really change positions that much. We didn’t feel any pressure to change or sell, far from it.”
The team’s approach is very focused on the long term and assessing positions on that basis. There was increased analysis of the portfolio during the market volatility, including every line item and the watch list grew from its usual 2-3 per cent, but there was not much movement in strategic positions.
“The process we have in place is very solid, every individual deal goes through an investment and risk committee and there is an independent role by the risk team to assess positions. The collective knowledge we have on individual positions is very high. That helped us not to panic and not to sell and that clearly paid off,” van Gelderen says.
The fund has around 47 per cent of assets in public equities which was the main driver of the 18.4 per cent return in the past financial year.
In the past financial year, which runs to March 31, there were 50 transactions that entailed cross-asset class collaboration, emphasising this collective knowledge, and evolving the total fund approach will continue into the next strategic plan.
PSP Investments, which invests funds for the pension plans of the federal public service, the Canadian Forces, the Royal Canadian Mounted Police and the Reserve Force, was formed in 2000 with less than 20 staff and about C$2.5 billion. It now employs more than 900 people and manages C$204 billion.
20 years ago it invested passively in public equities and bonds building up the private assets exposure over time including infrastructure, real estate and private equity which alone now accounts for 15 per cent of the portfolio. In the last few years the fund has expanded to open offices in London, New York and Hong Kong.
For two decades the effort has been on the bottom up, building different investment teams that were looking for best ideas.
“The emphasis has been on building up investment portfolios and now 20 years later while we have done a good job in generating returns going forward we need a more top-down total fund approach,” he says.
This includes examining the role of the different investment teams in the total fund.
“Not every team is about maximising returns, for example what are the roles of the different asset classes in mitigating funding risk?” van Gelderen says.
As an example he said a new infrastructure strategy was introduced last year which was not about return but driven by matching the pension liabilities, which are fully indexed to inflation.
“We do that with every single asset class,” he says.
The last 20 years has also been characterised by government cash injections and contributions being a major driver of growth.
“When we started to invest cash was the big driver now 20 years later the portfolio is the big driver, so the focus is on running the portfolio now not the individual deals. It’s about how we steer the C$204 billion going forward and match it with the mandate.”
A sector approach capitalises on collective knowledge
As PSP looks to the next five years a clear message is coming from the fund sponsor, the Canadian government, that risk is more important than the upside.
“It is about maximising returns but the funding risk is becoming the real driver going forward. Does that mean we change the portfolio construction process and emphasise that element more than we did before,” van Gelderen says, adding that there are a number of different projects underway that look at that.
One of the more interesting is a move to a more sector approach rather than asset class classifications.
“We already had an initiative with our healthcare team where different people from different asset classes come together, and by combining these people we have a very rich dialogue on how this sector is behaving and where the opportunities are,” he says. “It provides a lot of interesting investment opportunities going forward. We want to expand that model to other sectors too.
“A traditional divide between public and private doesn’t make sense, that is just packaging. It’s better to combine all the collective knowledge we have and see where the best opportunities are. It’s very exciting and is part of our total fund approach going forward.”
van Gelderen, who has been at PSP for three years coming from heading up APG via a brief stint at California University endowment, says technology is another sector the team is closely analysing, in particular to determine what technology represents incremental change and what is disruptive.
“Instead of saying let the asset classes themselves look into it we think it is a huge benefit to group everyone together and see what we really think is happening,” he says. “We have a part of the organisation looking at the more disruptive, longer term changes and how that will impact our portfolio. We are spending a lot of time on this.”
PSP’s new strategic plan has three pillars: this notion of a global fund first where total fund performance is emphasised, being insight driven, and a emphasising a high performing team.
Van Gelderen says from an investment perspective a lot of time and energy will be spent on technology and data.
“We have a lot of data on the asset classes but that doesn’t mean we have it on the total fund,” he says. “We feel that if we combine the different investment teams and have a dialogue and come to a conclusion we want it to be more fact based and data driven than before, we don’t want to make the decisions purely on a narrative but want the supporting data to come to that conclusion too.”
He believes that developments in digitalisation and the enormous increase in available data provide an opportunity.
“More data doesn’t mean better investment decisions, it’s the quality of that,” he says. “A lot of people immediately think of AI, but that is only part of it. It’s data-driven, insight-driven investment decisions. If you believe the investment world is a low yielding investment world then this is very important to help differentiate investments.”
This is an excellent interview with Eduard van Gelderen and I wanted to bring it to your attention as last week, I covered PSP's Investments' fiscal 2021 results but didn't cover this as I only saw it after.
In another article from Institutional Investor, Eduard highlighted what's next for PSP:
For Canada’s Public Sector Pension Investment Board, the fiscal year that ended on March 31 was its best in ten years, performance-wise.
According to a Wednesday announcement, PSP posted an 18.4 percent net return for the fiscal year 2021.
Now, as its most recent five-year plan comes to a close, the fund — and chief investment officer Eduard van Gelderen — have revealed the fund’s future priorities, which include taking a top-down investment approach, embracing big data, and considering what a hybrid workplace could look like.
PSP Investments is in a good position already: over the ten-year period, the 8.9 percent annualized return beat its benchmark by 1.1 percent per year. The five-year return — 9.3 percent — exceeded the benchmark by 1 percent per year.
“When you look at it, it was an interesting year in terms of performance,” van Gelderen said by phone. “That makes us very happy.”
Investing in the Land
Although it’s on the smaller side compared to the rest of the portfolio, PSP’s C$9.7 billion ($7.7 billion) natural resources allocation is beating its benchmark in a big way. Over the one-year period, it returned 10.6 percent, compared to the 7.7 percent benchmark. Over the five-year period, it returned an annualized return of 9 percent, as compared to the 3.7 percent benchmark return.
“Natural resources or commodities has always been considered as an interesting asset class because of the perceived inflation matching characteristics,” van Gelderen said, referring to the theory that the asset class could provide inflation protection. “That relationship is not that strong in practice. Especially when a lot of institutional investors entered the markets, the relationship was broken.”
PSP’s approach is “slightly different,” as the fund focuses on land, particularly where cattle are raised, he said. “The challenge going forward is that we’re already one of the bigger investors of natural resources in Australia,” van Gelderen said, referencing the fund’s farmland investments in the country. “Where do we find the best opportunities going forward?”
Vision 2021 comes to a close. Here’s what’s next.
This year also brought PSP’s Vision 2021, a strategic five-year plan, to a close. During the most recent fiscal year, that strategic plan contributed to over 50 transactions, according to the announcement.
Now, PSP is planning for the future. Alongside consultants, the pension fund’s staff considered about 40 different themes that they expect to impact the fund in the coming years.
The group landed on three specific initiatives. The first is to take a more top-down approach to investing. While Canadian funds are known for a bottom-up approach to investing that has defined their success over the years, van Gelderen said that PSP plans to start thinking about the total fund during decision-making.
“It’s where to invest in the world, but also related to what is the exact risk tolerance, and how can we express this?” he said. “We are in a good dialogue with our sponsor to fine-tune what they find important in our mandate in terms of risk.”
At present, PSP has risk and investment committees where “every deal is discussed.” The fund’s risk department also does independent assessments of potential investments. According to van Gelderen, this approach was particularly effective during the market turbulence amid the early pandemic.
“When March started and the fear came up, we had a very clear understanding of the underlying portfolio companies,” van Gelderen said. “We literally went through every single company to assess what was going to be the impact.” Although his team added more companies than usual to its “alert list,” he said they “never felt that we were not in control.”
PSP focused on keeping cash on hand during that period. “You run into trouble when you run out of cash,” van Gelderen said. “When there’s a margin call and you need to cough up cash and you don’t have it, you become a forced seller of assets and that will have an impact on performance. We made sure we had more than enough cash liquidity.”
Moving forward, van Gelderen said PSP will develop additional risk metrics to use on the total fund level to address the plan sponsor’s “greatest fears.”
PSP, Meet Big Data
The second initiative is to become a more “fact-driven investor,” van Gelderen said. And that’s not to say that the fund isn’t already, he noted.
“It's not that we don’t have any data now, but we know that there is this data evolution going on,” van Gelderen said. “We want to shift our decision-making more in that direction.”
This means sourcing data to improve decision-making, building a system to use that data, and creating insights based on the information they receive. “Just having data is not enough,” van Geldern said. “You need to know how you can work with that data and make better investments.”
The third part of PSP’s plan is to ensure that the organization is agile, particularly in a world that is moving toward virtual work. According to PSP’s announcement, one of the expected permanent changes to the fund will be a move toward a hybrid work model, where employees don’t need to be in the office every single day.
“If people are becoming less dependent on specific location, it will change the competitive environment for talent,” van Gelderen said.
Indeed, if you can hire talent from anywhere, it will change the competitive environment but thus far, I'm not seeing Canada's large pensions jumping on those opportunities (still hiring from their own cities almost mainly).
Anyway, there's a lot of food for thought here so let me share my thoughts with you.
First, a CIO needs to first and foremost think about the total portfolio, and to do that properly, they need to really understand what is going on at an asset class and sector level and everything in between.
This requires a considerable amount of collaboration and an experienced team that can easily work across public and private markets.
From my experience, it's not easy finding people who can go from real estate to private equity to private debt, then infrastructure, commodities, natural resources, stocks, bonds and everything in between.
But I noted this in the first article above:
In the past financial year, which runs to March 31, there were 50 transactions that entailed cross-asset class collaboration, emphasising this collective knowledge, and evolving the total fund approach will continue into the next strategic plan.
Of course, important details were left out: how big are those transactions (are they trivial in the grand scheme or worth doing), how exactly does cross-asset collaboration take place to ensure the best interests of clients and stakeholders and most importantly, who is ultimately responsible for these transactions, especially if they don't fit nicely in an asset class bucket?
Recall this table from last week when I went over PSP's results:
| ASSET CLASS (at March 31, 2021) | NET ASSETS UNDER MANAGEMENT (billion $)1 | ONE-YEAR RETURN | FIVE-YEAR RETURN | % OF TOTAL NET ASSETS |
|---|---|---|---|---|
| Capital Markets | $97.5B | 26.6% | 10.0% | 47.6% |
| Private Equity | $31.7B | 28.4% | 11.3% | 15.5% |
| Credit Investments | $14.5B | 10.5% | 11.7% | 7.1% |
| Real Estate | $26.8B | 3.8% | 6.1% | 13.1% |
| Infrastructure | $18.4B | 4.5% | 10.5% | 9.0% |
| Natural Resources | $9.7B | 10.6% | 9.0% | 4.7% |
| Complementary Portfolio | $0.2B | 0.2% | 11.2%2 | 0.1% |
As at March 31, 2021:
From my past discussions, I remember that the Office of the CIO handles the Complementary Portfolio. This portfolio was started a little over 4 years ago and it has generated impressive returns but it makes up a very small percentage of PSP's total portfolio ($0.2 billion).
Still, it's smart to have such a portfolio because it adds value over the long run and it makes sense to look at transactions that don't fit nicely into any bucket.
What else? Eduard talks about moving to a more sector approach rather than asset class classifications:
“We already had an initiative with our healthcare team where different people from different asset classes come together, and by combining these people we have a very rich dialogue on how this sector is behaving and where the opportunities are,” he says. “It provides a lot of interesting investment opportunities going forward. We want to expand that model to other sectors too.
“A traditional divide between public and private doesn’t make sense, that is just packaging. It’s better to combine all the collective knowledge we have and see where the best opportunities are. It’s very exciting and is part of our total fund approach going forward.”
Again, this makes sense, you want your public market experts sharing information with your private market specialists on trends they see and vice versa.
For example, life-sciences real estate is a hot area right now but if you see a slowdown in the VC cycle or in public markets, you might want to hold off on major transactions (just an example, remember these are long-term investments).
What I'm trying to convey here is whether or not you adopt a sector or asset class approach, you really need top analysts working together, hashing it out using the best quantitative and qualitative analyses.
In all these decisions, data is increasingly important which is why PSP is beefing up its data analytics.
And even there, there are data experts and best of breed data experts who have a lot of experience in markets and know how to find the right data and model it properly to come to proper decisions.
That job now falls under David Ouellet who was promoted to Senior
Vice President and Chief Technology and Data Officer and joined PSP
Investments’ Executive Committee in recognition of the important role
technology and data will play in the organization moving forward.
But Eduard is spot on when he states this:
“More data doesn’t mean better investment decisions, it’s the quality of that,” he says. “A lot of people immediately think of AI, but that is only part of it. It’s data-driven, insight-driven investment decisions. If you believe the investment world is a low yielding investment world then this is very important to help differentiate investments.”
You don't necessarily want more data, you want good data that leads to actionable decisions but I will admit, sometimes what looks like meaningless data to the human eye might turn out to be very robust data in a model.
Again, it seems easy but it's far from easy and there are a ton of steps in between to make sure the integrity of the data is sound and that all the systems are offering data which can talk to each other.
Lastly, Eduard talks about funding risk, ie the risk that assets won't match liabilities over the long run:
As PSP looks to the next five years a clear message is coming from the fund sponsor, the Canadian government, that risk is more important than the upside.
“It is about maximising returns but the funding risk is becoming the real driver going forward. Does that mean we change the portfolio construction process and emphasise that element more than we did before,” van Gelderen says, adding that there are a number of different projects underway that look at that.
In an interview with Bloomberg, PSP's CEO Neil Cunningham discussed asset allocation shifts during FY 2021:
“We’ve shifted money to these assets that can provide the same risk factors, but with higher returns,” president and chief executive officer Neil Cunningham said in an interview Wednesday.
In particular, PSP Investments is betting on infrastructure as the global economy recovers from a pandemic-induced slump.
“We’ve increased allocation to high-correlated infrastructure to capture that real return aspect of infrastructure on assets that are long dated and going to involve a lot of credit and operational risk, as we’ve been looking for alternatives to the traditional bond investments,” he said.
So, it's clear funding risk is already being incorporated into the asset mix and as PSP grows, it will be increasingly more important to focus on assets that offer a better match to long-term liabilities with a lot less risk.
There's a lot to digest here, I'd need to spend an entire day with Eduard to really understand well PSP's total portfolio approach but it's absolutely true that this approach has to be executed well and that is the future of managing assets, not just at PSP but for all long-term institutional investors.
Eduard van Gelderen has tremendous experience, he has a solid team to help him and that includes cross-asset collaborative efforts, but there's still a lot of work left and he doesn't hide the fact that it is evolving.
And tying all this together is risk, you need your risk department to be able to gauge liquidity, valuation and other risks of each transaction and to convey the risk of portfolio shifts to the sponsor and clients so they are comfortable with it.
Alright, let me wrap it up, I think this is a fascinating topic but definitely not an easy one.
Below, Episode 6 on TFM Capabilities of the seven-episode series "Introduction to Integrated Total Fund Management" that Mihail Garchev, VP and Head of Total Fund Management of BCI and I worked on last year.
I keep coming back to this series because it shows you how complicated a total portfolio approach can be and why all the critical elements (especially governance) have to be there in order to ensure its success.
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