OTPP's Big Push Into International Private Markets

Josephine Cumbo of the Financial Times reports top Canadian pension fund plans C$70bn push into private markets:

The Ontario Teachers’ Pension Plan is gearing up for a fresh C$70bn push into private markets, spanning assets from infrastructure to real estate, as one of the world’s largest retirement plans tries to escape the punishing effect of low interest rates. 

The C$221bn plan, which is responsible for managing the retirement savings of more than 300,000 Canadians, intends to invest the sum in private markets over the next five years, marking a break from the public markets it and other pension funds largely rely on for their returns. 

“We are investing a lot more in private activities and will do so over the next five years — so the best part of C$70bn will go into private activities around the world,” said Jo Taylor, the president and chief executive of the OTPP. 

 “For now, with very low yields available (from fixed income) we are looking to secure better, more balanced returns in other asset categories,” he added. 

The ambition is a significant step up from the C$45bn that the OTPP has in real assets. Its plans could see the share of real asset holdings rise to around a third of the portfolio, up from a fifth at the end of last year. 

Private markets encompass both real assets, such as real estate and infrastructure, as well as the debt and equity of privately-owned companies. 

Established in 1990, the OTPP is already a high-profile investor. Some of its biggest investments include White City Place, a “creative campus” in West London and The Ritz-Carlton in Toronto Complex. It recently bought Caruna in Finland, a utility business, and Evoltz in Brazil, an electricity transmission business. 

However, Taylor said its deepening drive into private markets would lift the weighting the fund has to regions beyond North America from its current 30 per cent, with Europe and Asia a particular focus. Under the plan, 50 per cent of future private investments will be made outside North America. 

“This is a major departure from our current portfolio — where some 70 per cent of our assets are based in Canada and the USA,” said Taylor. “We want to be an international investor”. 

Institutional investors, including pension funds, typically use bonds and equities as the two building blocks of their portfolios, with an investment horizon tied to the often long-term nature of their liabilities. 

However, analysts say that a combination of low bond yields and expected lower gains from stock markets will force more pension funds to shift allocations to private markets, including credit and private equity, where returns can be higher but assets are typically less liquid. 

“We expect asset owners, including pension funds, to continue raising allocations to the private markets,” said Michael Cyprys, an analyst covering brokers, asset managers and exchanges at Morgan Stanley. 

Taylor, who took over as head of OTPP in 2020, earlier this year unveiled plans to be “bolder and bigger” with investments in an effort to meet its target growing its assets to C$300bn by 2030 — an amount it calculates is needed to remain fully funded. 

Headquartered in Toronto, OTPP also operates out of London, Singapore, Toronto, Hong Kong alongside smaller operations in New York and San Francisco. Given the planned allocation to private markets, the fund is expanding its in-house investing team. 

 “We need the skills in-house to make sure that we continue to perform at a really high level, to make sure we get the returns to reach the $300bn target, taking the right amount of risk,” said Taylor. 

Addressing Asia, Taylor said “we do see strong growth” there “and would probably like to increase our exposure there over time”. 

“But that’s not to say we don’t still see great returns and growth in North America. The US market has been really successful for us for a long time. You can see with some of the stimulus there will probably be good growth coming through too.” 

Despite criticism of China’s human rights record, the Canadian fund has been growing its investments there, including in the country’s education and tech sectors. 

“There are issues around the world in terms of the political agenda of governments,” said Taylor. 

“When it comes to the businesses we invest in, we try to be thoughtful. But our requirement is to look around the world and say how do we get to a balanced portfolio internationally of C$200-C$300bn dollars and it is probably quite challenging to do that if countries like China are excluded completely.”

A couple of weeks ago, I wrote how OTPP is aiming for a bolder, more entrepreneurial future. 

Jo Taylor wants the world to know that OTPP is looking to expand internationally.

In particular, it wants to increase its real assets, such as real estate and infrastructure, as well as the debt and equity of privately-owned companies all over the world, especially in Asia-Pacific. 

Bloomberg recently reported that OTPP wants to double its investments in infrastructure:

Ontario Teachers' Pension Plan aims to double its infrastructure investments within the next five years.

"We are very much focused on the core infrastructure spectrum, but not exclusively," said Dale Burgess, senior managing director for infrastructure and natural resources, in an interview.

Mr. Burgess said he'd like to lift the level of investment in the asset class to C$40 billion ($33 billion) from currently C$17.8 billion, or about 8% of the total portfolio. Overall, the infrastructure and natural resources team has 60 people.

The Toronto-based pension plan is especially interested in assets that have high barriers to entry, the so-called core infrastructure, which usually have inflation protection, and provide a stable cash flow profile to the fund, according to Mr. Burgess. This category would involve airports, toll roads, regulatory utilities and renewable power.

It's also looking at "core-plus" or assets that are adjacent to that core sector that are slightly riskier, be it market risk, technology risk or commodity risk.

Ontario Teachers added to its infrastructure bets this year, buying stakes in the operator of thermal energy systems Enwave Energy Corp. in Canada, electricity transmission platform Evoltz Participacoes SA in Brazil and electricity distribution system operator Caruna in Finland.

Global assets

"We have a very global mindset and a great global perspective, we have a global investment committee, we all sit on it and we evaluate, you know, a toll road in Australia against a toll road in Mexico against a toll road in Europe," Mr. Burgess said.

"We try to compare and contrast, and one of the benefits of infrastructure is that you are looking at a smaller group of assets that, for the most part, have a similar purpose profile and it is easier to make those relative trade-off comparisons."

The pension fund is seeing rich valuation of assets across the board. It's seeing "a healthy level of competition" for core assets in both developed and emerging markets.

"We can't simply look at one or the other, but we do need to be selective in terms of the assets that we choose to go after. We want to make sure that we're getting a premium for the risk we're taking by going further afield to find that type of risk profile," he said.

While Ontario Teachers doesn't set hard targets by geographies, it sees the Asia-Pacific region as an underrepresented portion of its overall infrastructure portfolio. The pension fund recently opened up a Singapore office that's set up initially with people from the infrastructure group.

"We have the desire to grow in that part of the world, we want to make sure that it's done in the right pace," Mr. Burgess said.

The pension fund is heavily concentrated in airports, including in Birmingham, London, Copenhagen and Brussels, which have been hit hard by the pandemic. Ontario Teachers is working with the management teams of these companies to make sure that they're right-sizing their business from a cost perspective, and making sure that when traffic does recover, these assets will rebound as well.

"We do have a strong conviction that there will be a recovery of travel once it becomes safer," he said. "We take a longer term trajectory and some sectors were hit harder than others. Digital infrastructure, for example, really benefited from what we've seen during COVID."

Carbon neutrality

Earlier this year, Ontario Teachers committed to reaching net-zero emissions across its investment portfolio within three decades. It will increase investments in climate-friendly projects, ensure companies in its portfolio manage and report their emissions every year and work with them to reach carbon neutrality by 2050.

Still, the pension fund isn't ready to sell assets that don't fit into ESG criteria. When factoring in sustainability into its investment decisions, Ontario Teachers tries to strike a balance between making sure that it wants to have those assets that benefit from the tailwinds that are sustainable, while also making sure it's getting paid the right risk adjusted return to be able to pay pensioners, Mr. Burgess said.

Net-zero infrastructure requires some creative solutions and the pension fund prefers "engagement over divestments," he said.

"It requires us to rethink how we're actually looking at existing infrastructure, whether or not there are ways to be able to take some of the old infrastructure and reposition it so that it does actually have a place in a decarbonized world."

"Assets that may rely on fossil fuels will be a major essential part of most economies for several years to come, how do we reconcile looking at building a portfolio of infrastructure assets, knowing that this is a key part of infrastructure and will be for quite a while?" Mr. Burgess added.

Last year, the pension fund earned 8.6%, trailing its benchmark by 2.1 percentage points, as gains in fixed income and equities were partially offset by significant losses on shopping malls and other real estate.

The pension fund has slashed its holdings of government bonds from developed countries after reaping large gains during last year's plunge in yields. It eliminated exposure to sovereign debt with negative interest rates and reduced its holdings of the lower-yielding bonds, after its fixed income portfolio gained 20.7%. Real estate and infrastructure should play a "critically important role, providing stable cash flow and income that is linked to inflation," Ziad Hindo, chief investment officer of the C$221.2 billion fund, said at the time.

The message is clear, in an ultra-low rate environment, real estate and infrastructure will have to pick up the slack from low bond yields.

Moreover, with rates at record lows and public equities at record highs, OTPP is looking to place more money in real assets and private equity, including private debt. 

But in OTPP's case, it needs to diversify its real estate holdings outside Canada and that strategy is starting to take hold nicely

Today, Cadillac Fairview, OTPP's real estate subsidiary, welcome three new members to its senior leadership team:

In order for OTPP to execute on its strategy to diversify its portfolio internationally, Cadillac Fairview will need to step up its strategy to diversify across geographies and sectors:

Again, this is occurring but it will take time. 
As far as infrastructure, OTPP is already an international investor and it will grow this portfolio especially in the Asia-Pacific region where growth will be strong over the next decade. 

Still, doubling the size of the infrastructure portfolio over the next five years is an ambitious target and it will require a strong presence all over the world, especially Asia, to really find the best deals at a reasonable cost. 
I also think while core infrastructure is where the focus will be, OTPP should also look at more opportunistic infrastructure deals as they can capitalize there too.

Keep in mind, with bond yields at record lows, every major institutional investor is looking to invest more in privates in general and real assets in particular. 

That means intense competition but it also means OTPP will be able to partner up with the right partners to make bids on prize assets. 

Lastly, I expect OTPP's private debt portfolio will grow internationally over the next five years as it joins other large Canadian peers in diversifying its fixed income portfolio in a low-rate world:

Again, the message is clear, Jo Taylor is setting the course, he wants OTPP to transform itself into an international investment powerhouse under his watch. 

I have no doubt that OTPP will get there, it will take time but it has the in-house expertise and international offices to deliver on this mandate.

Below, Frank Kwok, Head of Macquarie Infrastructure and Real Assets in Asia-Pacific outlines some of the key factors driving the growing demand in the region.
Update: On Wednesday, OTPP and Macquarie Group announced they have entered into an agreement to jointly acquire Puget Sound Energy from CPP Investments:
Macquarie Asset Management (“MAM”) and Ontario Teachers’ Pension Plan Board (“Ontario Teachers'”) today announced the signing of an agreement to jointly acquire a 31.6 per cent stake in Puget Holdings (“Puget”) from Canada Pension Plan Investment Board (“CPP Investments”). Puget’s primary operating subsidiary, Puget Sound Energy (PSE), is the oldest and largest electric and natural gas utility in the state of Washington, serving approximately 1.2 million electric customers and 900,000 natural gas customers in the Puget Sound region. MAM and Ontario Teachers' will each hold a 15.8 per cent stake in Puget after the close of the acquisition.

The investment in Puget comes amid a requirement for electric utilities in Washington to eliminate coal-fired power by 2025 and supply 100% carbon free electricity by 2045. The state’s decarbonization policies align with commitments made by MAM and Ontario Teachers' to achieve net-zero greenhouse gas emissions by portfolio companies.

“We are very excited to once again partner with Puget and its strong management team,” said David Fass, Head of Macquarie Infrastructure and Real Assets, Americas. “We have always believed Puget to be an outstanding company with an industry leading commitment to safety, reliability and sustainability. Particularly after the passage of landmark environmental legislation like the Clean Energy Transformation Act, we are thrilled to be reinvesting in the company at this critical time.”

“We are pleased to become shareholders in Puget and expand our portfolio of core infrastructure assets in the United States,” said Dale Burgess, Senior Managing Director of Infrastructure & Natural Resources at Ontario Teachers’. “Puget will play a key role in decarbonizing Washington State’s power generation and assisting local industries and consumers to lower their carbon footprints, which is aligned with our own net zero ambition and focus on helping our portfolio companies transition to and thrive in a low-carbon economy.”

 Great asset for OTPP to own and it will help it with its goal of achieving net-zero emissions by 2050.