Hannah Zhang of Private Equity International reports on why CDPQ's head of Private Equity thinks the worst thing for a pension is to miss vintage:
When Martin Longchamps took over as head of private equity at Canadian pension fund Caisse de dépôt et placement du Québec
in late 2022, he faced an unprecedented challenge: the institution’s
allocation to private equity had reached 20 percent for the first time
in its investment history, raising concerns over potential
overallocation issues.
The country’s second-largest pension has been a seasoned private
equity investor for almost half a century. However, it wasn’t until the
last decade that the asset class began to account for a significant part
of its investment portfolio: CDPQ’s private equity assets nearly
doubled from 10.1 percent of its portfolio in 2013 to 20.1 percent in
2022. The upper limit for CDPQ’s allocation to PE was raised from 14.1
percent to 21.4 percent over the same period.
From the start of his tenure at CDPQ, Longchamps knew that his role
would be different from the mantle taken on by his predecessors, each of
whom had dedicated themselves to building and growing the pension’s PE
programme. In Longchamps’ view, CDPQ’s private equity strategy has since
reached a mature stage, particularly as it edges closer to its upper
allocation threshold.
“If you look at the story of private equity at CDPQ, it was all about deployment up until 2020,” Longchamps tells Private Equity International.
“Fast forward a couple of years later, private equity had performed
well with great returns. Approaching the end of 2022, we found ourselves
needing to address an overallocation issue.”
For the new helmsman of private equity at CDPQ, which has C$434.2
billion ($318.5 billion; €293.2 billion) in assets under management as
of December, the priority is to steer the pension’s PE portfolio back to
safe waters and ensure its allocation fits within the risk budgets of
its 48 depositors.
“‘Don’t think about making new deals. Let’s make sure we get back to
the allocation we should be.’ That’s the first thing I told my team,”
Longchamps says.
A change of philosophy
When Longchamps took charge of CDPQ’s private equity business, its PE
holdings were made up of 75 percent direct investments and 25 percent
fund interests. Moving into 2023, he set a goal of reducing the
pension’s PE allocation to 18 percent within three years, primarily by
selling companies and exiting fund stakes via the secondaries market.
The shift required “a change of philosophy” for investment staff on
the PE team, Longchamps adds. These professionals had been trained to
spot top private companies and PE funds, rather than to sell their
investments.
Divestments weren’t a major part of Longchamps’ past roles, either.
Before joining CDPQ, he spent two decades at various investment firms
across institutional and private sectors in Canada, where he oversaw
deal sourcing, managed investment professionals and worked with
executives at portfolio companies. Most recently, he served as head of
origination and execution of private equity at the Public Sector Pension Investment Board,
one of the largest Canadian public pension plans with C$244 billion in
assets. During his five years at PSP Investments, he was responsible for
identifying and executing co-investment opportunities with partner
funds, as well as creating value for portfolio companies.
At CDPQ, however, Longchamps has found himself in a place where he needs to implement “a mindset of net negative deployment”.
“Given that we are at maturity, we need to sell more than we buy
every year to avoid missing vintage years. That’s one of the [most]
important changes that we needed to bring forward and deliver against,”
he says. “Of course, the selling part is always the hardest, especially
as the team had been built to focus on increasing investments rapidly.”
For the first four to five months of his term, Longchamps focused on
uniting his team to embrace this transition within its private equity
programme. He wanted to come up with a plan quickly, even though the
market wasn’t favourable for sellers at the time.
“There is no rush to sell over the long term, but we [need] a plan
for implementation and know what steps are required to bring the PE
allocation back to 18 percent of the global portfolio.”
CDPQ wasn’t a stranger to the PE secondaries market prior to
Longchamps coming on board. In late 2022, the system explored a sale of
its PE fund stakes that was reported to be worth more than $1 billion,
before ultimately deciding to hold off as markets deteriorated and
pricing outlook appeared bleak, as affiliate title Buyouts
reported at the time. Prior to that, the system had completed several
large offloads of its PE fund portfolios, including a sale of nearly $3
billion to Ardian in early 2022 and a sale of $1.3 billion to an investor group led by Goldman Sachs in 2018.
“Have people been able to sell in the past? Yes. [But] at that time,
it wasn’t the focus of our team. It was more of an opportunistic
approach and not necessarily driven by allocation issues, as we were in a
ramp-up phase,” Longchamps says.
Longchamps’ monetisation plan went smoother than he had anticipated.
In 2023, his team generated C$9 billion in liquidity, including roughly
C$6 billion from selling direct investments and receiving dividend
recapitalisations, and around C$3 billion from selling PE fund stakes in
the secondaries market.
One of the biggest direct sales that CDPQ made last year was the
partial divestiture of USI Insurance Services, a US-based insurance
brokerage and consulting firm that the pension acquired in an equal
partnership with KKR
in 2017. In September, CDPQ sold nearly two-thirds of its stake back to
USI and KKR for C$1.5 billion, according to its 2023 annual report.
The C$3 billion divestment of PE fund stakes, meanwhile, comprised a
strip sale of C$1.7 billion, which was finalised last August, and a full
exit from a manager that no longer fit into CDPQ’s PE programme, which
was completed in December, according to Longchamps.
“The secondaries space was very crowded when we hit the market. We
decided to cut the trade in many transactions to expand the pool of
buyers, and we were delighted with how it worked out,” Longchamps says.
He adds that CDPQ was able to obtain an attractive price for its
portfolio sale in the secondaries market.
Unlike other big LPs selling in the secondaries market last year,
CDPQ didn’t allow buyers to cherry pick the best assets from its
portfolio, according to a source familiar with the strip sale
transaction. “It was ‘take it or leave it’,” the source says, adding
that CDPQ was able to trade at a higher-than-expected price because it
timed the market well.
The process went so smoothly that Longchamps’ team managed to bring
CDPQ’s PE allocation back to its 18 percent goal by the end of 2023,
well ahead of the initial three-year target. What’s more, it was the
first time in a decade that the institution’s PE allocation decreased
relative to the total percentage of its overall AUM.
“Quite frankly, the success of our monetisation plan exceeded our
expectations,” Longchamps says. He adds that monetisation “will always
be part of CDPQ’s muscle”, given private equity’s ability to outperform
in the long term.
“We have to bring velocity to the asset class,” Longchamps says.
“Private equity is the asset class that takes the most risk at a pension
fund. Therefore, it should deliver the highest return, which has
certainly been the case.”
CDPQ’s net assets have increased by C$108 billion over the past five
years, 38 percent of which stemmed from growth in its private equity
portfolio, according to the pension’s 2023 annual report. Its PE
investments achieved a 14 percent annualised return from 2018-23,
beating its benchmark by 1.6 percentage points. Over the same period,
its PE portfolio delivered the highest annualised return across all
asset classes, followed by infrastructure (9.5 percent), public equities
(9 percent) and fixed income (1.7 percent).
In 2023, however, the pension’s PE portfolio only returned 1 percent,
compared with an astonishing 17.7 percent generated by its public
market counterpart. The annual report cites a sharp rise in interest
rates and a slowdown in growth as factors that contributed to PE’s
relative underperformance.
Even so, the recent uptick in public markets has worked in
Longchamps’ favour: with PE’s performance lagging and his team selling
off assets last year, they can now focus on deploying capital without
concerns of overallocation in the near term.
“We are now back to our target allocation in 2024 and have regained
our agility and flexibility to invest,” he says. “The worst thing that
can happen at a pension fund is to miss a vintage.”
The alignment issue
How does CDPQ align with managers on its private equity fund sales?
For CDPQ’s GPs, accepting that
they may be sold in the secondaries market doesn’t come naturally.
However, the pension’s strip sale strategy seems to have worked well in
creating an alignment of interests.
CDPQ offered only 5-6 percent of its interest in funds involved in its partial portfolio sale last year, Buyouts
reported. Longchamps says the strategy was well received by GPs because
the pension keeps its vast majority of investments in the funds.
“Secondary sales are something
we envision doing on an opportunistic basis to help manage allocation,”
Longchamps says. “Our GP partners understand that it is now a tool for
pensions to manage overallocation, and they want to help us get there.
Additionally, the majority of what we sold was a strip of our portfolio,
so we were not ending existing GP relationships. [Instead, we have
retained] a collaborative approach.”
Peter Dubens, co-founder of
Oakley Capital – one such GP – says the growth of the secondaries market
is a healthy development and has made private equity more liquid. “If
an LP wants to create liquidity by selling down a position in a group of
GPs or a single GP while still being an investor, that’s just about
rebalancing the portfolio,” Dubens tells PEI. “We would have no issue with that. It’s actually the beauty of the market.”
Nicolas Zerbib,
co-president and CIO of Stone Point Capital, also supports LPs’
secondaries trades. “How LPs optimise their portfolio is their
prerogative. Our job is to generate the best returns we can,” he says.
“LPs have the right to transfer these stakes — it’s part of the free market that we live in.” Stone Point was among the managers involved in CDPQ’s strip sale last year, Buyouts reported.
Similarly, Jeff Rhodes,
co-managing partner at TPG, says he doesn’t worry about CDPQ’s
rebalancing exercise. “It’s very logical that with a new leader coming
into the programme driving a new strategy, there would be some types of
rebalancing… We are understanding of that.”
Expanding investments
Longchamps believes dealmaking activities will rebound in 2024,
driven by companies’ pent-up demand for capital after a prolonged period
of inactivity. “I think the second half of 2024 and 2025 [will] be a
time where market [transactions] will come back in a significant manner.
There are too many people sitting on the sideline waiting to sell their
companies,” he says. “Pipeline and banking mandates to sell have never
been greater. We see European dealflows improving significantly. We may
have to wait post-election to see the pick-up in the US.”
Longchamps wants to seize this opportunity to make more strategic
allocations, particularly through indirect investments. He aims to raise
CDPQ’s fund investments from 25 percent to 35 percent of its PE
portfolio in the next five years.
“We decided that an integrated, partner-driven approach is the right
one for us to create the velocity we need in our portfolio and to
generate optimum levels of dealflow and returns,” he says. “Previously,
we primarily made deals on our own and sometimes partnered with GPs, but
they were not necessarily GPs we were in funds with. Fund investment
acted more like a complementary strategy, and we are now fully
integrated.”
A partner-driven approach will lead to more co-investment
opportunities and help diversify CDPQ’s PE portfolio, he says, adding
that the pension will rely on funds in sectors where it lacks internal
expertise.
During the manager selection process, Longchamps says he values GP
commitments because they serve as evidence of confidence and alignment
of interests. The general rule of thumb is “the more, the better”.
However, the absolute amount of commitment doesn’t matter as much as the
relative significance of that commitment to the GPs themselves, he
believes. “Some GPs are early in their life, so they don’t have that
much capital to commit. In these cases, we look at how much it means to
them.”
Rebecca Gibson, a partner at UK-based Oakley Capital
— an €11 billion manager, according to a spokesperson, that CDPQ has
been investing with in recent years — says the Canadian pension conducts
detailed diligence on performance, distributions, unrealised return and
realised returns.
“They are one of the more thoughtful and highly analytical teams that
look at both current and past portfolios to understand what they can
expect,” Gibson says.
CDPQ’s fund investment strategy has evolved over the past decade.
While it was building out its PE programme, the pension was at one point
working with more than 100 GPs. This number was pared down to about
20-plus in a reweighting of the portfolio towards direct investing,
former head of PE Martin Laguerre toldBuyouts in 2021.
The number of active GP relationships was further reduced to 15 last
year, according to Longchamps. He aims to double the number to 30 in the
next five years with a focus on mid-market managers. “When we evaluate
new GP relationships, we always ask, ‘How can that relationship
complement what we already have?’ What we are missing right now is a
number of GP relationships in the mid-market.”
Mid-market investments will help CDPQ accelerate exits, boost
co-investments and gain access to a wider range of assets, he adds.
Longchamps says he believes returns are similar across large and
mid-market GPs. However, the latter group has more exit options. This
feature is particularly attractive as LPs and GPs continue to face
distribution challenges amid a sluggish IPO and M&A environment.
His expectation for mid-market exits is supported by the data: the
share of total PE exits made up by transactions under $500 million
increased from 82 percent in 2010 to 90 percent in 2022, according to a mid-market PE report published by Morgan Stanley Investment Management in January.
Working with mid-market managers also fits into CDPQ’s plan to ramp
up its co-investment activity. The institution’s sweet spot is deals of
less than $500 million, which is more suitable for mid-sized companies.
“We are developing a roster of mid-market GPs to execute
co-investments with,” Longchamps says. “Our PE strategy lends itself
better for deals in the mid-market right now versus mega-deals where you
have to put in $500 million-$1 billion.”
CDPQ has two co-investment strategies: passive co-investments for
deals under $100 million and co-underwriting for deals between $200
million-$500 million. “This combination aligns nicely with our strategy
and provides the foundation for a diversified PE portfolio,” Longchamps
says.
CDPQ’s plan to boost fund investments has been welcomed by GPs. Jeff
Rhodes, co-managing partner at TPG – which has been partnering with CDPQ
both on the fund and co-investment levels – says an increase in fund
commitments will help better align the interests of LPs and GPs.
“Martin has done a great job of having a partner-orientated
approach…that is focused on both fund commitments and co-investments in a
flexible way. We feel very supportive as a partner to them,” Rhodes
tells PEI.
Rhodes has known Longchamps since his time at PSP Investments, during
which they served together on the governance boards of portfolio
companies.
Nicolas Zerbib, co-president and CIO of Stone Point Capital, also
started engaging with Longchamps when he worked at PSP Investments.
Longchamps’ board governance approach has helped Stone Point enhance its
partnerships with management teams, he says.
“Martin reads the boardroom well,” Zerbib says. “As a partner to us,
he understands where the focus [is], where to lean in and where to
engage. That takes a lot of experience and judgment.”
Deployment preference
When it comes to geographical exposure, CDPQ’s PE investments are
mostly in North America (58 percent), followed by Europe (32 percent),
Asia-Pacific (7 percent) and Latin America (3 percent), according to its
2023 annual report. The system increased its US exposure to 39 percent
last year, a rise of 3 percentage points from 2022, while slightly
decreasing its allocations to Canada and APAC.
Longchamps aims to boost CDPQ’s APAC exposure to 10 percent in the
long term. His team is seeking to form partnerships with PE managers in
Japan, South Korea, India and Australia. “These are good markets for
buyouts,” Longchamps says. “We had more of a growth strategy in Asia
before I arrived. Now, we want to devote more to the buyout strategy.”
CDPQ has already built fund relationships in China. “When they come
[and] knock at our door for re-ups, we will decide what’s the best
option for us. We are taking a wait-and-see approach,” he says. The
pension has stopped making private deals in China and closed its
Shanghai office last year amid increasing tensions between China and the
West, according to media reports.
In terms of sector preference, CDPQ is mostly agnostic in its fund
investments. “A lot of it depends on the strength of the GP. Some GPs
are better in certain sectors than others,” Longchamps says.
For direct investments, it has dedicated teams covering technology,
healthcare, business services and financial services, which are
“promising and resilient areas”, according to its 2023 annual report. It
will take an opportunistic approach in other sectors, such as energy,
Longchamps says.
His belief that dealflow will pick up this year stems from a
stabilising macro environment, which will likely bolster investors’
confidence in private markets.
“When I first took the job, I felt that we were going into uncertain
years. However, we are now in a better place and the deals that I’m
seeing so far provide an indication that they are going to be a good
vintage,” he says.
“This year is all about execution – making sure we go back to the
marketplace, start to invest again while continuing to actively monetise
and manage our portfolio.”
This is an excellent interview with Martin Longchamps, CDPQ's head of Private Equity as it takes a deep dive into the organization's massive PE portfolio and how it's been refocused over the last few years.
It's a great interview for a lot of reasons because what is happening at CDPQ is also happening at other mature and not-so-mature pension funds that need to refocus their attention on managing liquidity a lot better in private equity (see for example, how BCI's head of PE, Jim Pittman, is staying liquid, focused and agile and why they recently sold more than US$1-billion of stakes in private equity funds to French buyout firm Ardian).
Martin Longchamps's strategy since getting into CDPQ has been to reliquify the PE portfolio by selling fund stakes and realizing on some long-held investments.
He and his team are doing this properly by not selling assets at deep discounts in the secondary market, instead taking an all or nothing approach there, and by refocusing their attention on few fund relationships in the mid-market sector where they feel they can obtain meaningful co-investments to reduce fee drag.
The shift in focus from large buyout funds to more mid-market funds for a fund the size of CDPQ is very interesting to say the least (hope they time this right).
But they’re doing it to secure better co-investment opportunities with their strategic partners.
And he's right, the worst thing that can happen to a pension fund in PE is missing a great vintage year, especially in this environment where higher rates for longer seem to be persisting. That's the real reason activity in secondaries has picked up at Canada's large pension funds over the last couple of years (ie vintage year diversification).
He's more confident than I am that deal activity will pick up in 2024-25 as I see a major recession ahead and all those PE funds sitting on a trillion plus in dry powder will need to put that money to work but in a staggered, opportunistic approach.
What the article also shows us is many pension funds have hit the upper allocations in PE recently as the "denominator effect" took hold and their PE valuations have not come down fast enough to reflect the true economic value of these assets so relative to the rest of the portfolio, they're over-allocated.
So, Martin Longchamps, a highly experienced PE manager with a Harvard MBA who previously worked at PSP Investments is now managing CDPQ's PE portfolio by being more nimble, focused and more liquid.
If this sounds familiar it's because many heads of private equity are adopting the same approach here.
Anyways, I invite my readers to read more about CDPQ's PE portfolio here and below:
I also think it is worth reading the 2023 annual report which is now available here.
Below, a small snapshot of the PE portfolio:
As you can see, the annualized five-year return is 14%, making it the best-performing asset class at CDPQ.
Will this be the case over the next five years? I have my doubts but it will continue to be a very important asset class, no doubt about that and partnerships are key (as BCI's Jim Pittman admitted to me over a beer, most of his time is taken up by managing key relationships with funds).
Alright, let me wrap it up but before I do so, a few other CDPQ related stories.
CDPQ ranks at the top of the pension funds included in the fifth edition of the Global SWF’s GSR Scoreboard published on July 1, consolidating its leading position among global investors.
With
a result of 100% for the second consecutive year, CDPQ shares the top
spot with three other leading investors, BCI (the British Columbia
Investment Management Corporation, also based in Canada) and sovereign
wealth funds Temasek (Singapore), ISIF (Ireland) and NZ Super Fund
(New Zealand).
The Global SWF 2024 GSR Scoreboard—a global
benchmark—assesses the governance, sustainability and resilience
practices of around 200 sovereign wealth and pension funds worldwide.
This
new recognition reflects the quality of our teams' work and the
organization's leadership in advancing sustainability issues in Québec
and internationally.
No surprise there, CDPQ remains a global leader in sustainable investing, and I'm also not surprised that it shares top spot with BCI (just covered their fiscal 2024 results and gave a shout-out to their sustainable investing team).
What else? Ivanhoé Cambridge, the real estate group of CDPQ, URBZ
Capital (“URBZ”) just announced the acquisition of two new last
mile facilities in Gothenburg and a disposition in Rotterdam.
In Gothenburg, URBZ acquired two highly reversionary last mile assets
totalling 27,866 square meters of logistics space situated on 46,399
square meters of prime freehold land. These facilities are strategically
located within a core micro-market in Arendal, benefiting from prime
(intermodal) harbour infrastructure as well as short driving times to
Gothenburg city centre. The facilities are scheduled for renovation in
the medium term to ensure they meet the URBZ Standard®, which is focused
on key social, sustainable and technological standards.
In Rotterdam, URBZ completed the opportunistic sale of a 13,675
square meters retail warehouse to an owner-occupier. Initially intended
for redevelopment into a last mile logistics facility, the sale yielded
significant outperformance relative to carrying valuation and business
plan.
These strategic moves underscore Ivanhoé Cambridge and URBZ Capital's
dedication to optimizing their last-mile portfolio, ensuring strong
returns and making sure to remain well-positioned to meet the evolving
demands of the market while maintaining a strong focus on sustainability
and operational excellence.
As a real estate boutique, URBZ focuses on creating CO2 neutral and
societally accretive last mile urban real estate in key cities in the
Netherlands, Germany, the United Kingdom and Sweden. URBZ sees the most
immediate need for sustainable solutions in the cities with high
population densities and which experience favourable consumption and
demographic growth. In order to address the customers’ challenges and to
meet tomorrow’s needs, URBZ aims to support the new last mile supply
chain by providing well-designed urban logistics real estate.
We would like to express our gratitude to our trusted partners for
their support throughout the process: JLL (Sweden), Nordic Gatekeepers
(Sweden), DLA Piper (Sweden), WSP (Sweden) and AKD Lawfirm (The
Netherlands).
Another example there on how strategic partnerships are helping CDPQ invest in the right areas with the right focus on sustainable investments.
Below, Michael Arougheti, Co-Founder, CEO & President, Ares Management analyzes the demand for privates including debt, credit and real estate with Bloomberg’s Sonali Basak at the Bloomberg Invest conference in New York. Great interview, well worth watching.
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