As inflation soars and stock markets swoon, the head of the country’s largest pension plan has a reassuring message for 21 million citizens who look to the Canada Pension Plan for a portion of their retirement funds: Don’t worry, we got this.
In a speech on Thursday, Canada Pension Plan Investment Board (CPPIB) chief executive officer John Graham predicted the global economy will face a “prolonged period of uncertainty” that could last up to two years, with persistent inflation and geopolitical tensions such as Russia’s war in Ukraine weighing on investment performance. Mr. Graham told a lunch audience at the Canadian Club: “This grim picture might seem overwhelming, but in many ways, CPP Investments was built for markets like this.”
“To be clear, this also means we might have a tough year, or two,” Mr. Graham said. However, he added that the $539-billion CPPIB fund has the scale, expertise and long-term approach needed to weather downturns. In an interview, Mr. Graham said: “If I had one message for Canadians, it’s that the fund is sound, and will be there for them.”
While CPPIB reviewed its approach to risk management in light of world events such as the Ukraine war, Mr. Graham said the fund’s investment strategy remains consistent. Over the last 10 years, the CPPIB returned 10.8 per cent annually.
Throughout several decades, CPPIB built a global portfolio of infrastructure assets – power grids, pipelines or toll roads – that provide stable returns due to contracts under which customers’ fees increase with inflation. These investments will prove their value in a prolonged downturn, Mr. Graham said. “You can’t just go out and buy infrastructure when you see inflation rising. It can take 12 to 18 months just to acquire one of these assets,” he said.
The fund manager plans to keep acquiring high quality infrastructure, real estate and private equity assets around the world, and Mr. Graham said the current gap between what sellers are demanding and what buyers are willing to pay is expected to narrow.
“The number of potential buyers for large, high quality assets is dropping,” said Mr. Graham, explaining the change in deal dynamics comes from rising interest rates and the challenges facing consortiums of smaller funds that previously were able partner to buy an asset.
“It’s getting harder to assemble a consortium of buyers for assets, because you’re only as strong as your weakest link,” Mr. Graham said. “That favours fund mangers capable of doing a deal all by themselves.”
CPPIB plans to increase infrastructure holdings in countries such as India and Brazil, Mr. Graham said, as these economies are expected to post strong growth.
The fund manager also added to its equity holdings this year as global markets declined, with North American indexes now in bear market territory, down 20 per cent. Mr. Graham said: “Our investment in growth-oriented companies will benefit from periods of economic expansion.”
“Looking ahead, I remain cautiously optimistic,” Mr. Graham said. “Cautious on the markets, but optimistic and frankly confident about CPP Investments’ ability to navigate markets.”
CPP Investments' CEO John Graham spoke at the Canadian Club Toronto in late June (June 23rd). You can read all about the new era of active investing here.
At the time, I embedded the clip of that interview at the end of my comment on HOOPP and Abacus Data's 2021Canadian Retirement Survey because I wanted to reassure Canadians their CPP contributions are well managed, well governed and invested in a well diversified global portfolio in their best long-term interest.
I also had a discussion with John Graham going over their fiscal 2022 results and he raised similar points with me, namely, they're preparing for a downturn, inflation can persist, the bid-ask spreads in private markets are still wide but narrowing, and most importantly, he's "cautiously optimistic" that CPP Investments can seize opportunities in this market environment.
There's no doubt, however, that in an environment where stocks and bonds are getting hurt, all large funds will get hurt.
A 60/40 portfolio of stocks/bonds is down 16% in 2022, and has experienced the worst start to a year in decades as inflation soars to multi-decade highs.
It actually tumbled 17% in the first six months of the year, its deepest first-half dive since 1988.
All this to say these these are treacherous markets for all investors.
But large global investors like CPP Investments, CDPQ, PSP Investments, OMERS, OTPP, AIMCo, BCI, and others aren't only investing in stocks and bonds, most of them are heavily invested in private equity, real estate, infrastructure and private debt.
Not to mention they are also invested in more liquid alternatives like hedge funds and well-known macro funds (like Bridgewater) have been on fire so far this this year.
The key point here is large, well governed pension investment managers are able to diversify their sources of risk by asset class, sector, strategy and geography and their approach is such that they're able to do this efficiently and in a cost effective way.
This doesn't mean CPP Investments and others won't be affected by what is going on in stock and bond markets, it means if they're doing their job properly, which they are, they will be adding significant alpha over traditional stock/ bond portfolios over the long run.
I remember Mark Wiseman, former CEO of CPP Investments and current Chair at AIMCo, telling me years ago: "CPP Investments will typically outperform in a bear market and slightly underperform in a roaring bull market."
There are a lot of reasons why including proper liquidity risk management, allowing the Fund to capitalize on opportunities as they arise.
This is why John Graham states he's cautious on markets but cautiously optimistic that CPP Investments will be able to navigate rough markets.
Rough markets means a lot of dislocations across stocks, bonds, real estate, private equity, infrastructure, private debt, you name it, and this is when these pension investment managers get to work seizing opportunities.
They might not make money right away but over a 5 and 10-year period, they will add significant alpha (value add over a public market benchmark).
The added advantages of a CPP Investments, and John Graham alludes to them, are scale and expertise, allowing it to go in alone on a deal, capitalizing on its ability to analyze complex deals quickly.
For example, CPP Investments uses platforms to make large investments in India's infrastructure and renewable energy in Europe.
These platforms are specialized companies that allow them to capitalize on the scale, expertise and independent governance of the CPP Fund to take advantage of opportunities all over the world.
Now, the size, breadth, depth and sophistication of CPP Investments is something you have to marvel. I recommend everyone reads its fiscal 2022 Annual Report which is available here to really appreciate all their activities across the globe.
Managing a massive Fund like CPP Investments with so many moving parts all over the world is no easy feat.
It takes teamwork, dedication and a unified approach.
Interestingly, Ben Hurley Top 1000 Funds posted a comment in mid-June where Geoffrey Rubin, Chief Investment Strategist at CPP Investments discussed how trillion-dollar funds need new incentives and investment styles:
Funds of enormous scale will require a new cross-disciplinary approach, and innovative incentive and rewards schemes to foster the organisational culture needed, according to chief investment strategist at CPP Investments’ Geoff Rubin, as it looks to move beyond a total portfolio approach to a “one fund” approach.
With a number of funds set to cross the $1 trillion threshold in the coming decades, new cross-disciplinary approaches will be needed to tap into investments spanning multiple asset classes and risk categories, according to the chief investment strategist of the investment arm of the $539 billion Canada Pension Plan.A ‘one fund approach’ that breaks down organisational silos can target investments that don’t fit neat boxes, therefore tapping into outsized risk-adjusted returns, according to Geoff Rubin.
CPP’s total fund approach’ has been picked up by numerous organisations around the world, including Australia’s Future Fund and New Zealand Super. Now Rubin is looking to a “one fund” approach where investments can “span asset classes, span the risk spectrum, [and] might require certain kinds of commitments over time that go beyond the individual, siloed, compartmentalised way that most investing in our industry happens,” Rubin said, speaking at the Fiduciary Investors Symposium held at the Chicago Booth School of Business.
Speaking with Amanda White, director of institutional content at Conexus Financial, Rubin said this could, for example, be an investment that is a combination of equity and credit, or an infrastructure opportunity that involves acquiring adjacent real estate to take advantage of the increasing effectiveness of the infrastructure.
Rubin said it is possible in the one fund approach to allocate funds to an investment with a return of zero or even negative expected return if it is a contributor overall in terms of diversification.
Contrasting the one fund approach to the total portfolio approach that is now in vogue, Rubin said doing this requires a deep change in organisational culture that draws on the skills and contacts of all employees in different teams, and an incentive and attribution scheme that encourages and rewards the required cross-organisational behaviours.
“The total portfolio approach… does not require the tearing down of silos,” Rubin said. “It requires an ability to look into each silo and understand exactly what you have, so you can manage that portfolio.
“One Fund is something different. We actually break down those silos and bring those investment teams together in a way that allows you to invest differently, in a way that allows you to pursue different types of Investments.”
At CPP, incentive compensation is geared to the performance of the total fund, but Rubin admitted that for organisational staff, those results can sometimes “feel somewhat remote from the work they do day to day,” and the organisation is considering more explicit expectations and reward structures “for those who reach out across silos.”
“We’re also going to try to ensure that we’re building a culture where that becomes a reflex…really trying to build a means of encouraging people to connect across their areas and make sure that they’re doing so with real passion.”
He admitted this becomes difficult when you start looking at attribution and incentive compensation. The funds management industry is accustomed to being organised by way of assigning benchmarks to teams who judge performance against their benchmark, “and don’t tell me about what’s happening in the rest of the fund,” he said.
“I think that works really well due to its simplicity, it works really well because we’re all accustomed to it,” Rubin said. “Not at all clear how that construct is going to allow our organisation, or any of these organisations, to address investment opportunities that don’t fit those neat boxes.”
This problem is yet to be fully solved, he said. “We’re going to have to work on driving our organisational culture and incentive compensation and alignment and reward systems, both formal and informal to really encourage that kind of appetite to solve a bigger problem than one that just resides within a group or team.”
Geoffrey Rubin is a really smart guy (he holds a a PhD in Economics from Princeton University). As the Chief Investment Strategist, it's his job to break down the silos at CPP Investments and make sure they're looking at all opportunities across many asset classes and anything in between. He's in charge of the Total Fund Approach.
Ed Cass is the CIO of CPP Investments. He works with investment leaders and others to strengthen the organization’s investment governance with the aim of generating greater performance gains.
I know it sounds easy but there's a lot of nuance in what Geoff Rubin is saying and it's hardly straightforward, especially when it comes to incentives and compensation, but it's critically important.
A couple of years ago, Mihail Garchev, Vice President of Total Fund Management at BCI, did a whole series on integrated total fund management on my blog (he later rejoined BCI). One of his most popular comments was Part 5.1, The Earth is (NOT) Flat.
And last year, I spoke with Kevin Zhu, Managing Director and Head of Portfolio Construction Group at OPTrust, on the organization's innovation journey, asset mix strategies and approach to address climate risk. I also had an in-depth conversation with their CIO, James Davis, on these same issues and more.
Integrated total fund management at these large funds is increasingly where you can extract a lot of alpha, but it's not as easy as you think, far from it.
There's no book on how to best extract alpha across and in between asset classes, aligning everyone with a one fund approach mentality.
Increasingly, you need to have talented people with cross-asset class experience and that isn't easy either.
For example, I've allocated to top global hedge funds and private equity funds, helped set up infrastructure and PE as asset classes at PSP, researched commodities, real estate, foreign currency hedging, and continuously write about investments on my blog, learning from specialists in their field.
It's very difficult becoming a specialist in everything, it's actually impossible, so you need people who are able to get the information (hustlers who aren't easily intimidated), dissect and understand it quickly and connect the dots by taking a holistic view across the entire portfolio.
Geoffrey Rubin talks about building the right culture and how implementing a One Fund approach isn't straightforward:
“We’re also going to try to ensure that we’re building a culture where that becomes a reflex…really trying to build a means of encouraging people to connect across their areas and make sure that they’re doing so with real passion.”
He admitted this becomes difficult when you start looking at attribution and incentive compensation. The funds management industry is accustomed to being organised by way of assigning benchmarks to teams who judge performance against their benchmark, “and don’t tell me about what’s happening in the rest of the fund,” he said.
“I think that works really well due to its simplicity, it works really well because we’re all accustomed to it,” Rubin said. “Not at all clear how that construct is going to allow our organisation, or any of these organisations, to address investment opportunities that don’t fit those neat boxes.”
This problem is yet to be fully solved, he said. “We’re going to have to work on driving our organisational culture and incentive compensation and alignment and reward systems, both formal and informal to really encourage that kind of appetite to solve a bigger problem than one that just resides within a group or team.”
Increasingly, I see investment opportunities that don't fit in the proverbial neat boxes. Oftentimes, these are great opportunities. Should these large pensions ignore them?
Of course not. At PSP Investments, CIO Eduard van Gelderen and his team have set up a complementary portfolio to scoop these cross-asset opportunities up (and they take ownership).
Eduard has also assembled a multi-asset class deal team — the Climate Working Group — to determine actionable investment opportunities and to start due diligence on a select number of them.
When you think just about responsible investing at these large pensions, you need a lot more collaboration between groups to make sure everyone is on the same page and doing their part to achieve a the target reduction in carbon intensity by 2050 or earlier.
Anyway, all this to say that I agree with Geoff Rubin, the total portfolio approach is NOT the same as the One Fund approach because it doesn't break down the silos.
And I don't care who you are, big or small, if you don't start breaking down the silos, no matter how hard this is in practice, then you are not really fulfilling your fiduciary duty, bolstering your fund over the long run.
But it's easy for me to write such comments. In practice, unless you have the full backing of CEOs, CIOs and investment leaders and the right people with the right attitude, skill set and inquisitive mind, then you will not be able to do this One Fund approach properly.
It sounds fantastic and easy but implementing and measuring the success of such an approach is anything but easy.
Trust me, I know many pensions who have tried unsuccessfully to break down the silos across asset classes over the years. With the primacy of responsible investing taking hold, it's starting to happen but there's a lot more work left to foster more collaboration to take it to another level, especially when it comes to cross-asset investments, balance sheet management and more.
The bigger these funds become, the more important it is for them to take a One Fund approach.
Alright, let me wrap it up there but before I forget, CPP Investments made its first direct private equity investment in Colombia, investing US$334 million, for a 19.3% (minority) stake, in D1, the market leader in Latin America’s expanding “hard discount” food retail space, which focuses on offering selections of private-label products at affordable prices. Read more about this deal here.
And CPP Investments recently announced changes to its executive leadership team as the organization continues to position itself for future growth.
The current role of Senior Managing Director & Chief Financial and Risk Officer will be divided into two distinct senior management positions. Going forward, the organization will have a Chief Risk Officer (CRO), and a Chief Financial Officer (CFO).
“The time is right in the evolution of CPP Investments to have separate senior executives, dedicated to risk, and to finance,” said John Graham, Chief Executive Officer. “By creating two stand-alone senior executive roles we can further strengthen the leadership, expertise and governance that helps to ensure the success of CPP Investments, contributing to the long-term sustainability of the CPP for the benefit of all Canadians.”
Neil Beaumont, Senior Managing Director & Chief Financial and Risk Officer, is leaving CPP Investments after five years in the role. During his time, Neil helped strengthen both our approach to risk management, with a foundational new Risk Policy, while enhancing how we report on the portfolio’s sources of returns.
“I would like to thank Neil for his contributions,” said Graham. “Neil leaves behind strong finance and risk functions, as well as a high-calibre team, both of which will continue to serve the organization well for years to come. On behalf of CPP Investments, let me extend our appreciation for his accomplishments and wish him the best in the future.”
Mr. Beaumont will remain CFRO until mid-summer to assist with the transition. Leadership announcements resulting from the process to appoint a CRO and CFO will be made in due course.
No word yet on who will be the new Chief Risk Officer (CRO) and Chief Financial Officer (CFO) but I agree with John Graham, the time is right to separate these senior executive roles.
In fact, and this is my personal opinion, you need a strong Chief Risk Officer who reports directly and equally to the CEO and Board, not one or the other but to both of them.
One day, I will interview Chief Risk Officers at these large pensions to provide my readers with insights on what they and their teams do in terms of operational and investment risk mitigation and more.
Below, on June 23rd John Graham, President and CEO, appeared in front of the Canadian Club of Toronto audience to update Canadians on CPP Investments and its solid performance amid uncertain market conditions. John addressed how the Fund is navigating geopolitical events, inflation, rising rates, and volatility.
As John noted during his speech: “It is going to be an investors market going forward, and active management is the best protection for today’s market conditions, amid the slowing of global growth.”
John’s remarks and discussion with the Globe and Mail’s Rita Trichur covered a wide range of topics, from investing in emerging markets and the energy evolution, to leading disruptive technologies.