Monday, November 12, 2012

Will Protectionism Stifle CPPIB's Expansion?

Andrea Hopkins of Reuters reports, Canada Pension Plan looks for big, global deals:
The Canada Pension Plan Investment Board, one of the world's biggest pension funds and global dealmakers, said it was looking for big, complex acquisitions to boost its portfolio and outmaneuver rivals as the world's economy improves.

CPPIB, whose assets rose to a record C$170.1 billion in the third quarter from C$165.8 billion three months earlier, said its long-term investment horizon and increasingly skilled team of dealmakers will give it an advantage as improving U.S. and Chinese economies bring competitors back to the playing field.

"I think you'll expect to see us favoring larger and more complex deals that are global in nature," Chief Executive Officer Mark Wiseman said in an interview after the fund's second-quarter results were released.

"What we try to do is exploit the areas where we have comparative advantages, and that tends to be in larger transactions, in transactions where the value creation will play out over a long period of time, and in transactions that are occasionally complex in nature," he said.

"We've now built a team with high capabilities that can transact globally and in complex large-scale opportunities."

He said the fund, which invests on behalf of 18 million Canadian contributors and beneficiaries, was still trying to diversify geographically out of Canada. He said it is focusing on emerging markets where the pace of growth was higher than the rest of the world.

Wiseman was optimistic about improving prospects for recovery in the United States, despite the fiscal cliff concern, and in China, where data on Friday showed infrastructure investment accelerated and output from the country's factories ran at its fastest in five months.

"I do think you are seeing signs of longer-term prospects for growth, both in the U.S. -- and that will obviously have an impact on Canada as well -- but also some of the numbers that came out of China this morning are cautiously encouraging," Wiseman said.

Toronto-based CPPIB reported a 1.9 percent return on investments for the fiscal second quarter ended Sept 30, as financial markets gained globally. The C$4.3 billion increase in net assets after operating expenses resulted from C$3.1 billion in investment income and $1.3 billion in net Canada Pension Plan contributions.

The massive size and long investment horizon of CPPIB has enabled it to do deals around the world, especially as cash-strapped governments and companies seek partners with deep pockets.

CPPIB shifted to an active investment strategy six years ago, seeking to boost returns on its portfolio by buying real estate, infrastructure and other assets while providing private equity and credit to partners looking for cash.

Wiseman said prices are recovering in some of the fund's favorite investment areas, including real estate, as investors seek stable returns and the low volatility the asset promises.

"I'm talking about really Class A office buildings and that sort of thing. We're seeing pricing in those assets increasing, with the arrival of a larger number of investors into the asset class. That doesn't mean we can't find value there, but we're feeling very cautious," he said.

In recent months, CPPIB has announced acquisitions across a broad swath of asset classes, including deals in motor sports, Australian shopping malls, British heating and air conditioning and Chinese logistics, adding to its massive portfolio of investments in real estate, infrastructure, private equity and global stocks and bonds.

The fund's five-year annualized investment rate of return edged up to 2.5 percent at the end of the quarter, while the 10-year rate of return rose to 6.7 percent.

CPPIB still has about nine years before benefits paid exceed contributions and it will need investments to help pay pensions.
If you look at CPPIB's news releases you'll see a sample of large and complex deals that Mark Wiseman is referring to. I'm not as enthusiastic as they are about the $445 million they forked out for prime Australian shopping centers but think the co-investment with BC Partners to acquire US cable operator Suddenlink for $6.6 billion was a very smart move (it better be because this is a huge deal!).

Given CPPIB's mammoth size, it's no wonder they are looking at large deals in private markets to deliver their active management returns. But large and complex deals are often fraught with pitfalls, something the Public Sector Pension Investment Board (PSPIB) found out with their investment in Telesat which is finally turning a profit as well as their investment in Revera Inc., where the Alberta government stepped in to end a strike after the CBC reported that an elderly resident died after replacement workers allegedly ignored her requests to call an ambulance.

CPPIB and other Canadian pension funds are also flexing their buyout muscles in Europe and expanding operations in Asia. As I stated in my last comment on brave investors and soldiers, there are deals popping up in Europe and top hedge funds and private equity funds are bidding fiercely on them.

In Asia, public markets are volatile but there is tremendous potential in private equity. Railpen's chief executive Chris Hitchen sums it up well in this Top1000 Funds article:
Another strategy is to push into emerging markets, where the scheme is modestly overweight, focused on greater China particularly, although he wants exposure to the “fantastic economic potential” of some African countries like Nigeria, too. Here, investment is limited to equities rather than resource or infrastructure plays.
In China private equity investment via the Private Equity Pooled Fund, which returned 13.9 per cent last year, is Hitchen’s preferred route to market rather than direct equity investment. Access to the benchmark Shanghai Composite Index for shares listed in China, known as A shares, is restricted to foreign investors due to Beijing’s tight control over both its currency and the flow of money across its boarders. China’s stock market is also dominated by retail investors adding to market volatility and risk, he says. “With private equity there is more of a feeling that you are getting to the real economy,” he says.
It’s a theme he raises again when explaining Railpen’s shift out of UK equities to a globalised equity portfolio. “UK equities account for 20 per cent of our stock portfolio; 10 years ago that would have been two thirds. Many large UK companies no longer exist. The FTSE isn’t a bellwether for UK PLC.”
CPPIB is big enough and has the expertise to go direct, but there are creeping concerns about expanding in Asia. One of them is the rise of protectionism. Nick Edwards and Kang Xize of Reuters report, China wealth fund eyes Asia "as Western protectionism rises":
China's sovereign wealth fund will focus more of its $482 billion firepower on Asia in twin bids to beat a rise in protectionism in the West and boost exposure to rapid regional growth, chairman and chief executive Lou Jiwei said.

The man charged with stewardship of a slice of the world's largest store of foreign wealth lauded the British approach to overseas investment in public sector projects as one for the world to follow and said the policy response to Europe's debt crisis was a reason to stay underweight bonds and stocks there.

"There is a rise in protectionism in both trade and investment in some Western countries," the China Investment Corporation chief, speaking on the sidelines of the Communist Party congress to choose a new leadership line-up, told Reuters in a rare interview.

"As compared to other financial investors we feel that the scrutiny on us is a little more strict, because of issues like national security," Lou said, adding that while not a major issue yet, he detected rising concern among foreign regulators when CIC partnered with Chinese firms to make acquisitions.

Tensions between Beijing and Washington have recently ratcheted higher thanks to a series of trade actions against China by President Barack Obama, including his blocking of a privately owned Chinese company from building wind turbines close to a U.S. military site, and his challenge of Chinese auto and auto-parts subsidies in a World Trade Organization case.

The U.S. House of Representatives' Intelligence Committee warned last month that Beijing could use equipment made by Huawei, the world's second-largest maker of routers and other telecom gear, as well as rival Chinese manufacturer ZTE, the fifth largest, for spying.

Canada has twice delayed a decision over whether to allow a $15.1 billion bid by CNOOC Ltd, China's top offshore oil and gas producer, for Nexen Inc NCY.TO, despite shareholders giving it their backing.

Having tackled some concerns about acquisitions by sovereign wealth funds, such as CIC, in 2008 through the adoption of guidelines brokered by the International Monetary Fund, known as the "Santiago Principles", governments worldwide now bristle at the rising number of investment bids for strategic assets made by state-backed firms that fall outside that framework.

Lou said CIC would not change its strategy of partnering with Chinese firms simply to assuage concerns of foreign regulators - particularly if such a partnership presented the best-value proposition to the fund, which is mandated to boost returns on a substantial chunk of China's $3.29 trillion stash of foreign reserves.

NO WELCOME, NO INVESTMENT

"We would avoid investing in countries that do not welcome us. There are other places to invest," Lou said.

Asia is a particularly favoured option for CIC, thanks to some of the fastest rates of growth and development in the world - which are themselves levered to China's own economic dynamism.

But while Asia is a target, the region's relatively shallow and under-developed capital markets make investments harder and prevent CIC investing as much as it would like.

"We would have to do direct investment projects one by one. That is very time consuming and we cannot really deploy that much investment capital into it," Lou said.

For now, liquidity makes Europe and the United States CIC's markets of choice for investments in publicly traded securities, while the UK is the fund's top infrastructure pick.

"We like the UK. It is very open on its infrastructure sector," he said, adding that Britain's use of private capital to build public sector assets was a model for other developed economies to follow - particularly those struggling to recover from the effects of the 2008-09 global financial crisis.

"Infrastructure investment can boost economic growth and employment and in fact it is fiscally neutral," said Lou, a former vice minister of finance regarded by Beijing insiders as either a future finance minister, or central bank chief.

Lou said the balance between growth and fiscal rectitude was key to Europe's ability to escape from a debt crisis that has dragged on for more than three years.

"Although people in Europe have agreed that they need a combination of growth and consolidation, in fact these two aspects are contradictory to each other and Europe hasn't really thought out a way to move forward," he said.

"The risk of the euro zone falling apart has now dropped to less than 20 percent, but it is still there. To look on the bright side, now Europe has an agenda compared to a while ago when there was only babbling."

UNDERWEIGHT EUROPE

That overhanging risk and the inability to persuade investors that a recovery plan is firmly in place are key to CIC being underweight on European bonds and equities, Lou said.

"That demonstrates somewhat our lack of confidence," he said. He added that the fund was on the lookout for assets in Europe's real economy - particularly among manufacturers.

"We believe that the manufacturing industry in Europe is still quite competitive and we believe that the European economy will recover some day," Lou said.

But European banks and peripheral euro zone sovereign debt were definitely off his shopping list.

"We dare not touch the banking sector there because we do not know how many more problems are there," he said.

"We would not buy peripheral country bonds because they do not fit our risk/return profile," Lou said. "Most importantly, the risk and returns of these bonds are determined by politics and it is very hard for us to make a judgment (on them)."

Judgment was becoming more important all round, Lou said, pointing out that easy pickings for investors had disappeared since 2009, when asset prices collapsed as the global financial crisis raged and buying cheap was an obvious strategy.

"We have to use more precaution and really watch the risks and how well the companies operate," Lou said.

But a tougher approach to investment management appears to be paying off on CIC's bottom line.

The fund suffered a 4.3 percent loss on its international portfolio in 2011 as total profits fell 6.1 percent on the year to $48.4 billion. Lou is confident that won't be repeated.

"We expect to book no loss by the end of this year. We are pretty satisfied with the performance so far, but we really cannot predict that it will be as good at the end of this year as it is today," Lou said.

"Nobody can predict what happens by the end of this year unless they liquidate all of their portfolio and lock in the returns. But nobody would do that."
Lou Jiwei is a very smart, cautious and powerful man but he needs to follow the lead of Fosun International, one of China's largest business groups whose main shareholder is billionaire Guo Guangchang. They are interested in buying a stake in Greece's gambling monopoly OPAP.

In fact, China is already one of the largest investors in Greece and looking at new investments after the successful running of Piraeus Port by China's shipping giant COSCO. I've long maintained that China should partner up with Greece, Italy, Spain and Portugal to develop solar farms and other ventures in southern Europe. It would be a slap in the face for Germany, but Frau Merkel just doesn't get it.

On UK infrastructure, CIC is following the lead of Canadian pension funds that own Britain. But there too, sovereign wealth funds and pension funds have to tread carefully, especially if they partner up with private equity funds. The case of Thames Water in the UK, which CIC bought a 9% stake in,  is a perfect example of how private equity powerhouse Macquarie played the Brits like fools.

But the article above raises concerns about the rise of protectionism. China wants an even playing field but many Western countries are reluctant to sell strategic assets to the Chinese. So far, there hasn't been any move to limit foreign direct investments in China but there could be if protectionism takes hold. And for all the talk of "partnerships" between sovereign wealth funds and Canadian pension funds, I haven't seen much action, just talk.

Below, Mark Wiseman, CEO, Canada Pension Plan Investment Board, speaks about the importance of Asia to Canada's future. And CBC reports on how CPPIB teamed up with BC Partners to buy Suddenlink, the seventh largest US cable operator in a deal worth US$6.6 billion.