Wednesday, February 21, 2018

The Caisse Gains 9.3% in 2017

Jacob Serebrin of the Montreal Gazette reports, Caisse posts $24.6-billion profit, says it's ready for market correction:
The head of the Caisse de dépôt et placement du Québec said he believes a market correction is coming but that the provincial pension fund manager is much better prepared than it was in 2008.

While corporate profits have risen, Michael Sabia, the president and CEO of the Caisse, said the market returns that reflect future expectations are rising faster.

And that is leading to a more fragile market, he said Wednesday.

In 2008, the Caisse lost almost $40 billion.

This time, Sabia said, the fund manager sees a correction as an opportunity.

“Unlike the situation of la Caisse in 2008 and 2009, where we did not have any room to manoeuvre, we were not able to move assets and capital to benefit from the resurgence of the markets,” he said. “This time, we are prepared. This time, we have the flexibility to move substantial capital in a highly liquid way from one or two asset classes into others as we benefit from what would be a repricing of the market.”

But he doesn’t know when that correction will come.

“Our job is not to try to predict the markets. It’s not to try to time the markets. Our job is to be ready,” he said.

The comments came as the Caisse announced net investment results of $24.6 billion in 2017. That’s an annualized return rate of 9.3 per cent, which brought its net assets to $298.5 billion.

It’s the Caisse’s strongest annualized return since 2014, when it generated an annualized return of 12 per cent, or $23.8 billion.

In 2016, the Caisse reported an annualized return of 7.6 per cent, worth $18.4 billion.

Sabia also addressed the decision to not choose Bombardier’s bid to build train cars for the Réseau express métropolitain, the light-rail network being built by the Caisse.

He said the Caisse wears two hats: it’s an investor in Bombardier and a project manager when it comes to the REM.

“As an investor, we made an investment of $2 billion in the Bombardier Transport during one of the most difficult times in the history of that company,” he said.

That investment helped save Bombardier, he said, and shows the Caisse’s commitment to the company’s success.

“From a project manager point of view, our job is to build the best possible project at the best possible price, and that’s what we’re doing,” he said.

Sabia said the Caisse nearly abandoned the project in November.

“We got proposals in November, on the engineering and construction side of the REM, that were highly problematic,” he said. “It just wouldn’t work from a user point of view, from a cost point of view.”

But by “sticking to our guns, negotiating the way we did,” the Caisse was able to find solutions and save the project, he said.

The Caisse, which manages Quebec’s public pension plan as well as several other para-public pension and insurance plans, said it generated returns of between 10.9 per cent and eight per cent for its eight primary clients in 2017.

That variation is because different clients have different risk tolerances and different approaches to funding, Sabia said. While the provincial pension fund has a very long-term strategy, other funds, like the Commission de la construction du Québec pension plan, have less risk tolerance.

Equities, which represent 50 per cent of the Caisse’s overall portfolio, generated a return rate of 13.6 per cent and net investment results of $17.6 billion.

That was driven by strong stock market performance, particularly in the United States and emerging markets like China and South Korea, where the Caisse has invested in technology companies.

Real assets generated net investment results of $4 billion and had a return rate of 8.7 per cent.

Daniel Fournier, the CEO of Ivanhoé Cambridge, the Caisse’s real-estate subsidiary, said it is narrowing its portfolio of shopping centres, focusing on the most profitable ones and selling others. As well, it is making investments in distribution and logistics, particularly in China.

Fixed income, the category that includes bonds, generated net investment results of $3.2 billion, a return rate of 3.5 per cent.

During the past two years, Sabia said, the Caisse has diversified its holdings in this asset category.

That includes a credit portfolio focused on corporate credit and specialized financing, like the $1.5-billion loan it made to SNC-Lavalin in April to help it acquire WS Atkins, a British competitor.

The pension fund manager said it made $6.7 billion in new investments and commitments in Quebec alone in 2017.

Sabia said the Caisse has increased its focus on investing in Quebec’s private sector, describing it as the motor for economic and employment growth in the province.

Its assets in Quebec’s private sector have risen from $27.6 billion in 2012 to $42.5 billion in 2017.

A big part of that is a focus on helping Quebec companies grow internationally, said Christian Dubé, the Caisse’s executive vice-president for Quebec.

The Caisse is also making investments in Quebec’s AI industry, he said.

“For us, it’s the new economy,” Dubé said.

Investing now will allow the Caisse to position itself and give it a sense of who the major players will be in five to 10 years, Dubé said.
Second, Reuters reports, Canada's Caisse fund reports 9.3 percent return in 2017:
Canada’s second-largest pension fund, the Caisse de depot et placement du Quebec, on Wednesday reported a 9.3 percent return on its clients’ funds in 2017, helped by a strong performance from its equities investments.

The Caisse said its net assets totaled C$299 billion ($236 billion) at the end of 2017, up from C$271 billion a year earlier.

The fund manages public pension plans in the Canadian province of Quebec. It has diversified to become one of the world’s biggest investors in infrastructure and real estate as well as a major investor in global equity and fixed income markets.

Chief Executive Michael Sabia said the fund was continuing to build a portfolio that can withstand geopolitical risks and market volatility.

“We are putting a big emphasis on resilience. Resilience is exactly what we need in this environment,” Sabia told reporters.

He said investors were currently “incredibly sensitive” to the actions of central banks, amid concerns about how changes in monetary policy to curb inflation could impact interest rates.
Allison Lampert and Matt Scuffham of Reuters also report, Caisse CEO urges Bombardier to be ready for M&A activity:
Bombardier should be “on alert” for merger opportunities that will enable its transportation unit to compete with larger rivals in an industry that is consolidating to help reduce costs, the chief executive of its biggest independent shareholder said on Wednesday.

“I think, in an industry that’s consolidating to the degree that it is and given the scale issues associated with the size of the Chinese presence in that industry, the company needs to be always alert to M&A opportunities,” Caisse de depot et Placement du Quebec CEO Michael Sabia told reporters.

Germany’s Siemens AG last September opted to merge its rail business with France’s Alstom SA instead of Bombardier’s rail unit, leaving Bombardier facing a challenge to compete in a market dominated by China’s state-owned CRRC, the world’s largest train maker, and the combined Siemens and Alstom group.

Sabia was speaking after Canada’s second-biggest public pension plan reported a 9.3 percent return on its clients’ funds in 2017, helped by a strong performance from its equities investments.

The Caisse, which invests on behalf of workers and retirees in the Canadian province of Quebec, has a near 30 percent stake in Bombardier’s rail division, which has a $33 billion backlog and reported strong earnings last week.

However, earlier this month, it missed out on a contract to provide rail cars for one of the world’s biggest light rail systems in Montreal, a project led and financed by the Caisse, its largest independent shareholder.

Ontario transit agency Metrolinx also cut its vehicle order from Bombardier following a dispute over Bombardier’s ability to fulfill its contract.

“The core challenge (for Bombardier) is improving execution,” Sabia said.

The Caisse also has a 2.5 percent stake in the parent.

The Caisse said its net assets totaled C$299 billion ($236 billion) at the end of 2017, up from C$271 billion a year earlier.

The fund has diversified to become one of the world’s biggest investors in infrastructure and real estate as well as a major investor in global equity and fixed income markets.

Sabia said it was positioned to take advantage if the prices of assets decline.

“If a correction arises I would see that as a very significant opportunity,” he said. “We have the flexibility to move substantial capital from one or two asset classes into others.”

Sabia said the Caisse was looking at possible investments in blockchain technologies but dismissed the idea of investing in bitcoin.

“I‘m not signed up for lottery tickets. That’s what I think bitcoin pretty much is,” he said.
Lastly, Ross Marowits of the Canadian Press reports, Caisse ready to pounce as market fragility makes it open for correction:
The fragility of global markets caused by soaring stock prices has opened the door to a correction that Quebec’s Caisse de depot pension fund manager is ready to pounce on, CEO Michael Sabia said Wednesday.

“If a correction arrived to be honest with you, I would see that as a very significant opportunity,” he said during a news conference about its improved 2017 results.

The Caisse said it earned a 9.3 per cent return in 2017, ending a three-year streak of decreasing returns. The performance marginally surpassed its reference index and compared with a 7.6 per cent return in 2016.

Unlike the situation during the economic crisis of 2008-2009, the large institutional investor has the flexibility to move substantial capital between asset classes to benefit from a fall in stock prices, Sabia said.

Although economic growth is strong and largely synchronized around the world, he said markets are fragile, making them more susceptible to shocks from unexpected interest rate increases or a geopolitical crisis.

“Because of that fragility that we see in the markets today, we’re very focused on this fundamental principle of resilience so that we’re ready in the event that something does change in the markets,” he told reporters.

The U.S. faces the possibility of higher interest rates to curb inflation, he said, but urged the Canadian government to be “measured” in its response to lower U.S. corporate taxes or contentious trade disputes.

“I don’t think there’s an immediate need for significant reaction with respect to the Canadian tax system,” he said.

The federal budget is scheduled for Feb. 27 but Finance Minister Bill Morneau has said that the government has no plans to “act in an impulsive way” in response to tax cuts south of the border.

In response to questions from reporters, Sabia said the Caisse isn’t looking to invest in marijuana stocks or the Bitcoin, which he likened to lottery tickets.

Total Caisse assets as of Dec. 31 were $298.5 billion, up $24.6 billion in one year, while net deposits totalled $3.2 billion.

Its eight main clients received returns between eight and 10.9 per cent last year.

Returns were $110 billion over five years for a 10.2 per cent annualized return over the period. Net assets have increased by $122 billion since 2012, including $12.6 billion from its clients.

In 2014, the fund manager posted a return of 12 per cent, marking the beginning of a three-year streak of decreasing returns. It finished 2015 with a return of 9.1 per cent and 7.56 per cent in 2016.

Equities did the heavy lifting last year, rising 13.6 per cent to $149.5 billion, while fixed income was up 3.5 per cent to $96.7 billion. Real estate increased 8.7 per cent to $50.4 billion.

Real estate was the only portfolio that failed to exceed its reference index. However, Ivanhoe Cambridge CEO Daniel Fournier said it faced heavy competition from sovereign and international pension funds and the impact of the shared economy.

“A return of eight per cent is more than respectable in our sector for the years to come,” he said.

The Caisse said it has diversified its geographic exposure over the last five years by expanding global presence and more than doubling its exposure in growth markets.

Canada’s second-largest pension fund manager made $6.7 billion in new investments with Quebec’s private sector, which it said is the main driver of the economy and jobs. It is now a partner with more than 750 companies based in the province.
Remember, unlike other large Canadian pensions, the Caisse has a dual mandate to achieve its required actuarial return and to promote Quebec's economy. And both these mandates need to be profitable over the long run.

You can also read Nicolas Van Praet's Globe and Mail article on the Caisse's 2017 returns here. From that article, I note the following:
Over nine years as Caisse boss, Mr. Sabia has helmed a sweeping strategic shift that has seen the pension fund expand its international investments while increasing its exposure to what it calls more concrete, "less liquid" assets such as real estate in a bid to generate more stable returns. At last count, about 60 per cent of the Caisse's asset exposure was outside Canada.

Emerging-market equities did particularly well for the Caisse last year, generating a return of 28.4 per cent. Chinese and South Korean markets made up the bulk of the gains, boosted by the information technology sector as smart selection by external investment advisers paid off. Big stock holdings for the Caisse in Asia include positions in Chinese internet giants Alibaba, Tencent and Baidu.

The Caisse's two equity portfolios generated combined returns of 13.6 per cent for 2017. So-called "real assets," like infrastructure and real estate, returned 8.7 per cent while fixed income returned 3.5 per cent.

Among Mr. Sabia's highest priorities right now is the renamed Réseau Express Métropolitain (REM), a $6.3-billion light rail transit system cutting across Montreal that the Caisse is shepherding as the project's manager and main financier.

The CEO has already met with a handful of U.S. state governors to explain the greenfield infrastructure project and promote the Caisse's model. That approach reverses the typical government-leads scenario for big public works projects and sees the pension fund take the helm while Quebec and Canada participate as minority investors.
And the Globe and Mail article ends with this interesting note:
Mr. Sabia's mandate as Caisse president and CEO was renewed last year until March, 2021. No changes were made to his compensation.

The pension fund still hasn't hired a replacement for chief investment officer Roland Lescure, who left nearly a year ago to help Emmanuel Macron become president of France. Mr. Sabia said it was never his intention to replace Mr. Lescure with one person and that a broader shakeup of the senior ranks is coming as the Caisse seeks to build its capability. Mr. Lescure was elected to France's National Assembly and now sits as the representative of French residents living in Canada and the United States.
So, this answers my question of why the Caisse has yet to name a replacement for Roland Lescure.

You'll recall last week I covered the Caisse's $300 million REM cost overrun, dispelling many myths on this project:
 A few key points I want to make here:
  • The price tag of this project moved up to $6.3 billion, but this isn't a $300 million cost overrun. Basically, the CDPQ Infra group had estimated costs for constructing and for operating this project and went out to get bids (a very competitive bidding process). 
  • The group came a little short on its estimates of the capital expenditure of the project, so when the bids came in for construction, they fell short by $300 million, well within the normal margin of error for a mammoth infrastructure project of this size
  • However, the group overestimated the cost of operating this project so even though their estimates of capital expenditures were lower than the bids, the estimates of operating were higher than the bids, so it will cost less to operate meaning the margins are higher
  • Importantly, over the long run, this extra $300 million which the Caisse is kicking in as an equity stake (not debt, the Caisse isn't borrowing to fund this project) to construct this project is trivial if user fees stay as planned. Moreover, the lower operational/ maintenance cost will offset this higher capital expenditure, allowing the Caisse to generate an 8-9% annualized return for Quebecers over the long run (see Michael Sabia's interview below).
  • These are subtle but critical points which have been lost or glossed over by the media as they rush to claim "the price tag will be $300 million higher and the project is delayed by a year."
By the way, the media got that wrong too, the first phase of the project will commence in 2021, it's impossible for the entire project to be ready and operational by 2021.
It's funny because just today I had lunch with a wise former employee of the Caisse and he asked me: "Where does Michael Sabia come up with his 8%-9% projected returns on the REM and where is the independent governance on this project? Why don't they nominate an independent board to oversee it?"

I actually shared these concerns with an expert who told me as far return projections, "concessions were making 12-13% annualized with no revenue risk, so the return projections sound right."

On the governance, he said: "The Caisse assumes all the risks of the REM. The Quebec and federal government have contributed a sizable amount but once the project gets going, it's off their balance sheet. For them, it's an investment and they will both earn a return. The Caisse put over 50% equity in this project and assumes all the risks. I don't understand why an independent board overseeing this project is needed if the Caisse assumes all the risks. That doesn't make sense. Moreover, alignment of interests are there and if they do a great job, everyone walks away happy."

Anyway, the Caisse's 2017 results are out and you can read the press release here. It's important to note the full 2017 Annual Report is not available yet. It will be available in mid-April and when it is you can read it here.

From the press release, it's important to emphasize long-term (5-year) results:

It's not just that compensation is based on these long-term results, it's also that these are the results that ultimately matter for depositors and Quebec pensioners.

The press release states:
La Caisse focuses on equities that provide stable and predictable returns to reduce sensitivity to market highs and lows. In 2017, la Caisse’s return reflects strong equity market performance, but does not fully capture the surge in multiples for tech companies and companies with an accelerated growth profile. Conversely, la Caisse’s portfolio should also provide greater resilience in volatile markets.

Detailed information on the returns of each asset class is provided in the fact sheets included with this news release.
The most important table is the one below showing returns by asset class over the last five years and for 2017 (click on image):

A quick glance shows me that apart from Emerging Markets stocks, Private Equity really performed well in 2017, returning 13% versus a benchmark return of 10.5%. I also noted solid performance in Real Assets (Real Estate and Infrastructure) and decent performance all around except for Canadian Equities (Canadian mandate) which underperformed the index by 100 basis points in 2017 (but outperformed it by 150 basis points over the last five years).

Unfortunately, I can't get into more details as the 2017 Annual Report isn't available yet. When it is in mid-April, you will be able to read more details here, including details on compensation, benchmarks, and a lot more.

One thing I was curious to know is whether F/X cost the Caisse returns given the decline in the US dollar in 2017. I'm not sure if the Caisse partially of fully hedges foreign exchange risk, I know CPPIB and PSP don't so their performance will be impacted by the decline in the US dollar last year.

Other than that, it was another solid year for the Caisse but it will be interesting to see how the portfolio withstands a real correction that lasts. Just like CPPIB and others, I'm sure the Caisse bought the last correction.

Below, CTV News Montreal reports the return for Quebec's pension fund, the Caisse de Depot, was up in 2017 to 9.3 per cent, two points higher than in 2016.

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