Asset Class – August 2008

The Canada Pension Plan Investment Board moves very large sums of money in and out of private equity. Direct investment is a key component of its strategy finds Philip Borel.

One thing on Mark Wiseman‘s mind is scale.

As senior vice president in charge of private investments at Canada Pension Plan Investment Board (CPPIB), Wiseman is in charge of an ambitious and rapidly growing private equity and debt investment programme. In fiscal 2008, his team committed C$7 billion (€4.4 billion; $6.9 billion) to 25 international private equity funds. It also inked 14 direct investments worth approximately C$2.3 billion. And had a C$40 per share offer to participate in the leveraged acquisition of Canadian telecom giant BCE succeeded, another C$3 billion of CPPIB money would have been spoken for. In the event, BCE went to a rival consortium for a higher price.

The large sums Wiseman and his colleagues handle come from a pool of pension money that on 31 March 2008 was valued at C$122.7 billion. Canada’s chief actuary estimates that by 2016, this pot will have doubled to around C$250 billion. In fiscal 2008, C$6 billion came in through new pension contributions alone.

The magnitude of the numbers involved makes clear why scale is so important: in order to move the needle, the Toronto-based group needs to make big investments. Venture capital funds tend to be too small and hence don’t feature prominently in the CPPIB portfolio. Late-stage private equity on the other hand – until recently at least – has offered a wealth of sizeable opportunities, and CPPIB has grabbed many with both hands.

The group also invests in real estate and infrastructure assets, and it is currently in the process of building a private debt platform. The latter was spearheaded last year by way of a C$2 billion commitment to credit funds managed by The Blackstone Group and Apollo Management in order to take advantage of mispricing in the leveraged loan markets. According to Wiseman, approximately one-third of this commitment was invested as at 31 March.

However, this kind of outsourcing will not be repeated: at press time, CPPIB was busy assembling an in-house team that will invest in an array of debt securities, including first and second lien loans, mezzanine instruments and infrastructure debt.

Inspired by recent events in global finance, Wiseman is upbeat about the prospects facing the new debt team. He says: “Capital markets have been brutal, absolutely brutal since last August – but this has also meant that there is a great opportunity.”

But although last year’s market dislocation has made the private debt strategy especially attractive, Wiseman is keen to emphasise that CPPIB’s foray into the segment is not an opportunistic move: “Plans for a dedicated debt team have been on the drawing board for three years – this is not a knee-jerk reaction.”

Wiseman makes the point to underline that short-termism doesn’t work for a fiduciary with a long-term time horizon. He says CPPIB is all about trying to anticipate the state of the world “40 or 50 years out”.

Following its long-term approach, the fund recently opened an office in Hong Kong to step up its activities in new markets. Currently less than 3 percent of CPPIB’s private equity investments are outside North America and Europe, but this mix is likely to change in the years to come. Last year the group increased its commitment to emerging markets funds to C$1 billion, up from $115 million 12 months prior.

Initially, says Wiseman, the focus will be on the economies of North Asia, but he also expects to spend more time investing in India and Africa in due course: “’Emerging markets will be a much larger percentage of the global economy. Even if you read the BRIC report and cut the projections by 80 percent, this statement is still true.”

International expansion was also the motivation behind the opening of a second overseas office in London in May.

As a limited partner in traditional private equity markets, CPPIB has been an increasingly influential participant ever since the late 1990s. Its portfolio of fund interests is currently valued at C$10.2 billion. Increasingly, however, it has also built a reputation as a direct investor in private transactions. Last year’s abortive effort to buy into BCE reflects this, as do the 14 co-investments the firm did complete. In total, CPPIB’s dedicated principal investment team has completed C$3.5 billion of transactions so far – more than most limited partners in the asset class.

Its penchant for direct deals is one of the features that give the pension an edge in the global limited partner universe. Wiseman clearly is pleased with how the group is positioned today: “We do take pride in how different we are.” He says Teachers’ Private Capital, another Canada-based giant of ground-breaking investment management, was first to succeed with a direct private equity model; CPPIB followed suit and is now reaping the rewards as well.

Is it a coincidence that a number of Canadian institutions are unusually active as direct investors in private equity? Wiseman thinks not. Part of the reason is historic: “In the early 1990s, there were no Canadian private equity firms to invest with. Teachers and also the Caisse [de dép^t et placement du Québec in Québec City] had to do private equity themselves, and we are the next generation.”

More importantly still, he argues CPPIB has the right corporate governance model to go direct. Created in 1997 by an Act of Parliament to manage the pensions of 17 million Canadians, Wiseman says CPPIB professionals operate at arms length from the Government and have “complete singularity of purpose” in their mandate: “We’re entirely driven by the idea of maximising risk-rated return, which is also how we get paid by the way. There is no secret sauce here: the key is to compensate people at the right level and based on performance.”

Wiseman has no doubt that CPPIB has proven its ability to co-invest and even originate deals – especially in its home market where it has repeatedly “reverse-engineered the process” and invited equity sponsors into deals. Fundamentally, however, the idea is not to disintermediate the GP groups in its portfolio: “Let’s be clear: these are very able partners. Far be it from us to go out and compete with them.”

Will private equity as an asset class continue to provide sufficiently sizeable investment opportunities to keep CPPIB interested? There is nothing in Wiseman’s comments to suggest he may think otherwise. And even if there was a slowdown in global private equity activity, the group’s “total portfolio approach” is designed to help it make the necessary adjustment.

Sums up Wiseman: “We don’t allocate capital to private equity as such. Fundamentally we say, ‘an equity is an equity – a residual claim on a company’s cashflow’. As part of this we will do as much or as little in private equity as makes sense in terms of the opportunity cost of investing in public markets.”

In other words, scale can and will be achieved regardless of what happens in the equity markets.

Given its size, CPPIB has no choice but to continue to place big bets. When it started in 1997, 100 percent of its capital was in government bonds. Today, some 65 percent is in equity, with private equity accounting for approximately 11 percent of total assets. The Plan has come a long way already and can be expected to carry on in the same direction – especially with equity enthusiasts like Wiseman cast in leading roles.