Leo de Bever Finishes Off and Starts Up | Chief Investment Officer

As he wraps up his tenure as the founding CEO of the Alberta Investment Management Corporation (AIMCo), de Bever looks ahead to the next frontier: fostering innovation with institutional capital.

“The reason I made money in infrastructure at AIMCo and Ontario Teachers’ was because I was an early adopter. The market used to be incredibly inefficient. Others followed the example, but didn’t always understand that it’s not just about buying infrastructure assets. The price matters. I’ve lost most of my bids over the past year and a half, and so have my very disciplined peers. What worked in the past, almost by definition, won’t continue forever. You must find new opportunities.

A lot of successful startups end up selling for much less than they’re worth. The structure of their venture capital financing forces them to sell too early or IPO [initial public offering] at a poor time. And when a company hits on a very good product or service, there’s often not enough capital available to bring it to market. The big players want to invest in this sector, but they’re looking for a solution to high costs and mediocre returns. Too many people in venture capital are getting paid for nonperformance.

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Furthermore, listed companies have become very, very short term: They are unable to make investments that take 10 years to pay off. We don’t have any Bell Labs anymore. Cenovus, a Canadian energy company, just disbanded its innovation group. But long-term institutional investors can fill the gap. We can provide capital when it’s needed most, and capital that can afford to be extremely long-term. That’s attractive to other investors, start-ups themselves, and corporations.

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For example, AIMCo has been very active with a company called Bloom Energy, which makes fuel cells. Corporate clients have said, ‘Look, we’d like to pay you like a utility every month, instead of buying the equipment and amortizing it on a monthly basis.’ We found that we were part of an effort to engineer equipment financing.

Getting new technology into energy has the longest fuse—the longest J-curve—of any sector except pharmaceuticals. Moving a new drug to market can take 10 to 15 years, and energy technology has a similar timeline. You need investors that don’t really care when the return comes and how it comes—in cash or total return. If we know a company very well, and we’re comfortable financing the commercialization of its technology, we can shorten the market cycle. The combination of real engineering expertise and our financial expertise has the potential of paying off rather handsomely.

We have to change the whole food chain from angel investing to pre-commercialization. We will also have to train a lot more people to help these start-ups be efficient. What I’m trying to do is recruit retired engineers and executives to work with these companies. The province likes this initiative for energy investing, and it feels it’s necessary.

Right now, directly financing innovation is only feasible for a few major institutional funds. But that’s no different from when I started investing in infrastructure and timberland and commodities. In fact, the only reason I could at Ontario Teachers’ was protection from my CIO, who said, ‘It sounds interesting. Do it, and see what happens.’ I predict that in five or ten years, investing in technology this way will be as common as infrastructure investing is now.

We’ve been working with other investors to socialize some of these ideas. But the problem is, it takes guts. It takes guts on the part of management; it takes guts on the part of boards. And often that is not in big supply.

There is a lot of career risk in this—and I’ve felt it personally. People have come at me and said, ‘You shouldn’t be doing this.’ But experts in the industry—people like Keith Ambachtsheer, who’s running the Rotman International Centre for Pension Management—have said, ‘You are absolutely right. This is the area where pension funds can find a new application and make real money.’ And this is where I want to spend my post-retirement efforts.”

“Institutions Shift to Exchange-Traded Funds as Futures Grow Costly”; “Institutional Investors Jump on Cheaper Junk Bonds, ETFs”; “Canadian Funds, Money Managers Increasing Fixed-Income ETF Use.” One glance at these recent headlines and one would imagine major investors eagerly snapping up ETFs and carving out large habitats for them in their long-term portfolios.

Don’t believe the hype, one consultant advises.

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Wall Street and asset management firms are “always looking to sell the ‘next new product,’ aren’t they?” he asks. The US-based consultant services some of the largest corporate institutions in the nation. “But despite this buildup from research and the media, the truth is, ‘The Boom’ has yet to translate into portfolios of true, long-term institutional investors.” These asset owners lack not only the need for daily liquidity, but also are neither tactical nor nimble enough to facilitate frequent trading of ETFs, he continues. “It takes weeks and months to put a strategy in place and implement them for these clients with assets in the billions of dollars. They aren’t day traders.”

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But couldn’t even the most diligent investor occasionally get swept up in the media frenzy—enough to lose its “institutional mind?” Yes, the consultant admits. He has come across one or two investment board or committee members who will cite the Wall Street Journal and insist on the purchase of, say, gold mines or Japan equity ETFs. “Some investors buy odd, one-off exposures largely because of what they read. We then reel them back and remind them to keep with an institutional strategy and a strategic allocation for the long term,” he says. “The media touts ETFs as a tool to gain exposure to niche markets—a catch-all—but in reality, larger asset owners are more suitable for institutional-quality vehicles.”

However, another consulting firm—Connecticut-based Greenwich Associates—asserts that the once retail-centric ETF has successfully seeped into the institutional space and will continue to do so. A May report observed asset owners turning to ETFs of new asset classes, especially fixed income, in a shifting interest-rate environment. New regulations following the financial crisis have resulted in “reduced dealer inventories of fixed securities and lower levels of liquidity in the secondary markets,” also driving growing opportunities for ETFs in institutional portfolios, the firm says.

The evolution doesn’t stop there. Investment advisors are placing ETFs at the heart of their strategies, beyond filling an asset class gap or accomplishing short-term tactical goals, Greenwich Associates argues. Not only are holding periods lengthening, but ETFs are expanding into strategic roles such as liquidity, risk management, and hedging. “Both usage rates and allocations are expected to continue rising as institutions discover new applications for the vehicles and innovation by providers make ETFs more flexible,” the firm said.

BlackRock, purveyor of iShares—the world’s largest ETF provider—partnered with Greenwich Associates to produce the report.

Whether it’s hype or an honest-to-goodness shift in uptake, asset owners can and should wait for sweeter fee structures, the consultant stresses. There exist other institutional vehicles—that fit the long-term mindset of institutional investors—with better fee structures, he continues, leaving no immediate need to incorporate ETFs. “Or, we could wait for investment boards to alter their decision-making timeframe completely. If clients can make decisions in a matter of days, then maybe we’ll say yes to ETFs.”