October 17, 2019

Canadian Institutions Unlock Unique Opportunities for Alpha Through a Progressive Emerging Markets Approach

Pensions exploring the world economies and infrastructure to find different avenues for return.

Reported by Steffan Navedo-Perez

Art by David Plunkert

As with the rest of the world, Canadian institutional investors are keeping up with new investment strategies that deviate from traditional investment models to find new ways to generate stable revenue streams. At the same time, they’re focusing on an osmosis between their respective pools of capital to keep their beneficiaries afloat and correlated with updates to the consumer price index. They’ve been diligently keeping up with the evolving legislative and political environments encircling international markets that unlock unique opportunities for alpha, and establishing a physical presence in these regions to help keep up with the times.

Spanning different frontiers including infrastructure, emerging markets, and private debt, the Canadian investors are pushing the boundaries of their portfolios by distancing themselves from the norm and following their own line of thinking.

One new avenue of growth is private credit in India, which was enabled after Prime Minister Narendra Modi’s government introduced new legislation that streamlined the bankruptcy court process and timeline in the country, subsequently providing an opportunity for a corporation’s debt holders to assume control of the organization after the equity sponsors had failed.

Tarik Serri, director of hedge funds and alternative investments at Air Canada Pension Investments, told CIO, “Enforceability for debt holders became effective, which changed the whole landscape…So in this case, the original sponsor or promoter would lose control of the company, so the debt holder can take over the company and go through the court process and actually unlock value, and that’s where the restructuring of private debt comes in.”

“I think for us, from our perspective, finding these niche opportunities [adds value] to the overall pension plans because they have a very unique source of return stream and risk within the context of total investor portfolio,” Serri said.

The pension plan is still new to embracing this change in India and does not presently have an interest in a dedicated India fund, but rather within an Asia-focused multi-strategy fund where there’s a “respectable” allocation to India.

“We are not heavily invested in it yet at this point,” said Vince Morin, president of pension investments at Air Canada. “We are looking at this region of the world through various asset classes, but this regulation is quite new and we want to be prudent in approaching that, and we believe that opportunities will be rewarded.”

The Air Canada pension plan is driven to niche alternative opportunities such as private debt in India namely due to its liability-driven framework that has allocated more of its strategy towards fixed income and less toward equities, leaving room for return-driven asset classes that provide diversification, such as alternatives investments.

Morin and Serri both described how they remain poised, diligent, and nimble to take advantage of opportunities presenting themselves throughout the world, saying they were early movers in the US real estate distressed market back in 2010 and are now early movers in emerging markets, private debt, and other kinds of sub-asset classes within the private debt sector.

Serri explained his team’s perspective on the shifting global macroeconomic themes, and how perpetual canvassing has helped the pension fund identify opportunities for exploitation, namely through identifying dislocations occurring throughout the international community.

“We look down at the world as a platform and we see where are the dislocations overall, and then we want to identify a theme of dislocation. [Subsequently], we’ll do a bottom-up [investigation, seeking] who is the best executor or manager who can execute the theme for us?” Serri said. “And the important thing is really to be nimble and quick. You need to act fast, and you need to have the knowledge to know the players in that space.”

Canadians are traditionally the standard-bearers of advanced alternative investment strategies that allow them to be nimble and creative in the alternatives space, and Serri and Morin’s behavior in these particular markets is solid evidence of the country’s state-of-the-art approach to alternatives.

The two explained they believe a large part of the country’s development in alternative assets is their compensation structure for investment officers working in the space, and having their salaries flexible and correlated with investment performance. “Once your compensation is aligned with the returns you generate and try to realign, then you push hard to innovate and get these better returns, which may be because we spoke with many of our US peers and sometimes it’s not the case. Some of them do have competitive compensation with the asset management industry, but in Canada, the bigger funds took the leadership in that and they actually are paying and aligning the interest to generate these returns.

“So I believe that’s probably one of the indirect reasons why there was innovation in Canadian plans and people wanted to move fast—because their competition is directly linked to innovation,” Morin said.

The funds are different structurally as well, as Canadian funds have the opportunity to go into international deals where they see fit, for the most part.

“They’re incentivized to take the risk that they can, like in China or India, for example,” Serri said. Also important is “how we invest our alternative portfolio. In many plans, we see very specific allocations, sub-asset classes like real estate, private equity, private debt, and infrastructure. [At Air Canada Pension Plan], we decided to take more of an opportunistic strategy. So we don’t have a specific allocation but we do go in private investments in a niche market where we believe there’s value,” Morin said.

EM and Infrastructure

Caisse de dépôt et placement du Québec (CDPQ) is another such institutional investor in Canada that has developed developed a strong alternative investment programs, particularly within the infrastructure asset class. To date, it is building the largest institutional investor-backed greenfield project in history, the Réseau express métropolitain (REM) transit line running through Montreal, a CAD$6.3 billion effort spanning 67 kilometers of tracks across 26 stations.

Emmanuel Jaclot, executive vice-president and head of infrastructure, spoke with CIO about finding niche opportunities in emerging markets for the asset class, similar to Morin and Serri’s opportunistic monitoring of emerging markets for avenues in private credit.

“In order to execute good deals in a given country, I think you need people on the ground to have a local footprint,” Jaclot said. “We moved to emerging markets as part of a big decision in 2015, and opened offices in Delhi, in Singapore, Mexico, and more recently in Sao Paulo. We have individuals in these offices looking for deals, understanding the regulation, and looking for partners. In [emerging market] geographies, it’s even more important to have the right partners, who understand the market and can bring good opportunities to you.”

“We have a very distinct proposal for partners in these geographies, we are long-term, and we have the expertise from the asset class that we bring as well, so it’s a good mix to the local partners, and being able to bring this level of firepower to the table with them. It’s a good win-win.”

Jaclot illustrated the point that emerging markets have typically had a great need for infrastructure assets, so it comes down to he and his team being selective with which opportunities they pursue.

“These markets have huge needs for capital, usually for infrastructure, so it’s a matter of being very selective and applying our selectivity standards that we’ve developed for the last 20 years into these geographies. It’s very important to find the right partners for those kinds of transactions.”

“There are lots of opportunities in Brazil, Chile, Peru, Mexico, Colombia, and India,” he added. He and his team recently acquired two ports in Chile earlier this year, and are working on several opportunities in these geographies, notably backing renewable energy developers to see a host of renewable energy assets pop out around the region.

Jaclot and his team took a long time—nearly 20 years—to reach the point where they could develop large-scale greenfield projects on their own, such as the REM project and back-to-back developments in emerging markets. They’ve been adamant to curtail their concerns on risks, particularly with regard to greenfield infrastructure projects.

Partnerships Are Key

CDPQ is keen to take advantage of international opportunities in developing regions throughout the world, having raised the portfolio’s exposure to such markets from 5.4% in 2013 to 15% today. It has offices in Singapore, Mexico City, Shanghai, Sao Paolo, and, Delhi.

Executive Vice-President and Head of Strategic Partnerships for Growth Markets Anita George spoke with CIO about CDPQ’s strategy in emerging markets, and how it establishes a physical presence wherever it feels necessary.

“Before we go into countries, we spend quite a bit of time understanding the lay of the land,” George explained. “Specifically for investments, we look at the growth potential of a particular sector, and the risk factors that can affect the growth of that sector; the regulatory and legal framework…[and] the kind of partners we could potentially work with.”

“No. 1 is really having the right partners who share the same values and the same alignment of interests in terms of being a long-term investor; willing to work with us over the long term towards building the business,” she said. Relatively safe metrics for a country, such as stable macroeconomics, contained inflation, levels of leverage within bounds, a rule of law, and some clarity on regulation, especially in the sectors that it is active in, are prioritized.

Typically, CDPQ establishes a presence to build an allocation for the country’s opportunities across infrastructure, real estate, private equity, fixed income, and listed equity. In India, it began with infrastructure projects, and since 2016, it has developed two renewable energy platforms in the country.

George explained a particular case in which CDPQ is partnering with a well-regarded Indian entrepreneur, Nandan Nilekani, to assist in his Fundamentum fund, which is credited by many as being part of the architectural team behind modern digitized payment systems and innovations in the sector. CDPQ has had about CAD$6 billion in India since establishing its presence in the country in early 2016.

In regards to selecting where to invest next, George explained that sometimes a particular partner’s introduction to market through a segue of business opportunities occurs. She explained that CDPQ’s partnership with DP World, which helped see through the development of two Chilean ports recently, has introduced the team at CDPQ to new geographies in Latin America.

Having a foothold in one part of an interconnected economy through a particular region, such as the firm’s Shanghai office in the Asia markets, also helps to facilitate a decision on whether to land there or not.

“We are starting to look at other countries in the region, for example, since we are active in Asia, it makes sense to start looking at Southeast Asia, and sometimes our partners take us there. For example, we’ve invested with a company that specialized in warehouses, and we’ve partnered with them in Singapore, China, Indonesia, and India. This partner is looking at other opportunities in Southeast Asia, so we will work with them also to explore those countries.”

Finding Stability Through Mergers

On top of such emerging markets strategies, Canadian institutional investors are going through mergers to develop their scale and benefit their own retirees, increasing pensions by a healthy amount despite low recent investment performance after the turbulent Q4 2018 period. This year, the Healthcare of Ontario Pension Plan merged with four other pension plans to help “provide greater flexibility for members in their working years…and benefitting from ongoing retirement security.”

Following the announcement, the pension’s board of trustees approved a cost-of-living adjustment equal to 100% of the change in the consumer price index over the previous year, despite generating a lesser investment return for 2018 (2.17%) compared to 2017 (10.88%).

As a result, all pensions for retired and deferred members, and surviving spouses and beneficiaries saw a 2% increase. “We are proud to grant this valuable benefit to help protect your pension against rising prices,” the pension said in a statement. The pension was also allowed the flexibility to carry out such a benefit through its strong funded status, in part perpetuated by strong real estate and fixed income strategies. Investment income generated for 2018 was $2.17 billion, compared to $7.6 billion in 2017.

HOOPP’s real estate strategies are led by Stephen Taylor, who has led the portfolio’s acquisition of real estate assets throughout Canada, as well as in New York and England.

“Looking ahead, HOOPP continues to explore new and effective investment opportunities and strategies,” the fund’s President and CEO Jim Keohane said in a statement. Whether this will follow CDPQ and Air Canada Pension Plan’s emerging markets strategies has yet to be discussed with the team, however it has recently strung out its real estate target geographies to include non-domestic assets in Western Europe and the US.