Exotic Aspirations

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Want to save on 30 long-haul flights, countless cups of coffee, and several bleary-eyed meetings for your staff?

Open an office in London’s Mayfair, says Alberta Investment Management Corporation’s (AIMCo) CEO and CIO Leo de Bever—who announced early this year that he’s doing just that, adding to the growing number of foreign offices operated by large institutional investors.

For de Bever, the cost of opening the two-person office will be easily outweighed by the benefits it will bring, and his views are being echoed by some of the largest investors around the world.

At the last count, 11 pensions, sovereign wealth funds, and government-backed capital pools were operating one or more satellite offices—and more are on the way. The Canada Pension Plan Investment Board (CPPIB), which already has offices in Hong Kong and London, has just landed in São Paulo, and before this magazine is published, there may be even more announced.

One common factor across all these institutions is the continuing trend to in-source investment management capabilities. Due to the sheer size of their portfolios, these teams need to look outside of their domestic markets to allocate capital.

Despite technology reducing the size of world markets, there is no substitute for having men—or women—on the ground, these investors say.

“You want to see what opportunities are really there, or if it is all just noise,” says de Bever. “We are also looking at other European countries from the UK. I don’t care what the market in general is doing. I care about opportunities within it—the opportunities that others are missing.”

It is the targeting of opportunities that has drawn investors to rent office space in foreign lands, but these opportunities do not just come in the form of a rising stock or high-yielding bond.

“You want to deeply understand the market, understand exactly where you are investing, and you want to be approachable, to be part of the network,” says Fer Amkreutz, chief financial and risk officer in New York City for APG, the company that runs assets for Dutch pension giant ABP.

Being part of the network is one of the key factors when opening an outpost. Of the $50 billion in direct deals made by institutional investors in 2012, some 44% were co-investments, says Patrick Thomson, global head of sovereign clients at JP Morgan Asset Management. And this number grew substantially in 2013. “Investors want to be in the centers where they are closer to their partners, deals, and capital markets—the flow, essentially—and the flow of information,” he says.

Having people on the ground full time allows not just business alliances and mutual trust to grow, which are essential to any investment venture, but a certain amount of burden-sharing can take place, too.

“Due diligence is critical in any investment decision,” says Amkreutz, who was also president of APG’s Hong Kong office for a time. “If you can share information, risks, costs, and the experience among great institutional investors, everybody benefits. If we invest in Asia, we do the same; the Ontario Teachers’ Pension Plan and CPPIB have offices there, so we team up on investments.”

AIMCo’s last direct venture in Europe was the purchase of UK cinema chain Vue in June. It was a co-investment with the Ontario Municipal Employees Retirement System, which has had an office in London since 2009. The establishment of AIMCo’s office in the UK will help the cinema chain push into Poland and Germany, de Bever says, a move that will be much more efficient to conduct in the right time zone and with local specialists.

Having staff that speak the language and understand the culture is vital to ensure you make the right business decision, says Amkreutz. “You open a regional office to attract local people, so the majority of your investors should be local—but what is ‘local’? In our Hong Kong office, we have 10 different nationalities—from India, China, Australia, Thailand, Malaysia—are they local? Well, they understand their local markets. For the US, a local is someone who understands the local market and has lived here for a long time, but their background can vary.”

Finding these new staff members might be a chronic headache-—-but not for the ex-pat institutional investor network.

“There are a lot of informal and more formal meetings between investors that operate satellite offices,” says Amkreutz. “APG has a culture of sharing information with other pensions. We have had Korean, Malaysian, and Japanese pensions coming in to see us in New York and Hong Kong, and asking what it takes to create what we have.”

Along with sourcing new staff on the ground, there has to be a smattering of the home team present, too, investors say. AIMCo dispatched Canadians to set up the London office; the Korea Investment Corporation has sent a large number of domestic staff to its New York and London stations. Yet getting the right mix of people in the right roles is important.

There are 110 people in APG’s US outpost, 90% of whom are local. The remaining 10% is made up of Dutch ex-pats who have slotted into mainly non-investment roles. “These people manage the office and look to the alignment with the Netherlands and vice versa—those need to be people who understand the Dutch culture and the company culture,” says Amkreutz.

Managing the alignment and maintaining a common culture between the offices can be a tough job, investors say, but it is necessary if the system is to function.

“Modern technology helps if you know each other,” says de Bever, who managed the Canadian office of a large US company before AIMCo. “Sometimes you get frustrated as you think people consider you to be a smaller part of the business—but you have to be determined to make it work.”

For APG, it all starts with the board committing to support the offshoot project and ensuring stability for all involved.

“We have a lot of information sessions,” says Amkreutz. “We bring the client to visit us, so the ABP board will come to the New York and Hong Kong offices, just to understand what we do. We also do a lot of knowledge sessions with both our clients and our employees, which means focusing on what we do and how we do it, what we believe in, and what we think should change.”

But Where Are the Americans?

Therein lies the rub for some of the largest institutional investors, whose international offices are conspicuous by their absence. None of the large US public pension plans—with assets that dwarf their Canadian counterparts’—have been able to set up investment posts outside their home turf, and this has caused some consternation.

“We and the California Public Employees’ Retirement System have talked about trying to do this a number of times, but there’s just no way, given the governance structure,” says Chris Ailman, CIO of the California State Teachers’ Retirement System (CalSTRS).

Together, the funds’ assets total almost $450 billion, which would place them in the top 50 largest investment firms list—if they were permitted to operate as such.

“Virtually all of the large public funds in the US were set up in the 1970s as divisions of governmental agencies,” says Ailman. “Smart business decisions such as setting up global offices are common sense for a money manager, but nearly impossible for a governmental agency.”

California has even closed its tourist agencies that were scattered around the world.

“If you look at us through the lens of a governmental entity and compare us with the department of licensing, our structure and operation look expensive. That’s because we are not a state entity in that way—we’re a money manager, a global money manager who has to compete with global entities,” says Ailman. “If you look at us through the lens of a Wall Street money management firm, you would be shocked the other way at how inexpensive and frugal we are.”

Considering these public funds as part of the local government fabric cuts them off from the co-investments and direct deals their relatively smaller peers are pushing further into.

Even without the additional complication that California and other westerly and southern states are geographically distant from the main financial centers, their set-ups are not adequate to facilitate such deals. Flying to London—in the rear section of the plane—for a week and expecting to pull off a complex investment deal is -unrealistic—and risky.

“Those satellite offices are directly investing in real estate and infrastructure, which by their nature are 10- to 15-year deals,” says Ailman. “For long-term investments, you can’t make decisions and evaluate the deal in one week. You need to know and understand your business partner as well as the investment itself.”

Thomson at JP Morgan, who spent five years in Singapore with the firm, understands US public funds’ frustrations—but also the issues faced by their boards.

“You have to look to your stakeholders,” he says. “What is the advantage to them of you setting up a foreign investment office? Is there a net benefit to your members? If you are an intergenerational fund, you can make the argument that it makes sense as you are working towards the wealth of the country.”

Singapore’s GIC and some Middle Eastern funds have proven the value of outposts, having seen financial benefit across their funds, says Thomson. However, even this might be a hard sell to US taxpayers who are not au fait with the financial world.

But it is not just the potential missed returns that concern Ailman. He has graver worries about not having staff on the ground.

“Everyone looks at these offices in terms of opportunity,” he says, “but people need to look at them in terms of risk management. It’s a balance of risk and return. Some of my best money spent was sending people to do due diligence and they’ve come back saying we shouldn’t do the deal. Although it’s difficult to measure, the deals those offices pass up are much more advantageous than us parachuting in for a week, having a couple of meetings, dealing with the jetlag and the travel.”

Amkreutz at APG understands this problem, too.

“If you want to buy a house in Spain and you live in London, you can do it via a brochure—it’s not that difficult—but I think you would want to see it. If you want to buy a lot of houses, you start thinking, ‘Well, why wouldn’t I open an office there?’”

If you are prevented from doing so, you are unlikely to discover the risks that may be lurking under the surface.

And the Australians?

Even farther away than Sacramento from the world’s financial centers is Australia, which is home to the ever-growing superannuation system. An uptick in contribution levels is set to boost a capital pool that is already larger than the market capitalization of the country’s stock market—but to date only one fund has ventured to open an office outside its national borders.

The A$70 billion AustralianSuper has a small operation in Beijing. Speaking to a reporter last year, Stephen Joske, senior manager in Asia for the fund, said: “Being on the ground in Beijing gives us really important insights into the future of the Chinese economy. On the one hand, we can see what’s actually happening, whereas if you’re farther away from it, often it can be hard to distinguish government intentions from actual reality.”

So far, it is the only super fund to have taken the plunge, but where US public funds complain of arcane and limiting governance structures, Damian Lillicrap, head of investment strategy at QSuper, thinks in Australia it is only a question of time.

“The lack of outposts is largely a reflection on the current state of evolution of the structure of Australian funds,” he says. “While funds are relatively large, in-house teams haven’t been that common or big. QSuper, for example, has only had an in-house investment team for the last four years. So our focus has been on less esoteric things than global outposts.”

Lillicrap says that looking at the evolution of the global economy—with emerging markets making up an ever greater slice of the pie and investment opportunity set—it seems a good possibility that such outposts will emerge as part of many investment processes.

“In the meantime, we have the luxury of watching and assessing the pros and cons of different structures being implemented around the globe,” he says, “from small, tight teams focused on strategy to large, global teams deeply involved in the deal process for individual assets.”

But Outposts Don’t Equal Success…

CalSTRS’ Ailman is also watching the outposts with interest, and is inclined to believe that the story is not yet complete.

“We need to see these outposts go ‘round trip’. Anecdotally, there is success, but there are also challenges with doing direct deals,” he says. “Most of the challenges deal with governance: managing and keeping and retaining staff.”

At AIMCo, one of de Bever’s concerns for outpost staff is that they understand their limits. “If you have people on the ground, you don’t want them to take everything just to justify their presence,” he says. “Considering the wear and tear on our people that we are avoiding—and all that comes with it—I think our London office is necessary, although it won’t be getting much bigger.”

There will be more of these offices, de Bever thinks, but investors need to consider the incremental costs and determine if they are really necessary.

Thomson thinks that the size, scale, and increasing global complexity of investors will dictate their expansion. “The average team for a sovereign wealth fund is 90 investment professionals, and 50% of them have been created since 2005,” he says. “They are expanding and are looking much more actively across different asset classes. It is evidence of their increased sophistication as investors.”

With this in mind, improving pension fund governance structure should see the largest investors haul their might around the world—and even the US public funds may get a look in.

“I think it will actually change, and it will be massive,” says Ailman. “Like adopting a new technology, it will change everything, and people will ask why we didn’t always do it that way. But I don’t know what the catalyst to change will be.”