PSP Investments Up 14.5% in FY 2011

CNW reports, PSP Investments Reports Fiscal Year 2011 Result:

The Public Sector Pension Investment Board (PSP Investments) announced today that it recorded an investment return of 14.5% for the fiscal year ended March 31, 2011 (fiscal year 2011). The robust overall performance for fiscal year 2011 was driven primarily by strong results in Public Market Equity portfolios as well as in Private Equity and in Real Estate, and follows on the heels of the 21.5% total return recorded in fiscal 2010. The fiscal year 2011 investment return exceeds the Policy Portfolio return of 12.7% by 1.8%.

Consolidated net assets increased by $11.7 billion, or 25%, to a record level of $58.0 billion. During fiscal year 2011, PSP Investments generated net income from operations of $6.9 billion and received $4.8 billion in net contributions.

"The latest results reflect solid performances and contributions from every part of the organization and point to the success of the diversification strategy we began implementing in 2004, with the introduction of private market asset classes such as Real Estate, Private Equity and Infrastructure. Our Public Market equity portfolios also recorded substantial gains, adding to the strong performance of the previous year," said Gordon J. Fyfe, President and Chief Executive Officer of PSP Investments.

For fiscal year 2011, Public Market equity portfolio returns ranged from 6.6% for the EAFE (Europe, Australasia and the Far East) Large Cap Equity portfolio to 19.7% for the Small Cap World Developed Equity portfolio. The Canadian Equity portfolio return for the year was 19.3%.

In private markets, the Private Equity and Real Estate portfolios posted strong investment returns of 20.9% and 13.8%, respectively. The Infrastructure portfolio earned a slightly negative investment return of 1.6% for fiscal year 2011.

The asset mix as at March 31, 2011 was as follows: Public Market Equities 56.5%, Private Equity 9.6%; Nominal Fixed Income and World Inflation-Linked Bonds 20.7%; Real Estate 9.1% and Infrastructure 4.1%.

Special Examination

During the fiscal year 2011, the Office of the Auditor General of Canada and Deloitte & Touche LLP (the Examiners) jointly carried out a Special Examination in accordance with applicable legislation, which requires such an audit at least once every 10 years.

The Examiners concluded that PSP Investments maintains systems and practices that provide it with reasonable assurance that its assets are safeguarded and controlled, its resources are managed economically and efficiently, and its operations are carried out effectively. This is the best possible conclusion to such an examination.

"Given that PSP Investments has existed for little more than a decade, has experienced tremendous growth, and is engaged in a business where the requisite systems and controls tend to be both complex and constantly evolving, this finding is a testament to the strength and rigour of our organization," said Paul Cantor, Chair of the Board of Directors of PSP Investments.

For more information about PSP Investments' fiscal year 2011 performance and the Special Examination, consult PSP Investments' Annual Report available at www.investpsp.ca.

About PSP Investments

The Public Sector Pension Investment Board is a Canadian Crown corporation established to invest the amounts transferred by the Government of Canada equal to the proceeds of the net contributions since April 1, 2000, for the pension plans of the Public Service, the Canadian Forces and the Royal Canadian Mounted Police, and since March 1, 2007, for the Reserve Force Pension Plan (collectively the Plans). The amounts so transferred to the Corporation are to fund the liabilities under the Plans for service after the foregoing dates.

Its statutory objects are to manage the funds transferred to it in the best interests of the contributors and beneficiaries under the Plans and to maximize investment returns without undue risk of loss, having regard to the funding, policies and requirements of the Plans and their ability to meet their financial obligations.

I will cover the Auditor General of Canada and Deloitte & Touche Special Examination of PSP Investments in my follow-up comment because in my opinion, they omitted far too many important governance gaps which I will meticulously expose.

Back to the results and private equity, which is once again the flavor of the day among large pension funds. Tim Kiladze of the Globe and Mail reports, PSP making a name for itself in private equity:

The Public Sector Pension Investment Board, the investment arm of the Public Sector Pension plan, isn’t a name you hear too often. But if it continues to put out numbers like the ones it just posted for the last fiscal year, you’ll probably be hearing it a lot more.

Often overshadowed by behemoths such as Canada Pension Plan Investment Board and Ontario Teachers’ Pension Plan, PSP manages the pension funds for public service employees, Canadian Forces and RCMP. In total, it watches over $58-billion in assets.

In the past year, funds like CPPIB, OTTP and OMERS were very active in the private equity market, making big investments in global companies such as Tomkins PLC. But lately PSP has picked up its activity as well, co-investing with BCIMC in TimberWest Forest Corp., and more recently alongside CPPIB and Europe’s Apax Partners in Kinetic Concepts Inc. in a $6.3-billion (U.S.) buyout.

In fact, PSP has made it a priority to increase the private equity portion of its portfolio (much like the other funds). For the fiscal year that just ended, private equity accounted for 9.6 per cent of its total portfolio. As of April 1, PSP looks to expand that to 14 per cent.

There’s good reason to do just that. Last year, its private equity portfolio posted a return of 21 per cent. That beat out Teachers’ Private Capital’s return of 19 per cent and CPPIB’s private equity return of about 18 per cent.

In other words, PSP is on par with the biggest and best in Canada.

As for total size, PSP is still behind. CPPIB has about $23-billion in private equity investments, most of which are in private equity funds, but it does manage $5.6-billion in direct investments. Teachers has $12-billion in private equity, which includes both fund and direct investments. PSP has $5.6-billion overall.

Of note, these private equity portfolios do not include real estate and infrastructure, which the pension funds separate out on their own.

My sources tell me that PSP sold a significant portion of its private equity fund holdings to CPPIB in FY 2011 for "a song." If true, I can pretty much figure out which vintage years they sold. They did this to focus more on internal private equity activity, which is mostly co-investing alongside funds and direct deals. They're not the only ones. This brings down fees and allows funds to have more control on these investments. But you need to have the proper skill set internally to adopt this approach.

One thing I have to emphasize, however, is that PSP is no better than anyone else in private equity. I know both guys running the PE portfolio there because I helped set up that operation when I worked at PSP. Good, smart, hard working guys (Derek is a hardass but straight shooter and Jim is a great operational guy) but nothing out of the ordinary and if they were that good, they'd be running their own PE fund. Period.

Same goes for anyone else at large Canadian pension funds who thinks they're worth the big compensation they're getting and can compete with the Ray Dalios, David Bondermans or Tom Barracks of this world. If you're that good, have the guts to go out on your own and start collecting 2 & 20, earning some serious money!

One senior pension fund manager shared these comments with me after reading the Globe article:

Hard to take, but the annual contest means no one has a time horizon that makes sense. Hard to expect the media to reflect otherwise. May as well go with the flow, and advocate for better disclosure of short and long term results, directs vs funds, pre and post currency, etc. The data will set you free....

Unfortunately, the data is not available because none of the large Canadian public pension funds disclose short and long-term performance of direct vs fund private equity investments or internal alpha in public markets versus that from external fund managers. They mix it all up and call it "alpha," which of course, suits their compensation.

Moving on, I suggest you take the time to carefully read PSP Investments' 2011 Annual Report. As I've stated before, there is a tremendous amount of work that goes into these annual reports and its worth taking the time to go over them carefully.

You can begin on page 4, the Chair's Report, and read Paul Cantor's comments:

While understandably pleased with this year’s strong performance, we must always be mindful of the cyclicality of markets. We will always be exposed to market volatility even as we maintain a sharp focus on risk management.

Our diversification strategy is derived from our long-term target asset mix. This is what we call the Policy Portfolio.

It is designed with the goal of achieving the long-term returns that are used by the Chief Actuary of Canada to calculate the sustainability of the Plans as it relates to the Post-2000 Liabilities.

During fiscal year 2011, we undertook a comprehensive review of the Policy Portfolio to ensure that it remains effective in delivering the targeted return. Factored into the review were our most recent expectations of long-term market conditions. Other factors taken into account included the inflation-sensitive nature of the Plans’ Post-2000 Liabilities and the net positive inflows expected for at least the next 15 years.

As a result, effective April 1, 2011, we made significant changes that increased the allocation to Real Return Assets such as Real Estate and Infrastructure. Real Return Assets are a good match for the inflation-sensitive nature of the Plans’ Post-2000 Liabilities and will thus contribute to reducing funding risk. This change contributed to an overall shift in our asset mix from publicly traded securities to Private Markets, which will move over time from 28% to 40% of our overall portfolio.

Skip over to page 6, and read the President's report where Gordon Fyfe states:

Contributing to PSP Investments’ strong performance in fiscal year 2011 was the success of two key investment strategies implemented over the past several years.

One such strategy entails expansion into high-growth emerging markets, primarily developing countries that are experiencing robust expansion of their domestic economies. For instance, PSP Investments was among the first foreign institutional investors to take advantage of real estate opportunities in Brazil and Colombia, where rapidly expanding middle-class populations have been driving demand for new housing, retail and, more recently, office space.

Over the past five years, our Real Estate Group has developed solid partnerships in Brazil and Colombia and assembled an attractive portfolio of shopping centers and office buildings, mainly in the metropolitan areas of Sao Paulo and Rio de Janeiro, Brazil. During fiscal year 2011, we were able to realize significant gains from the divesture of some of the Brazilian retail properties. We intend to continue investing in these markets, where sustained economic growth is certain to create new needs — and new opportunities.

Another strategy that has paid off entails capitalizing on PSP Investments’ exceptional liquidity to acquire quality “distressed assets” in developed markets, where sellers are seeking to monetize their investments. Our decision to allocate capital to distressed debt in public markets back in the 2007-2008 period has generated solid added value, and we are continuing to seek and find additional opportunities.

We also expect that several noteworthy private-market transactions completed by our PSP Investments teams during fiscal year 2011 will yield considerable gains down the road. Among them was the acquisition of a significant participation in five container-terminal ports in Australia — which have approximately 50% of that country’s container terminal capacity. We also acquired a 40-story Class-A office tower in Manhattan, in collaboration with local partners that have extensive experience in the New York City real estate market.

Basically, PSP won't have to pay out any benefits over the next 15 years, enjoys roughly $4 billion in contributions every year and is going long public and private emerging markets as well as distressed debt. And they're increasing their allocation to Real Return Assets (Real Estate and Infrastructure) because like everyone else in the world, they're betting on inflation, collecting big bonuses along the way as they trounce their private market benchmarks that don't reflect the risks they're taking. And here is a scary thought: what if a prolonged period of debt deflation sets in? They and other pension funds are pretty much screwed (another reason why extend and pretend must continue).

On private market benchmarks, you can see that PSP is still not publicly disclosing them (page 24, click on image to enlarge):

I am told that as long as the Board and stakeholders are informed of the private benchmarks, the public doesn't have a right to know. But the problem is that if they're not publicly disclosed or if the Special Examination does not undertake a comprehensive review of all private and public benchmarks, then there is the potential for abuse and paying out huge bonuses based on bogus benchmarks. That's just one of the glaring governance gaps that the Special Examination did not address and let me remind everyone taxpayers pay the salaries of public servants, including the good folks over at the Office of the Auditor General of Canada (a little conflict of interest having the OAG and Deloitte do a Special Exam, don't you think? Should have hired me and some former PSP employees instead...that would have been barrel of fun!!!)

Click on the table at the top of this comment to view the breakdown of portfolio returns for each asset class. You see that Canadian Equity underperformed its benchmark (they foolishly got rid of two of the best Canadian portfolio managers in the industry while I was working there), made money in EAFE Large Cap (wisely kept that internal portfolio manager), made a bit in Fixed Income moving assets internally, made money in Private Equity (20.9%) and Real Estate (13.8%) but lost money in Infrastructure (-1.6%).

Importantly, overall the Fund returned 3.6% over the last five years , underperforming its benchmark Policy Portfolio which returned 4.4%, or 80 basis points below the Policy Portfolio in the last five years.

And for all this, what was Management's compensation for FY 2011? It's all there on page 55 (click on image to enlarge):

You can see that Mr. Fyfe and the heads of Private Markets have enjoyed excellent total compensation over the last three years despite underperforming their Policy Portfolio during the last five years. Bruno Guilmette, head of Infrastructure, lost money in FY 2011, underperforming his benchmark by 8.4% and saw his total comp jump to $1.5 M. Even John Valenti, PSP's CFO and COO, enjoyed huge total compensation during the last three years. This man was on the hot seat in front of a parliamentary commission two years ago, squirming to answer basic questions, but is now enjoying the benefits of bloated compensation (ridiculous, he's making triple the money of Michael Sabia, President and CEO of the Caisse!).

To be fair, PSP's compensation is in line with other large Canadian public pension funds (not the highest paid -- CPPIB and Teachers' are), and is far below what the sharks on Wall Street make, but that doesn't tell me much. My humble father and doctor friends who enjoy excellent salaries all roll their eyes when they hear of how much some people in finance make. It's a joke and everyone knows it.

In my follow-up comment, I'm going to go through the Special Examination, exposing several serious governance gaps that were not covered. And it's not only going to be PSP-specific. Most of these governance gaps can be found elsewhere, which is why I urge you to read my follow-up comment as well.