Interview with Mark Wiseman
The Ivey Business Review discusses investment strategy with the man protecting your pension.
If you have held a job, you are one of the 18 million Canadians whose public pension is managed by Canadian Pension Plan Investment Board (CPPIB). With unparalleled scale, certainty of assets, and an open investing mandate, it has freedom to make investments few others can.
IBR: CPPIB is in an envious situation, you take in more money than you pay out every year, right?
MW: We do have net positive cash flows overall each year, but it’s actually quite seasonal. Earlier in the calendar year we tend to have fairly large cash inflows, but as the year goes on we’re actually sending cash back to Ottawa to ensure that they have enough cash to pay CPP benefits. If you think of it, after the higher income earners max out their annual CPP contributions early in the year, the payments – the amount of capital we bring in – goes down. So it’s actually quite seasonal.
IBR: So when CPPIB receives a dollar from contributors in excess of payout, how do you handle that?
MW: We invest that money immediately into our passive reference portfolio, buying 65% equities and 35% fixed income with each dollar that comes into the fund. So for us, the idea of the reference portfolio isn’t just a theoretical benchmark, it is an actual portfolio that is invested in. Therefore, we can use those reference portfolio securities, which are all liquid, as we need them to make active investments.
IBR: When you do go about making active investments, how do you fund them? Sell off the passive reference portfolio to an equivalent amount? How do you determine what makes up the reference portfolio?
MW: Well, the reference portfolio doesn’t change; it is the fixed passive alternative. If you want to think about it, everything we do is an active strategy overlay on the reference portfolio. There are two legs to the decision:
1. The short side (or the passive side) which is whatever you are going to sell from the reference portfolio; and,
2. The long side (or the active side) is the investment we’re going to make, whether that is another public security, a real estate asset, an infrastructure asset, or a private equity asset.
The first thing we try to do is match what we sell with what we buy, so that we aren’t taking any uncompensated or unintentional risk. Secondly, we try to do it as efficiently as possible, so that we can get the best risk return trade-off for the total fund.
IBR: How closely can you match the asset-specific risk to that of the reference portfolio?
MW: We aim to express the complete systematic risk characteristics of our long-only active investments. Market beta is the most prominent systematic risk, but we also consider geographic risk, interest rate risk, sector characteristics, and other risk factors of the investment. Having identified the complete set of systematic risks of the long-only investment, we sell a mix of reference portfolio assets that best matches these characteristics (total portfolio approach). Our “cell” approach to funding private equity exemplifies this overall approach.
First, we assess the levered market beta of the long-only asset. Next, we consider the sector and geographic exposure of the asset (the 10 GICS-code sector designations and 7 S&P regional designations give a total of 70 “cells” to describe the sector/geography of the asset). We then sell reference portfolio assets with aggregate beta, sector, and geographic characteristics that match those of the long-only asset.
IBR: During the financial crisis, obviously public equities saw a large devaluing and CPPIB saw some amazing buying opportunities on the private side. Do you ever think that, in circumstances like that, it might be better to hold a cash position to fund those investments rather than selling recently devalued equities?
MW: We don’t believe that we can be particularly good market timers. I think that’s very hard for any investor. Some people can be reasonably adept at it for a short period of time, but in the long run, if you could time markets you’d be very very rich, very very quickly. So if equity markets are down 20%, are they going to be down the next day or up the next day?
What we do first is manage the passive portfolio. We consistently rebalance our portfolio to 65% equities and 35% fixed income. This is a brilliantly simple methodology that all investors, in my view, should employ.
During the crisis, as equities sold off, what we were doing was selling bonds and buying equities – rebalancing to the 65% equity weighting on a dollar basis. Then as the equity market rebounded, we were selling equities and buying bonds.
All we look to do is to outperform equities going forward from whatever point in time we’re at. The decision to hold cash instead of equities during a crisis would simply put you in the position, potentially if equity markets rallied, of just underperforming the market. We don’t know when they’re going to rally or turn bearish, so we just say what we want is to be consistent in keeping that 65% equity weighting through the cycle. That is a very, very powerful self-leveling mechanism. You’re buying on the way down and selling on the way up. That systematization of that process creates fantastic discipline.
IBR: Could you tell us about CPPIB’s core philosophy of maximizing return without undue risk of loss and how the organization, as a 900-person group, delivers on that?
MW: We start with the idea that the reference portfolio is expected over the long run to deliver the 4% real rate of return that is required for the CPP Fund to be sustainable over the next 75 years. There is no guarantee that it will, but it’s exected, on balance of probabilities, that the reference portfolio is well placed to deliver 4% real returns and we could deliver on that with a fairly simple organizational design.
However, we have a number of comparative advantages as an organization: we have scale; we have a long investment horizon; we have certainty of assets; plus, we have developed the total portfolio approach. We have developed a partnership mentality inside the organization and we have developed a team with well-aligned culture and investment capabilities. What we can do is use those comparative advantages and, in our mind, take a reasonably small amount of incremental risk in excess of that market risk embedded in the reference portfolio and, we believe, earn a return in excess of the return that would be generated by the reference portfolio in the long run.
We actually measure how many dollars of value-add are generated through our active activities net of all the costs of running the organization. It’s very clear to everyone whether we added value net of operating costs compared to what we could have achieved by investing in the reference portfolio.
IBR: What do you think is the importance of a strong corporate governance structure?
MW: Strong corporate governance is a critical element in our investment decisions. For example, one of the advantages of investments in private equity is the strong governance structure – the high level alignment between board and shareholders. Simply put, we believe that companies that are well governed will be more valuable in the long run. For private companies, we will not invest sizable amounts without ensuring that we obtain appropriate governance rights. In the case of minority public investments, strong corporate governance is a prerequisite and an important element of our valuation analysis. Where our ownership stake was sufficiently large to justify it, a board seat would be mandatory.
IBR: One of the areas you have started investing in over the past few years is in things like pipelines, toll-roads, etc. What’s the thesis behind these? Is it just a low-interest environment driving the shift, or is there something specifically attractive about these asset classes to you?
MW: Let’s talk about infrastructure specifically, for example. What is attractive is that the asset class is particularly well suited to our comparative advantages. To the extent that there is a low interest rate environment prospectively, that would mean we would be willing to accept a lower rate of return on an infrastructure asset. That is true of all assets. A lower risk free rate means a lower expected rate of return on all assets, that’s very basic to capital asset pricing.
For us, what determines whether or not we are going to buy that infrastructure asset is not where we are in the interest rate cycle, it is where those assets are pricing relative to, in this case, bonds. So it’s not driven by interest rates, it is driven by relative value.
IBR: You underwrite infrastructure and other investment decisions past 20 years. What allowance do you make for disruptive technologies and trends? Do you have a company-wide threat monitoring strategy?
MW: The answer is, we are making long-term decisions. We’re being incredibly diligent in how we make them and, like any decision we make, making them with the best information we have at the time. That information is always, by definition,imperfect. We try to be as smart as we can, and we try and manage our risks not by just looking retrospectively through models, but by stress testing the portfolio and by trying to imagine what risk may come to the fore: what are the risks that haven’t exhibited themselves in the past? We’re always trying to think what the future is going to look like, and of course the further out that you go, the band of outcomes becomes wider and wider and you have to discount that appropriately.
The alternative is to say we don’t know what the world is going to look like; we have no clue, therefore let’s do nothing. We make decisions trying to inform ourselves, do as much diligence as we can, and make the best decisions because the alternative is to not do anything.
IBR: Through private equity funds, you’ve deployed over $19 billion giving you interest in thousands of private companies. Are you able to leverage the information as you diligence new assets?
MW: Absolutely. One of the things that we have is a really good information advantage. We have information, as you rightly point out, not just in public companies, which by-and-large is available to everyone, but we also have at last count close to 3,000 private companies through our private equity funds. We use that information in a number of ways: we use it when we are making other private investments, we use it to inform what we are doing in public markets, and we also use it as a participant in the secondaries market. In fact, we are one of the largest, if not the largest, buyer in the world of limited partnership units in private equity funds from other institutional investors who are seeking liquidity. One of the reasons we have been confident and successful in doing that is because of the way that we try and glean information from the portfolio of companies that underlie those fund investments.
IBR: You originally trained as a lawyer yet ended up in finance – what value do you see in an interdisciplinary background; and how has your background in law changed your approach to investing and the diligence process?
MW: Investing is not just about numerical analysis. It is about understanding the world around us and how it operates. I believe that having a multidisciplinary background is important for both individuals and teams. One ought to be able to approach any given problem from as many perspectives as possible prior to making a decision. I believe that my legal training provided me with both a different perspective than most investors in terms of looking at business or investment problems as well as a framework for the analysis of issues that has proven to be very valuable over time.
IBR: What asset class do you see CPPIB growing the most over the coming years?
MW: You know, I actually don’t have an answer to that question. It really depends on what market conditions are like. The one thing that I will say is the fund will continue to diversify globally. In almost any asset class, we will become more global in where we invest. A great measure of that is if you look back in 2005, in excess of 70% of our assets were invested in Canada, and today only 40% of our assets are invested in Canada. Canada represents 3% of global capital markets, so we’re still heavily overweight in Canada, and I suspect that trend to continue in the long run.
IBR: You mentioned that you are a global investor yet your offices are only in Toronto, HK, and London. What three cities can we expect to see you in next?
MW: Stay tuned… I mean, you can expect that we will expand. We can cover Asia reasonably effectively from Hong Kong, Europe from London, and the Americas from Toronto. I think you can expect to see us open offices in other key markets around the world and you could probably triangulate what those might be fairly easily. But we’re going to have the appropriate number of offices that will be regional in nature, over time. That’s not 100, since we aren’t out there trying to source capital for example, or cover clients around the world. Speaking with McKinsey, they have 99 offices around the world today including in places like Angola. I can assure you we will not have 99 offices. But we will in all likelihood have more than three.