PSP Investments Gains 7.1% in Fiscal 2019

Today, the Public Sector Pension Investment Board (PSP Investments) announced its fiscal 2019 results:
The Public Sector Pension Investment Board (PSP Investments) announced today that it ended its fiscal year March 31, 2019, with net assets under management (AUM) of $168.0 billion, compared to $153.1 billion the previous fiscal year, an increase of 9.7%. The investment manager also reported a one-year total portfolio net return of 7.1% and a 10-year net annualized return of 10.7% on its investments and generated $90.1 billion of cumulative 10-year net performance income and $48.8 billion of cumulative net investment gains above the return objective.

“We have great reason to be proud of our strong performance and evolution on the world stage,” said Neil Cunningham, President and Chief Executive Officer at PSP Investments. “We saw robust levels of investments throughout fiscal year 2019 and, despite market headwinds, these results clearly show the long-term success of our diversified investment approach in delivering value for our stakeholders.”

“Fiscal year 2019 was impacted by higher volatility in public markets amid concerns of a global economic slowdown”, added Mr. Cunningham. “Our performance demonstrates the benefits of our strategy to diversify the portfolio across a number of public and private asset classes, to produce a strong positive overall return. Likewise, our strategic partners and platforms across all asset classes continued to generate attractive risk-adjusted investment opportunities, as we all worked together to spot the edge on investments to generate robust long-term returns.”

PSP Investments’ net assets increased by nearly $15 billion during fiscal year 2019. The increase is attributable to net contributions of $3.7 billion received by PSP Investments and the net return of 7.1% in the current fiscal year.
Take the time to read the rest of PSP's press release here, it contains the important highlights. Also, take the time to read PSP's fiscal 2019 Annual Report here and the 2019 Responsible Investing Report here.

I read the annual report this morning, it's very well written. The report begins by highlighting the importance of diversity and inclusion at PSP (pages 10-15), stating:
We value and leverage our differences—whether in culture, background, experience, abilities, knowledge, language, education, or even our approach to problem solving. We believe that when everybody is included and can share their different points of view and ideas, it leads to better decisions and more creative solutions, and ultimately helps us realize the full potential of our ambitions.
PSP has come a long way since my time at this organization. There are more women at senior roles, there are more visible minorities, there are proud members of PSP's LBGTQ+ affinity group, and just generally, the culture seems a lot better nowadays (much less toxicity).


Still, I'd like to see PSP and all of Canada's large pensions make a serious concerted effort to hire more people with disabilities at all levels of their organization. Paying lip service and stating you don't discriminate simply isn't enough, you need to back those words by concrete actions and post statistics.

Getting back to the annual report, I read Martin Glynn's message on page 16 (he is the Chair of the Board) and Neil Cunningham's report (pages 18-20). It's worth reading these pages to get a better sense of PSP's strategic initiatives.

On page 28, there is an excellent interview with PSP's CIO, Eduard Van Gelderen who was appointed last July. Over the weekend, I sent him a message on LinkedIn after reading a year-old article on the crisis at Jagdeep Bachher’s University of California Investment Office.

He didn't reply but after reading that article, I was shocked and disgusted by how he and others were treated at the University of California’s investment office in Oakland working for Bachher. Van Gelderen was livid with Bachher and I can't blame him.

Anyway, PSP's CIO clearly outlines his priorities in the annual report:
The number one priority is maintaining our focus on the long term and ensuring that our portfolio is resilient through economic cycles and can deliver on PSP’s mandate. There are certain activities, such as analyzing the portfolio’s sensitivities and steering the portfolio toward its long-term goals, that can only be approached from a top-down perspective.

However, thinking long term does not mean that we do not manage actively. I’d like to see a more dynamic process for rebalancing the portfolio, which will also allow us to take advantage of opportunities that arise due to market cycles within our long-term investment horizon. Again, it’s not about drastically changing risk profiles or stopping strategies; but more about putting in place a stricter framework and introducing a few new activities with the long-term return objective in mind.

I'd also like to see us take a more coordinated approach to our relationships with external managers and partners. With most asset owners growing in size and looking for additional yield, there’s more competition to access quality investment opportunities and we want to be the first to hear about them. The CIO Office can play a coordinating role in establishing strategic relationships with select partners that will benefit all asset classes.
I've never met Van Gelderen but Iike the way he thinks, taking a top-down dynamic approach to rebalancing the portfolio when opportunities arise (remember my December 26 comment on making stocks great again?!?).

I also agree with him on taking a more coordinated approach to their relationships with external managers and partners. There's no use investing with external managers in private and public markets if you're not leveraging off these relationships to the max.

Now, management's discussion on PSP's performance and results begins on page 31 of the annual report. Take the time to read this section carefully.

I note the following:
A key priority of PSP Investments’ strategic plan is to implement an investment approach that focuses on the total fund rather than only on individual asset classes. The total fund approach, implemented by the CIO group, guides our long-term investment strategy and focuses on managing total fund allocations and exposures in terms of asset classes, geographies, sectors and risk factors. The objective of the total fund approach is to complement asset classes’ bottom-up perspective with top-down views, and act on them.
Let me jump right into the returns by asset class (page 40):


As shown, PSP gained 7.1% in fiscal 2019, underperfoming its benchmark by 10 basis points (Policy Portfolio returned 7.2% in fiscal 2019).

Fiscal 2019 wasn't a spectacular one in terms of value add which is why PSP focused more on 10 and 5-year annualized returns relative to the Policy Portfolio benchmark in the annual report:

No doubt, long-term results are what count but I find it a little disingenious not to put up a chart of one-year results relative to the Policy Portfolio benchmark.

In terms of individual asset class performance, Private Equity led by Simon Marc was the best performer by far, delivering a full 380 basis points above its benchmark (16.1% vs 12.3%). I recently covered the Apax, CPPIB and PSP deal to sell Acelity to 3M and think Simon and his team are doing an outstanding job on directs and co-investments.

In the annual report, I note the following however on private equity's long-term performance:
Over five years, Private Equity achieved a rate of return of 7.9%, compared to a benchmark return of 12.2%, primarily due to the past underperformance of certain investments in the communications and technology sectors.
This has nothing to do with Simon Marc and his team, it was legacy investments made long ago, like Telesat which turned out to be a legal nightmare.

What else did well in fiscal 2019? Private Debt led by David Scudellari in New York City. That group delivered 350 basis points above its benchmark (9.2% vs 5.7%) in fiscal 2019 and has delivered very strong returns since its inception 3.3 years ago. The problem with private debt is there is too much money chasing deals and if a recession strikes the US, returns will suffer (returns have been coming down in recent years).

I also note the outperformance of Natural Resources headed by Marc Drouin, up 11.1%, a full 190 basis points above its benchmark of 9.2%.

Infrastructure headed up by Patrick Samson also delivered a solid performance in fiscal 2019, up 7.1%, a full 250 basis points above its benchmark (4.6%).

Real Estate headed up by Darren Baccus didn't have a good year in fiscal 2019, underperforming its benchmark by 420 basis points (7.6% vs 11.8%). I must say, that benchmark for Real Estate seems awfully high compared to peers, which is a bit peculiar.

PSP used to have an easy benchmark for Real Estate when I was there back in 2003-2006. It was CPI + 500 basis points and the Real Estate team was gaming that benchmark like crazy buying up opportunistic real estate to trounce it every year (not Neil Cunningham, his real estate predecessor, André Collin who is now making a fortune running Lone Star for John Grayken).

As far as Public Markets and Absolute Return Strategies (PMARS) headed by Anik Lanthier, it was a flat year as they underperformed their benchmark by 20 basis points (4.3% vs 4.5%). I note the following:
The externally managed absolute return portfolio posted positive absolute returns, but the returns were insufficient to offset the rising costs of funding as some central banks started to raise rates. Net of funding costs, the portfolio slightly detracted value. This portfolio’s performance does compare favourably on a risk-adjusted basis against broad hedge fund indices.
It wasn't a great year for hedge funds, something CPPIB's Mark Maichin told me over the phone when we went over CPPIB's fiscal 2019 results.

As far a comparisons, CPPIB gained 8.9% in fiscal 2019, a full 230 basis points above the base CPP Reference Portfolio returns and 190 basis points above the additional CPP Reference Portfolio returns.

Admittedly, CPPIB trounced all of Canada's large pensions last year, including PSP, and even delivered stellar returns in calendar year 2018 which is remarkable given how hard stocks sold off in Q4.

Interestingly, the Office of the Parliamentary Budget Officer just put out a report on active versus passive management at Canadian public pensions, analyzing CPPIB and PSP Investments's results.

The full report is available here and you can read the summary below:
In response to parliamentary interest, PBO analyzed the investment performance of the Canada Pension Plan Investment Board (CPPIB) and the Public Sector Pension Investment Board (PSPIB). More specifically, the objective was to determine whether their active management strategy resulted in higher returns compared to a passive strategy, once additional management costs related to active management were netted out.

Active management can be defined as trying to achieve higher returns by identifying investments which will outperform a chosen benchmark. This is usually accompanied by higher complexity and additional personnel costs.

Passive management tries to mimic a certain benchmark or index, with the goal of achieving the same or very similar returns.

PBO’s analysis compares the actual returns of the CPPIB and the PSPIB, both of which use active management strategies, to that of a customized passive portfolio. It spans from 2006-07 until their most recent annual reports (2018-19 for the CPPIB and 2017-18 for the PSPIB). All transaction costs and management fees associated with actively managing the funds were netted out from the annual returns, while operating expenses were assumed to be the same under either approach for both the CPPIB and the PSPIB.

The passive portfolio was constructed using two large public equity and fixed income indices. The baseline scenario for the passive portfolio used a weight of 70 per cent equity and 30 per cent fixed income. PBO also performed a sensitivity analysis on the weights allocated in the passive portfolio, with a higher (85 per cent) and lower (55 per cent) portion allocated to equity.

In all three scenarios, the CPPIB’s actual net returns outperformed the returns of the passive strategy. For the baseline scenario, total net assets under management at the end of the period were $48.4 billion higher than they would have been under the passive strategy, which represents an average additional annual return of 1.2 per cent. For the higher and lower equity weighting scenarios, total net assets under management at the end of the period were $31.5 billion and $66.7 billion higher, which accounts for an average additional annual return of 0.6 per cent and 1.8 per cent, respectively.

The PSPIB’s actual net returns were roughly the same as the returns of the passive strategy. For the baseline scenario, total net assets under management at the end of the period were $1.7 billion higher than they would have been under the passive strategy, which represents an average additional annual return of 0.3 per cent. For the higher and lower equity scenarios, total net assets under management at the end of the period were $6.1 billion lower and $9.8 billion higher, which accounts for a lower average annual return of 0.4 per cent and a higher average annual return of 0.9 per cent, respectively.
To be fair, PSP Investments isn't CPPIB and it's not appropriate to do a direct comparison even if they have a lot in common.

I reached out to PSP's CEO Neil Cunningham to get his take on this PBO study but didn't hear back from him (PSP doesn't talk to reporters but I'm not a reporter, I am a senior investment analyst covering pensions and markets, and I'm read by the who's who of the pension world).

Lastly, have a look at senior management's compensation on page 74 of the Annual Report:


It's important to read the detailed discussion preceding this table and the footnotes. It's also important to note that compensation is mostly based on 5-year annualized returns:


In the last five years, Public Markets and Absolute Return Strategies (PMARS) generated significant returns, with a 5-year annualized return of 9.3%, which helps explain why Anik Lanthier is one of the highest paid ladies at Canada's large pension funds (good for her, she works extremely hard and is a nice person).

Guthrie Stewart is the SVP and Global Head of Private Investments, which is where a lot of the added value is being generated, so it isn't surprising he's doing well.

Darren Baccus's compensation is explained in a footnote:
Mr. Baccus was hired on December 1, 2016. Pursuant to his employment agreement, Mr. Baccus was entitled to a guaranteed annual cash compensation of no less than 700,000 for FY2017 and FY2018, and a discretionary cash bonus for FY2017, FY2018 and FY2019, which are included as part of “Other compensation”. Mr. Baccus was appointed Senior Vice President and Global Head of Real Estate and Natural Resources on November 1, 2018. Compensation components such as annual cash and deferred cash reflect his tenure as former Senior Vice President and Chief Legal Officer up to October 31, 2018
David Scudellari based in New York City gets paid in US dollars (rightfully so) and he and his team have delivered great long-term results to justify his compensation.

Eduard Van Gelderen joined PSP last July, his compensation will undoubtedly show up next year and he will be the second highest paid person given his responsibilities.

Lastly, Neil Cunningham is a solid CEO with tremendous experience. Prior to becoming CEO, Neil was the Head of Real Estate at PSP, and it was he who is mostly responsible for delivering that 11.8% and 14% annualized 5 and 10-year rate of return in that asset class.

Neil is also a very decent guy and I can honestly say his compensation is well deserved. Being the CEO of PSP is no picnic, far from it, and he has stepped up to the plate and is doing a great job.

Below, PSP Investments’ President and CEO, Neil Cunningham reflects on FY19, a year of progress and renewal. And PSP"s new CIO Eduard Van Gelderen discusses how PSP thinks long term to ensure its portfolio can weather different economic environments. This also means systematically assessing and addressing ESG factors like climate change thoughout their investment processes.

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