PSP Investments Up 21.5% in FY 2010

Via Pension Pulse.

The
2010 Annual Report of the Public Sector Pension Investment Board (PSP
Investments or PSPIB) was tabled with the Parliament of Canada on July
21st, 2010. On Thursday, PSP Investments posted this press release on its FY2010 results:

The
Public Sector Pension Investment Board (PSP Investments) announced
today that it recorded an investment return of 21.5% for the fiscal year
ended March 31, 2010 (fiscal year 2010), exceeding the Policy Benchmark
return of 19.8% by 1.7%. The 2010 performance is one of PSP
Investments’ best performances to date and reflects a return to
fundamentals from the distressed valuations resulting from the liquidity
crisis of the past two years.

In
fiscal year 2010, consolidated net assets increased by $12.5 billion,
or 37%, to reach $46.3 billion, a new high which exceeds the previous
peak of $38.9 billion recorded at the end of March 2008. During fiscal
year 2010, PSP investments generated net income from operations of $7.5
billion and received $5.0 billion in net contributions.

“PSP
Investments’ 2010 results demonstrate the resilience of our long?term
investment strategy, which began in fiscal year 2004. At that time, we
identified the corporation’s strongest competitive advantage to be
long?term liquidity provided from the large annual cash inflows expected
to continue beyond 2020,” said Gordon J. Fyfe, President and CEO. “It
allows PSP Investments to buy and hold Private Equity, Real Estate and
Infrastructure assets for the long term, even during periods of extreme
stress as we have just experienced. Unlike other investors, we were not
forced to sell high?quality assets at the most distressed time,”
concluded Mr. Fyfe.

The overall
performance for fiscal year 2010 was driven primarily by strong results
in Public Market equities and the Private Equity portfolio. Investment
returns for the public equity portfolios ranged from 20.1% for the US
Large Cap Equity portfolio to 47.4% for the Emerging Markets Equity
portfolio, while the Private Equity portfolio recorded an investment
return of 28.8%. The Real Estate portfolio recorded an investment return
of 0.6% while the Infrastructure portfolio achieved a 7.2% investment
return for fiscal year 2010.

The asset mix as at March 31,
2010 was as follows: Canadian Equity 29.2%, Real?Return Assets 20.2%,
Foreign Equity 19.8%, Nominal Fixed Income 19.1% and Private Equity
11.7%.

For more information about PSP Investments’ fiscal year 2010 performance, consult PSP Investments’ Annual Report available at www.investpsp.ca.

About PSP Investments

The
Public Sector Pension Investment Board (“PSP Investments”) is a
Canadian crown corporation established to invest the amounts transferred
by the federal government 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.

Its
statutory objectives are to manage the funds entrusted to it in the best
interests of the contributors and beneficiaries of 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.

The full 2010 Annual Report is available on-line (click here for PDF file). Obviously, PSP did a 180 degree turn from FY2009 where they lost 23% and severely underperformed their policy portfolio.

Let's begin with PSP's Chairman of the Board, Paul Cantor's message. On page 4, Mr. Cantor states:

As
we can see from the latest results, a substantial portion of the
unrealized losses from a year ago have been recuperated, which
demonstrates the solid long-term value of PSP Investments’ assets. The
fiscal 2010 results also reflect initiatives taken to benefit from the
remarkable turnaround of markets.

New
investment opportunities will arise as global markets continue to
normalize. Given our expected annual cash inflows of approximately $4
billion, PSP Investments is in a favourable position to seize those
opportunities. But risk is the handmaiden of opportunity, and we will
still need to grapple with the inevitable challenges of future markets.

For
PSP Investments, keeping a long-term perspective means remaining
faithful to the orientation of a highly diversified portfolio that
includes a significant portion of private equity and inflation-hedging
real estate and infrastructure assets. Such investments increase the
probability of meeting or exceeding the targeted 4.3%-above-inflation
level of returns, without an unwarranted increase in risk and provide
for a better match with the Plans’ liabilities.

We
are mindful that PSP Investments’ legislated mandate is to “maximize
returns without undue risk of loss”. The events of fiscal year 2009 made
evident the need to more clearly define this notion of undue risk with
our stakeholders.

The Board has been addressing this
question, and will be proposing a comprehensive framework in fiscal year
2011. Beyond that, internally, one of the Board of Directors’ on-going
priorities entails working with management to further enhance risk
management practices. Our aim is to use what we have learned from the
recent crisis to further refine both our quantitative and qualitative
parameters for evaluating, monitoring and mitigating risk.

It
worries me that after all these years, and after experiencing the 2008
financial crisis, PSP Investments is still trying to figure out the
notion of undue risk with their stakeholders. The latter are mostly to
blame for this lack of proper oversight.

As I have repeatedly
stated, managing pension money isn't about shooting the lights out,
doubling down when things go wrong, it's mostly about managing downside
risk. And managing downside risk in today's zero interest rate policy
world where pension funds, sovereign wealth funds, insurance funds are
all chasing indexes and "hot alternative investments" isn't as simple as
people think. Importantly, correlations are breaking down a lot more
often nowadays, placing a lot of pressure on senior pension officers
struggling to find viable ways to minimize downside risk.

How are
pension funds responding? I had lunch today with an industry contact
who told me how he sees more and more pensions adopting a
liability-driven investment (LDI) approach, moving assets away from
public equities into fixed income. He added: "they're leveraging up
their bond portfolios like crazy. It's like picking pennies in front of a
steamroller...one day they'll get caught and lose their hand."

I replied: "True, this business of pension funds leveraging up their bond portfolio
makes me nervous. But if senior pension officers believe we are heading
for a protracted period of deflation, why risk their portfolio chasing
high beta stocks, hedge funds, private equity, commodities or real
estate? You're better off keeping it simple, investing a good chunk of
assets in high quality government bonds, protecting your downside (but
capping your upside)."

Back to the results. On page 7 of the Annual Report, PSP's President & CEO, Gordon Fyfe, had this comment on FY 2010 results:

The
past two years saw the worst financial crisis since the Great
Depression, demonstrating the risk of leverage and a lack of liquidity. Many
investors missed the sharp rebound in asset prices starting in March
2009, having been forced to sell high-quality assets at the most
distressed time.

This was not the case for PSP
Investments. In fact, during fiscal year 2010 as our assets under
management grew, we were able to purchase an additionnal $3.5 billion in
public equities (including emerging markets where PSP has a relatively
large exposure) at attractive prices.

Overall, our public equity
portfolios generated an investment return of 37.9%, contributing to a
strong investment performance for fiscal year 2010.

We
also benefited from the high quality of our Private Market assets.
Being in a position to hold on to illiquid assets that had been written
down to distress valuations as a result of the liquidity crisis enabled
us to generate significant investment returns, as values returned to
fundamentals. The most probing example is the 28.8% return achieved in
our Private Equity portfolio in fiscal year 2010.

Finally,
we were able to rebalance our portfolio, at or near target asset
allocation as our confidence in the strength of the rebound in public
equities grew.

Gordon is right, many investors did miss
the sharp rebound in asset prices starting in March 2009, and were
forced to sell high-quality assets at the most distressed time. It was a
matter of liquidity - those pension funds that needed it the most
during the crisis were the ones who suffered the most. Other funds like
PSPIB and CPPIB, were able to sit back and wait out the crisis without
having to sell any of their public or private market holdings (at the market
bottom).

Sure, PSP got hit on their illiquid assets in FY 2009,
and had to write down their Private Equity portfolio, but as markets
rallied sharply since March 2009, those assets were written back up.
That's why just like those California pension giants, PSP's Private Equity portfolio had a 29% gain.

How important was that 29% gain in Private Equity? Consider this, on the bottom of page 16 of the 2010 Annual Report:

The
excess return of 1.7% (compared to the Policy Benchmark) achieved
during fiscal year 2010 was primarily generated by the Private Equity
and Infrastructure asset classes, as well as by absolute-return
mandates.

Major contributors to excess return in
absolute-return mandates included externally managed debt portfolios
that benefited from the effect of narrowing credit spreads. PSP
Investments’ holdings in collateralized debt obligations and
asset-backed term notes (referred to as asset-backed commercial paper in
last year’s annual report) also were contributors to the fiscal 2010
excess return. For the fiscal year ended March 31, 2010, investments in
collateralized debt obligations increased overall returns by 1.2%, as a
result of $393 million in investment income generated in the fiscal
year. Our investment in asset-backed term notes generated investment
income of $260 million in the fiscal year, increasing the overall rate
of return by 0.9%.

Tightening
credit spreads and generally favorable market conditions, compared to
the previous year, were the primary reasons for the increase in value of
these investments. As was mentioned in last year’s annual report, the
losses recorded in fiscal year 2009 financial statements related to
these investments were primarily the result of stressed market
conditions and not related to any significant realized credit losses.

Taking an even closer look at Private Equity's performance (page 19):

Net
assets of the Private Equity portfolio totalled $5.4 billion at the end
of fiscal year 2010, an increase of $1.2 billion from $4.2 billion at
the end of fiscal year 2009.

Private
Equity generated $1.2 billion in investment income for a rate of return
of 28.8% for fiscal year 2010, compared to the Policy Benchmark return
of 13.5%. The robust Private Equity performance for fiscal year 2010 was
driven mainly by the direct and co-investment portfolio, which
generated $489 million in investment income during the fiscal year, as
well as significant performance from a select number of key partners.

On
a five-year basis, Private Equity investments generated a negative 0.9%
compound annualized return, compared to the Policy Benchmark negative
return of 6.7% for the same period.

The Private Equity
portfolio has a long-term focus. Investments are held for an average of 5
to 10 years. The Private Equity portfolio is invested globally in
collaboration with strategic partners with whom PSP Investments has
established relationships. PSP Investments continues to diversify its
Private Equity portfolio, with direct and co-investments playing an
increasingly important role. As at March 31, 2010, direct and
co-investments accounted for 27% of assets of the Private Equity
Portfolio, up from 21% at the end of the previous fiscal year. Direct
and co-investments amounted to $1.4 billion at the end of fiscal year
2010.

Overall, the Private Equity Portfolio is well diversified
both from a geographic and sector perspective. The increase in Canadian
and telecom assets is mainly related to the strong performance of
Telesat.

We still don't know the details about Telesat's performance, but as I suspected, the $1.5B plus secondary market sale
PSP is reportedly engaged in, has more to do with a shift towards
co-investments and direct investments which allows them to realize gains
on their private equity investments more quickly.

Now, a note on
the Private Equity benchmark. PSP does not publicly disclose the benchmarks for
private markets citing "competitive reasons", but the biggest problem
with PE (and infrastructure) is that it is still in ramp-up mode. I
mention this because it's not fair comparing PSP Private Equity or
Infrastructure benchmarks to other more mature funds that have ramped up
their portfolios.

Infrastructure, led by Bruno Guilmette, is
just ramping up, and earned $158 million in investment income for a
return of 7.2% in FY 2010, compared to the Policy Benchmark of 3.7%:

A
significant portion of the portfolio return was generated by cash
distributions (interest and dividends) and realizations from direct or
co-investments. Again this year, the performance was largely
attributable to direct investments. Since inception (3.75 years),
Infrastructure investments have generated a 6.2% compound annualized
return, compared to a Policy Benchmark return 3.4% for the same period.

Real Estate, led by Neil Cunningham, has fully ramped up but has
struggled in the last couple of years. Still, it is doing comparatively
better than large US and Canadian funds:

Real Estate earned $28 million in investment
income for a return of 0.6% in fiscal year 2010, compared to a Policy
Benchmark of 7.4%. The Real Estate portfolio maintained its value during
the year despite an extremely adverse market.

This
is largely attributable to a strategy of investing a large portion of
the portfolio in the Canadian market, which has shown more stability
than other markets during this period, and the adoption of a defensive
asset mix over the past three years, with a significant portion of the
portfolio being invested in residential, retirement and long-term-care
facilities.

On a five-year basis, Real Estate investments
have generated a 6.5% compound annualized return, compared to a Policy
Benchmark return of 7.3% for the same period.

Let me wind
down here by commenting on overall results. While PSP Investments did
bounce back solidly from last year's disaster, not missing the rally in
stocks since March, the results are not as spectacular as the headline
figure implies. In fact, the table below was taken from Brockhouse Cooper's Q1 Universes (click on image to enlarge):

As
you see, the median one-year return for Canadian Balanced funds at the
end of Q1 2010 (PSP's fiscal year ends March 31st), was 23.1% and the
Brockhouse Cooper Balanced Index was up 21.2% for the year ending March
31st, 2010. Hence, while PSP delivered a solid performance, it wasn't
"stellar", and PSP was lucky its fiscal year ended before the May-June
period where equity markets got whacked hard.

In his message, Mr. Fyfe didn't place too much emphasis on the annual result, focusing more on long-term results:

While
we are pleased with our strong performance in fiscal year 2010, one
cannot fully judge the effectiveness of a long term investment strategy
like PSP Investments’ on the basis of a single year’s results — good or
bad.

Perhaps the best measure of
success is to look back at PSP Investments’ performance since fiscal
year 2004, when we began implementing our diversification and active
management strategy. During this seven-year period, we have achieved a
net 5.8% annualized real rate of return (i.e. after subtracting expenses
and inflation), exceeding the 4.3% real rate of return objective. This
investment return was achieved despite experiencing the worst
deterioration of financial markets since the 1930s in fiscal year 2009.

With
the prospect of positive net cash flows of more than $4 billion per
year in the near future, and positive net contributions expected for the
next two decades, PSP Investments’ strategy remains sound. Moreover, at
a time when some asset classes are still distressed, we are well
positioned to capitalize on investment opportunities.

True, but over the last five years, PSP's returns are 4.4% while the
Policy Benchmark returned 5.3% (click on first chart above). Despite
this long-term underperformance, PSP's senior officers enjoyed another
stellar year in terms of compensation. Once again, top compensation went
to senior officers in the Private Markets. Derek Murphy, First
Vice-President of Private Equity, garnered the largest compensation
among senior officers, earning $1,543,265 for FY 2010.

The summary compensation table below was taken from page 46 of the 2010 Annual Report (click on image to enlarge):

The Chairman of the Board defended PSP's compensation practices:

During
fiscal year 2010, PSP Investments completed a thorough analysis of its
overall compensation practices and procedures and evaluated their
compliance with the recommendations of the G20 Working Group which are
based on the Financial Stability Forum Principles for Sound Compensation
Practices. This self assessment concluded that PSP Investments’
compensation programs and policies are consistent with the G20
Recommendations, and that compensation programs are effectively designed
to reduce the potential for rewarding excessive risk taking.

In
the interest of sound governance and impartiality, the Board and the
Human Resources Compensation Committee also mandated Deloitte &
Touche LLP to conduct an independent review of PSP Investments’
assessment. Deloitte & Touche LLP confirmed PSP Investments’ level
of compliance with the G20 Recommendations.

But union
leaders representing federal civil servants aren't happy with
compensation and other governance issues at PSP. In fact, the Public
Service Alliance of Canada (PSAC) shared these concerns with me:

1- the return of the PSPIB must be put in perspective: There is a 21.5% return for fiscal year ending March 31^st 2010, but over the same period time the S&P/TSX Composite Index increased by 34.6%.

2- PSPIB has underperformed against the established policy benchmark in 5 of the 10 years since commencement of operations.

3-
A total of $4.2 million in incentive bonuses (annual and deferred)
paid to the top 6 executive officers of PSPIB in fiscal 2010 in
comparison with a total of $3.8 million in incentive bonuses (annual
and deferred) paid to the top 6 executive officers of PSPIB in fiscal
2009 - an approximate increase of 10%

4-The Unions are still prevented from serving on the PSPIB.

5- The Federal government is currently contemplating even higher contribution rates on behalf of employees.

It's
easier to defend bonuses when the PSP Fund performs well as it did in
FY 2010. But as I stated before, nobody should have received any bonuses
last year after that disastrous performance. And given that PSPIB is
underforming its Policy Benchmark over the last five years, I can see
why some are concerned about the level of compensation doled out to
senior officers during that period.

As far as board representation, I do feel that unions of all three key
stakeholders should have some representation on the Board. This may not
please other board members who are nominated, but unions have every
right to have representation on that Board (right now, the Act governing PSPIB prevents union members from sitting on the Board).

Let me end this long comment by noting something Mr. Fyfe wrote in his message:

An
on-going priority to successfully implement our 2012 strategic plan has
been the recruitment, development and retention of the top talent
required to effectively manage a large and complex investment fund.

As
we round out the leadership team, PSP Investments’ pool of human
resources has acquired the critical mass and collective expertise that
enable us to shift our primary focus from recruitment to professional
development and succession planning. Accordingly, we are conducting
talent reviews with middle management, developing formal succession
plans and implementing a structured approach to the development of new
managers, while continuing to refine our hiring practices.

I am happy to hear that PSP is placing priority on recruiting, developing and retaining
top talent. My measure of success at any investment shop - be it a
pension fund, a mutual fund, or a hedge fund - is the turnover rate at
these places.

Unfortunately, the turnover rate at some long-term
pension funds has been abysmally high in recent years. This is totally
unacceptable and a clear sign of managerial weakness. I mention this
point not to target anyone in particular, but because I believe in
retaining good people and developing them as they progress in their
career.

Finally, let me personally congratulate Gordon and his
senior team for delivering solid results in FY 2010. I haven't always
been easy on PSP but I am able to give credit where credit is due.

And
while some think I want PSP to fail, nothing can be further from the
truth. Gordon came through for me at a very difficult time in my life, offering me an incredible opportunity to work in a field I truly love. My
experience at PSP was for the most part a positive one where I learned a
lot about various asset classes in both private and public markets. Montreal is better off for having PSP's business office here and I
wish them many more years of success.

Comments

[Leo Kolivakis]

***Feedback on PSP's FY 2010 Results***

A senior pension officer shared these thoughts with me:

Telsat looks like the outlier sized direct PE investment that is going well. Satellite is an area that is getting more valuable, regulatory changes and spectrum requirements mean that while they bought this asset for a very high price it should provide a decent medium term return potential, although their old satellites are of waning value by nature.  Deals are apparently imminent on their sale of pe funds, probably some structured deal of sorts.  So it appears they will free up capital and be a force to be reckoned with going forward.  But it all remains a large experiment with people who remain unproven investors.  

Like CPPIB, they have not provided any net value since their creation versus and all Canadian bond portfolio, nor has PE made any money since inception, even after currency gains.  Yes, it is still (relatively) early days, etc. but the bottom line is these places take way too much risk before they are operationally seasoned, and people have had a chance to work together.  And, it looks like the strategy is, “we survived, now we will take advantage of others who failed and all the opportunities out there”. This is naïve. Few others actually failed, and the global glut of capital means returns for risk remains highly problematic.  They have few if any advantages as investors other than their non-taxable status which they generally pay away to the sellers of assets due to the competitive market out there.  I think that in the next ten years, once again these places will add no value (make no money).

And he added:

I don’t mean to be too negative, it’s just that being accountable means at a Board they need to revisit the entirely of what they are trying to achieve, and whether it is possible.  They obviously think staying the course is appropriate, but if they don’t say stop, or slow down, who will?  Looks like a self perpetuating organization, which is why there shouldn’t be many of these created, and why they should be capped in the amount of capital allowed to any one organization.  The govt. needs more diversity of approaches, even if that costs economies of scale (which may not exist beyond a certain point anyway). 

Note that the Dutch pension giant ABP is essentially setting the stage to exit PE as a line of business. They are recognizing the reality of the glut of capital, and why be illiquid if you don’t get paid for illiquidity?

[ZackAttack]

Still laughing at this little blurb

reflects a return to fundamentals from the distressed valuations resulting from the liquidity crisis of the past two years.

Everyone up the chain, all the way through our own Fed, believes that the 2008 was the anomaly and that the world up until 2007 was the benchmark. If we can *just* kick the can a little further down the road, surely things will return to "fair value."

They further seem to believe that it was just a temporary "liquidity crisis," not an issue of fundamental solvency, reflecting a secular demographic shift, as it really was.

Just like the Japanese, this will still be the official line of shit for the next two decades as we slowly swirl down the toilet into 3rd world-dom.

I don't think they're going to like The New Normal very much.

[tecno242]

here's the horrible math problem though..

if you lose 50%..

you need 100% to get back to where you were...

so 21% really doesn't get you very far.

[The Alarmist]

That is admirable performance ... if you are running a hedge fund.  If you are running a pension fund, you undoubtedly have taken a "risk be damned" tack, which only a public pension, which essentially has an unconstrained call on the full faith and credit of the people and their property, can. 

[ejmoosa]

Let's see, I was up 42.7% for the same time frame.  Marking your performance off the market bottoms is disingeneous.

I'm not fooling myself.  I am pretty sure they are fooling themselves if they are patting themselves on their backs.

Hell,  they even got paid massive bonuses.   And for what?  Underperforming?

As a reference, for the same period mentioned:

Vanguard 500 Index Fund (VFINX)  47.5%

[Mercury]

Quick! call City Hall and tell them to hire more diversity counselors, community outreach coordinators and public service liaison officers with gold-plated benefits for life while everyone is wow-ing at the report!

[Squid-puppets a...]

plus, i just love the gratifying feeling of being the 1st turkey to comment on a new article, however worthless and inane my commentary 

[Squid-puppets a...]

I've often scoffed at Leo's optimism, but you have to admit in this day and age it's refreshing - and in this article, supported by a reasonable modicum of evidence

[snowball777]

If I saw the 'returns' being spent in the economy somewhere, I'd be more impressed.

I don't see this 'wealth' remaining on pensioners statements for very long, but it may prevent several elderly suicides in the short-term.