Our $3.4 billion Private Equity currency hit at CPPIB

With the release of the most recent CPP Investment Board quarterly results, I can give you a modest update on the $32.8 billion we have invested/committed to external private equity fund managers. As of the most recently-released quarter (Sept. 2012), we have $9.5 billion of unfunded PE commitments. Similar level to prior years, and this includes the $3.54 billion we committed to 10 new funds during the first nine months of 2012.

I’d love to be able to tell you how we’ve done of the tens of billions we’ve invested in the space since 2000, but I can’t. Other than the fact the CPPIB’s private investing group had a 1% negative “value add” as compared to the benchmark over the four years ending in fiscal 2012 (from pg. 52 of the CPPIB annual report).

The challenge we have is that because the CPPIB reports the results of the 145 different managers and fund-of-fund managers in their home currency, we have no idea the value of the Canadian dollars we’ve invested or received back via distributions. As such, there’s no chance of knowing whether or not we actually made money on our capital. To whit, the Euro has fallen from 1.70 on Dec. 31/08 to 1.26 (Sept. 28/12) during this period, while the USD has gone from 1.225 to below par. That’s painful, considering we had C$15.4 billion drawn by Euro ($5.1B) and USD ($10.3B) denominated managers at the end of 2008. Not that any of this is news to our followers (see representative prior post “CPPIB’s $29 billion PE program largest naked currency bet in Canadian history” March 31-11).

Here’s the CPPIB’s stated position on hedging:

Currency Hedging

Most developed, and many developing, countries have adopted an open regime for their currencies. Exchange rates can then fluctuate signifi cantly, although central banks may intervene to stabilize excessive movements. Many pension funds use partial or full hedging programs to protect their assets from adverse currency moves. Hedging, however, comes at a financial cost. Also, cash must be tied up or generated quickly to meet obligations on the hedging contracts when the Canadian dollar depreciates. The only component in the portfolio that is hedged to Canadian dollars is foreign bonds or equivalent debt exposures arising from other investments. This is to neutralize changes in foreign currency values and allows foreign bonds to serve as a reasonable substitute for Canadian bonds. It also signifi cantly reduces the volatility of this component of the portfolio.

We see little reason to believe that there will be a sustained long-term trend to net returns from exchange rate movements for the currencies associated with the Fund’s equity holdings. Accordingly, we do not hedge this exposure. If a country has substantially higher infl ation than others, investors will demand a corresponding risk premium against the likely decline in its currency. Further, the impact of currencies on the volatility of returns from foreign equities is minimal. By far, the largest component of that volatility is the local equity market returns themselves.

But all is not lost, so to speak. I have been tracking the individual fund data since 2007, and can at least give you a sense of what has happened to those 2008 unhedged Canadian dollars during the past four years.

As of December 31, 2008, we had US$8.392 billion drawn by private equity fund managers who run their funds in U.S. currency. At that time, the USD was worth 1.225 Canadian dollars. We also had E3.023 billion drawn by PE fund managers who invest in Euros; seems hard to believe now, but back then one Euro got you 1.705 Canadian dollars.

Fast forward to the end of September 30, 2012 (the most recently available data from CPPIB), and we can get a sense of how much hurt we’ve suffered from our two large unhedged investment positions.

Leaving aside the profits and losses that these funds have experienced since 2008 on their individual underlying investments, this much is clear: The C$15.434 billion that had been drawn by these USD and Euro funds as of Dec. 2008 is now worth C$12.078 billion due to the strength of the Canadian dollar. (And our losses would be higher if I included the 2009 PE fund drawdowns.)

A not-so-easily identifiable $3.356 billion currency loss in less than four years, just from that one point in time. 21.7% of our original investment. And since 59% of CPPIB PE dollar commitments I could track produced internal rates of return below 6% in their home currency (see prior post “Solvency canary alert?: 59% of CPPIB PE $ commitments producing IRRs below 6%” Dec. 6-12), that 21.7% currency haircut must be particularly painful.

If we had invested with CalPERS, CalSTRS, Oregon, WSIB or UTIMCO we’d know for sure (see prior post “12 questions CPP Investment Board won’t be answering on BNN today” Jan. 17-13). But, according to CPPIB, this information can’t be released as it’s not “material” to the performance of the fund.

If taxpayers can get information about a $1.65 charge for a “cup of tea” in the $1 billion E-Health scandal, it’s odd that CPPIB’s own disclosure policies treat a $3.4+ billion currency hit as being immaterial to our $172.6 billion CPP.

Where’s Kevin Donovan when you need him?

MRM