12 questions CPP Investment Board won't be answering on BNN today

Humour me, please, and try this test.

Call you broker right now. Ask him/her how your individual investments are performing. Imagine that 23% of your money is in private placements, alternative assets, or vehicles where a human determines the value of the underlying illiquid, untraded asset, rather than an active quote; push your Investment Advisor to explain how the valuation in your monthly statement was arrived at.

If you own a basket of mutual funds, say, and wanted to understand which managers were performing well and which weren’t, tell you trusted advisor to break down the individual internal rates of return for each and every fund you own if they weren’t already published on your monthly statement – how else could you know if AGF’s Balanced Fund was doing better than CI Financial’s or vice-versa?

Imagine if you didn’t get answers to your questions. If your IA said: “you don’t need to know how the individual funds are doing, just how the basket of managers that I’ve chosen for you are performing”, you’d have every right to call IIROC (the Regulator) and complain. It is your money, after all. The Investment Advisor works for you, not the other way around. You pay the fees, and imagine how annoyed you’d be if those fees work out to be more than 0.55% of your total assets per annum and you still can’t get to the bottom of the drivers of your investment performance.

What if you thought the refusal to answer your questions was sufficient reason to change IA’s? Wouldn’t you be cross if the rules prevented you from firing your broker? That opaque reporting of your personal retirement fund would go on forever, and that you couldn’t do anything about it?

IIROC wouldn’t stand for it, and nor would you.

Which brings us to the money you and I have entrusted to CPP Investment Board. $170 billion and counting.

A recent CBC news article was pretty glowing about the performance of CPPIB, which prompted me to delve into the topic in our blog (see prior post “CBC falls prey to CPPIB’s spin doctors” Jan. 8-13) and on BNN last week (see prior post “Mark McQueen co-hosts BNN” Jan. 11-13). As you saw or read, things aren’t nearly as rosy as the CBC would have us believe.

So BNN invited a representative of CPPIB to come on the show this afternoon and address the points and answer some basic questions; we weren’t going to ask about anything that was understandably secret, just performance-related questions regarding information that’s already being disclosed by publicly-funded pension plans in places such as California, Oregon, Texas and Washington. Or questions that arise from statements they’ve made publicly. They politely declined, citing something called their “broadcast policy”. No offer was made to answer the questions in writing; having already declined two other written requests to answer performance-related questions in 2012, it didn’t come as a surprise.

Here are the 12 questions we would have asked the CPP Investment Board (with some background for you). If only they’d answer them:

1. According to CPPIB’s March 31, 2011 listing of public equity holdings, the agency owned $21 million of Sino-Forest shares. This investment exceeded the CPPIB’s investments in several other more established Canadian companies, including BCE, Bombardier, Brookfield, CIBC, Canadian Tire, Imperial Oil, National Bank, Onex, Power Corp., Shoppers Drug Mark, SNC, Telus, Thomson Reuters, TMX and TransCanada. What independent due diligence did CPPIB conduct to give it the confidence to go very over-weight into what the OSC says turned out to be a corporate fraud?

2. What are the individual IRRs of our 135 private equity fund investments? Background: According to the CPPIB 2012 “Report on Responsible Investing”, the agency says that it “adheres to the highest standards of transparency and accountability”. The state pensions of such places as California, Oregon, Texas and Washington all disclose the individual internal rates of returns on all of their private equity, debt and venture capital funds, such as Apollo, Blackstone, Carlyle, KKR, Silver Lake, etc. The “IRR” calculation is a widely-recognized metric to determine the true performance of an investment over time. CPPIB has invested in dozens of these same funds, and yet refuses to disclose the IRR calculation, preferring to report nominal performance based upon dollars in and dollars out in the home currency of the fund in questions (CAD, Euros, USD, etc.).

3. Over the past 10 years, the Canadian dollar has strengthened appreciably. The CPPIB has substantial investments in assets that are denominated in foreign currencies, and has a policy of not hedging our risk to changes in the relative valuation of these currencies against the Canadian dollar. What is the true individual performance of our 135 private equity fund investments when you take into account the huge swings in the currencies we’ve invested in? Background: At the present time, CPPIB only discloses the nominal investment performance of a USD private equity fund in its home currency, even if we ultimately lost money on the investment once the supposed “profits” are converted back to Canadian dollars at the end of the fund’s life cycle. CPPIB reports its individual fund performance data in the currency of the (usually foreign) fund manager, rather than Canadian dollars, which is the currency that we surely must use to fund the lion’s share of our commitments to these largely U.S. and Euro-denominated multi-billion dollar private equity vehicles. CalPERS, CalSTRS, Oregon, WSIB and UTIMCO all report the individual fund level return data on the basis of their own invested currency (being U.S. dollars), rather than the currency of the private equity vehicle in question (whether it be denominated in Canadian dollars, Euros or Renminbi, for example). It makes sense. Reporting a profit on a fund investment is misleading if it turns out that you actually lost money when you converted the original investment back to the currency that you use for financial statement reporting purposes. Since CPPIB has a policy of not hedging foreign currency exposure, this issue cannot be foreign to the Board of Directors. By publishing the information in the home currency of the fund, and not Canadian dollars (which is the currency of our audited financial statements, our original private equity fund investment and likely each subsequent capital call during the life of the individual fund), Canadians are unable to ascertain whether or not we made a profit or loss on each of these 135 investment vehicles – leaving aside the absence of an individual fund IRR calculation. As such, Canadians cannot asses “how [our] investments are performing”, since we have no idea about the impact of the changes in the relative values of the Canadian and U.S. dollars (or Euros) are having on our specific investment in this fund. Worse, CPPIB’s current disclosure approach invariably misleads Canadians.

Here’s an example: On June 30, 2005, to satisfy a capital call on our US$413.5 million commitment to Blackstone V, CPPIB needed to convert 1.2256 Canadian dollars to buy 1 U.S. dollar. Over the course of the next few years, we would have paid rates such as 1.115 (June 30, 2006), 1.0634 (June 29, 2007), and so forth to satisfy follow-on capital calls for this U.S. dollar investment vehicle. A year ago, for example, when distributions flowed back to CPPIB from this particular fund, CPPIB would have been converting U.S. dollars at a rate of 1.0192: about 20% below the value of the representative 2005 capital call. However, according to the CPPIB’s website, we still made a positive return 3.3% on the investment due to the CPPIB’s U.S. dollar fund performance reporting approach. Given Blackstone V’s modest nominal return of 3.3% on our capital (according to CPPIB’s website), we likely lost money on our investment when the currency impact is taken into consideration…which is what is ultimately baked into the audited financial statements of the CPPIB. Yet unavailable for specific fund level review by Canadians, unlike the people of Oregon, for example, a state of 3.8 million people.

4. CPPIB has committed over $30 billion to external private funds over the past decade. What IRR has CPPIB earned on its investment via the entire asset class of its external LBO managers, since the inception? Weighted by dollar invested / realized.

5. CPPIB has disclosed to the media that it made hundreds of millions via its co-investment in Skype when it was acquired by Microsoft in 2011. At the same time, CPPIB refuses to disclose to the media how much we’ve lost on other mega private equity LBO co-investment deals that went south, such as EMI (went bankrupt in 2011), Freescale, SunGuard, TXU…. Why does CPPIB only disclose the details of the PE wins and not the losses? CPPIB’s spokesperson claims it’s because Skype was public information, and yet Freescale is now a public company again, and the EMI bankruptcy was a very public event when Citibank took control.

6. As CPPIB’s size grows, so too does the relative cost of the overhead associated with the internal management of the fund. This is counterintuitive. CPPIB’s MER is about 25 basis points, while the MER for similarly-large Ontario Teachers Pension Plan is approximately 20 basis points. Which means CPPIB spends 25% more to manage the same dollar. Why is that? Background: In 2006, the CPPIB spent $54 million on salaries and staff pension contributions ($26M), general and administrative costs ($21M), and professional fees ($7M). With $73.6 billion of average assets under management that year, our Management Expense Ratio was 0.07%. In two year’s time, the MER doubled to 0.13%, as average assets grew to $119.3 billion and our SG&A tripled to $154 million as the not-so-new management team of CEO David Denison and then-EVP Mark Wiseman settled into their roles. For the 2012 fiscal year, our CPPIB MER was up four fold to 0.28%, with $440 million of internal overhead managing $154.9 billion of average net assets. During David Denison’s tenure as CEO, internal management costs grew 286%, and $1.347 billion in aggregate was spent between 2008-2012 on overhead — all to achieve an annualized total return of 2.2% — well below the 4% plus inflation target required to keep the plan solvent. Last time I checked, Ontario Teachers’ MER was a modest 0.20%-0.21%, and the HOOPP was getting by with 0.18%-0.22% of their gross assets under management. On a gross asset basis, CPPIB’s internal staff MER drops to about 0.25% from 0.28%, which means it still would cost the CPPIB $60-70 million more internally than the Teachers to manage the same asset pool. Moreover, with $30 billion of external private equity commitments, unlike HOOPP and OTTPP which limit the use of external PE managers as much as they can, CPPIB is paying external management fees of between 1-1.5% per annum there too. Another $300 million to $450 million in fees and expenses to manage that pile of dough (according to CPPIB’s annual report, they paid $650 million in total external management fees in 2012), pushing our comparable MER closer to 0.55%, dramatically higher than OMERS’s figure of 0.45-0.47%.

7. CPPIB owns $233 million of stock in four U.S. tobacco companies. As a founding signatory to the United Nations’ Principles for Responsible Investing, CPPIB has agreed to define responsible investing as “excluding companies from the investment universe on the basis of criteria relating to their products, activities, policies, or performance. This includes sector-based screening (where entire sectors are excluded)….” According to the CBC, CPPIB advises that “The CPPIB is mandated by law to evaluate companies only by their investment potential; morals and politics generally don’t enter the picture.” How does the CPPIB explain investing in tobacco firms, unlike CalPERS for example, while at the same time adhering to its duties to the United Nations?

8. One of CPPIB’s stated PRI tests is “anti-corruption practices”. As of its most recent financial statements, CPPIB owned $175 million of HSBC stock and $74 million of UBS shares. Together, these banks recently paid US$3.5 billion in fines after admitting they were engaged in illegal activity over an extended period of time. In HSBC’s case, the fine was for multi-billion dollar drug money laundering. These firms have broken the “anti-corruption” requirement of the CPPIB’s Policy for Responsible Investing. Has the CPPIB sold these shares now that the banks have plead guilty? If not, why not?

9. How many individual investments over the last 5 years were rejected or subsequently divested by CPPIB due to a conflict with CPPIB’s Policy on Responsible Investing? What drove those decisions?

10. According to my analysis, 59% of a broadly representative group (53 of 135) of CPPIB’s external private equity managers were producing an IRR below 6%, which is what CPPIB’s Chief Actuary says is required for the CPPIB to be solvent over the long term. Is this of concern? If not, why not?

11. In February 2010, CPPIB announced that it was making a new $400 million allocation to Canadian venture capital and private equity managers via an external manager (Northleaf). At the time, CPPIB CEO Mark Weisman told the Globe and Mail’s Boyd Erman that he was excited about the opportunity presented by the Canadian venture landscape. As of March 2012, only $39 million of the $400 million had been drawn by fund managers. Over the past three years, a raft of Canadian innovation-related funds have closed, including Vanedge, Georgian, iNovia, Lumira, Merck Lumira, Rho, Celtic, TVM and Wellington Financial. According to industry sources, none of the CPPIB’s $400 million was committed to these nine funds. Is this true? If not, how much of CPPIB’s 2010 $400 million vehicle has been committed to date to Canadian-based venture funds?

12. In October 2012, CPPIB announced that it had loaned $400 million to the company that puts on the Formula One car races. CPPIB exec Andre Bourbonnais told the Globe and Mail that the CPPIB’s analysis was simple: “For us is was really an analysis of who was the counter-party, and in F1 if your counter-party is the principality of Monaco you’re pretty sure they’re going to be good on their commitment”. Since the Formula One is owned by CVC Capital Partners, Waddell & Reed Financial and Bernie Ecclestone, what role does Monaco have in guaranteeing our $400 million 7-year loan?

MRM