Why did CPPIB sell our stakes in buyout firms PAI and Welsh, Carson & Stowe?

News report: HarbourVest to Buy Welsh Carson, PAI Stakes From CPPIB

No sooner had we put on our blogging shoes and brought you some exclusive return data from CPP Investment Board (see prior post “CPP Investment Board Private Equity IRRs” May 19-15), word leaks that CPPIB has sold our interests in several funds managed by two huge LBO shops. PAI and Welsh, Carson, Anderson & Stowe may not be household names in Canada, but they are definitely established, respected players in the international leveraged buyout world.

In 2001, CPPIB committed 100 million Euros to PAI III under then-CEO John MacNaughton. In 2005, the year current CEO Mark Wiseman joined our organization as SVP Private Investments, CPPIB committed 200 million Euros to the E2.7 billion PAI IV. This was quickly followed with another 175 million Euro commitment to PAI V in 2007, which also raised E2.7 billion from pension plans the world over. When the incoming CPPIB senior managers reduced our allocation to a follow-on fund that closed on the same size of vehicle as their prior fund — which is unusual as this team usually increased its allocation to LBO managers during that period (TPG got US$500M in 2006 and US$750 million in 2008, for example) — the writing was on the wall then. Getting “cut back”, as we say in the industry, is a bad sign, unless the “denominator effect” is at work and your LP can’t maintain their proportional stake due to issues within their own plan; that wouldn’t have been the case with CPPIB with the huge inflow of funds from our weekly payroll deductions. This chain of events means there should be no surprise that CPPIB appears to have committed none of our retirement money to PAI’s VI fund, which raised E3.3 billion in 2015 nonetheless.

What drove the change of heart? Was it personality? Was it concern about Greece leaving the Euro, and an extended recession in PAI’s area of focus? Was it the return profile on PAI’s prior funds? And, if it was the latter, how did PAI subsequently raise E3.3 billion from other, equally responsible fiduciaries? What did our crystal ball tell us that other pension plans missed? According to CPPIB’s own disclosure, PAI III earned us a simple return of 172%, while PAI IV and V each gained 35%. Whether or not the latter two figures are good is likely a function of what kind of harvesting opportunities were available following the impact of the 2008 global financial crisis. If other 2005-08 vintage funds with a similar focus and strategy did far better, then we should be delighted that our team at CPPIB was being clinical when the time came to “re-up” on PAI VI over the past 12 months.

While 172% and 35% might sound like great gains, we have no idea what our Internal Rates of Return were on these funds; and that’s before the impact of currency swings, which would have enhanced or reduced our apparent gains. One would assume that the IRR is one of the key figures that would have determined whether or not CPPIB continued with the PAI team for its E3.3 billion Fund VI. The fact that we have now sold our stakes in PAI IV and V to Harbourvest tells us that whatever additional gains might have been in store from those two vehicles, CPPIB staff didn’t want to wait around to find out. Nor did they want to “stay connected” to the PAI team in case we changed our minds and wanted some visibility into an eventual PAI Fund VII down the road. In fact, it appears they wanted our money back so that they could put it into a more attractive investment somewhere else.

Enter Harbourvest, who obviously concluded that, at a price, their investors WOULD make an attractive risk-adjusted return from the very private equity assets we have just sold. A classic case of the cliché, “for every seller, there’s a buyer.” Except here, we are the reported seller of $1.5 billion of aggregate investment pools, and CPPIB has a policy of refusing to disclose the IRRs that were generated during our 10 years with these two funds. Leaving us in the dark.

The Welsh, Carson, Anderson & Stowe experience is different than PAI given the signals we appear to have been sending their way during our relationship. We committed US$200 million to Fund X in 2005, and increased our allocation to US$300 million on the US$4 billion the firm raised in 2008. According to CPPIB’s disclosure, we are up 47% on one fund and 44% on the other (as at 9/14). The returns got better with the release of our December 2014 figures. Fund X was now up 55%, while Fund XI stayed flat at 44%. According to the fund level IRR results released by the California State Teachers Retirement System, Fund X’s IRR is 7% while Fund XI’s clicked in at 14.1%. These return figures are in keeping with many of our other PE relationships, so it is interesting that these two managers have seen their funds sold, but apparently none of the other 36 of the 54 funds I have analyzed that are all producing IRRs that are lower than 14% according to data released by large U.S. pension plans (see prior post “How many of CPP’s Private Equity Funds Are Underperforming Bonds?” May 28-15).

And that’s the thing. I love that our management team at CPPIB is reviewing the data and making hard decisions about which relationships they want to retain. In 2013 and 2014, when CPPIB acquired portfolios via secondary transactions, there were press releases. However, since we have seen no disclosure about the rationale for exiting over 4% of our entire C$34 billion (as of Sept. 2014) drawn investment in global buyout funds, we are left wondering.

Which is odd, since CPPIB’s media department was quick to put out a press release about a $200 million investment in Hong Kong Broadband Network Ltd. last March, a A$525 million deal for Australian Infrastructure a few weeks ago, as well as the $1.6 billion sale of our stake in Air Distribution Technologies, Inc. last year.

The excuse can’t be “materiality” this time (see prior post “12 questions CPP Investment Board won’t be answering on BNN today” Jan. 17-13), since these other press announcements are of a same or far smaller dollar size.

Canadians deserve to know what the performance threshold is. What is the definition of a good manager? What has to happen for us to send them packing so quickly, given Canadians were told by folks like Mark Weisdorf and John Breen that CPPIB was choosing private equity relationships that were designed to last a generation? With about 170 different investment funds in our current external PE program, managed by 93 or so different firms, that’s plenty of relationships to monitor. Perhaps 20 of those 93 relationships are at least 12 years old, and appear to have long since been severed, but for our legacy investment.

What are we doing with the balance? Are we exiting every single PE fund relationship that has performed worse than the 14% reported IRR one we sold, managed by the stalwarts at Welsh, Carson and Stowe? And, if not, why not?

MRM