Pension funds around the world watched in awe when Canada’s C$326.5 billion ($260 billion) Canada Pension Plan Investment Board took a stake in Chinese e-commerce giant Alibaba and hit the jackpot.
CPPIB, Canada’s biggest pension fund, first invested in Hangzhou-based Alibaba in 2011, when it was an unknown tech company; just a few years later, Alibaba became the world’s largest-ever sharemarket float, raising $25 billion.
Today, CPPIB’s $314 million stake in the company, which has more sales than Amazon and eBay combined, is one of its most prized assets.
Executives at CPPIB were quick to attribute this success to boots on the ground, strong local relationships and a robust understanding of the Chinese market, all nurtured long before 2011. As the fund’s commitment to emerging markets grows, it is these core principles, coupled with a steadfast commitment to the long term and a preference for in-house, active management, that is driving strategy.
Back in 2000, more than 80 per cent of CPPIB’s portfolio was invested in Canada. Today, more than 80 per cent is invested outside Canada, and although the lion’s share remains in developed markets, China, India and Brazil’s influence on the portfolio are growing.
About 10 per cent of the fund’s assets are invested in emerging markets, and this is forecast to grow to 15 per cent in the next three to five years, with a particular focus on boosting the current 4.4 per cent allocation to China and 1.8 per cent allocation to India, where the fund opened a Mumbai office in 2015.
Recent stakes include a Chinese shopping mall, key telecoms infrastructure in India and prime real estate in São Paulo, with strategies set to span public and private markets across equity, credit, bonds and real assets.
“We firmly believe that our mandate to maximise returns at a targeted level of overall risk compels a substantial investment in emerging markets,” says Geoffrey Rubin, who was recently promoted to senior managing director and chief investment strategist. He leads the design and management of the overall portfolio.
“Without the diversification and risk-adjusted returns contributed by emerging-market investments, our overall portfolio performance would fall short of its full potential,” he says.
It’s a commitment being fanned by the evolution and growing sophistication of emerging markets. Until recently, barriers to large players such as CPPIB purchasing sizeable stakes, plus local resistance to foreign ownership and risks around picking partners, have put off investors.
“We have noticed a few key trends,” explains Rubin, who details how deal size has “scaled significantly in the last decade” and opportunities to have more control in transactions have grown.
“There are an increasing number of cross-border opportunities; professional management teams are more prevalent as founders of businesses are going through a generational change, and we also see both opportunities and threats from innovations related to the internet.”
CPPIB – which is forecast to have $296 billion under management by 2020 and contributions exceeding annual benefits paid until 2021 – has invested in logistics and warehouses, most recently committing $259 million to projects in Singapore and Indonesia with Australia’s Logos property group and Ivanhoé Cambridge, the real estate arm of Caisse de dépôt et placement du Québec.
Equities account for the bulk of the emerging-market allocation, with 1.8 per cent in private equity and 5.7 per cent in public equity, allocations that posted returns last year of 15.4 per cent and 18.9 per cent, respectively.
A recent strategy includes the Hong Kong-based fundamental equities team doubling its active exposure in Asia to $4.8 billion, boosting investments in six different companies. Looking ahead, the internal team will increasingly tap opportunities in the renminbi-denominated China A-share market.
Overall, CPPIB achieved an 11.8 per cent return for fiscal 2017 but underperformed the 14.9 per cent return of its benchmark reference portfolio, a passive portfolio of public-market indices. Despite those bumper index returns, Rubin is steadfast in his commitment to costly active management in public equities. He is convinced better returns will ultimately outweigh the cost of active management in emerging markets.
“We feel strongly about the security selection or alpha returns from actively investing in these markets, for the simple reason that our comparative advantages of size, certainty of assets, long horizon, and strong partner relationships are even more pronounced in less-efficient markets.
“Our local presence and strong partner networks demonstrate a commitment that provides access to attractive opportunities and returns – net of all costs – that we believe will exceed those of the corresponding index over time.”
The CPPIB strategy is also guided by a belief that private-market investment in emerging economies isn’t necessarily any riskier than investment in public markets.
The liquidity benefits of investing in public markets aren’t guaranteed because “in downturns, that liquidity profile will likely erode”, Rubin says. And because CPPIB invests for the long term, it is “willing to bear illiquidity risk if appropriately compensated”. So much so that once an opportunity has been identified, he spends little time worrying about entry and exit points.
“Given CPPIB is a long-term investor, we tend not to think in terms of entry and exit. Our due diligence process is very thorough; once we identify an opportunity we like, we tend to remain invested for multiple years.”
He also points out that private companies offer the best opportunity to tap emerging-market growth.
“Ironically, many emerging-market, public-market investments have less exposure to local economic growth because listed companies can have more globally diversified revenue and earnings footprints,” he explains. “Our private investments typically provide a more direct link to local economic performance.”
That said, some risks will always be greater in private markets: “Execution risk is higher for private investments, something that we mitigate by investing only with the highest-quality funds and partners.”
Relationships with managers
The right partner is particularly crucial in emerging markets, where finding suitable assets is often the easiest part of a long investment journey that involves due diligence, accurate valuations, complex negotiations, closing deals and ongoing management. At CPPIB, detailed manager screening and evaluation leads the fund to good partners, Rubin says, which include Beijing-based CDH Investments, China-focused CITIC Capital Partners and the India Value Fund.
“In our manager relationships, we look for well-researched investment opportunities, high-quality local experience and partners with whom we can build long-term relationships. We benefit from their expertise, which provides a good complement to our internal capabilities. We feel that an on-the-ground presence is critical to investing in emerging markets, so we tend to prefer country-specific managers with local language expertise who are based in the regions where they invest.”
And although the fund is committed to “strengthening its [general partner] network”, strategy in emerging markets is also focused on in-house management.
“The single biggest driver of cost in all geographies is direct versus indirect implementation; even with the cost of hiring and housing world-class talent in global hubs like London and Hong Kong, direct investment – which is expanding in our emerging-market portfolio – reduces overall costs,” Rubin says. “Whether investing directly or indirectly, we evaluate investment strategies on risk-adjusted returns net of all costs, so those with higher expenses must have proportionally higher gross return prospects.”
He says success in emerging markets hinges on seeing the different economies as separate entities. Rather than a “single emerging markets label being applied to a large and varied set of countries”, obscuring “the fundamental and diversifying differences among them”, he advises different approaches for different markets.
“Over the longer horizons, the fundamental economic performance unique to each geography will dominate. By spreading our emerging-market investments across a number of distinct geographies, industries, asset classes and risk factors, we can enhance long-term diversification.”