A couple of months ago, investment executives at Montreal-based Trans-Canada Capital, TCC, travelled to Colombia to carry out due diligence on a niche Columbian asset manager. It was an unusual opportunity.
Following a recent court decision, the Columbian government has pledged to pay reparations to victims of the Latin American country’s past conflict. The manager’s strategy involved settling the claims with the victims and waiting for payback from the government.
“It will accrue around 18 per cent interest. We hedge the currency risk and are then left with a 12-13 per cent risk on Colombian government paper. It’s a good trade that is already popular in Brazil but no one was looking at Colombia,” says Marc-André Soublière, senior VP fixed income and derivatives at TCC.
The strategy is a direct reflection of TCC’s innovative, untraditional investment strategy.
With a different world view from its Montreal home, the asset manager of flagship carrier Air Canada’s C$21 billion ($15.9 billion) pension fund fuses its pension fund roots with the ethos of a relative value hedge fund for a unique investment approach that hunts uncorrelated alpha across the entire portfolio.
Since setting up shop in 2019 after being spun out of the investment arm of Air Canada Pension Investments to create a new entity able to manage assets for external firms, TCC has attracted a growing cohort of institutional clients, and more recently, family offices.
Seed investor Air Canada remains TCC’s biggest client, comprising the bulk of its C$27.2 billion assets under management that includes leverage and LDI strategies. But Air Canada’s different portfolios comprising bonds (where it allocates 50 per cent) alternatives (30 per cent) hedge funds (roughly 15 per cent) and equities (5 per cent) now provide an investment template increasingly tapped by other clients, drawn to a bold strategy that has transformed the pension fund from deficit to C$4.4 billion surplus.
Multi-strategy hedge fund
One of the jewels in TCC’s crown is a $1.3 billion multi-strategy hedge fund targeting multiple, diverse alpha streams coupled with an eagle eye on tail risk and sizing. A 10-person team invests globally in all asset classes spanning volatility to credit, commodities, equity, currencies, and real and nominal interest rates to bring multiple diversification seams into the portfolio using different strategies and financial instruments.
All investments are viewed in the context of risk, and the strategy is fiercely anti-silo in an approach equally split between systematic strategies and human expertise.
“For us, it is one portfolio,” explains Simon Guyard, senior portfolio manager at TCC. “No one is forced to trade in a certain way. It is just about the best implementation and the best asset class.”
Add to this TCC’s pension fund roots allowing the hedge fund team to be patient and take a long-term view.
For example, Soublière, who was at PSP Investments and Hydro Quebec before joining Air Canada in 2009, says that for some trades, TCC is undaunted by the wide bid ask spreads that deter other hedge funds.
“If we look at it and it makes sense and we expect to make money, we will put it in the book.”
In another example, TCC gets involved in risk transfer trades, another area many investors steer clear.
“It surprises a lot of people that we do this because we are only a small hedge fund,” reflects Guyard, who explains the trade suits TCC because of its whole portfolio approach that prizes diversification.
Moreover, risk is always limited by a strategy to never invest too much.
“Instead of eating four slices of pizza we will be content with two, hedge out the risk and get a bigger sharpe ratio. We don’t just focus on returns; we focus most on the sharpe ratio and limiting the downside,” says Soublière.
Soublière and Guyard are also convinced TCC’s adventurous investment approach is also rooted in their Montreal base – although a source of curiosity (and the odd joke) amongst hedge fund rivals in New York and London. TCC’s view of the world from French-speaking Quebec gives the firm a different perspective which in turn leads to different kinds of investments to other hedge funds, many of which, they reflect, are invested in the same trades.
It is also possible to attract and retain talent in Montreal thanks to Canada’s vibrant pension industry.
“We get them in and then get them comfy with taking risk,” laughs Soublière. “Our staff turnover is close to zero. Over the last 13 years I’ve lost two employees, and both wanted to come back!”
unconstrained Fixed Income
The same unconstrained approach characterises the fixed income portfolio. Here, like in the hedge fund allocation, sizing is key with a focus on independent trades that work together in a constant portfolio churn.
“Few other Canadian investors rotate their fixed income portfolio as much as we do,” says Soublière.
The allocation goes above and beyond a typical manager strategy shaped around duration, curve, and credit. Instead, TCC has developed a global-macro, relative-value approach that trades curves from around the world; corporate credit, negative basis and cross market long short positions.
It would be impossible to find uncorrelated trades by just staying in Canada, explains Soublière, who believes this makes the fund unique for Canadian investors.
“We blow out the silos, and look across European, US and Asian curves to find risks that are uncorrelated to our home market. Name a country and we’ve probably traded something,” he says, adding that trades in emerging markets are limited to swaps and futures, rather than buying physical paper.
TCC’s Alternative Fund is another key portfolio, a mature program invested across multiple managers in real estate, infrastructure, private equity, and private debt and increasingly popular with family office clientele seeking to outsource management of private markets.
“The big advantage for these investors is that there is no J curve,” explains Soublière. “They invest directly into a mature portfolio that also offers liquidity.”
The liquidity comes from a sleeve that allows TCC to keep a portion of the portfolio in liquid units, moving money around when it comes in to suit clients.
“It’s an open-ended fund with quarterly liquidity. It’s part liquid, part private,” says Soublière.
Other features of the private market allocation include eschewing core allocations in real estate where the risk premiums are too low. “We would rather do other stuff where the risk premiums are higher.”
Despite welcome volatility and dislocation fanning opportunities over the last year, the rise in interest rates has provided challenges. None more so than careful cash management given the LDI element of the Air Canada allocation, and wide derivative use to express trades.
TCC posts collateral with its banking partners in return for balance sheet to allow it to use leverage. Yet banks grew wary when the value of the fixed income portfolio collapsed to the extent the levered long bond portfolio lost 45 per cent of its NAV in six months as rates climbed higher.
TCC runs a 2:1 leverage on one bond fund (in contrast to the UK where much higher leverage levels on longer duration bonds got many LDI strategies into trouble last year) but it was still hairy, explains Soublière.
“The last thing you want to do is run out of collateral to post to banks to get money for a capital call. When you do LDI, it’s important to never run out of repo-able assets.”
TCC’s holistic view of cash where stress tests are carried out weekly, monthly and yearly stood the investor in good stead, he adds.
“You never want to get close to a level where you might not have enough cash.”
In many ways the pandemic, which hit just a few months after TCC launched, was easier to navigate than higher rates. Not through any great foresight of a pandemic (Soublière and Guyard add in unison) but rather because of an early 2020 strategy to snap up cheap risk premiums, TCC found itself risk off with multiple hedges on its book just as COVID broke.
As central banks embarked on fresh rounds of quantitative easing, TCC pivoted the other way. “We kept a bullish view for the whole year,” says Soublière, explaining that relative value proved one of the best strategies, trading corporate spreads as central banks injected liquidity.
“The Fed was the first to act and corporate spreads in the US shrunk versus Canada and Europe. We bought the spread in Canada and Europe and hedged in the US and then rolled this trade as central banks rolled out QE,” he recalls. “It really is our edge to look everywhere and find the best way to implement a trade.”