The active equities team at CPP Investments has abandoned antiquated investment categorisations, such as style and size, and views companies through a more holistic “domain” interpretation. Amanda White spoke to the global head of active equities Frank Ieraci about the unique insights and organisational structure of the team; and the contributions it makes to the total fund, including capital efficiency, agility and pure alpha.
Frank Ieraci runs a giant hedge fund within CPP Investments. As global head of active equities, one of six investment teams at the C$570 billion Canadian pension fund, he has a mandate to deliver alpha in global public equities markets, and it’s done in one concentrated portfolio.
“We are a long-short, market-neutral strategy, and from that perspective we are very similar to hedge funds,” Ieraci says.
His team of 170 delivers a single C$69 billion portfolio driven by fundamental research, unique insights predicated on a long-time horizon and investment beliefs that have been empirically tested.
“We have a set of investment beliefs in active equities, that are not articles of faith, they are empirically tested facts. We have put the time in to think about what long-term fundamental investing looks like and empirically test what works and what doesn’t, and it’s that set of investment beliefs that really drive the way we structure ourselves and the way we make decisions,” he told Top1000funds.com in an interview.
“We can demonstrate empirically that markets are less efficient when you start to extend the forecast horizon. At approximately the one-year mark you start to see a big difference in both how information is priced in and the speed at which it is reflected in market prices . At about that one year mark it breaks down, publicly available information is not uniformly or ubiquitously priced in, and that trend continues to break down as you push out the horizon. The drivers of returns over the long run are company specific fundamentals. So for individuals who can think and act as long-term fundamental investors there is opportunity to generate alpha.”
He believes the ability to exploit those market inefficiencies is predicated on unique insights, and it’s the proprietary company specific fundamental research that yields a collection of high-conviction, single-company investments that are assembled into a highly concentrated long/short, market-neutral portfolio. An optimization process removes unintended factor exposures.
The active equities team is organised around regions and ‘loosely’ around sectors, that internally are labelled as domains. Unique to its approach is redefining the ecosystems within which businesses operate either through the lens of a theme business model, or value chain.
“It’s not enough to just have fundamental insights, those insights need to be unique,” Ieraci says.
“It’s not enough to just have fundamental insights, those insights need to be unique”
It means approaching investments with a holistic, broader view of business operations and drivers of success and not through the lens of pre-constructed investment criteria such as capitalisation or factors and styles.
“When I was early on in my career I struggled to label whether I was a value investor or some other description,” Ieraci says. “Over the years I have just got to better understand what active security selection, and more specifically fundamental investing, meant. Increasingly we are seeing there is not that much difference between say factors and small cap or mid cap, so why have those distinctions? It’s tough to appreciate why that exists today.”
How to get unique insights
It’s this domain expertise that defines the analysts in the active equities team.
“We believe that domain expertise is necessary, we don’t think about a generalist model. At the same time we don’t need marketing-driven labels such as value or momentum, they have been created to market to clients and it’s not how we think about the world,” he says.
Instead a more inclusive and universal view of a company means they are viewed through mini eco-systems that operate in larger systems.
“We need to understand the business model of each company and the competitive dynamics that exist within the systems within which they operate and become an expert in that to really understand what will be the long-term drivers of success for these businesses,” he says.
That domain expertise is how the analysts are organised. Eco-systems are identified around emerging themes, business models, value chains, and in some cases a more traditional industry definition.
“It could be any of those, and it is any of those. We look at building expertise in that space and from there our fundamental, and in some cases data-driven, research comes in to produce those fundamental unique insights.”
By way of example he says AT&T or Verizon might be traditionally covered by a telecommunications analyst, but at CPP it’s not so narrowly defined.
“You need to understand the parts of the value chain that go left and right of that. For example the handset makers, the tower companies, software, the equipment providers and how that is changing how consumers use their devices, you need to understand the unique partnerships attracting customers. All of these things are part of the value chain, but the traditional analyst is just set up to look at that company in the telcos lens.”
Ieraci says there is a culture at CPP of collaboration and knowledge sharing as an important part “of the way we apprentice our analysts and how we build investors”. But to some extent the need to share knowledge misses the point of how the team is organised and researches companies.
“In the traditional sense you would need to be collaborate across industry analysts to get the full 360 view. But our analyst already looks across industries. We handpick the companies in those domains to create these structures. It’s one person that does all of that. At first blush you might say that seems hard. But I think it’s the opposite. I actually think it is impossible to fully understand A&T and Verizon without understanding the other parts of the business. So when you are separated you actually hinder people from truly understanding the ecosystem and developing those more unique insights that they could develop.”
Portfolio optimisation
The active equities portfolio has a three-to-five year horizon, although it can be longer. Turnover is about 20-25 per cent with a holding period of about four years. One position has been in the portfolio for 11 years.
Consistent with a long/short approach investments can be opportunistic and as a market-neutral approach it is by definition not tilted.
“We do think opportunistically, agility is the important piece of that,” Ieraci says. “We want to operate in areas where there is an alpha opportunity we can exploit through our fundamental research and if we have a unique insight then we will deploy capital there. For example on the long side of the portfolio we could have a big position in India or more in tech than industrials, but that changes frequently because we operating opportunistically.”
The short is used where a company is in structural decline and there’s a view that hasn’t been priced in, or to mitigate the exposures it doesn’t have a view on.
The portfolio optimisation process has three layers that gradually brings the view of risk down from 30,000 feet.
“We start with off-the-shelf risk models we refine for our needs, they have factor exposures including sector, geography, beta, momentum, value etc and that allows us to structure portfolios to neutralise standard factors. Those risk models will get from 30,000 to 10,000,” Ieraci explains. “At the next level we think carefully about the nature of the company and specific exposures that may not be captured in off the shelf factor models. For example there could be an exposure we have where regulation may change the outcome of the company and we want to neutralise it.”
The third layer, he explains is the toughest to get right and a constant area of improvement, looks at emerging correlations.
“It’s where we are trying to identify those situations where there is a lurking correlation that will only present itself when something goes wrong. Covid showed us there were some companies where there was no historical correlation but post-Covid there was. These were out of model risks. We’re looking to see if there are any early correlations where we can examine them through a fundamental lens. We are experimenting with new data and analytical techniques to identify emerging correlations.”
Research clarity
It’s possible for active equities to manage as one portfolio, because it has a platform that allows the team to think and operate as a long-term investor with scale, certainty of capital, and a sophisticated internal team.
“We know what will matter the most and over what horizon, so we can laser in on those,” he says. “Others are having to consume vast amounts of information and trying to process that in a mosaic, which is impossible to do. I don’t think humans are very good at doing this.”
“We know what will matter the most and over what horizon, so we can laser in on those”
Because of how hard that is people end up taking short cuts like reading other peoples’ research without validating it. “Other peoples’ research has an element of postulating and is not really evidence-based or data driven” he says.
CPP’s active equities research has clarity with the team identifying one or two questions to focus on and get right over the next three to five years.
“We focus solely on that and bring as much evidence as we can to those questions, and don’t rely on other peoples’ research, we do it ourselves. We read it but because we’re not tasked with doing what others do, and having to know everything about a stock at any given time, we can actually can do the work that we think is the most relevant.”
The research process is protracted and detailed with specific research being identified and bought, which in some cases has taken months to negotiate and evaluate.
“Once we have identified the key question we can take the time to do the research and find the evidence and data that can support that,” he says.
The questions being posed are always company specific.
“We are very clear about what specific performance we are investigating. Earnings don’t matter to every company. For some revenue or operating margins or investment capital might matter more. We identify what matters for each company and then we are laser focused on those questions that will drive that fundamental outcome,” he says.
Serving the total portfolio
At CPP, teams are broken into six groups: total fund management, active equities, credit investments, capital markets and factor investing, real assets and private equity.
Like any of the groups active equities delivers alpha, so at the most basic level its commercial imperative is to deliver outperformance to the fund. But as a long short portfolio it doesn’t deliver any other factor exposure.
“We don’t deliver any public market beta, just alpha,” says Ieraci. “So as a result how we contribute to the fund tends to be a bit more simplified in terms of the factor exposure but in other dimensions we can do things that other long-only strategies can’t.”
This means the contributions to the total fund are more than just alpha. The long short positions mean it is a very capital efficient portfolio, using less dollars to deliver the same alpha; and the liquidity of the fund means it is very agile.
“We deliver an agile strategy that can expand and contract very quickly if we need to move capital from a relative value perspective to other parts of the organisation,” he says.
While it doesn’t happen very frequently, Ieraci says the conversations are constant.
“Our CIO, Ed Cass, in partnership with each investment department head, is constantly trying to identify where the best relative value opportunities are , and how would we tactically allocate capital to them. That conversation happens regularly given our size we need to constantly be thinking about how to set ourselves up at any point in time for the next two to three years,” he says.”
