The $165.8-billion Canadian Pension Plan Investment Board (CPPIB) has substantially increased its investment in logistics properties in China, doubling its funding of a partnership with the Goodman Group.

It is the second time in a year that CPPIB has doubled its exposure to logistics properties in this Chinese joint venture, with its latest injection of funds totally $400 million.

Goodman, which also partners with CPPIB in logistics-themed property investments in North America, Hong Kong and Australia, will kick in an extra $100 million into the Goodman China Logistics Holding (GCLH) fund.

It is understood that CPPIB has invested more than $2.2 billion in co-investments with Goodman across these three countries in the past two years.

CPPIB’s most recent expansion in its China investments comes on the back of announcing earlier in the month that it would make its first direct investments – also via a Goodman joint venture – in US industrial real estate.

Goodman and CPPIB have targeted an equity amount of $890 million on a 55/45-per-cent basis, representing a $400 million investment from the Canadian investment manager, which manages the assets of 18 million Canadian contributors and beneficiaries.

 

The American ventures

The North American joint venture will target logistics and industrial properties in key North American markets.

Other large Canadian institutional investors such as the Ontario Teachers’ Pension Plan and la Caisse du dépôt et placement have been among the most active deal makers in recent years, making major investments in both North America and Europe.

CPPIB’s allocation to property now totals more than $17.7 billion, representing about 10.7 per cent of its total portfolio.

The Pension Real Estate Association’s August investment report reveals that 46 per cent of funds in its database report a target allocation to real estate of less than or equal to 8 per cent of their total portfolios.

About a quarter of funds reported they targeted a 10-per-cent allocation.

Across all the funds the average actual allocation was 9.1 per cent in 2011 up from 7.7 per cent the previous year.

The database covers 1000 US public and private pension plan sponsors, endowment foundations and other funds.

 

Logistics lowdown in the People’s Republic

CPPIB’s increased commitment to China takes the GCLH to $1 billion, with the joint venture having a portfolio of 12 properties in the key Chinese cities of Shanghai, Beijing, Tianjin, Kunshan, Chengdu and Suzhou.

The joint venture partners report that the portfolio has a 100-per-cent occupancy rate, with a strong tenant base.

Despite fears of an economic slowdown in China, Mark Machin, president of CPPIB Asia says that rising domestic demand will underpin its logistic property investments.

“CPPIB’s additional investments reflect our belief that China’s logistics sector will continue to grow as demand for modern, efficient logistics facilities is being fuelled by a rising domestic demand for consumer goods,” he says.

“Together with Goodman, we expect that GCCLH will continue to perform well over the long term through its participation in the rapid growth of this market.”

Other investors that are seeing an opportunity in investing in Chinese logistics real estate include Global Logistics Properties, a unit of Singapore’s sovereign wealth fund.

Bloomberg reports the company invested $1 billion in China last year, with online retail giant Amazon among its list of tenants.

 

Many portfolio managers use multi-factor models, but these are only as good as the various inputs used to construct them.

MSCI looks at how flawed-model construction can result in optimised portfolios that are not efficient.

The paper, Is Your Risk Model Letting Your Optimized Portfolio Down?, reveals that faulty risk models tend to underestimate risk in times of increasing market volatility and to overestimate risk when market volatility is falling.

MSCI finds that this can still occur despite models having both the correct underlying risk factors and an accurate process for estimating risk.

This can occur through sampling errors due to a limited history of returns, and a misalignment that arises from discrepancies between risk and alpha factors.

Portfolio managers’ alphas are often based on asset characteristics that are similar, but not identical to, those used to form risk factors.

A portfolio manager attempting to use an optimising model might tend to emphasise the part of the alpha that is not shared by the risk factors ­– also known as the residual alpha – because the risk model believes that part has no systematic risk. This might create bets in the portfolio that the manager did not intend to take.

MSCI proposes a number of solutions to these problems.

To read the paper, click here.

 

Two of the world’s biggest institutional investors have recently made significant forays into Australian infrastructure, seeing opportunities in the country across a wide array of assets.

Canada’s second largest pool of pension assets, la Caisse de dépôt et placement du Québec (the Caisse), has made a $139.2-million investment in five projects. Macky Tall, the fund’s senior vice president of investments in infrastructure, says the Caisse team is looking at other opportunities in Australia.

Meanwhile, the $77-billion Australia’s Future Fund has swooped on the assets of the listed-Australian Infrastructure Fund (AIX), announcing this week it had entered into a memorandum of understanding to pay $2 billion for the portfolio of assets.

 

Expanding infrastructure

While not being drawn on what its target allocation is, Tall says the Caisse has plans to increase its allocation to infrastructure, which is currently at 4 per cent of the total portfolio.

It is a strategy shared by the Future Fund, set up to help Australian governments meet the cost of public-sector superannuation liabilities, which has been building out its tangible asset program in recent years and has flagged increasing its exposure to both international and local assets.

The Caisse’s infrastructure portfolio was one of its best performing asset classes last year, returning 23.3 per cent in 2011, and beating its benchmark by more than 10.5 per cent.

On the back of this strong performance, Tall says the Caisse will add five more infrastructure-investment staff, taking its internal management team for the asset class to 20.

“There is a desire to increase the size of the infrastructure portfolio and it does sit well with some of the investment objectives of some of our clients,” he says.

“There is an appetite to grow this portfolio in a significant way, but it will depend on the opportunities but we would expect to continue this growth.”

 

Opportunities abound                                                                                                                

The Caisse attributes the good returns from its infrastructure portfolio to the strong performance of its energy and airport-services sector. Airports are also seen as a potential return-driver by the Future Fund, despite these infrastructure assets generally being viewed as pro-cyclical in nature.

The portfolio of assets it will acquire from AIX includes stakes in airports in Perth, Melbourne, the state of Queensland and the Northern Territory.

The fund’s chief investment officer, David Neal, says that Australian infrastructure assets offer correlation with Australia’s relatively strong economic growth, inflation protection and high levels of earnings certainty.

“Over the last five years, the Fund has been building its tangible-assets program. The infrastructure program is part of that and is now valued at over $4.3 billion or 5.6 per cent of the portfolio. We continue to seek opportunities to increase our exposure to quality Australian and international infrastructure assets,” Neal says.

In Australia, the Caisse has invested in social infrastructure, allocating to five public-private partnerships (PPP) that include a police and courthouse complex, Australian defence-force accommodation and a hospital in South Australia.

“Australia is a newer market for us and will provide over the coming years a number of opportunities and we initially focus there and we don’t have any immediate plans for Asia in terms of infrastructure investments,” he says.

Offshore money and Australian

It is the first time the fund has invested directly in Australian infrastructure assets.

The deals form part of a strategic alliance with the Plenary Group, an independent investor, developer and operator of infrastructure projects.

Tall says the fund has another project set to be finalised by the end of the year and, under the terms of the agreement, will consider investing in other projects initiated by the Plenary Group.

This first tranche of social infrastructure projects involves up to 30-year contracts with Australia’s state and federal governments that provide inflation-linked streams of revenue.

Roger Lloyd, director of infrastructure at fund manager Palisade Investment Partners, which is also a signatory to the strategic partnership, says that the attractive returns from Australian infrastructure investments has caught the attention of overseas investors.

“There is more offshore money buying Australian infrastructure assets than there is Australian money,” Lloyd says.

Palisade’s investors include Australian superannuation funds. Lloyd said that these mid-market-sized social-infrastructure investments are seen as offering attractive yields in the context of the current low-interest-rate environment.

Lloyd notes that social infrastructure investments of this type typically pay 600 to 700 basis points above Australian Government bonds, which have provided a yield around the 3-per-cent mark.

 

Developed-market focus

While the Caisse is looking to increase its footprint in Australia, the country still represents a small slice of its infrastructure portfolio.

The fund has focused on developed-market core assets, with 57.7 per cent of its portfolio in Western Europe and the UK.

Assets in the United States make up a further 23 per cent of its infrastructure portfolio, with those in its home province of Quebec the next biggest slice at 15.7 per cent.

Australia and other developed-market investments make up 1.7 per cent of the portfolio.

The energy and industry sectors account for the biggest sector exposures at 45.3 per cent and 41 per cent, respectively.

Wherever it invests, Tall says the fund has a simple strategy of seeking local partners with attractive track records to invest with.

Tall says the fund will limit its investment to developed markets, with no plans to expand its infrastructure investments into Asia.

Infrastructure is part of the Caisse’s inflation-sensitive investment portfolio, making up $5 billion of the $25.2 billion portfolio of assets.

The Caisse manages more than $165 billion on behalf of a number of public and private pension and insurance funds.

 

Governor of California, Edmund G Brown Jr, has announced proposed legislation that outlines sweeping reforms to the state’s pension system, but appears to have stepped back from a proposal to create a hybrid pension plan.

The hybrid defined-contribution/defined-benefit plan was proposed last year when Brown launched a 12-point reform package.

It was widely opposed by the state’s Democrat-led legislature after pressure from public sector unions and has been seemingly sidelined since Brown announced the key components of the Public Employee Pension Reform Act of 2012.

The governor claims he has reached agreement with the legislature, a point some Democrats have contested, but the plan – as it currently stands – stipulates all current and future state employees are to contribute at least 50 per cent of their pensions.

The reforms also eliminate state-imposed barriers that have prevented local governments from increasing employee contributions.

While the hybrid scheme is seemingly mothballed, it could be potentially revived via a provision that permits employers to “develop plans that are lower cost and lower risk if certified by the system’s actuary and approved by the legislature”.

According to the National Association of State Retirement Administrators there are 10 US states that currently adopt some form of hybrid pension scheme.

At the end of last year CalPERS released a working paper analysing the reforms that found if the hybrid scheme included closing off the current DB scheme to new members, it would result in lower investment returns and increase contribution to fund existing pensions.

By stopping the flow of any future new member contributions, a hybrid system would also further worsen the current 75 per cent funded ratio of CalPERS’ current DB scheme.

Governor Brown originally proposed that all new public employees would be required to join a hybrid pension plan that would target a 75 per cent income replacement ratio after 30 to 35 years of service.

The retirement benefits would be provided equally by the DB and DC component and social security. If a member did not access social security their benefit would consist of two-thirds DB and one-third DC components.

“It should be noted that if the design of the Hybrid Plan results in the closing of the current DB plan there would be a significant cost impact to the employer due to the changes in asset allocation and amortization methods,” CalPERS noted in its analysis of the effect of the proposed reform package.

In separate issue briefing released earlier in 2011, CalPERS said that closing off the current DB scheme would mean that investments would gradually shifted into lower risk, more liquid assets such as fixed income to ensure benefit payments for existing members.

Governor Brown’s reforms also include:

  • Increasing the retirement age by two years or more for all new public employees
  • Ending so-called spiking, calculating end-benefits over three years of final compensation
  • Rolling back retirement-benefit increases granted in 1999 and reducing benefits below current levels
  • Prohibiting retroactive pension increases and pension holidays where employers and employees agree to halt contributions for a specified period of time.
  • Establishing consistent formulas for calculating the future benefits of new employees.

Senior Democrats involved in negotiations have been reported as predicting that the raft of changes will save the state tens of billions of dollars over the next 20 to 30 years.

Brown says that the reforms will involve considerable sacrifice from public employees and predicts reforms will slash what some regard as bloated retirement benefits relative to the private sector.

“If the legislature approves these reforms, public retirement benefits will be lower than when I took office in 1975,” he says.

Some of the proposed changes will require a referendum before they can be enacted, according to the Governor.

Democrats in the legislature predict the final package of legislation will be passed by the end of the week.

CalPERS will hold a special board meeting today to consider the implications of the legislation.

The funded status of US defined-benefit corporate-pension plans continued to worsen last year, despite plan sponsors increasing contributions by $70 billion, a new Mercer study reveals.

Mercer found funding levels have slipped to 2009 levels, with the outlook for 2012 likely to extend the bleak news for plan sponsors.

The funded status of pension plans sponsored by companies in the S&P 1500 declined from 81 per cent at the end of 2010 to 75 per cent by the end of 2011. Funded status continued to decline in 2012 as these plans hit a record low of 70 per cent as of July 31, representing a shortfall of $689 billion.

 

Low growth, high volatility

Eric Veletzos, principal and consulting actuary with Mercer’s retirement, risk and finance business, puts the blame for the continuing slide in funded status on the low-returns environment coupled with record-low interest rates.

“Liability growth exceeded asset returns for the fourth consecutive year, offsetting these contributions,” Veletzos says.

The median asset return for 2011 was 2.9 per cent, down from 12.1 per cent in 2010 and 18.5 per cent in 2009.

Meanwhile, the median pension liability grew by 13.7 per cent in 2011, the third consecutive year with liability growth in excess of 10 per cent.

The high liability rate of growth is driven by decreasing interest rates.

 

Stacking up risk

Mercer’s research paper, How Does Your Retirement Program Stack Up, bases analysis on information contained in the 10-K reports filed by companies in the S&P 1500 for the 2011 fiscal year.

The figures reveal that the prevalence of what Mercer describes as “risky” plans in the S&P 1500 increased from 4.7 per cent during 2001, an increase of nearly 70 per cent.

“These plans are poorly funded and more material compared to the size of the corporations, so pension risk is a major issue for these organisations,” he says.

The tough environment is reflected in the expectations of plan sponsors, with Mercer noting median expected return had declined marginally from 7.92 per cent to 7.73 per cent by the end of 2011.

Part of this can be explained by a general trend among corporate defined-benefit plans to gradually de-risk their investments away from high-risk assets, such as equities, to fixed-income investments.

Mercer is seeing a range of strategies from funds aimed at controlling the volatility of their funded status. These include liability-driven investing and other risk-management strategies.

The consultant is also seeing increased interest in risk-transfer strategies such as lump-sum cash-outs and annuitisation.

Ford and General Motors are two recent high profile examples of corporate-pension plans that have looked to transfer risk to a third party. This trend is expected to gather pace in the coming years.