Recent high profile investor losses under score the importance of due diligence. As Compenswiss looks to mandate new private debt managers, chief investment strategist Frank Juliano talks through the importance of the due diligence processes at the Swiss pension fund.

Recent high-profile pension and sovereign wealth fund losses in collapsed crypto exchange FTX, or when Silicon Valley Bank suddenly hit the wall, have cast a spotlight on due diligence.

Whether competition for returns, more investments flowing into less regulated private markets and the speed investors are required to commit capital, or just a prolonged period of relative calm in financial markets since the GFC lulling investors into undervaluing its importance, hands-on due diligence is in danger of being replaced by a tick the box exercise. So warns Frank Juliano, chief investment strategist and member of the executive committee at Switzerland’s CHF39 billion ($43 billion) Compenswiss.

As the fund prepares to bring new asset managers on-line in a boosted allocation to private debt, the process of checking that a new cohort of external mangers will deliver all they promise and the bone fide credentials of the team behind the strategy is front of mind.

“A simple questionnaire sent to managers is a recipe for disaster,” explains Juliano, who says the fund’s manager relationships (it has around 44 mandates with 27 managers) are partnerships not friendships, and for whom the value of due diligence is engrained from previous roles as head of portfolio management at Merrill Lynch and heading up hedge funds at Lomboard Odier.

The process

Compenswiss will only select managers with proven experience and expertise in a process that begins with reviewing all documents and references. The team get to know the firm and the people, especially the portfolio managers; the firm’s capabilities surrounding the investment and their risk management operation.

Once the strongest contenders have been selected (typically between 12-15 are shortlisted) each manager has a three-hour video conference with Juliano’s team. From this, between four to six go onto the next stage, an in-person visit and another 3-4 hours of onsite due diligence.

Of course, in person meetings don’t always flush out red flags. Famously, when executives at Sequoia Capital met FTX founder Sam Bankman-Fried in person he was playing video games and the firm still sunk $214 million into the exchange.

But it is this part of the process that Juliano feels is particularly crucial. Recalling a recent experience, he says on-site visits sometimes lead compenswiss to rethink manager selection.

“We thought we’d selected the final candidate but when we visited them, we decided to go with another. We discovered aspects to their strategy that were well described, but in reality, the manager was no doing what they said.”

Not being able to visit managers in-person meant compenswiss didn’t onboard any new managers during Covid.

A time it was also impossible to visit the managers it had in place and monitor strategies. Following selection, compenswiss meets managers at least quarterly – twice remotely, once at its Geneva headquarters and once on the manager’s own turf. Not being able to meet face-to-face was an increasing source of angst, he recalls. “I grew concerned about the pension fund’s ability to effectively monitor managers remotely.”

“We have strong partnerships with our managers, but they are not our friends,” he continues. “We are a good partner but at the same time we have to be bold enough so that when things don’t go well, we can take a tough stance and sort the issues.”

That could include a portfolio manager unexpectedly leaving the firm. In this case, compenswiss would immediately place the manager on watch. “When a manager changes course like this, a firm will quickly reassure and minimize the materiality of the departure. But for the next six months we make sure there is continuity, and we monitor them closely.”

Private debt

Juliano says that approval of the first wave of shortlisted private debt managers is currently in the investment committee process, awaiting sign off. compenswiss will likely relaunch an RFP in the next two years to increase the private debt segment again with a focus on diversifying across vintages and pushing the allocation to 3 per cent of assets under management over the next 3-5 years.

The move is a consequence of a combination of factors, he explains.

On one hand, building out the allocation to illiquid assets is due to compelling opportunities in private debt as fixed income as a whole becomes more attractive. After years in the doldrums, yield to maturities are more attractive and investment grade corporate bonds offer decent returns. A conservative risk profile means the fund has a large, diversified, fixed income allocation of 56 per cent. Equity accounts for 26 per cent of AUM, real assets 15 per cent and gold 3 per cent.

On the other, the move is due to an unexpected swelling of assets under management at the pension fund because of social security reforms. From 2017, assets under management were expected to steadily decrease as compenswiss entered run off mode. Now assets are expected to increase over the next 5-6 years by around $10 billion before they decrease again, offering a window to invest more in illiquid markets.

“The liquidation of assets has been significantly postponed and we can invest more in private assets to capture that illiquidity premium,” says Juliano.

As to what other illiquid assets will be added to the allocation remains under wraps. “We are exploring how comfortable we feel [with more illiquid assets] and determining what contributes more to the portfolio. There is room to go up more.”

Gold

Gold, an allocation that now replaces a broader commodities portfolio, has given the portfolio a recent sheen.  Juliano likes gold because it is “anti-fragile” so that when inflation spikes it lends support.  “Gold is a really good diversifier from a portfolio construction perspective,” he says, explaining that gold does best just after inflation has spiked and just before central banks start to hike rates. “When inflation surprises, the first reaction on gold is usually good.”

Over his tenure, Juliano has steadily increased internal investment capability at compenswiss with around half the portfolio run internally including most of the fixed income and local equity allocation. An 18-person team comprises eleven portfolio managers, and smaller teams involved in portfolio construction, ESG and manager selection.

The focus on internal management has driven costs lower. But in a counterbalance, onboarding costly strategies in private markets will see costs creep higher. Not only are private assets more expensive, due diligence requires that external managers have a strong commitment to resources, efficiency and good risk adjusted performance.

“People won’t work for us for free. You have to pay for what you get.”

The asset allocation of the $63 billion Maryland State Retirement and Pension System is “better than a 60:40” protecting the fund on the downside. But now CIO Andrew Palmer is looking at the allocation in the context of cash rates persistently at 4 per cent, what that means for various asset classes and how the fund should be allocating accordingly.

The asset allocation of the $63 billion Maryland State Retirement and Pension System “is working” according to its chief investment officer Andrew Palmer with the fund producing a relatively good year of returns despite the market conditions.

The fund’s asset allocation is “better than a 60:40” according to Palmer with the asset mix specifically protecting the fund on the downside.

The long-term strategic asset allocation is 34 per cent public equities, 21 per cent rate sensitive assets, 16 per cent private equity, 8 per cent credit/debt strategies, 15 per cent real assets, and 6 per cent absolute return, designed to produce greater protection during short-term market volatility.

In fiscal year 2022 the portfolio returned -2.97 per cent, net of fees, which was well below the 6.80 per cent assumed actuarial return rate but ahead of the plan’s policy benchmark of -3.48 per cent.

“Returns relative to risks are very good. That’s what we are aiming for. We can always get higher returns by taking more risk,” says Palmer in an interview with Top1000funds.com.

“The high allocation to private markets has worked well over the past year, although with recovering public markets it’s holding us back a bit this year.”

The fund continues to tweak its allocations and is making some changes around the edges, including winding back allocations to emerging markets and bond protection over the next year or so.

Emerging markets has made up about 7.5 per cent of the total public equities allocation, and an asset allocation discussion in February specifically focused on China.

“When we made our move into emerging markets, China was a small part of that allocation now China is 40 per cent of EM equities,” Palmer says, adding that after an evaluation of the return expectations the fund has decided to wind back emerging markets and a lot of that is due to the outlook for China.

“Among EM we think China will have a lower return expectation than the rest of emerging market and developed market stocks and we think we should have a premium for investing in China equities,” he says.

The adjustment over the next two years will rebalance towards US equities (6-10 per cent).

“We think returns are broadly higher respectively in public markets now, so we can move back to less risky stocks,” Palmer says.

Biggest risks in the portfolio

While Palmer is clear that any investment decisions are based on risk /return assessments and not politics, he is aware of the geopolitical risks to the portfolio.

“The biggest thing we should be advocating for is China and the US to figure out their differences,” he says. “Biden and McCarthy need to figure out the debt negotiations and then China and the US need to respect each others’ sovereignty and look at the bigger things they can work together on, such as climate change, and partner together to be more impactful. This will take a reset.”

As part of a recent risk assessment of the portfolio by a large investment bank, scenario analysis looked at the impact of an invasion of Taiwan by China and the possible US reaction to that.

“With a Ukraine-like reaction by the US we would see a fall in the portfolio of 8 per cent immediately,” Palmer says. “If we reduce our exposure to China from 10 to 5 per cent then we can reduce that to a 7.5 per cent loss. There is so much interconnectivity because of the impact on global growth and inflation, the interruption to global trade is orders of magnitude bigger than Russia.”

Scenario analysis of various risks is a contributor to asset allocation changes for the fund and Palmer also points to climate risk analysis as a driver of the decrease in the absolute returns portfolio and an increase in infrastructure and natural resources a few years ago.

In 2015 when Palmer joined the fund as CIO the absolute returns allocation was 16 per cent, now it’s down to 6 per cent.

“A couple of years ago we shifted the absolute returns portfolio from 8 to 6 per cent and moved it into natural resources and infrastructure. The return scheme is diversifying but not sensitive to inflation and we wanted to add inflation sensitivity,” he says, adding he is still worried about inflation.

“After the financial crisis the central banks were fighting against deflation and fiscal stimulus that ended up driving the inflationary impulse. We are going to have a similar problem on the other side, to get inflation back down. It will be hard for them to get it materially lower,” he says. “The Fed has done a fair amount and needs to let it work a little bit. They were late to this, they should have been tightening when the government was stimulating.”

Recognising that all asset class teams do things differently when it comes to climate risk, one of the key projects at the fund is to coordinate efforts across asset classes to drive more effective practice.

Using the Alladin risk system to evaluate risks and build functionality to identify, reduce, and hedge climate risks Maryland is also incorporating an engagement program by first identifying the most effective places to engage.

“The focus for the next year or so is to build that out,” Palmer says.

Looking forward from a top-down perspective, the team is assessing the performance of non-zero cash rates and what that means for the portfolio.

“We are trying to earn 6.8 per cent and if you can earn 4 per cent on cash what does it mean for other asset classes and what should our return hurdles be for those,” Palmer says. “If an infrastructure manager is earning 2 per cent over cash and the money is locked up why is that exciting for us?”

Palmer still sees a lot of value in the private world and a differentiation of investments that can’t be replicated in the public space. But he wants to make sure the tradeoff is clear.

“It really depends on how permanent this non zero cash rate of 3-4 per cent will be,” he says.

Like many large pension funds, British Columbia Investment Management Corporation, BCI, the $211.1 billion asset manager for around 30 Canadian pension funds and insurers, has steadily internalised asset management over the years.

Now BCI’s reduced reliance on external managers requires a similar in-house approach to ESG and sustainability that is also bespoke, expert, consistent and controlled. Enter Jennifer Coulson, BCI’s first global head of ESG, recently promoted to the new position.

Coulson joined BCI eleven years ago as part of the public equity team, back when ESG strategy was primarily focused on voting, engagement and public policy, and BCI had little in-house management.

Today a total portfolio programme built on four pillars (invest, integrate, insight and influence) seeks to capture ESG opportunities and manage risks in a nuanced and fast-changing environment where the benefits of internal management are manifold. “As our assets have been internalised, our focus has shifted to ESG integration through a comprehensive corporate-wide programme,” she says.

For example, managing assets internally has allowed BCI to integrate ESG at the ground level across all asset classes, bringing complete control of the process.

“We really love the flexibility of being able to design something that is a fit for us,” says Coulson. “It is about the flexibility of doing it internally and doing it how we want. We don’t have to continually go back to an external manager, who will have several clients that they need to accommodate, with our expectations.”

Working with global frameworks like SASB and ISSB provides essential tools for the team. But BCI also takes pride in pursuing and developing its own, bespoke processes. For example, it has created an ESG risk and opportunity framework that involves comprehensive scenario planning for systemic issues like climate change across different sectors, revealing how an asset will behave based on BCI’s own underlying assumptions.

These internal models provide full granularity, she continues. “It helps us at a total portfolio level to see if we are getting too much exposure in one area and not enough in another.”

Elsewhere, BCI has partnered with Dutch investors PGGM and APG, as well as AustralianSuper, to develop the AI-powered Sustainable Development Investments Asset Owner Platform, SDI AOP.

total portfolio approach

As BCI grows its internal ESG expertise, how to structure integration has been front of mind. In a total portfolio approach, ESG professionals are embedded into each asset class across the fund, fully aligned with asset class teams and investment committee members making decisions.

This approach replaces a previous system she describes as “de-centralised” whereby members of the different asset class teams would call on the ESG team for expertise.

“Now the ESG perspective is within the asset class,” she says, describing one of her roles as providing an overarching consistency, bringing the 16-person team of which she has 5 direct reports together to function as a cohesive unit.

Another part of the role involves ensuring that ESG is treated differently in different asset classes. ESG due diligence on an infrastructure asset, that the fund might own for 30 years and is vulnerable to physical climate change, will differ from analysis of a liquid asset that is easy to sell.

“ESG integration looks different in fixed income than infrastructure or equities given the varying investment horizons and the physical nature of the asset,” she explains. “We are trying to create something that provides consistency, but which is also sensitive to the realities of the asset class.”

Private market nuance

ESG also looks different in private markets. And because most of her expertise lies in public markets, managing ESG integration in BCI’s private markets, where the investor still uses external partners, has been a new experience.

She is particularly focused on working with GPs and portfolio companies to ensure they understand BCI’s expectations in a joint effort between her team and people in those asset classes looking after the relationships.

She is also focused on bringing real consistency to manager selection in private markets. Strategies include careful assessment prior to onboarding and regular monitoring as well as tracking managers committed to the Principles of Responsible Investment – around 80 per cent of BCI’s managers in private markets have signed the PRI.

She notes that in many cases, engagement in private markets is quicker.

“As an owner in private markets, you can get into a room together and present a case; show how it would add value, and implement it, pretty much right away.”

That compared to public markets where it takes time for investors to build relationships with the company, ensure they understand the business and where (because these companies are accountable to more shareholders and stakeholders) discussions never comprise just one conversation.

BCI’s engagement program is run around KPIs where it uses specific indicators to measure corporate performance around, say, climate or diversity and can chart the change in the numbers over time. “We are aware that engagement takes time. It is not a silver bullet; it takes time and persistence to do it well and it means we have to put actions behind our words and really invest in engagement.”

Increasingly her focus is turning to policy engagement too.

“When you advocate at the policy level you are lifting all boats. If you go straight to the regulator, you can achieve widespread change and we are spending more time on this,” she says. “We will continue to push on the regulatory front to try to ensure governments hit the appropriate targets and push companies to innovate and invest in research and development. The transition involves everyone, but governments must set the tone.”

In one high profile example, BCI is currently engaging with Ontario Securities Commission (OSC) and other regulators to improve corporate disclosure, requesting companies on the exchange publish diversity statistics of their board members beyond just gender.

The investor can’t implement its proxy guidelines and enforce expectations if it doesn’t have this disclosure from companies, explains Coulson. “We can’t judge if a director is from a minority or not; it needs to come from the company.”

BCI has contributed to an ongoing consultation process around better disclosure at an Ontario, BC, and federal level. Progress to date includes new regulations like the Canada Business Corporations Act now demanding better corporate disclosure, although only for a subset of companies.

Will that be extended? “I am hopeful we will get greater disclosure,” she says. “It is hard for them not to do something in this space. It is just a question of how specific it will be, but we are going to push for specificity.”

Hard won, slow victories amount to big rewards in the role, but she reflects that although some elements of ESG have got easier over the years (like the availability of data for larger and private companies) it is still fraught with complexity. Like the constant evolution of tools and methodologies that don’t always make ESG easier. “Keeping up with the pace [of change] is very challenging,” she says.

“For me, ESG is just part of the investment process,” she concludes. “We are not here trying to take on a specific issue; we are doing everything in the best interest of our clients from a financial standpoint. In terms of managing risk and capturing opportunities, ESG is still financially material and not looking in this area would be imprudent.”

Kosovo, a small country in south-eastern Europe that emerged as an independent state after the Balkan conflict, plans to create a sovereign development fund, SDF, the first of its kind in the region.

The SDF, distinct from sovereign wealth funds set up by resource-rich countries to manage and ring fence surplus revenues, will act like a strategic investor in the Kosovan economy, tasked with transforming unprofitable state-run industries and attracting foreign investment into one of Europe’s poorest corners.

It is the latest country to establish a sovereign fund in a growing trend that has seen the number of funds jump fivefold from 20 to approximately 100 over the last 20 years.

“Kosovo has not done well in terms of attracting foreign investment,” explains Besnik Pula, associate professor of political science at Virginia Tech, the US university, who as chair of the working group behind the launch of the fund has helped shape its key objectives, institutional design and purpose, the details of which now await parliamentary approval. “With this fund there will be more certainty and security to invest in Kosovo.”

Kosovo’s SDF is modelled on Ireland’s €9.5 billion ($10.2 billion) Strategic Investment Fund (ISIF), established in 2014 with a double bottom line to both invest commercially and support economic activity and employment in Ireland, explains Pula.  The team have also drawn inspiration from the Slovenian Sovereign Holding, asset manager of Slovenia’s state’s holdings, and Greece’s similarly structured Hellenic Corporation of Assets and Participations.

Under the current plan, the government will seed the fund with a €20 million investment. Next, Kosovo’s state-run energy, telecom and mining groups (Trepča Mines, Kosovo Energy Corp and Telecom of Kosovo) will be absorbed into the fund, becoming its first asset base.

“A series of companies will form the base of the fund in addition to the investment the government will make,” he says. “Since independence, these enterprises have not been managed or governed successfully but there is great potential for these sectors. The idea is to incorporate these industries into the fund’s asset base and lead the development of these sectors of the economy.”

In time, additional assets will also come under the fund’s management umbrella, fed via Kosovo’s privatization agency and likely to include real estate and agricultural assets.

Once these companies are restructured, and management overhauled, the hope is foreign investment will follow. “The second step would involve opening up these companies for equity investment and introducing foreign investment into these sectors,” explains Pula. The fund would also be able to establish new companies, offering the potential for co-investment with foreign investors.

So far the team have talked mostly with peer funds and developmental banks like the EBRD and World Bank. The conversation is still focused on the best model, rather than pitching to investors, he says. “We want to make sure we have a structure in place before we reach out to investors and offer particular opportunities,” he says.

Still, conversations with peer funds can lead to investment under some SDF models. For example, India’s government-seeded National Investment and Infrastructure Fund, NIFF, has tapped a rich seam of investment from fellow sovereign investors including Abu Dhabi Investment Authority and Temasek.

Governance

Pula and the team are also laying governance foundations, designed to keep political influence at arms length. “It is a high priority to create a fund that is not under the political influence of the government,” he says. Kosovo’s parliament will monitor and supervise the fund, also responsible for appointing an independent supervisory board with ultimate control. The board will appoint a CEO and executive structure, and the investment strategy will be established and managed by these fund executives.

“Once the law is passed, hopefully everything will quickly move to a more concrete stage,” he concludes. “This is the first fund of its type in the western Balkans and if it succeeds it could be a model for other countries like Montenegro, Albania and Northern Macedonia. Our neighbours are taking an interest in what we are doing and if we succeed, more countries will follow suit.”

Kosovo declared independence from neighbouring Serbia in 2008. Serbia (plus a handful of EU countries) still doesn’t recognise its former province as independent.

 

 

 

Visible positioning on the inclusion of women and minoritized groups in financial services and investment management is now the norm.

Much has changed in a decade to improve upon diversity and inclusion in finance, and is wonderfully portrayed by “Fearless Girl”  and her statuary presence on Wall Street.  Many financial and investment firms have positioned themselves as advocates for gender and racial diversity across not just finance but throughout corporate America for years. But, as we all know, positioning and doing are two distinct things.

Initially “Fearless G,” as we now call her, was defiantly staring down the Charging Bull statue near Battery Park in New York’s Financial District. The statue was installed on March 7, 2017, in tribute to International Women’s Day and ever since has attracted ever-expanding interpretations of her purpose and import. To us, at least, she is more than a tip of the hat to International Women’s Day.

On our data, women represent just 19 per cent of CFA Institute members globally – often seen as a proxy for the investment industry – and only 17 per cent in the US. We are actively committed to changing these metrics.

Fearless G has since relocated to her new location across from the New York Stock Exchange, just a couple of blocks away from her original perch. Now she glares at Wall Street personified, the iconic stock exchange building located at the corner of Broad and Wall streets in New York, where her rebel with a cause symbolism has become even more pronounced.

Many feel she embodies a glass-ceiling protest in the financial services sector where women and other underrepresented populations have faced long and continuing barriers to promotion, equal opportunity, and equal pay.  To us at least, while it’s clear that Fearless G has more work to do, we think she shouldn’t have to do it alone.

According to 2023 figures reported in the Pensions & Investments publication, the use of money management firms owned by women, minorities, people with disabilities and veterans (WMDV) by the top 200 US retirement plans is exceedingly small. Of the top 200 defined benefit pensions surveyed for 2023, only 22 funds reported WMDV allocations, amounting to AUM of around $130 billion. It sounds sizeable and it is an increase over the $120 billion reported in 2022. Yet, when compared to a total AUM at these pensions of over $3.32 trillion – it is scarcely 3 per cent of pension assets held by the top 200 funds.

While progress has been slow in advancing the aim of diversity, equity, and inclusion in finance, many pension executives are affirming a commitment and focus on allocations to diverse managers. Actions have included the adoption of formal diversity hiring policies at funds as well as the addition of diversity and inclusion factors in every manager search process. Importantly, these plan executives are quick to point out these hires are not an affirmative-action plan for the pension fund but are an acknowledgment that a diverse pool of asset managers can reduce volatility as it increases cognitive diversity, portfolio diversification and alpha opportunities.

Beyond diverse management and ownership of firms lies the more foundational matter of ensuring that the broader employee base in the investment management and financial services industry is becoming more inclusive and diverse in its make-up. Human resource departments across a wide range of employers have worked at varying paces to build a more diversified work force for decades. But progress depends in large part on a range of factors including the available candidate pool, the size of firms and a level of dedication in the C-suite to race, culture, and gender diversity.

Based on the work we have done at CFA Institute with a wide range of asset owners, asset holders and other market participants, we lay out a few basic principles for expanding a diverse pool of employees and prospects that are vital to the investment industry’s long-term success.

First, ensuring that all aspects of hiring practice are equitable and inclusive, from university graduate recruitment to experienced hires and senior roles, is critical to improving diversity.

Second, the aspects of promotion and retention are key features of an effective diversity plan that are often overlooked. Firms that ensure access to training, new opportunities, and initiate performance appraisal processes that seek to improve diversity are key to building employee visibility and experience. The principle of retention involves designing and maintaining inclusive support systems, such as mentorship and sponsorship, work–life accommodations, and efforts to eliminate harassment, which can be a principal cause of departure.

Third, the attributes of firm leadership are key in the diversity equation. If leadership sets clear diversity expectations for inclusive behavior and then modelsthat behavior, they establish a culture that becomes embedded and supported. To drive progress, leadership itself must be diverse, inclusive, accountable to stakeholders, and trained to manage and lead diverse teams at all operational levels within the organization.

more action needed

We should be proud of the progress we are making, but it is safe to say that Wall Street diversity and inclusion is still a work-in-progress.

We are encouraged, however, that signs are everywhere that this has become far more than a talking point.

Women are now 28 per cent of CFA candidates in the US, those just starting out in their careers, 33 per cent pre-pandemic. Not enough, but back on an improving trend.

Now, progress is being supported by the growing influences of investment management clients and the consumers of other financial services that have the ability to urge principles and practices that promote greater diversity within the industry.

Whether it is diversity of financial firm ownership, within the firm’s leadership team or among the firm’s rank-and-file employee base, Fearless G’s steady gaze must persist.

Sarah Maynard is global senior head of diversity, equity and inclusion and Paul Andrews is managing director of research, advocacy, and standards at CFA Institute.

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.”

Challenging environment

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.”