Infrastructure Investments: A Group Thing
Part 2 of our coverage of the Investment Innovation Conference.
BY Caroline Cakebread | April 24, 2012
Infrastructure is one long-term asset class that is well-suited to meeting the long-term liabilities of pension funds. However, it has traditionally been available to the largest pension funds only, those with the capital and contacts to access the best deals. In Canada, however, a new consortium approach has given a handful of smaller pension funds a leg up in the growing infrastructure space.
Two delegates at Canadian Investment Review’s 2011 Investment Innovation Conference shared their experience with using the consortium model to access infrastructure. Presenters Terri Troy, CEO with Halifax Regional Municipality Pension Plan, and Dan Goguen, head of private investments with New Brunswick Investment Management Corp., presented on how their group of pension plans pooled their money together to invest alongside the Canada Pension Plan Investment Board (CPPIB). The group banded together for two recent infrastructure deals, including an interest in the 407 toll road in Toronto.
“Infrastructure is an important asset class for us because the assets are long term and a good match for long-term pension liabilities,” Troy explained. “With high barriers to entry, these assets bring stable cash yields, and are often indexed to inflation.”
The CPPIB deal looked like a great opportunity, but with a minimum ticket size of $100 million, it was out of the range of Troy’s plans. She, along with other like-minded pension plans, pooled their resources to reach the $100 million mark.
Today, consortium members are working with the CPPIB as a partner in this investment. The concept is working well and the investment partners are working on other deals together.
The theme of volatility emerged again with Andrew Marchese, head of Canadian equities and portfolio manager with Pyramis Global Advisors. His presentation, “Market-Neutral Investing: A Canadian Perspective,” focused on how market-neutral strategies can be used to mitigate volatility risk.
“Consider that between 1990 and 2005, the standard deviation of market-neutral returns ranged from 3.1% to 3.9%, depending on the arbitrage strategy used by the portfolio manager,” Marchese explained. “Compare that to the S&P 500 during the same period, with a standard deviation of returns at about 14.4% (and nearly 18% for the TSX). These indices also tended to have much lower Sharpe ratios over the same period.”
However, in the Canadian context, a traditional market-neutral approach is a bit tougher to execute than in other markets. This is primarily because the market is highly concentrated in a handful of sectors.
“What makes the Canadian market truly unique is the role that sectors play. Canada’s equity market is highly concentrated in just three—energy, materials and financials—and there isn’t much liquidity in between,” Marchese said.
A market-neutral approach to Canada must therefore be “sector neutral,” he explained, going beyond energy, financials and materials and looking at the performance of “super sectors” that better reflect the fundamentals of the Canadian market.
As plan sponsors continue to manage volatility in poor markets, some of the traditional tools they have turned to have been rendered obsolete—especially Modern Portfolio Theory, a staple of investment management that today has become all but useless for pension funds. In fact, it can be downright harmful to their health, according to presenter Thomas Schneeweis, Michael and Cheryl Philipp professor of finance and director of the Center for International Securities and Derivatives Markets, Isenberg School of Management, University of Massachusetts-Amherst.
His presentation, “Post-Modern Asset Allocation—A Risk-Based Analysis,” tackled Modern Portfolio Theory, which he believes is based on the wrong assets and correlations, which relate to outdated, 1950s market conditions.
While some pension funds understand this, Shneeweis warned that many still cling to the tenets of the theory simply because teaching textbooks are filled with assumptions based on it.
Until something changes, it’s going to remain the dominant paradigm, even though it no longer applies to a changed marketplace.