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Institutional investor profile: Mark Weisdorf, Vice President, Private Market Investments, CPP Investment Board

Weisdorf on investing over truly long-term horizons, on putting together a totally new portfolio, on why CPPIB wants to disclose information on its private equity investments and on the subject of diversification.

Created in 1998 and based in Toronto, the Canada Pension Plan Investment Board is an independent investment organisation that manages the excess of contributions to Canada's national pension scheme over current benefit payments. The board currently manages C$17bn, although this is likely to increase to C$85bn over the next three years. It decided in June 2001 to invest up to ten per cent of its total assets in private equity and has since committed C$5bn to venture capital, buy-out and secondaries funds across North America and Western Europe. Weisdorf joined the board in 2000 and previously held senior positions at HSBC Securities (Canada), CIBC World Markets, and Merrill Lynch Canada. He is also on the board of the Institutional Limited Partners Association and chair of its Research, Benchmarking and Standards Committee.

Why do you invest in private equity?
‘Our decision to invest in private equity reflects the fact that we have a very long-term investment horizon. We are different from many other investors in the respect that we are not a pension fund and so we do not manage liabilities - that's what the CPP does. Unlike most investors, we do not have current obligations and our capital will not be called on for many years to come. Our purpose is to invest CPP's surplus assets. At the moment CPP is receiving more in contributions than it is paying out in retirement benefits. But with demographic change, the situation is likely to reverse in 20 or 25 years' time. Our job is to invest money, over the long term, to produce returns that will be sufficient to meet the CPP's future liabilities. In some ways, we're like an endowment fund or a foundation. As a result, we're more focused on re-investment risk than liquidity risk.

‘These factors, plus a number of others, led us to conclude after a year of research that investments in private markets (real estate, infrastructure, private equity and anything else that is not publicly traded) should make up up to 15 per cent of our total investments, which includes ten per cent going to private equity. Having said that, we don't have a target of investing ten per cent in private equity - it just means that we are able to go up to ten per cent.

‘We feel that this is a good way to start and we will reassess our allocation every year. If we find enough opportunities to put the capital out, then we may find that, in five years' time, we increase our allocation. Equally, if we feel that there aren't sufficient opportunities to warrant that allocation, we may reduce it. Simply because we have an allocation and a growing pool of capital doesn't mean that we will commit. There have to be excellent funds raising money that we believe will produce first-quartile results. The economic conditions also have to be right for investing in private equity.'

What type of investments do you tend to look for?
‘We invest across the whole private equity spectrum and have decided to seek some diversification. We look for investments in North America and Western Europe and try to have some balance between the regions - although we don't have a specific numerical constraint on this. Within those regions, we look for buy-out and venture capital fund investments. Again, there is no set allocation to these sub-types. But we have said that, when the portfolio settles down and is built out, we'd like to have at least 30 per cent in venture capital.

‘Beyond that, we look at all strategies, investment styles, and private equity types, including distressed, restructuring, turnaround and secondary funds. In fact, we have agreed that we can commit up to 25 per cent in the early years into secondaries. We have felt that secondary investments are sensible in the current environment, given that there is a significant supply of opportunities relative to demand. But we haven't committed as aggressively as we originally thought we would and they stand at around ten per cent of our private equity allocation. We have, however, found that restructuring and turnaround funds have offered greater opportunities than we first anticipated. That is the kind of fine-tuning that you have to do when you start investing.'

How do you put together your portfolio?
‘The overriding factor is that you need to work with the best managers in the best funds. Be opportunistic. We are not overly concerned if we are slightly overweight in one region or sector or style. We are a new investor with a new portfolio and so it will take four or five years before we have a balanced portfolio. We don't want to invest in funds because we have an allocation to a certain style, etc if the best GPs that follow that strategy are not available because they're not fundraising for another two or three years.

‘We have also decided that we do not want to be too strict in our allocation or diversification plans within our private equity portfolio. The reason for that is that we see private equity mainly as a source of enhanced return. We are not in private equity for diversification - we assume that private equity is quite highly correlated with public equity over the long term. So if we're in this to enhance our return, we don't want to limit our ability to achieve our objective by putting constraints on the way in which the portfolio is designed. We don't need diversification in private equity as much as we need diversification in the total portfolio, so we find it's more appropriate to rebalance in the public equity portfolio. Our focus is on CPPIB's total portfolio when we're looking at diversification.'

What do you look for in a private equity manager?
‘We look for the standard things. We look at track record, not just as individuals, but as a team. We look for discipline in terms of the manager not only knowing what they are good at, but also what they are not good at, while at the same time being able to adjust to changing market environments. We talk to the teams and to their portfolio companies to help us assess their past performance, but also to give us a view on how successful the fund will be in the future.

‘But over and above the standard things, we focus on two main areas. The first is whether the fund manager really adds value to the companies in their portfolio. We believe that there are a lot of smart financial people who are able to assess and negotiate good entry prices and negotiate the value on exit. But there are fewer GPs who can add value during the investment period. I'm not talking about people just sitting on a board. I'm looking for people with operational or strategic consulting expertise in a given industry. Have they been in that industry long enough to have built up a network and knowledge? Can they help recruit new management team members to a company? So we look at how a fund manager can add value to companies so that they can differentiate themselves from other sources of capital and be more attractive to the business owners and managers. We want to back GPs that are companies' first choice for capital.

‘The other is alignment of interests. That's a structuring issue in terms of the relationship between GP and LP. We want the management team to do well when we do well. We are less interested in funds that have become asset managers - they do quite well regardless of how well the portfolio does because they earn enough from their management fee. We're looking for general partners that have sufficient love of the business and conviction in their abilities to invest a significant portion of their net worth in the fund. If they aren't investing their own wealth in their own fund, then we'd like to know where they are putting their money that will give them a better return - we'd like to invest there, too.'

What is the biggest mistake that you've ever made?
‘Our portfolio is too young to have shown up any mistakes. We work hard to avoid mistakes, but inevitably we will make them - that's why we are building a portfolio. You can only assess your success over the longer term in private equity. One thing that works to our advantage is the fact that we were not investing in private equity in the late 1990s and 2000. We hadn't started then, so we managed to avoid the funds that are now suffering significant write-downs.

‘One thing is certain, though, and that is that the mistakes show up before the winners in private equity. If we have made any, I expect that they will show up in a year or two. But no-one should judge the performance of private equity on the early results. You can only assess that towards the end of the ten-year life of a fund.'

What is the biggest issue in private equity at the moment?
‘There are a few big issues. One of these is write-downs in the venture capital market. The fact is that a lot of investments were made at exorbitantly high prices. To be fair, this was not confined to venture capital - it was equally true of the public market. Many investors in these funds will suffer. They will be very fortunate if they get their capital back. The question is: how will that affect their appetite for venture capital in the future.

‘Succession and dislocation is another issue. This is not just confined to venture capital - it relates to all private equity. Many of the early general partners who have been in the business for up to 20 years are getting ready to retire. They have done well and they are of an age when they want to spend time on other things or the market environment is so challenging now that it's time for them to pass on the reins. You have younger folks spinning out and setting up their own funds or that are unhappy in the firms they are in. There is a lot of risk and uncertainty for investors to judge which GPs are stable and have their succession plans sorted out in such a way that they will retain the best and the brightest of the next generation. We also think that a lot of shops will close up. Many firms started in the late 1990s and some of those will disappear. They will not be able to raise a second fund. So there will be consolidation and restructuring in the industry and we will see some new leaders emerge in the market.

‘The third issue is reporting and disclosure and all the sub-issues that go along with those - valuation, accounting, reporting between GP and LP and ultimately reporting between LPs and their stakeholders. I don't subscribe to the view that the whole system is broken and needs to be fixed;  only that there are a lot of improvements that can be made. We can update, modernise and improve guidelines, standards and reporting practices. We can make the information more robust and we can bring the methods used by Europe and the US more in line with each other. During the heady days of 1998, 1999 and 2000, when things were going well, people didn't focus so much on issues that were considered mundane. But with valuations declining and fundraising more difficult and the transition that the industry is undergoing, the back office issues have started to come much more to the fore.'

You have committed to disclose the performance of your private equity portfolio. How have your GPs reacted?
‘We have agreements with our GPs to disclose information of interest to our stakeholders. We think it's important, as part of our commitment to transparency, that we keep our stakeholders informed. We believe that they should know who we have committed to, how much we have committed, how much has been drawn down, what distributions we have received and what the value is of our unrealised investments. It's important to ensure that we remain accountable to our stakeholders.

‘But there is so much work still to be done on valuation guidelines and accounting standards - even on the way in which IRRs are calculated. Given that best practices have not yet been agreed, we think that it is not that useful, and perhaps misleading, to calculate interim IRR numbers. We're also not doing that because we are so early on in our investments. We would like to give our stakeholders information on cash on cash IRRs rather than on unrealised investments - that's much more valuable and indicative of how the portfolio is performing. It's going to be five years or more before we can produce cash on cash IRRs.

‘We will be providing fund-level disclosure once we have cash on cash IRRs and once many of the comparability and best practices issues have been resolved.

‘We have agreed with our GPs that it is not appropriate to publish individual company figures. That simply hinders fund managers from maximising the value of their investments and so is detrimental to our returns and therefore to our stakeholders.'

How do you think that the market is likely to change in the future?
‘Transparency, disclosure and reporting will be much improved from that which exists today. There will be a lot fewer firms in five years' time than there are today. The industry is slowly but surely starting to mature. The last five years saw an explosion of new firms, established in an unusually positive environment. Over the next five years, we'll see which of those firms and the old established firms can withstand both the ups and the downs of the market cycle, and an extreme one at that. Those that perform well will be the ones that survive. That's exactly as it should be.'

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