We don’t have a target for alternatives in general. Rather, we have an allocation to infrastructure of 10%. That is our policy allocation, but it’s going to take us awhile to get there. Our current actual allocation is approximately 2.0%. Infrastructure is the only allocation to alternatives we have right now, but we’ve looked at others and will continue to do so.
Why the focus on infrastructure?
Our primary objective is to have higher risk-adjusted returns. From an investment perspective, infrastructure is expected to have very attractive characteristics—low correlation with other asset classes, stable and predictable long-term cash flows, low bond-like volatility and equity-like returns. Also, it brings inflation-adjusted revenues. There are a lot of great characteristics in infrastructure—it’s almost tailor-made for pension funds.
How have you invested?
We’re invested in infrastructure through funds. We do not have the internal resources to do deals involved in direct investment.
What drove you to make a commitment to infrastructure?
In addition to the other positive characteristics, infrastructure is attractive to us because it’s a real asset. Some other investments that are classified as alternatives, such as hedge funds, are very sketchy. The value of the asset base underneath is questionable and fleeting at best. Even if the capital markets are struggling, there is still a real asset underlying an infrastructure investment—there’s something that has value. Certainly, there is always a risk that we may not achieve our return targets, but it’s very unlikely that we would not get our capital back.
Which other alternatives have you considered or are you still considering?
Hedge funds are still being considered, but we are not yet comfortable with them—primarily because of the lack of transparency. We won’t be investing in them in the near-term. We won’t be investing in private equity or real estate, either.
Why aren’t you planning allocations to private equity and real estate?
Because we see infrastructure as a hybrid between the two. If we were a huge megafund and needed to diversify on that level, then we would have them. However, we don’t have the resources—we don’t even have the assets behind us to invest in all of those areas—so we determined that infrastructure is a good hybrid of real estate and private equity. It kills two birds with one stone, so to speak.
Have you looked at other hybrid approaches such as 130/30?
We’re looking at them, but we haven’t made any decisions yet. Are there any other alternatives that you considered but passed on? Other areas we looked at and didn’t follow up on were a dedicated emerging markets mandate, commodities and foreign small cap. We rejected them because they were either too high risk or too difficult to implement given our resources.
What challenges have you faced in increasing your allocations to infrastructure?
Finding managers is always a challenge in infrastructure, so we are making our commitment in two phases. In the first phase, we committed a significant portion of our allocation to large global diversified infrastructure funds. Now, for phase two, we’re in the process of looking for smaller niche infrastructure managers based in Canada who, preferably, will invest in Canada.
What makes Canadian infrastructure so attractive?
We’re Canadian, and it’s close to home—that’s part of it. I also think that, in the general infrastructure space, there are many investment opportunities in Canada. At the same time, for infrastructure investments, the political climate, the stability of the markets and the regulatory environment are all really important factors.
From that perspective, Canada is a great place to invest. It’s much more stable than, for example, Bolivia or Russia, where there might be a lot of opportunities, but we’re not going to invest there because it’s too unstable. We know Canada, and we are familiar with it. There are so many opportunities here that there’s no reason not to invest in them.
Does infrastructure investment require anything different on the risk management side?
Infrastructure is different from a “know-what-you’re-buying” perspective. A lot more due diligence is required upfront to ensure that we know what we are buying. From my experience, every single infrastructure fund is different. Differences include the legal structure being proposed, the projects they’re going to invest in, the geography, the sectors, the size of the organization and how they make their investment decisions. They’re all different, so you need to really understand and make sure each fund meets your needs and the objectives you’re trying to achieve.
We’ve also had to do a lot more work on the legal side in reviewing the fund structures. They’re limited partnerships, so the acquisition process is much more rigorous from a legal perspective. We’ve also had to do much more accounting and monitoring internally because the communication with the custodian is very different than it is for publicly traded investments.
Down the road, do you think the fund will increase its commitment to alternatives above 10%?
I don’t want to speculate, but it’s certainly a possibility. Our fund has an absolute return objective and many alternative investments have absolute return objectives as well, as opposed to traditional investments with return objectives relative to an index. So alternatives could be a good match for our fund to reach its investment objectives, as long as the appropriate risks are taken into consideration and evaluated.
Do you have any advice for other plan sponsors moving into the alternatives space?
I’d reiterate that every investment and every pension fund is different. In particular, each pension fund has a different governance structure. That means, plan sponsors need to ensure that the decision-makers responsible for approving allocations understand what it is they are being asked to approve. And the decision- makers need to make sure that they understand what they’re investing in, and that it meets their objectives.
If you have a lay board, as many pension funds do, then you are likely dealing with intelligent people who aren’t necessarily experienced in financial instruments. When you start talking about shorting, hedge funds, derivatives and commodities, these are topics they are not familiar with. Educating the decision-makers is extremely important.
Caroline Cakebread is the editor of Canadian Investment Review. caroline.cakebread@rogers.com
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