Guest Post: A Closer Look at PSP’s FY 2009 Results

Submitted by Leo Kolivakis, publisher of Pension Pulse.

Last week, I reported on PSP Investments’ terrible 23% loss in FY 2009. I think it is worth going over the FY 2009 annual report to try to understand where they lost money.

Let’s begin on page 4, the Chair’s report, where Mr. Cantor states the following:

Our continuing diversification could not entirely shelter PSP Investments from the worst effects of the financial crisis. PSP Investments recorded a 22.7% loss during fiscal year 2009. We continue to believe that our portfolio represents solid long-term value and we expect our unrealized losses to recover when markets eventually return to health.

A critical question is how is PSP Investments positioned to respond to what happens next? For the next 21 years, PSP Investments’ inflow of funds is expected to exceed our obligations to pensioners. Unlike many funds, we have no pressing short-term obligations to pensioners that will force us to sell assets today at distressed prices. In this highly fluid and uncertain market environment, it is extremely important to remain patient and grounded in our decision making if we are to take advantage of our substantial liquidity for the benefit of our stakeholders. To do so, it is critical that we move ahead on our goals and objectives.

Could not entirely shelter PSP? Mr. Cantor, PSP got whacked in FY 2009 as diversification failed miserably (except for government bonds)! The Fund underperformed its policy portfolio by 5.1% (-22.7% vs. -17.6%; click on image above to view results). This isn’t just a bad year; it’s a disaster.

Yes, PSP will have inflows over the next 21 years but if you continue losing these amounts, it will take you many years before you recoup those losses. In the meantime, I guess you can continue compensating your senior managers the big bucks based on some “soft objectives”.

On page 5, you state:

PSP Investments’ Compensation Policy is designed to attract and retain talented employees, reward performance and reinforce our business strategies and priorities. As is the case throughout the investment industry, variable incentive compensation is the most important component of the total compensation offered to executives and portfolio managers.

Attract and retain talented employees? I know of a few who warned you about the credit crisis and the failure of diversification but they were let go on dubious grounds. What exactly was the turnover rate at PSP Investments in the last five years and what were the key departures at the senior management level over that period?

Let’s move on to the President’s report. On page 7, Mr. Fyfe opens up by stating:

After three years of first quartile performance amongst large Canadian Pension Plans, outperformance is lagging that of our peers in fiscal year 2009. Our four-year average, on the other hand, remains at the median when compared to our peers.

Ah, the old peer argument. When you are wrong, seek refuge with the rest of the pension herd who performed miserably. Well not all your peers were chasing alpha in high risk assets. Some of them had the foresight to protect their downside risk by investing in bonds. And none of PSP’s peers underperformed their policy portfolio by a whopping 5%.

On that last point, Mr. Fyfe states the following on page 8:

Our Policy Portfolio’s benchmark had a return of negative 17.6%, primarily as result of the sharp decline in global public equity markets. While we are disappointed with our relative performance, our underperformance is mainly attributable to additional write-downs on our asset-backed commercial paper and collateralized debt obligations investments which impacted our total return by negative 3.0%. Our Real Estate portfolio, with an annual return of negative 16.8% also underperformed its benchmark of positive 6.6%, impacting our relative return by negative 2.4%. Over a five-year period, our Real Estate portfolio has recorded an annualized return of 9.3%, outperforming its benchmark by 2.2%.

So 3% of that 5% underperformance relative to the Policy Portfolio came from their asset-backed commercial paper (1%) and collateralized debt obligations (2%). Interestingly, there was no mention of the credit portfolio losses in the highlights of the report. When I went over FY 2008 losses last year, I noted the following statement from PSP’s president:

There are very little, if any, credit losses in both ABCP and CDOs and the possibility of recovering the nominal investment value in a subsequent period is probable if general credit conditions improve. The losses were not allocated to any particular asset class but are included in PSP Investments’ total return.

Oops, general conditions did not really improve and they had to write these assets down further. But hey, no worries, these assets were not allocated to any particular asset class so nobody is responsible for that investment blunder!

Moreover, why does PSP insist on using the politically palatable term “collateralized debt obligation” portfolio when Diane Urquhart clearly demonstrated that PSP was taking undue risks selling credit default swaps?

But 2.2% of the underperformance was attributable to the -16.8% return in the Real Estate portfolio. Wow, what a shocker! Back in 2005, when I was still employed at PSP, I remember sending an article to the then First VP Real Estate, André Collin, and senior management, on how Tom Barrack, the world’s best real estate investor, was cashing out.

My actions drew an irate response from Mr. Collin, but I trusted my judgment and Mr. Barrack a lot more than I trusted Mr. Collin. There was something that Mr. Barrack said that still rings true today: “There’s too much money chasing too few good deals, with too much debt and too few brains.”

And where is Mr. Collin today? He is long gone from PSP Investments after cashing in on a couple of exceptional years where he handily beat his bogus benchmark. He signed off and left the organization right before the real estate crisis hit. It would be interesting to know exactly why he left PSP and where he landed after reaping a few million dollars in bonuses.

Let’s go back to Mr. Fyfe’s comments on page 8 on the FY 2009 annual report:

Private Market investments had a positive impact on overall results as they outperformed public equities. For instance, our Infrastructure portfolio, the result of our diversification strategy which began in 2004, recorded a positive return of 6.0% outperforming its benchmark of 5.8% for a three-year return (since inception) of 5.5%, 2.2% above its benchmark. Private Equity returned negative 32.3% below its benchmark of negative 31.6% for the year, but is outperforming its benchmark by 0.6% since inception.

Our Private Market investments suffered from fair-value or mark-to-market adjustments which require us to value our assets as if they were for sale as of March 31, 2009. We continue to hold effectively all of the investments for which we have recorded unrealized losses and remain confident in the quality of our assets. In a period when there are few buyers and weak sellers as well as limited transactions, we have to value our private market assets as if they had to be sold during the crisis and in a market with very few comparables. As long-term investors with no pressure to sell our investments in the short term, we measure the progress of our investments by improvements in the fundamentals such as cash flows and earnings. Our principal private market assets are continuing to perform well and according to plan.

And which plan is this? Because from my vantage point, private markets remain vulnerable to further downside risks. Private equity is in a deep freeze and the amount of troubled U.S. commercial real estate loans may double to $100 billion by year end as delinquencies rise and financing remains hard to find. Infrastructure deals are also getting pricey as more pension funds pile into this asset class.

Bottom line: there really is no plan when it comes to private markets. Moreover, PSP still refuses to publish its benchmarks for private markets citing “competitive reasons”. What competitive reasons? Are they afraid someone will poach all their “top talent” away?

But let me not be too cynical, after all, PSP has 21 years to go where their inflow of funds is expected to exceed their obligations to pensioners. By that time, all of the current senior managers will be long gone with enough money to enjoy a golden retirement.