The Exchanges

Q Great. Well, a lot of the subject of what we're going to talk about today relates to the Standards Board for Alternative Investments, and I know both of you have been involved for a while, and why don't we start with what this board is? So Mario, why don't you go ahead?

A The SBAI, which was formerly called HFSB, Edge Fund Standard Board, Is a neutral standard setting body for the alternative investment industry, and more specifically for hedge funds. We were covering a little more than hedge funds, but it's essentially for hedge funds. It's a not for profit. We've been active over a decade. I was established in, 20 oh eight, following the concerns expressed by the G eight over the financial stability of hedge funds. You might recall that period, Ted, It's a board of trustees. We are 15 on the board of trustees. We're really targeting a good balance between managers and investors. We also have a small SBAI team that runs sort of the business. We've also added over the years the regional committees for APAC, EMEA, and North America. We have, in parallel to this, working groups. We're working on specific issues to advise the board. And to obviously we're surrounding ourselves with industry leaders, institutional investors. This buy also has just about a 130 different signatories who have all committed to adhere to the standards that represents over one trillion in AUM worldwide. The investor chapter, which is the balance with the signatories. It's about 80 major investors around the world, and we cover north of 3.5 trillion in assets.

AI assessment note: “Is a neutral standard setting body for the alternative investment industry”

Q one in the past and had some of your background. And so I'm going to have Luke start out with his background. But before we do that, Mario, I know since you were on the show a few years ago, you've had a little bit of a change in your role. So why don't you just touch a little bit on how you're spending your time at CDP these days?

A What we've done essentially is, you know, as you remember, I was mainly responsible for external funds with in public markets, and we just started the strategic partnership effort. This is all still going on. I think that what we've added now is we have reunited under one single roof, all of the activities that we do with external managers at CDPQ. So we're covering the whole spectrum of liquidity. So from hedge funds to long only in both equity and fixed income markets to private markets to VC. To private debt. Everything that we do at CDPQ with our external funds, which covers about forty five billion dollars Canadian, which is about close to 15% of total assets of CDPQ, and that covers about a 130 different GPs around the world. So it's one group under one practice, external funds doing all of the pre-investment and post-investment work for the benefit of the internal managers at CDPQ.

AI assessment note: “we have reunited under one single roof, all of the activities that we do”

Q So let's, let's start working backwards on that, on this question of talent. Is the compensation structure Different such that the expectations of someone talented compared to, you know, Bay Street is US's version of Wall Street. Is it hard to compete with Bay Street talent?

A I think it's, you know, in the long run, when you think of it, I think that we're trying to take away the volatility attached to compensation. So when you have a more of a longer term sort of formula, if you like, well, first of all, the formula is, is twofold. There's a part of formula that Is all about you being a good citizen, right? Uh, working with your colleagues, making sure that you're, you're making a difference within the organization. So that's really important. There's the results of the plan as a whole, making sure that we all work for the same PNL. And then there's your portfolio. And what, what's been, you know, put in place in, in various plans is that over the long run, if you are sort of beating your objectives, whether it's an absolute or a relative, uh, I think that the share of that profit that we've been sort of making over the years has been increased to a point where people feel that, you know what, yeah, you can make more money on Bay Street for three, four years. It's like, you know, do I want to play for a hockey team for four years making a lot of money or signed for a longer term contract that makes, that gives me more assurance that I'll get paid for long term. So I think that when, when people NPV sort of that, that, that payout They see that it's not such a bad sort of proposition, I would say.

AI assessment note: “when people NPV sort of that, that, that payout They see that it's not such a bad”

Q decision-making unit, the governance board, to suffer through a challenging time, which might be just, ah, you know, 2008, but it also might be that you're so different from your peers that you look bad for a period of time. So As you lay out the asset allocation, how much attention do you pay to the other Canadian plans and what the structure of, you know, their portfolios look like?

A We, we spend a lot of time. All of us have our own network with our peers in each of the asset classes. We obviously we're not, you know, we're not so many big institutions in Canada, so we follow what the others do more and more. But what we come to realize, I mean, if you go back 1520 years ago, there was more of a compete, I would say. I think nowadays people are getting to know more and more the differences in mandates For example, CPPIB was a much younger fund. We're still getting lots of inflows. They have a reality that's much different, for example, from the Ontario teachers, who's a much older demography. Who have to devise a strategy that's really focused around asset liability, absolute return, making sure that you increase the probability of making that four, five, six percent every annum. So I think that there's more of a knowledge, even financial press, I believe, is sort of making more of these nuances where they know that, you know, if the performance of XYZ is lower, there's always explanations underneath that I would say are well taken.

AI assessment note: “We, we spend a lot of time. All of us have our own network”

Q Yeah, that's great. What is your favorite book?

A The books that have influenced me quite a bit over the last, uh, I like, I like to read biographies, but the books about where you can make a link with the analogies between sport and, and money management. So I'll start with Moneyball, which was a great influence. To me, it was like a eureka moment in terms of how you build portfolios. And then from Big Data Baseball that you introduced me to, uh, Ted, and, uh, and I read recently, uh, The Cubs Way, which is sort of the two point zero version of Moneyball with, uh, Teo Epstein, which I really sort of like because it's, it brings quant and qualitative empathy. I just finished A Man for All Markets, the, the story of Ed Torp, which is actually making me think, A lot faster now about the, you know, the future of equity market neutral quant and, uh, seeing him how he went through blackjack and, and then blackjack, there was an inefficiency. He wrote a book and the inefficiency went, went away and, you know, applying this to, to markets and obviously he managed the money in the seventies as well. So, but I, I liked sort of these books where, uh, you know, you can make analogies like that.

AI assessment note: “So I'll start with Moneyball, which was a great influence.”

Q When you think about the team around her in a strategy like that, what are the important factors?

A Well, first of all, it's a quantitative strategy, so you need to hire the right skill. So you and me could probably not work there, but for sure, it's all about the quality of the people working the How technical they are in their own field from physics to mathematics, but also their pedigree, their background, their intellectual integrity as to how they model, how they validate what they build. So for us, we spent a lot of time there, and clearly this strategy is much more technical than understanding a more fundamental strategy, but there were things even back then, and we had a few people working with me, Where we could say that this shop was really a strong shop in terms of investment process.

AI assessment note: “it's all about the quality of the people working the How technical they are”

Q When you think about the team around her in a strategy like that, what are the important factors?

A Well, first of all, it's a quantitative strategy, so you need to hire the right skill. So you and me could probably not work there, but for sure, it's all about the quality of the people working the How technical they are in their own field from physics to mathematics, but also their pedigree, their background, their intellectual integrity as to how they model, how they validate what they build. So for us, we spent a lot of time there, and clearly this strategy is much more technical than understanding a more fundamental strategy, but there were things even back then, and we had a few people working with me, Where we could say that this shop was really a strong shop in terms of investment process.

AI assessment note: “How technical they are in their own field from physics to mathematics, but also their pedigree”

Q the negotiation of a fee. So given this ecosystem you described where there's more and more concentration, there's probably a hundred hedge fund firms that manage most of the assets in the industry. How do you get from a historical fee structure that was a one size fits all for the package to something where you really do have a disaggregation and sort of appropriate paying for the value add?

A From our standpoint, one of the variation that we brought, which is in parallel to what Luke said, was the fee structure, which is X or Y. So we pay 1.5 or 15%, depending, instead of 1.5 and 15%, which actually helps us capture the portion of the alpha that's closest to 70% if we're in a low return type environment. So it's been very difficult on that side. I mean, the thing is, I still realize that there are still not a lot of investors that are voicing that portion of negotiation. Or trying to align. There's still a lot of price takers out there, and ultimately the pressure comes from the board, where the pressure comes from the return. So it's been clearly a very tough spot, but I think that if you compare to private equity, for example, I think it's, we've had more wins in hedge funds versus private markets for the very different reasons, I would say, but it's something that we try to bring at the table all the time, and it ultimately The fee is part of the decision process because the fee impacts the alpha and ultimately what stays with us.

AI assessment note: “one of the variation that we brought... was the fee structure, which is X or Y.”

Q As you apply that, so how many, how many investment professionals are there at CDP?

A Jeez, it's over a hundred. I mean, I don't have the precise number. I should know that, but You know, CDP is, is north of 800 employees, counting all of our different groups. It's a big shop. We now have offices around the world, and this is towards the quest of doing more business in EM. So we've opened offices in, in Singapore, in New Delhi. We have offices in London, Mexico City, Uh, Washington also. Paris. So we've been quite active on that side, and the idea is not to just have a sort of an address on the street, but also find the people over there that will be sourcing these deals. That's, I mean, that's the other area also that separates the Canadian model where, you know, CPPIB, Ontario Teachers, and now PSP in Montreal are all opening offices across the emerging market countries.

AI assessment note: “Jeez, it's over a hundred. I mean, I don't have the precise number.”

Q So one last question I want to ask you before we kick off the conversation, which is how do you think about sizing a position in a strategy like that in your portfolio?

A If you want to manage a portfolio that's more sensible to tail risk, obviously you'll put less of these types of strategies, that strategy as a, a positive gamma. That strategy thrives in more volatile markets. And we've seen it in the past for many, many years now. So it's all about how you want to manage that downside volatility. And as we know, markets go up and markets are generally stable. So it's that mix where you decide to put a little more of that spice versus another one so that you You reach to an expected return. For us, it became very important to calibrate well here because we have an overlay program. It's not a funded program. So we use our balance sheet to invest in hedge funds. So we need to make sure that this is calibrated well enough so that when markets are hostile, we're not losing too much money out of the program. So this is where That strategy plays a very specific role.

AI assessment note: “it's all about how you want to manage that downside volatility.”

Q belief system at CDP. As I took out last year's annual report, you see words like strategic partnership, patience, flexibility, collaboration. And I'm assuming this isn't just because Of my stereotype of Canadians being nice people. So, as you walk through this, what is, what does patience mean in investing? We all talk about being long-term. We all talk about being patient investors. How does that play out at CDP?

A That's a good question. I think, first of all, what you've read in, in our latest, for example, latest annual report, I think is, I mean, I'm biased a little bit, but these are really things that are Brought together by the leadership, the leadership of Michael Sabia, the change of culture following the financial crisis have been quite, quite amazing. It's been, it hasn't been easy again because, you know, let, let's not forget we're a pension plan, but, ah, these, these are the things that I can say today really work, but we still need to really nurture. Patience in, in the context of a pension plan Is, is being able to sort of shy away from, you know, the fads, shy away from sort of the trends, the momentum that can build up into sectors, into some stocks. Patience also means what? Means underperform. Underperform in times of speculation. And this patience, and patience is from top to down, It's, it's on our board. It's the governance and ever is, it's everything. So this is how it plays out. And I would say that today we have some, you know, some senior guys that they, they really sort of apply this with, with, with us. And I applied this with my group and patience is to procrastinate is to be attentive, to make sure that we have deep knowledge. We spent a lot of money just investing into research. We have an equity research group that has been developed over the years, whic…

AI assessment note: “Patience in, in the context of a pension plan Is, is being able to”

Q How do you measure the impact of the standards over the years?

A When I look at the comments, especially for the smaller managers, the standards have been structuring a lot of what they do on the operational side, and we've had a lot of good comments from These smaller managers, they would write to me and say, your ODD team did great work. There's a lot of things that we were not covering, but these are a lot of things that we were not covering usually are standards and things like that. So we've had some very good comments on that side. As you know, like the startup managers, they're not usually up to par with the operational part of their business. And I think that this has provided them with a very good framework to address ODD, especially as it pertains to what institutional investors are looking for. So I would say from my part, this is what I've seen. The larger managers, sometimes you would be surprised by the quality or the standard of their operations. But I think also we're starting to see from their point of view as well that from the ODD part of what we do, it helps them quite a bit in terms of aligning each other in terms of what we're looking for.

AI assessment note: “When I look at the comments, especially for the smaller managers”

Q And you're managing a battleship, not a fleet boat. So even if everyone agreed, oh boy, we should take some risk off the table, it wouldn't be easy to do that. So what, what is that board conversation like today to prepare for the possibility of a rough patch of water sometime between, you know, now and smoother seas ahead?

A I think it goes back to, you know, the statement you said earlier, investing in great businesses. I think that we invest in, we have, you know, less line items than the past, and I think that boards have a better handle of the concentrations that we have in the portfolio. They have a better understanding of their valuation, and how robust they will be, because they know, I mean, they know that in, in sort of a bad period, These things will lose money as well. So they have a better understanding of that. There's always a discussion around macro. There's always a discussion around macro. I mean, let's face it. You open, you know, the media today. There's a lot of focus on valuation of markets. Markets are gonna, we've never been overextended since, you know, the 2000 year bubble. So I think there's always a discussion like that. But I think that where people feel very comfortable is that these businesses will probably lose less in a reset, if you like. So that'll be, again, interesting to see. Investing more money in illiquid assets also mitigates sort of the optical risk, if you like.

AI assessment note: “There's always a discussion around macro... where people feel very comfortable”

Q And then two other ones, strategic partnership and collaboration. Oftentimes, as capital allocators think of that in terms of external managers, but as you said, most of the assets are internally managed. So what, what is that form of collaboration and strategic partnership?

A I think that one thing I should have had earlier on, on the Canadian model is that what you see in Canada is everybody uses external managers to a certain extent. But I would say that what we've been very proactive about is to say, you know, we approach a large organization in private equity, real estate, some hedge funds, infrastructure, and say, we're going to be investing money with you, but help us better manage the rest of our plan. Can you help us better manage the rest of our plan? So, so we're doing a lot of that. So it's, yeah, it's investing with groups that are disciplined and Passionate and creative, but at the same time, people that are, you know, respectful, people that are willing to help us better ourselves in a very generous way, I should say. So, so we've been doing a lot of that, and, you know, a way for us actually to, we could talk about fees with external management, but a way to sort of reduce sort of that absolute return to fee for us is to do these types of co-investments, I would say, and to be able to Also, I mean, what's the hardest thing I find with strategic partnership is to find the right metrics to evaluate the quality of that partnership outside of saying, well, this guy's made 10% annualized for, you know, five years. I mean, that's sort of the hard data, but sort of the soft data. How do you evaluate if it was a good relationship, strategic r…

AI assessment note: “we're going to be investing money with you, but help us better manage the rest”

Q It seems like that's better understood in Canada than the constituents in the U S and it doesn't even matter, right? The, the troubles that Harvard management had some years ago with the disconnect between the alumni base and the investment team and the board. Is there something to that alignment across ultimately your pensioners, the governance board and the investment team that works well?

A That's a good question. I think I mean, I, I'm not the specialist in the U.S. Obviously, we hear about stuff, but we, um, I think when you look at that in Canada, the, the, the alignment, is the alignment much better? I mean, the last time really we had a hostile period that lasted more than a week was in 2008, 2009. It's been sort of a quiet time, I would say, for the, the 60, 40, Sharp ratio. I mean, if you look at, if you, if you went back to 6040 sometime in, in 2009, it was a great, the greatest trade of all, right? So, so we'll see how this plays out in the next round of, of hostility in markets. I would say in general that most of Canadian plans seem to have a better diversification than they had before. They seem to have a better handle on risk. They seem to have been able to communicate, you know, their, their strategy, their beliefs. I mean, I can talk for ourselves. We've been, we've been spending a lot of time with the clients, really make sure that they get what we do, and making sure also that they understand that, you know, uh, there might be a time or a period that's going to be more difficult, so. But, you know, we'll see when, you know, when you have a couple of bad quarters and you're really underperforming, let's say both on the relative and absolute, there might be a different situation. But I, I feel that this time around, perhaps we, we, we probably have …

AI assessment note: “We've been spending a lot of time with the clients, really make sure that they get what we do”

Q I imagine somewhere along the way in the last couple of years, particularly since the crisis with the restructuring, there has to be some discussion of active and Passive investing. Particularly when there's such a large pool to manage and the notion is owning great companies and compounding capital. What does that debate look like internally?

A That is a great debate. I mean, we could, we could talk for hours about this debate, especially at this, this time in this environment of markets. I think that ultimately we believe in active management, but we also believe in, in longer term horizon. We can arbitrage that in some ways. I think that we feel that active management in the more liquid assets has become more and more difficult. And we see that. We see, you know, we see the, the impact of AI. We see the impact of the quantitative process. We see the impact of, of hedge funds, for example. So we feel that it's just getting more and more difficult To actively beat the market, especially in the more liquid asset classes. But at the same time, I mean, the jury's still out. I mean, are we in a secular change in terms of, is finance going to be uberized? Like, or money management being uberized, right? I think it'll never be uberized to a certain extent. I think that, you know, there's, there's been some people talking about sort of the, the mix between quant and And fundamental. I think in the future, the managers or the money managers that will sort of grow the best will be the people that will marry both discipline. And, and it's, it's going on and it's underway right now. So, and this is, this is actually making, this is actually keeping me up at night in, in various hedge fund strategies, actually, how we, how we inv…

AI assessment note: “ultimately we believe in active management, but we also believe in, in longer term horizon.”

Q Yeah. And, and a little bit more on risk management. So what, what does that mean when you frame out A focus on risk management. What are the risks you're looking to manage?

A I mean, before talking about risk, I forgot to mention that earlier. One thing that really Canadian model is, is espousing, I would say, is more and more focus on absolute return. And what does that mean? I mean, it's not absolute return in the context of a long, short manager that has a low beta. I mean, we, we all know that Any Anglo-Saxon pension plan as a, as one big risk, which is risky asset risk that is coming from real estate equities and private equity. I think that absolute return meaning that in the, you know, making, taking decisions in the long term, investing in businesses, investing in skills that in the long run will give you a chance of accomplishing these absolute return, which for us, you know, we, we're, Targeting just, just a little north of six percent for our clients. So, so that's, that's the portion. So making sure that the investment beliefs and mindset are all sort of focused on this absolute return mindset, thinking outside the box, thinking away from the benchmark. I think that's, these are the things that culturally over the last five, six, seven years, especially since the financial crisis, we've been really, really focusing on. So that's, but that's not easy. It's not easy because You know, a manager that's running sort of a long only book in Canada or in the U.S. has this tendency to look at the benchmark, right, and say, well, I should own more…

AI assessment note: “before talking about risk, I forgot to mention that earlier.”