FEATURED TOPIC
The Yale Model Revisited: Private Markets and Canadian Endowments
The Yale Model Revisited: Private Markets and Canadian Endowments
AIR DATE
June 21, 2023 | 10:30 AM, EDT
June 21, 2023 | 10:30 AM, EDT
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DISCUSSION HIGHLIGHTS
Made popular by the long-term CIO of the Yale Endowment, David Swensen, the so-called “Yale” or “Endowment” Model has traditionally leaned on private assets to generate the income needed by universities to grow. We gathered together a panel of experts over breakfast to check in on the role private markets are playing today at Canada’s top university endowments.
This inaugural CLC Breakfast Club will address key questions endowment investors have about private markets, portfolio diversification, and some of the challenges and opportunities that lie ahead in today’s rising rate environment.
Made popular by the long-term CIO of the Yale Endowment, David Swensen, the so-called “Yale” or “Endowment” Model has traditionally leaned on private assets to generate the income needed by universities to grow. We gathered together a panel of experts over breakfast to check in on the role private markets are playing today at Canada’s top university endowments.
This inaugural CLC Breakfast Club will address key questions endowment investors have about private markets, portfolio diversification, and some of the challenges and opportunities that lie ahead in today’s rising rate environment.
TRANSCRIPT
Breakfast Club: The Yale Model Revisited — Private Markets and Canadian Endowments
Air Date: June 21, 2023 | 10:30 a.m. EST
Caroline Cakebread: Good morning, everyone, and thanks for joining us. I'd like to welcome you to our very first Breakfast Club hosted by the Canadian Leadership Congress. Our Breakfast Club discussion today is on the Yale Model revisited private markets and Canadian endowments. Participating in today's conversation are Marc Gauthier, university treasurer and chief investment officer with Concordia University, Taylor Servais, director, investments with the pension fund and investment management at the University of Ottawa, Martin Belanger, director, investments at the University of Western Ontario, and Ash Lawrence, senior vice president and head of AGF Private Capital, with AGF investments. Welcome to all of you.
Ash Lawrence: Good morning.
Caroline: I'd just like to call upon Ash, if you don't mind, to start us off with some opening comments to really set the table for our discussion this morning. Over to you, Ash.
Ash Great. Thanks, Caroline. Great to be here, along with my panelists as well. I think this is going to be a great conversation. What I thought I would do to open is maybe just lay the foundation of what exactly we're talking about when we talk about the endowment model and the Yale model, and what it really means for folks like my panelists on a day‑to‑day basis, and how their universities run their endowments.
The first thing I'd say is, Yale is the cream of the crop in terms of how they run their portfolio. They've seen 11% and 12% returns over 20 and 10‑year periods, they run a $41 billion endowment, and perhaps more importantly for the universities on the call, is they contribute about a third of the annual operating budget to the university. That's more than $1.5 billion that's coming out of the endowment to fund operations at Yale. I think everyone can agree they would aspire to that and that level of ability to support their institutions.
I think everyone is also aware that, generally, when people say the Yale model, they're talking about a higher allocation to alternatives, illiquid and liquid alternatives. I think one of the things that typically doesn't get discussed as much other than the allocation is some of the processes that run around the manager selection process and how they actually mitigate a lot of the risk that comes with being 20% to 25% venture allocated, 20% to 25% hedge fund allocated. They do run a portfolio that most would look at at 50% illiquid, 25% total return. That has a relatively high‑risk profile.
How do they actually go about minimizing that risk profile? It's really all in their manager selection process, how they run their relationships with their managers, in order to get that 12% long‑term return that they do get. Just to put that 12% in context, you think maybe about some of the Canadian pensions, which have a very good track record and very good system that is viewed at globally, in terms of bringing in‑house expertise as a model, and think about maybe some of the ones that people consistently talked about CPP and teachers, their 10‑year returns are around 10% and 8.5% respectively.
If you think about that being the cream of the crop in Canada, Yale's outperforming them by anywhere between 200 and 350 to 400 basis points. That model is also performing its endowment peer group in the US by roughly the same amount, even in a down year, this last year, where I think their returns were just under 1%. The balance, I think, with the exception of one, the balance of the peer group of endowments in the US was negative, anywhere from ‑3 to ‑7.
Even in down years, it continues to outperform, but I think it's important for everyone to realize you don't just go and allocate to these, somewhat, high‑risk venture hedge fund portfolios without another part of your process to go with it to mitigate the risks. If you can do all that properly, well, then you can enjoy the same type of returns and double‑digit range.
Caroline: Excellent, those are great remarks, Ash. I think that really helps to set up our discussion and leads really into my first question, which again, touches on this so‑called Yale endowment model that you've described. I'd like to get a sense from each of you about how you've seen that reflected in your portfolios and whether or not there's been any shift given today's rising rate environment. Marc, I'd like to start with you.
Marc Gauthier: Yes, some time in markets have massively grown, in my case, and I'll specifically speak to, although we mentioned the endowment assets or foundations, but include, obviously, the endowments, what has massively changed and risen for me is the whole aspect of sustainable investments. For our foundation, we have committed to what we call to become 100% sustainable by 2025. Essentially, what that means is that we're pretty much going to be what I define as capital allocation for purpose and intentionality.
What that means is, how private markets play a role in all this, is that private markets tend to have a greater alignment of interests relative to the public market. They have a longer‑term vision, longer‑term planning, greater direct risk management. It suits well the whole notion of sustainable investments. As a result of that alignment, and that growth in private market, what I've seen, in terms of rise in specific classes of private market, specialized venture capital, I've seen that growth a lot, very niche type. Microlending, also, there has been a rise.
Also, we often talk about co‑investment but co‑investment field in sovereign nations in the private markets, where there's an incentive provided by the sovereign nations to encourage the private markets to go into and drive innovation, and so they offer both capital protection and a share of the upside. What I've seen massively, also, is a concept of a thematic investment.
In my case, name it from the Blue and Natural Resources driven economy to their bio‑economy and mental health, low carbon economy transition, social equity, just transition, sustainable technology, community‑focused intention. These are thematics that didn't exist simply when the Yale model was introduced, but certainly, in my context now it's part of the inventory I look into.
I would just conclude that certainly, my aspect of how private markets have played a role with respect to my foundation, is a whole notion of, what I call, mission‑related investment, and the whole notion of local investment, not only into your local city, states, province you're into, but in terms of ecosystem within their own university and incubators, startups from students and graduate students, they are incubators, and want to— Our foundation is not investing, co‑investing into them. This whole notion, certainly, I don't think was available back then. That's really what I've seen how private market has impact from the foundation perspective.
Caroline: That's really interesting. Very much thematic and sustainable view. Martin, how do you view this issue?
Martin Belanger: Well, our exposure to private markets has increased significantly since I've been in this role that I started in this role in 2009. At that time, our only private market allocation was a small hedge fund allocation, a 5% allocation. Now we have a 47.5% target allocation to private markets. We're not fully funded in all asset classes, so we're not at target in private equity and real estate, but we're in all of them, the major buckets so we do have an allocation to private equity, to infrastructure, to real estate, and we also have some allocation to commercial mortgages, private debt, and some absolute return strategies.
Obviously, we've been very aggressive in moving into private markets. In terms of the impact of rising interest rates, we don't see us changing our long‑term target allocation. It's probably going to be more difficult to find some private equity infrastructure and real estate deals with higher interest rates so we focus on managers that use leverage in a conservative manner, and also that have locked up their long‑term financing, especially in the infrastructure side. In terms of allocation, as I said, we are not planning on changing our long-term allocation. There might be some — we may delay or commit faster in some areas depending on opportunities that come along. Especially private credit looks more attractive in this current environment, but overall, no changes due to rising interest rates.
Caroline: Okay. Good insight. Taylor.
Taylor Servais: An increasing trend, at our organization, for the endowment fund, the real assets was increased to 30% from 25%. Private debt was increased to 10% from 5%. Our total private, I call it, private markets liquid strategies totals 45% once hedge funds are added across both the pension fund and endowment. Prior organization, similar story, increase in private markets. Over the past few years, I've been involved directly and indirectly in a few asset‑liability studies and every time it's been an increase in private markets.
In general, our organizations tend to take a walk before you run approach. Some organizations which might be getting exposure of 3% or 5% in some of these strategies may, over time, increase that on the next ALM review. I see this trend continuing in terms of just growing exposure over time. As Martin alluded to, these are long‑term decisions, and the yield characteristics and the return characteristics of these asset classes have proven to be, especially in down markets, as highlighted in his opening remarks. They've done well for the portfolios and for our respective funds and turbulent public market times.
Caroline: Exactly. I want to pick up on that and turn to you, Ash, and get a sense of how you see risk and volatility in private markets compared to public markets. Walk me through that.
Ash I'll start with the risk side. Generally, like the public markets and the private markets and any investments, it's going to depend on the strategy. It's going to depend on the underlying strategy, what you're investing in, where the risk sits. I tend not to put a blanket across the private markets in terms of risk is higher or lower than the public markets because if you break it down into each individual sector, even sub‑sector, senior secured private debt, that's a very different risk profile than venture as an example.
I tend to think of it as like any other investment. You look at each piece individually and the underlying strategy and think about your risk. The only aspect of risk that I would say is perhaps a little more enhanced on the private side, is what I'll call the manager risk. I mean, the expertise of the manager because most of these strategies tend to be much more active management‑type strategies.
If you think about private equity and the role the firm plays in setting the business plan and executing the business plan and working with the senior leadership team at their portfolio companies to get that done, putting the capital stack in place, that's a very different risk profile than buying into a public markets company where you don't really have all of that control through your long equities manager, let's say. I would say manager risk is different between the two categories, depending on how you're investing.
From the volatility side of things, and we have this conversation a lot these days because of all the chatter around valuations between public and private markets, the one thing I always start with is, I think we should move away from using the public markets as the arbiter of value. The public markets have a lot of factors that go into how a stock trades on any given day that are unrelated to the underlying value of that business and the underlying operation of that business, algorithmic trading, high‑speed trading. Once a month our head trader here, he comes and says, “Oh, it's index rebalance day this week so everyone watch it.” All those things impact the value of a company on a day‑to‑day basis.
In AGF, we're a public company. If our stock moves around from Monday to Friday, does that really mean the underlying business has changed that much in four days? I tend to separate the comparison to the actual values in the public markets to the private markets and then lean on how are the managers actually valuing it and how are they looking at it. If they're using comparable trades, if they're using full DCFs, then they should be valuing it based on the underlying business. The generation of cash flow is the value creation.
Now, what does happen in times like now is it does look like that volatility is a little lower than it should be because of the speed with which interest rates have risen. I know you asked about interest rates in your prior question. I would say the higher rate environment is not so much an issue when we're in the four or five range because we've been there for many, many years before. I think the issue is the speed with which it went from near zero to four‑and‑a‑half. That's what's really causing a lot of volatility in the market. That aspect of it is taking a little more time than you would think to flow through into the private markets, creating a somewhat subdued volatility.
That being said, you are starting to see it come through now with some of the returns from the second half of last year. Most of the private equity sub‑sectors did go negative. Real estate is now bouncing around zero and slightly negative if you look at Q4 numbers. It is starting to come through, but it did take a full year to get there. The other thing I would say is public markets are back up again. Very concentrated admittedly, but they're moving around again, trying to figure out what's about to happen in the future. Volatility‑wise, I would say, typically, they would be less volatile than public markets, but that's because there are completely different factors at play.
Caroline: Does anyone want to chime in on some of those dynamics, particularly some of the volatility we've seen over the last year in private markets? Taylor?
Taylor: I will comment on valuation risk. I think that is a very big one when you go from public to private. Ash brought it up on real estate. Real estate valuation is always a question mark, especially whenever transactions are limited. We've all seen what's happened in the office market, which is an easy one to pick on, but if any of us have exposure to open‑ended diversified funds with office exposure and you see what they're valued at and you see what stuff is or is not trading for in the public markets, valuation risk is real.
I would say from a structuring perspective, whether it's an open or closed‑ended fund, valuation risk differs slightly in the sense that eventually in a closed‑ended fund, you will realize your marks, whether they're real or not, the market will tell you what they are because the fund will eventually liquidate. Whereas in an open‑ended fund over time the volatility is perhaps a little bit less as a result of this valuation smoothing. That's what I'll add on the risk side and the valuation risk piece.
Marc: What I can add, Caroline, is I think— First of all, I totally agree with what Ash had mentioned. I think public is more trade‑based. I think private is more investment‑based approach. Having said this and the whole notion of volatility and so on, I think from a portfolio construction perspective, you have greater opportunity to diversify your risk in the private market than you have in the public. There's so many ranges of private markets you can invest into. We mentioned a bit real estate, and within real estate is many, infrastructure, private debt, ILS, agriculture, timberland. Then there's private equity, but there's the alternative private equity. There's a massive— and then now the whole thematics. There's a lot of ways you can really diversify your way through volatility more than it is on the public side.
Caroline: Does that resonate for you, Martin?
Martin: Yes. I agree with everything that was said. Obviously, manager selection is a key risk there because of the dispersion between the top and the bottom manager evaluation risk. Also, a key element for us is liquidity risk. Obviously, it has a huge component in your risk management framework. You need to model your future commitments, your capital costs, and your distributions. Another thing I'd like to mention is complexity. These deals, private deals are much more complex than public deals. You need to budget for much bigger staff and also much higher legal bills when you review those deals. When your committee decides to go in through private markets, you need to factor that from the beginning, otherwise, it's going to be a very unpleasant surprise if you don't factor that in from the beginning.
Caroline: I think those are great points. I want to turn to something you were talking about earlier, Marc, and that's your shift to a more sustainable investment structure around your portfolio, more impact, more purposeful, I believe, purpose‑driven, you were saying. Universities have a unique set of stakeholders. I think you might all agree with that. There might be more of a tilt towards impact, ESG, et cetera, how do you think this has been reflected in your private markets portfolios? Marc, has a lot of this been driven by some of your members for example and some of the individuals who benefit from the work you do?
Marc: How is it driven, is really, I would say, it's university, I guess I cannot speak to all universities, but I think my peers here, my colleagues will agree we are in a very engaged community. I'm talking about here, students, donors, professors, staff, and all the way down to even the government. Universities always want to be leaders in terms of advanced knowledge, really progressing, advancing the path for the future. Sustainability has been at the forefront of this for a long time now. My case, it's been more than 10 years. The challenge, of course, is a polarizing topic, people have views but it all seems to be circled on around investments.
Investments, not everybody understands, but for the construction now everybody understands how you go about really setting your objective. Then the challenge becomes about really making sure that once you take into account everybody's interests and intention and how they put it all together, that is all about communication. Then the communication, it's more of art than a science with respect, especially those who are more intense in terms of engagement.
That's where I find, and I circle back to our topic today of private markets, I find that alignment a lot more powerful to address really specific issues. On the other hand though, if I look at community, they're more interested on the public side because that's where it's more common to see the whole notion of divestment. Then it comes then the notion of engagement. It's something incredible to participate in, very complex. It's a journey that keeps evolving over time.
Caroline: Martin, is that something you've seen at Western?
Martin: Yes, we do have our endowment fund as a 10% target allocation to impact sustainable investment which we define as impact investing, investment that meets one of the 17 United Nations sustainable development goals. We found especially with private markets there are a lot more opportunities in private markets than in public markets because when you control the underlying portfolio companies, it's much easier to influence it and meet your sustainable goals.
These investments have come up with engagement from some of our stakeholders. It started mainly with environmental divestment from fossil fuels. We did get a lot of requests in that regard but we've expanded our strategy to incorporate both environmental and social factors. So far we've committed around $110 million US into impact investing. We are invested in renewable, energy transition but also other areas, more social minded areas like education and financial inclusion. It is a big part.
Obviously, as Marc mentioned several times, the fact private markets is better suited for impact investing than public markets basically.
Caroline: I want to pick up on something you were talking about earlier, Taylor, and that's in the private credit space. I wanted to look a little bit about what specific areas of private credit you're looking at and any headwinds all of you see coming towards us in that space. I'd like to start with you, Ash, on that.
Ash Sure. I agree with Taylor, private credit, and I think Martin said it as well, is one of the more attractive places to be right now specifically in certain areas of the market that are benefiting from what I'll, generically, just say capital constraints across the system, especially when you look at the banks, whether it's either Canada or the United States quite frankly. You think about the regional bank issues in the US, that those particular banks have been funding a lot of mid‑market and lower mid‑market type businesses, also, real estate businesses. A lot of those firms now will have liquidity crunches in terms of borrowing and potentially in terms of equity as well.
If you can select the right manager, pick the right borrowers where you're sure the underlying health of the borrower and the business is still bankable, so to speak, [chuckles] then you can also take advantage of where rates are at the moment. If you combine the lack of capital out there in the market for these types of firms with the rise in rates, you end up making very good returns, and in a lot of cases, on senior secured lending.
I think the thing you do have to be careful about now is, obviously, if we think we're looking into the face of a recession you do have to think about as you're choosing your borrowers, especially if they were potentially borrowers that were screened out from some of the bank lending programs that maybe they would've qualified a few years ago. More generally, you are just seeing borrowers screened out just because the banks don't have credibility or it's an impact on their buffers and things like that.
I agree, I think it's a great space. Personally, here, we, at AGF, are looking at, what I would call, smaller enterprises, mid‑market, but really look the bottom half of the mid‑market where we see the really great opportunities in the credit space.
Caroline: Great. Anyone else want to chime in on private credits? Martin?
Martin: I do agree with everything Ash said. We do have allocation right now in it, so we're not planning on adding more with banks reducing their lending. Obviously, that's a good opportunity. The only thing that I'm going to mention, the longer lock ups compared to public debt is, obviously, a key factor to take into consideration when you invest in private credit but overall it seems like there's more tailwinds than headwinds for private credit.
Caroline: Another big area that's really growing in the private market spaces is infrastructure, especially particularly around the energy transition, around climate change, some of the developments in the US, and even beyond that. What are the opportunities that you're seeing right now? Again, is there anything that's got you a little bit more concerned? I'd like to start with you, Taylor.
Taylor: Infrastructure has been a great yield alternative to fixed income especially with inflation being at the forefront of everybody's minds. The capital that's gone into infrastructure has grown tremendously. You mentioned it, energy transition, tons of opportunity in that space, digitalization of the economy, tons of opportunity in that space. The issue with new opportunities in those areas is what is the definition of infrastructure and how is that getting stretched.
I'm sure many folks, if not everybody, has seen it here what the definition of infrastructure is really getting stretched by some managers to meet return targets. That's exposing our underlying plans to different types of risks than what were perhaps intended at the onset of an underlying investment. To answer your question, energy transition, digitalization, tremendous opportunities, but as those get stretched and as the opportunities in those areas become apparent and the opportunity set the definition's getting stretched and the underlying risks to our portfolios are potentially changing as a result of that.
Caroline: For sure. Marc, yes, you were going to chime in now?
Marc: Maybe I could add to what Taylor mentioned, we often think about infrastructure, I guess, more traditional way, but what's fascinating now I found, especially in the transition towards a lower carbon economy, is a whole notion of infrastructure asset management. For example, you have marine vessels and then you have railways, so the whole class, it needs to be decarbonized and so it provides a different approach to infrastructure than what the plant‑based one that people often think of, which could be an issue with respect to acquisition costs. Also, the whole notion of secondaries, I think, is growing in infrastructure which I don't think was much more before. I think that is also interesting.
Caroline: Great. It's definitely an expanding space. On the private equity side, just shifting over to another area of the private market space, how challenging has it been to allocate within private equity and what are the biggest opportunities right now? Marc, do you want to comment on that?
Marc: Yes. It's funny you started with challenges and it’s reverse in private equity, massively outperforming my best asset classes and massively outperforming my public equities, and I go back 10 years now. I'll speak more about the pension here than the foundation because the foundation, I mentioned, is now, we're evolving towards its sustainability, 100% wise. The pension is really— The allocation for private equity is regional based. We have a North American program and an Asian program, but what I've seen, the rise is, what I call, alternative private equity, GP ownership, minority interest ownership, LP financing. Now I see VC lending, and when you do your technical third capital call, instead of getting equity, you're now into lending of it. These are very interesting classes that allows you to diversify your global private equity.
I mentioned about the whole notion of thematic private equity but I've seen also the growth is instead of having acquisition cost competitiveness against each other and rise, you've seen a lot of private equity funds after they gained knowledge of a company, decided to spit it off and grow their own, which saved a lot of acquisition costs. You see that organic growth of a fund to another fund of previous funds, but derivatives of it. That's, This all speaks about how you came from a portfolio construction perspective can grow your private equity in a diversified in a risk management way.
As for opportunities, I would say otherwise, I will take a look. I would address it one on a regional basis because I tend to be focused on that. The Indo‑Pacific region, which is essentially the oceans of India, Western, and Central Pacifics, I think is a demographic play. They have 10 years to optimize their demographic, and I think it's a very good opportunity there. From a thematic, obviously, outside of what people really are, I think, tend to be on, which is tech and AI, and tech and blockchain. I will throw a couple of more ideas to you. I think the green economy I mentioned, obviously, it's big. Life sciences, I think, offer a different perspective, a different alpha. Then tech enable education. I think that business is massively growing. It will massively grow. It's very interesting to see that evolution as well.
Martin: We do focus on the small and mid‑market buyouts in developed markets, North America, and Western Europe. To answer your main question about the challenge of investing. We haven't seen any issues. We've managed to get our asked allocation for every fund. We've never been reduced because the fund was oversubscribed. Typically those are companies, underlying companies with enterprise values worth less than $2 billion, and we have a diversified portfolio across various industries. Healthcare has a lot of opportunities, but also consumer sector industrials, also some software‑related and tech‑enabled businesses. We've seen a lot of opportunities in that.
The secondary market is also very attractive at this time. It's trading at discounts averaging about 20%. It's very attractive and also there's a lot of liquidity and it allows you to deal with the denominator effect on your portfolio. As Marc alluded, on the impact side, we've seen a lot of opportunities. We've made commitments to two private equity impact funds that have a very diversified approach to impact investing in both environmental and social segments. Those are the main areas where we're focusing with our private equity portfolio at the moment.
Caroline: Ash, how challenging right now is diversification in the private market space? When you compare some of the areas that we've been talking about, whether it's private equity, real estate, infrastructure, how challenging can that be, and what are some ways around it?
Ash I think when we're out there talking with managers, and we wear a little bit of two hats at AGF right now, we're out talking to managers to partner with or acquire, at the same time we're also thinking about our client's needs and wants in terms of investment strategies and diversification. One of the things that is difficult in diversification is that if you do not have enough capital or sizable capital to allocate to individual managers, it had started to become tough. That has eased up now for obvious fundraising reasons, but it had started to become tough to spread it out properly, to diversify your manager concentration risk. If you have a large enough book, then that was fine, but in the pre-fundraising slowdown of the last 12 months you needed to start increasing your allocations to individual managers to get that done.
In some aspects, if you're a much smaller foundation or endowment, you should start thinking about multi‑strategy portfolios. There's a little bit of a fee premium, but you can negotiate those to be pretty minimal, and then you can almost customize your allocation amongst managers that, again, depending on who you are, you might not otherwise have access to. Now, that may be a dated statement because the last 12 to 14 months and fundraising has been so tough for a lot of managers that I think that dynamic has probably shifted.
The other aspect of multi‑strategy portfolios and diversification is if you are of a size or scale where you aren't staffed, and have skill sets in a way that you really shouldn't be because you just can't take on that kind of operational expense, then you should also think about multi‑strategy portfolios as well as a way to diversify. When I say there's a little extra fees, they're not tremendous. We're talking 30 to 50 basis points and usually minimal, if any, carry for some of these managers, but it does give you a way to access skillset and to access managers that might otherwise be tough to access either because of the queue or because of the scale.
Caroline: Martin, how are you approaching the diversification question in private markets?
Martin: Well, obviously, we were in several markets in private equity infrastructure and real estate. In terms of private equity, we're in the process of transitioning our portfolio from a fund of fund approach to a direct fund manager approach. Obviously, it requires a lot of time to have access. You need to have a foundation of managers, at least a 10 to 15 different managers to have proper diversification. It takes a lot of time and effort to put that portfolio in place. That's what we've been doing right now, but obviously, you need to be fairly diversified in order to reduce the risk to your portfolio.
Caroline: Yes. Ash mentioned cost, fees, and there's a perception that private markets are expensive. Can you give me a little insight into how you approach costs and what you think investors might need to keep in mind? Is that something you've thought about, Marc?
Marc: Yes. I have a different approach on fees. I don't look at fees, I look at value, and so I don't mind paying for fees. For example, if you measure on a basis point, I'm probably one of the most expensive funds, but if I remove my most expensive strategies, they're my top five managers. Then there's a circular, the Catch‑22 situation. I think, to me, either way, I see fees is about the uniqueness of the strategy and what role it plays into portfolio construction, if it has a unique role and really adds effectiveness, and I think the fees are worth it because it plays such a unique role. If it's mainstream and can be easily replaceable, I think, this is when you want to then look at the cost structure. What I've seen though lately, I see a trend, and hopefully, it's just starting, is a greater alignment of interest in fees. I see now in respect to carry fees alignment with this and most on a sustainable end. For example, if the underlining positions are not meeting their intentional targets, and then so the carry fees are not materialized. I've seen that trend, which is, I think, a good thing.
Caroline: Yes, for sure. Taylor?
Taylor: Yes, I echo some of Marc's comments. It's important but from my perspective, net returns are the most critical and, of course, whenever we're evaluating managers across different strategies or similar strategies, evaluating fees, depending on fund size and commitment, we'll see anywhere from 75 to 125 bips on some of the larger open‑end more core, core plus type funds. Some of the more, we'll call, value add, up higher risk strategies, we'll see somewhere around 1.5 on committed. Some of the more club deals, those will go lower but it's always top of mind, of course, but at the end of the day, net returns are the most important. We'll gladly pay a little bit more if those net returns on a risk‑adjusted basis are higher.
Caroline: Okay, Martin?
Martin: Yes, I totally agree. The net returns is where you should focus. Just by example, our private equity managers are the most expensive, but they're the only ones that have met their target. We have a target of outperforming public markets by a 200 basis point after fees, and they've done it constantly while our public managers, it's been hit and miss. Obviously, if the managers can provide value that's the most important thing to look at. In terms of trends, we've seen, as I mentioned earlier, we're moving, transitioning from fund of funds to direct fund investments. There's been a significant reduction in fees for fund of fund managers but not so much for the underlying GPs, especially the successful managers, it's very difficult to negotiate with them.
The only other thing I will mention is that if a private equity manager is deviating from the typical 2 and 20, they need to demonstrate a very good alignment of interest or if they get an additional carry, obviously, you need as an investor to benefit from it too. It's not just feed money for the manager. The interests have to be aligned with the investors. That's my two cents on fees.
Taylor: The one comment I'll add on fees that I forgot to bring up and a lot of these companies are providing related party services, so the asset manager might have an advisory business that provides related party services or a debt placement business that provides related party services. Those are one area of fees that perhaps don't get discussed but need to be watched to keep the managers on us and to ensure their market fees.
Caroline: Okay, great. Finally, I'd like to look a little more broadly at the array of private markets and get a sense of what you buy today and what you might consider to be outside of your risk comfort zone. Ash, I'm going to start with you.
Ash Sure. It's come up a few times in the conversation, private credit for all the reasons stated before. Maybe just to mix things up, I'll mention a few that maybe some folks wouldn't mention, but I would argue that right now is probably the right time, whether it's thinking about manager selection or thinking about allocation, to start thinking about it might be a very good time to invest in real estate over the next 12 months or at some point in the next 12 months. While at the moment, there's a lot of negative headlines and a lot of headlines around the office and maybe the office is not the place to be although I think there'll be some value there at the right time.
When you go into these time periods and some of these sectors, whether it's real estate like we're seeing now or whether it's the impact of a potential recession on other sectors, that is really the time you want to have your money allocated ready to go and with a manager. Some of their best vintages will come in times. I'm not an economist and I can't read a crystal ball but, hypothetically, their best vintages will come in times like the next 12 to 24 months.
I wouldn't necessarily think about today's world when I say private credit which is today's world, but what happens over the next little while and where do you want to put your money. That leads me to say people should start thinking about real estate again and for the same reason, venture right now is a lot cheaper than it used to be and if you can find the right manager who picks the right opportunities, those investments are much cheaper than 12 or 18 months ago.
Caroline: Taylor.
Taylor: Yes, I'll echo private credit. It's been, obviously, a hot topic across many different allocators and different publications, but if we've got an actuarial return of 6%-6.5% at 40% LTV, you're earning another, call it, 600 bps minus one point on fees, you're earning a 10 net plus-minus at 40% LTV, pretty attractive. Infrastructure, I think, is also very attractive. Tons of opportunities there. Another area, of course, I'll say real estate but I think real estate, you have to be very selective. I do think call it small bay industrial self‑storage, diversified cash flow streams with, call it, structural drivers benefiting the underlying asset classes, very good. Yes, probably, those three.
Caroline: Okay — Martin.
Martin: Well, again, private equity, we focus on small and mid-market buyouts. In infrastructure, as well, as Taylor mentioned, lots of opportunities. We focus on renewable energy transition, digitalization, and also, the globalization team, the entire issue around energy security. We have a number of managers focusing on that. Real estate, as Taylor mentioned, the industrial distribution centers, also mult‑risk on the real estate sector.
We're a little bit well‑selected in the other areas. Private credit, as I mentioned, we already have some so we are not planning on reallocating but also non‑traditional absolute return strategies like life settlements, insurance linked securities, and litigation funds are areas that we're looking at just to diversify the portfolio as those types of investment have a very local relation with the market. That provides good diversification to our portfolio. That's where we find opportunities at this time.
Caroline: Great. Marc.
Marc: Yes, I'll continue just to add to the conversation. I'll continue what— so Martin ended with different types of private markets that often you don't look at. There are so many of them. They're very idiosyncratic. For example, electricity trading. I think it's a great diversifier in the private market. Mining royalties or any intellectual property royalties, I think, it's a different source. Water rights. You’ve also got different types of focus on GP minority investments. Also, there's some demographic play with Millennials and so there's a lot of opportunities from the different types of private markets. What I would also mention is a bit to what Ash mentioned, but I think, instead, start at looking multi‑strategies, multi‑manager platforms as well. I think that's also a very interesting and good diversifier. Also another one, the art market. Nobody thinks about that but it's also a very different type of private markets. There's a lot of ways if you open and you get that trust with the committee to look into different types, there's a great way to diversify.
Caroline: Ash, final thoughts?
Ash Yes, just maybe I'll segue off what Mark was saying because Mark, and throughout the conversation, has mentioned a lot of more specialized sectors. I think one of the things to keep in mind, I don't think it should change your allocations but it could potentially change your manager selection, one of the things to keep in mind is the size of the private markets and the capital headed towards it has grown tremendously. There are pockets, whether it's sectors, specialties, or geographies where there is a tremendous amount of dry powder sitting there from the fundraising that occurred before the current slowdown. Up until the mid part of 2022, the fundraising was still going very, very strong, and for various reasons, the deployment of that capital has been slower than normal.
As you think about certain sectors, and I don't mean to pick on it but I'll say it because it's the obvious one, the big bio sector, there's a tremendous amount of backed‑up capital if you look at the North American big bio sector. You should think about that from your manager selection perspective if you are going to go into a sector or allocate to a sector where there's going to be a lot of competition for, at present, at least, very few deals.
Caroline: All right, so lots to keep in mind and an absolutely terrific discussion with excellent comments here today. I'd like to say a huge thanks to all of our panelists here today and thanks to everyone for joining us for our inaugural Breakfast Club round table. Terrific. Thanks very much, all of you. I'm going to say keep an eye out for upcoming Canadian Leadership Congress Breakfast Clubs and Monday minutes by subscribing to our newsletter and visiting leadershipcongress.ca or following Canadian Leadership Congress on LinkedIn. You'll get updates about all our events, virtual and in‑person, and we look forward to seeing you again soon. Thanks, everyone.
Breakfast Club: The Yale Model Revisited — Private Markets and Canadian Endowments
Air Date: June 21, 2023 | 10:30 a.m. EST
Caroline Cakebread: Good morning, everyone, and thanks for joining us. I'd like to welcome you to our very first Breakfast Club hosted by the Canadian Leadership Congress. Our Breakfast Club discussion today is on the Yale Model revisited private markets and Canadian endowments. Participating in today's conversation are Marc Gauthier, university treasurer and chief investment officer with Concordia University, Taylor Servais, director, investments with the pension fund and investment management at the University of Ottawa, Martin Belanger, director, investments at the University of Western Ontario, and Ash Lawrence, senior vice president and head of AGF Private Capital, with AGF investments. Welcome to all of you.
Ash Lawrence: Good morning.
Caroline: I'd just like to call upon Ash, if you don't mind, to start us off with some opening comments to really set the table for our discussion this morning. Over to you, Ash.
Ash Great. Thanks, Caroline. Great to be here, along with my panelists as well. I think this is going to be a great conversation. What I thought I would do to open is maybe just lay the foundation of what exactly we're talking about when we talk about the endowment model and the Yale model, and what it really means for folks like my panelists on a day‑to‑day basis, and how their universities run their endowments.
The first thing I'd say is, Yale is the cream of the crop in terms of how they run their portfolio. They've seen 11% and 12% returns over 20 and 10‑year periods, they run a $41 billion endowment, and perhaps more importantly for the universities on the call, is they contribute about a third of the annual operating budget to the university. That's more than $1.5 billion that's coming out of the endowment to fund operations at Yale. I think everyone can agree they would aspire to that and that level of ability to support their institutions.
I think everyone is also aware that, generally, when people say the Yale model, they're talking about a higher allocation to alternatives, illiquid and liquid alternatives. I think one of the things that typically doesn't get discussed as much other than the allocation is some of the processes that run around the manager selection process and how they actually mitigate a lot of the risk that comes with being 20% to 25% venture allocated, 20% to 25% hedge fund allocated. They do run a portfolio that most would look at at 50% illiquid, 25% total return. That has a relatively high‑risk profile.
How do they actually go about minimizing that risk profile? It's really all in their manager selection process, how they run their relationships with their managers, in order to get that 12% long‑term return that they do get. Just to put that 12% in context, you think maybe about some of the Canadian pensions, which have a very good track record and very good system that is viewed at globally, in terms of bringing in‑house expertise as a model, and think about maybe some of the ones that people consistently talked about CPP and teachers, their 10‑year returns are around 10% and 8.5% respectively.
If you think about that being the cream of the crop in Canada, Yale's outperforming them by anywhere between 200 and 350 to 400 basis points. That model is also performing its endowment peer group in the US by roughly the same amount, even in a down year, this last year, where I think their returns were just under 1%. The balance, I think, with the exception of one, the balance of the peer group of endowments in the US was negative, anywhere from ‑3 to ‑7.
Even in down years, it continues to outperform, but I think it's important for everyone to realize you don't just go and allocate to these, somewhat, high‑risk venture hedge fund portfolios without another part of your process to go with it to mitigate the risks. If you can do all that properly, well, then you can enjoy the same type of returns and double‑digit range.
Caroline: Excellent, those are great remarks, Ash. I think that really helps to set up our discussion and leads really into my first question, which again, touches on this so‑called Yale endowment model that you've described. I'd like to get a sense from each of you about how you've seen that reflected in your portfolios and whether or not there's been any shift given today's rising rate environment. Marc, I'd like to start with you.
Marc Gauthier: Yes, some time in markets have massively grown, in my case, and I'll specifically speak to, although we mentioned the endowment assets or foundations, but include, obviously, the endowments, what has massively changed and risen for me is the whole aspect of sustainable investments. For our foundation, we have committed to what we call to become 100% sustainable by 2025. Essentially, what that means is that we're pretty much going to be what I define as capital allocation for purpose and intentionality.
What that means is, how private markets play a role in all this, is that private markets tend to have a greater alignment of interests relative to the public market. They have a longer‑term vision, longer‑term planning, greater direct risk management. It suits well the whole notion of sustainable investments. As a result of that alignment, and that growth in private market, what I've seen, in terms of rise in specific classes of private market, specialized venture capital, I've seen that growth a lot, very niche type. Microlending, also, there has been a rise.
Also, we often talk about co‑investment but co‑investment field in sovereign nations in the private markets, where there's an incentive provided by the sovereign nations to encourage the private markets to go into and drive innovation, and so they offer both capital protection and a share of the upside. What I've seen massively, also, is a concept of a thematic investment.
In my case, name it from the Blue and Natural Resources driven economy to their bio‑economy and mental health, low carbon economy transition, social equity, just transition, sustainable technology, community‑focused intention. These are thematics that didn't exist simply when the Yale model was introduced, but certainly, in my context now it's part of the inventory I look into.
I would just conclude that certainly, my aspect of how private markets have played a role with respect to my foundation, is a whole notion of, what I call, mission‑related investment, and the whole notion of local investment, not only into your local city, states, province you're into, but in terms of ecosystem within their own university and incubators, startups from students and graduate students, they are incubators, and want to— Our foundation is not investing, co‑investing into them. This whole notion, certainly, I don't think was available back then. That's really what I've seen how private market has impact from the foundation perspective.
Caroline: That's really interesting. Very much thematic and sustainable view. Martin, how do you view this issue?
Martin Belanger: Well, our exposure to private markets has increased significantly since I've been in this role that I started in this role in 2009. At that time, our only private market allocation was a small hedge fund allocation, a 5% allocation. Now we have a 47.5% target allocation to private markets. We're not fully funded in all asset classes, so we're not at target in private equity and real estate, but we're in all of them, the major buckets so we do have an allocation to private equity, to infrastructure, to real estate, and we also have some allocation to commercial mortgages, private debt, and some absolute return strategies.
Obviously, we've been very aggressive in moving into private markets. In terms of the impact of rising interest rates, we don't see us changing our long‑term target allocation. It's probably going to be more difficult to find some private equity infrastructure and real estate deals with higher interest rates so we focus on managers that use leverage in a conservative manner, and also that have locked up their long‑term financing, especially in the infrastructure side. In terms of allocation, as I said, we are not planning on changing our long-term allocation. There might be some — we may delay or commit faster in some areas depending on opportunities that come along. Especially private credit looks more attractive in this current environment, but overall, no changes due to rising interest rates.
Caroline: Okay. Good insight. Taylor.
Taylor Servais: An increasing trend, at our organization, for the endowment fund, the real assets was increased to 30% from 25%. Private debt was increased to 10% from 5%. Our total private, I call it, private markets liquid strategies totals 45% once hedge funds are added across both the pension fund and endowment. Prior organization, similar story, increase in private markets. Over the past few years, I've been involved directly and indirectly in a few asset‑liability studies and every time it's been an increase in private markets.
In general, our organizations tend to take a walk before you run approach. Some organizations which might be getting exposure of 3% or 5% in some of these strategies may, over time, increase that on the next ALM review. I see this trend continuing in terms of just growing exposure over time. As Martin alluded to, these are long‑term decisions, and the yield characteristics and the return characteristics of these asset classes have proven to be, especially in down markets, as highlighted in his opening remarks. They've done well for the portfolios and for our respective funds and turbulent public market times.
Caroline: Exactly. I want to pick up on that and turn to you, Ash, and get a sense of how you see risk and volatility in private markets compared to public markets. Walk me through that.
Ash I'll start with the risk side. Generally, like the public markets and the private markets and any investments, it's going to depend on the strategy. It's going to depend on the underlying strategy, what you're investing in, where the risk sits. I tend not to put a blanket across the private markets in terms of risk is higher or lower than the public markets because if you break it down into each individual sector, even sub‑sector, senior secured private debt, that's a very different risk profile than venture as an example.
I tend to think of it as like any other investment. You look at each piece individually and the underlying strategy and think about your risk. The only aspect of risk that I would say is perhaps a little more enhanced on the private side, is what I'll call the manager risk. I mean, the expertise of the manager because most of these strategies tend to be much more active management‑type strategies.
If you think about private equity and the role the firm plays in setting the business plan and executing the business plan and working with the senior leadership team at their portfolio companies to get that done, putting the capital stack in place, that's a very different risk profile than buying into a public markets company where you don't really have all of that control through your long equities manager, let's say. I would say manager risk is different between the two categories, depending on how you're investing.
From the volatility side of things, and we have this conversation a lot these days because of all the chatter around valuations between public and private markets, the one thing I always start with is, I think we should move away from using the public markets as the arbiter of value. The public markets have a lot of factors that go into how a stock trades on any given day that are unrelated to the underlying value of that business and the underlying operation of that business, algorithmic trading, high‑speed trading. Once a month our head trader here, he comes and says, “Oh, it's index rebalance day this week so everyone watch it.” All those things impact the value of a company on a day‑to‑day basis.
In AGF, we're a public company. If our stock moves around from Monday to Friday, does that really mean the underlying business has changed that much in four days? I tend to separate the comparison to the actual values in the public markets to the private markets and then lean on how are the managers actually valuing it and how are they looking at it. If they're using comparable trades, if they're using full DCFs, then they should be valuing it based on the underlying business. The generation of cash flow is the value creation.
Now, what does happen in times like now is it does look like that volatility is a little lower than it should be because of the speed with which interest rates have risen. I know you asked about interest rates in your prior question. I would say the higher rate environment is not so much an issue when we're in the four or five range because we've been there for many, many years before. I think the issue is the speed with which it went from near zero to four‑and‑a‑half. That's what's really causing a lot of volatility in the market. That aspect of it is taking a little more time than you would think to flow through into the private markets, creating a somewhat subdued volatility.
That being said, you are starting to see it come through now with some of the returns from the second half of last year. Most of the private equity sub‑sectors did go negative. Real estate is now bouncing around zero and slightly negative if you look at Q4 numbers. It is starting to come through, but it did take a full year to get there. The other thing I would say is public markets are back up again. Very concentrated admittedly, but they're moving around again, trying to figure out what's about to happen in the future. Volatility‑wise, I would say, typically, they would be less volatile than public markets, but that's because there are completely different factors at play.
Caroline: Does anyone want to chime in on some of those dynamics, particularly some of the volatility we've seen over the last year in private markets? Taylor?
Taylor: I will comment on valuation risk. I think that is a very big one when you go from public to private. Ash brought it up on real estate. Real estate valuation is always a question mark, especially whenever transactions are limited. We've all seen what's happened in the office market, which is an easy one to pick on, but if any of us have exposure to open‑ended diversified funds with office exposure and you see what they're valued at and you see what stuff is or is not trading for in the public markets, valuation risk is real.
I would say from a structuring perspective, whether it's an open or closed‑ended fund, valuation risk differs slightly in the sense that eventually in a closed‑ended fund, you will realize your marks, whether they're real or not, the market will tell you what they are because the fund will eventually liquidate. Whereas in an open‑ended fund over time the volatility is perhaps a little bit less as a result of this valuation smoothing. That's what I'll add on the risk side and the valuation risk piece.
Marc: What I can add, Caroline, is I think— First of all, I totally agree with what Ash had mentioned. I think public is more trade‑based. I think private is more investment‑based approach. Having said this and the whole notion of volatility and so on, I think from a portfolio construction perspective, you have greater opportunity to diversify your risk in the private market than you have in the public. There's so many ranges of private markets you can invest into. We mentioned a bit real estate, and within real estate is many, infrastructure, private debt, ILS, agriculture, timberland. Then there's private equity, but there's the alternative private equity. There's a massive— and then now the whole thematics. There's a lot of ways you can really diversify your way through volatility more than it is on the public side.
Caroline: Does that resonate for you, Martin?
Martin: Yes. I agree with everything that was said. Obviously, manager selection is a key risk there because of the dispersion between the top and the bottom manager evaluation risk. Also, a key element for us is liquidity risk. Obviously, it has a huge component in your risk management framework. You need to model your future commitments, your capital costs, and your distributions. Another thing I'd like to mention is complexity. These deals, private deals are much more complex than public deals. You need to budget for much bigger staff and also much higher legal bills when you review those deals. When your committee decides to go in through private markets, you need to factor that from the beginning, otherwise, it's going to be a very unpleasant surprise if you don't factor that in from the beginning.
Caroline: I think those are great points. I want to turn to something you were talking about earlier, Marc, and that's your shift to a more sustainable investment structure around your portfolio, more impact, more purposeful, I believe, purpose‑driven, you were saying. Universities have a unique set of stakeholders. I think you might all agree with that. There might be more of a tilt towards impact, ESG, et cetera, how do you think this has been reflected in your private markets portfolios? Marc, has a lot of this been driven by some of your members for example and some of the individuals who benefit from the work you do?
Marc: How is it driven, is really, I would say, it's university, I guess I cannot speak to all universities, but I think my peers here, my colleagues will agree we are in a very engaged community. I'm talking about here, students, donors, professors, staff, and all the way down to even the government. Universities always want to be leaders in terms of advanced knowledge, really progressing, advancing the path for the future. Sustainability has been at the forefront of this for a long time now. My case, it's been more than 10 years. The challenge, of course, is a polarizing topic, people have views but it all seems to be circled on around investments.
Investments, not everybody understands, but for the construction now everybody understands how you go about really setting your objective. Then the challenge becomes about really making sure that once you take into account everybody's interests and intention and how they put it all together, that is all about communication. Then the communication, it's more of art than a science with respect, especially those who are more intense in terms of engagement.
That's where I find, and I circle back to our topic today of private markets, I find that alignment a lot more powerful to address really specific issues. On the other hand though, if I look at community, they're more interested on the public side because that's where it's more common to see the whole notion of divestment. Then it comes then the notion of engagement. It's something incredible to participate in, very complex. It's a journey that keeps evolving over time.
Caroline: Martin, is that something you've seen at Western?
Martin: Yes, we do have our endowment fund as a 10% target allocation to impact sustainable investment which we define as impact investing, investment that meets one of the 17 United Nations sustainable development goals. We found especially with private markets there are a lot more opportunities in private markets than in public markets because when you control the underlying portfolio companies, it's much easier to influence it and meet your sustainable goals.
These investments have come up with engagement from some of our stakeholders. It started mainly with environmental divestment from fossil fuels. We did get a lot of requests in that regard but we've expanded our strategy to incorporate both environmental and social factors. So far we've committed around $110 million US into impact investing. We are invested in renewable, energy transition but also other areas, more social minded areas like education and financial inclusion. It is a big part.
Obviously, as Marc mentioned several times, the fact private markets is better suited for impact investing than public markets basically.
Caroline: I want to pick up on something you were talking about earlier, Taylor, and that's in the private credit space. I wanted to look a little bit about what specific areas of private credit you're looking at and any headwinds all of you see coming towards us in that space. I'd like to start with you, Ash, on that.
Ash Sure. I agree with Taylor, private credit, and I think Martin said it as well, is one of the more attractive places to be right now specifically in certain areas of the market that are benefiting from what I'll, generically, just say capital constraints across the system, especially when you look at the banks, whether it's either Canada or the United States quite frankly. You think about the regional bank issues in the US, that those particular banks have been funding a lot of mid‑market and lower mid‑market type businesses, also, real estate businesses. A lot of those firms now will have liquidity crunches in terms of borrowing and potentially in terms of equity as well.
If you can select the right manager, pick the right borrowers where you're sure the underlying health of the borrower and the business is still bankable, so to speak, [chuckles] then you can also take advantage of where rates are at the moment. If you combine the lack of capital out there in the market for these types of firms with the rise in rates, you end up making very good returns, and in a lot of cases, on senior secured lending.
I think the thing you do have to be careful about now is, obviously, if we think we're looking into the face of a recession you do have to think about as you're choosing your borrowers, especially if they were potentially borrowers that were screened out from some of the bank lending programs that maybe they would've qualified a few years ago. More generally, you are just seeing borrowers screened out just because the banks don't have credibility or it's an impact on their buffers and things like that.
I agree, I think it's a great space. Personally, here, we, at AGF, are looking at, what I would call, smaller enterprises, mid‑market, but really look the bottom half of the mid‑market where we see the really great opportunities in the credit space.
Caroline: Great. Anyone else want to chime in on private credits? Martin?
Martin: I do agree with everything Ash said. We do have allocation right now in it, so we're not planning on adding more with banks reducing their lending. Obviously, that's a good opportunity. The only thing that I'm going to mention, the longer lock ups compared to public debt is, obviously, a key factor to take into consideration when you invest in private credit but overall it seems like there's more tailwinds than headwinds for private credit.
Caroline: Another big area that's really growing in the private market spaces is infrastructure, especially particularly around the energy transition, around climate change, some of the developments in the US, and even beyond that. What are the opportunities that you're seeing right now? Again, is there anything that's got you a little bit more concerned? I'd like to start with you, Taylor.
Taylor: Infrastructure has been a great yield alternative to fixed income especially with inflation being at the forefront of everybody's minds. The capital that's gone into infrastructure has grown tremendously. You mentioned it, energy transition, tons of opportunity in that space, digitalization of the economy, tons of opportunity in that space. The issue with new opportunities in those areas is what is the definition of infrastructure and how is that getting stretched.
I'm sure many folks, if not everybody, has seen it here what the definition of infrastructure is really getting stretched by some managers to meet return targets. That's exposing our underlying plans to different types of risks than what were perhaps intended at the onset of an underlying investment. To answer your question, energy transition, digitalization, tremendous opportunities, but as those get stretched and as the opportunities in those areas become apparent and the opportunity set the definition's getting stretched and the underlying risks to our portfolios are potentially changing as a result of that.
Caroline: For sure. Marc, yes, you were going to chime in now?
Marc: Maybe I could add to what Taylor mentioned, we often think about infrastructure, I guess, more traditional way, but what's fascinating now I found, especially in the transition towards a lower carbon economy, is a whole notion of infrastructure asset management. For example, you have marine vessels and then you have railways, so the whole class, it needs to be decarbonized and so it provides a different approach to infrastructure than what the plant‑based one that people often think of, which could be an issue with respect to acquisition costs. Also, the whole notion of secondaries, I think, is growing in infrastructure which I don't think was much more before. I think that is also interesting.
Caroline: Great. It's definitely an expanding space. On the private equity side, just shifting over to another area of the private market space, how challenging has it been to allocate within private equity and what are the biggest opportunities right now? Marc, do you want to comment on that?
Marc: Yes. It's funny you started with challenges and it’s reverse in private equity, massively outperforming my best asset classes and massively outperforming my public equities, and I go back 10 years now. I'll speak more about the pension here than the foundation because the foundation, I mentioned, is now, we're evolving towards its sustainability, 100% wise. The pension is really— The allocation for private equity is regional based. We have a North American program and an Asian program, but what I've seen, the rise is, what I call, alternative private equity, GP ownership, minority interest ownership, LP financing. Now I see VC lending, and when you do your technical third capital call, instead of getting equity, you're now into lending of it. These are very interesting classes that allows you to diversify your global private equity.
I mentioned about the whole notion of thematic private equity but I've seen also the growth is instead of having acquisition cost competitiveness against each other and rise, you've seen a lot of private equity funds after they gained knowledge of a company, decided to spit it off and grow their own, which saved a lot of acquisition costs. You see that organic growth of a fund to another fund of previous funds, but derivatives of it. That's, This all speaks about how you came from a portfolio construction perspective can grow your private equity in a diversified in a risk management way.
As for opportunities, I would say otherwise, I will take a look. I would address it one on a regional basis because I tend to be focused on that. The Indo‑Pacific region, which is essentially the oceans of India, Western, and Central Pacifics, I think is a demographic play. They have 10 years to optimize their demographic, and I think it's a very good opportunity there. From a thematic, obviously, outside of what people really are, I think, tend to be on, which is tech and AI, and tech and blockchain. I will throw a couple of more ideas to you. I think the green economy I mentioned, obviously, it's big. Life sciences, I think, offer a different perspective, a different alpha. Then tech enable education. I think that business is massively growing. It will massively grow. It's very interesting to see that evolution as well.
Martin: We do focus on the small and mid‑market buyouts in developed markets, North America, and Western Europe. To answer your main question about the challenge of investing. We haven't seen any issues. We've managed to get our asked allocation for every fund. We've never been reduced because the fund was oversubscribed. Typically those are companies, underlying companies with enterprise values worth less than $2 billion, and we have a diversified portfolio across various industries. Healthcare has a lot of opportunities, but also consumer sector industrials, also some software‑related and tech‑enabled businesses. We've seen a lot of opportunities in that.
The secondary market is also very attractive at this time. It's trading at discounts averaging about 20%. It's very attractive and also there's a lot of liquidity and it allows you to deal with the denominator effect on your portfolio. As Marc alluded, on the impact side, we've seen a lot of opportunities. We've made commitments to two private equity impact funds that have a very diversified approach to impact investing in both environmental and social segments. Those are the main areas where we're focusing with our private equity portfolio at the moment.
Caroline: Ash, how challenging right now is diversification in the private market space? When you compare some of the areas that we've been talking about, whether it's private equity, real estate, infrastructure, how challenging can that be, and what are some ways around it?
Ash I think when we're out there talking with managers, and we wear a little bit of two hats at AGF right now, we're out talking to managers to partner with or acquire, at the same time we're also thinking about our client's needs and wants in terms of investment strategies and diversification. One of the things that is difficult in diversification is that if you do not have enough capital or sizable capital to allocate to individual managers, it had started to become tough. That has eased up now for obvious fundraising reasons, but it had started to become tough to spread it out properly, to diversify your manager concentration risk. If you have a large enough book, then that was fine, but in the pre-fundraising slowdown of the last 12 months you needed to start increasing your allocations to individual managers to get that done.
In some aspects, if you're a much smaller foundation or endowment, you should start thinking about multi‑strategy portfolios. There's a little bit of a fee premium, but you can negotiate those to be pretty minimal, and then you can almost customize your allocation amongst managers that, again, depending on who you are, you might not otherwise have access to. Now, that may be a dated statement because the last 12 to 14 months and fundraising has been so tough for a lot of managers that I think that dynamic has probably shifted.
The other aspect of multi‑strategy portfolios and diversification is if you are of a size or scale where you aren't staffed, and have skill sets in a way that you really shouldn't be because you just can't take on that kind of operational expense, then you should also think about multi‑strategy portfolios as well as a way to diversify. When I say there's a little extra fees, they're not tremendous. We're talking 30 to 50 basis points and usually minimal, if any, carry for some of these managers, but it does give you a way to access skillset and to access managers that might otherwise be tough to access either because of the queue or because of the scale.
Caroline: Martin, how are you approaching the diversification question in private markets?
Martin: Well, obviously, we were in several markets in private equity infrastructure and real estate. In terms of private equity, we're in the process of transitioning our portfolio from a fund of fund approach to a direct fund manager approach. Obviously, it requires a lot of time to have access. You need to have a foundation of managers, at least a 10 to 15 different managers to have proper diversification. It takes a lot of time and effort to put that portfolio in place. That's what we've been doing right now, but obviously, you need to be fairly diversified in order to reduce the risk to your portfolio.
Caroline: Yes. Ash mentioned cost, fees, and there's a perception that private markets are expensive. Can you give me a little insight into how you approach costs and what you think investors might need to keep in mind? Is that something you've thought about, Marc?
Marc: Yes. I have a different approach on fees. I don't look at fees, I look at value, and so I don't mind paying for fees. For example, if you measure on a basis point, I'm probably one of the most expensive funds, but if I remove my most expensive strategies, they're my top five managers. Then there's a circular, the Catch‑22 situation. I think, to me, either way, I see fees is about the uniqueness of the strategy and what role it plays into portfolio construction, if it has a unique role and really adds effectiveness, and I think the fees are worth it because it plays such a unique role. If it's mainstream and can be easily replaceable, I think, this is when you want to then look at the cost structure. What I've seen though lately, I see a trend, and hopefully, it's just starting, is a greater alignment of interest in fees. I see now in respect to carry fees alignment with this and most on a sustainable end. For example, if the underlining positions are not meeting their intentional targets, and then so the carry fees are not materialized. I've seen that trend, which is, I think, a good thing.
Caroline: Yes, for sure. Taylor?
Taylor: Yes, I echo some of Marc's comments. It's important but from my perspective, net returns are the most critical and, of course, whenever we're evaluating managers across different strategies or similar strategies, evaluating fees, depending on fund size and commitment, we'll see anywhere from 75 to 125 bips on some of the larger open‑end more core, core plus type funds. Some of the more, we'll call, value add, up higher risk strategies, we'll see somewhere around 1.5 on committed. Some of the more club deals, those will go lower but it's always top of mind, of course, but at the end of the day, net returns are the most important. We'll gladly pay a little bit more if those net returns on a risk‑adjusted basis are higher.
Caroline: Okay, Martin?
Martin: Yes, I totally agree. The net returns is where you should focus. Just by example, our private equity managers are the most expensive, but they're the only ones that have met their target. We have a target of outperforming public markets by a 200 basis point after fees, and they've done it constantly while our public managers, it's been hit and miss. Obviously, if the managers can provide value that's the most important thing to look at. In terms of trends, we've seen, as I mentioned earlier, we're moving, transitioning from fund of funds to direct fund investments. There's been a significant reduction in fees for fund of fund managers but not so much for the underlying GPs, especially the successful managers, it's very difficult to negotiate with them.
The only other thing I will mention is that if a private equity manager is deviating from the typical 2 and 20, they need to demonstrate a very good alignment of interest or if they get an additional carry, obviously, you need as an investor to benefit from it too. It's not just feed money for the manager. The interests have to be aligned with the investors. That's my two cents on fees.
Taylor: The one comment I'll add on fees that I forgot to bring up and a lot of these companies are providing related party services, so the asset manager might have an advisory business that provides related party services or a debt placement business that provides related party services. Those are one area of fees that perhaps don't get discussed but need to be watched to keep the managers on us and to ensure their market fees.
Caroline: Okay, great. Finally, I'd like to look a little more broadly at the array of private markets and get a sense of what you buy today and what you might consider to be outside of your risk comfort zone. Ash, I'm going to start with you.
Ash Sure. It's come up a few times in the conversation, private credit for all the reasons stated before. Maybe just to mix things up, I'll mention a few that maybe some folks wouldn't mention, but I would argue that right now is probably the right time, whether it's thinking about manager selection or thinking about allocation, to start thinking about it might be a very good time to invest in real estate over the next 12 months or at some point in the next 12 months. While at the moment, there's a lot of negative headlines and a lot of headlines around the office and maybe the office is not the place to be although I think there'll be some value there at the right time.
When you go into these time periods and some of these sectors, whether it's real estate like we're seeing now or whether it's the impact of a potential recession on other sectors, that is really the time you want to have your money allocated ready to go and with a manager. Some of their best vintages will come in times. I'm not an economist and I can't read a crystal ball but, hypothetically, their best vintages will come in times like the next 12 to 24 months.
I wouldn't necessarily think about today's world when I say private credit which is today's world, but what happens over the next little while and where do you want to put your money. That leads me to say people should start thinking about real estate again and for the same reason, venture right now is a lot cheaper than it used to be and if you can find the right manager who picks the right opportunities, those investments are much cheaper than 12 or 18 months ago.
Caroline: Taylor.
Taylor: Yes, I'll echo private credit. It's been, obviously, a hot topic across many different allocators and different publications, but if we've got an actuarial return of 6%-6.5% at 40% LTV, you're earning another, call it, 600 bps minus one point on fees, you're earning a 10 net plus-minus at 40% LTV, pretty attractive. Infrastructure, I think, is also very attractive. Tons of opportunities there. Another area, of course, I'll say real estate but I think real estate, you have to be very selective. I do think call it small bay industrial self‑storage, diversified cash flow streams with, call it, structural drivers benefiting the underlying asset classes, very good. Yes, probably, those three.
Caroline: Okay — Martin.
Martin: Well, again, private equity, we focus on small and mid-market buyouts. In infrastructure, as well, as Taylor mentioned, lots of opportunities. We focus on renewable energy transition, digitalization, and also, the globalization team, the entire issue around energy security. We have a number of managers focusing on that. Real estate, as Taylor mentioned, the industrial distribution centers, also mult‑risk on the real estate sector.
We're a little bit well‑selected in the other areas. Private credit, as I mentioned, we already have some so we are not planning on reallocating but also non‑traditional absolute return strategies like life settlements, insurance linked securities, and litigation funds are areas that we're looking at just to diversify the portfolio as those types of investment have a very local relation with the market. That provides good diversification to our portfolio. That's where we find opportunities at this time.
Caroline: Great. Marc.
Marc: Yes, I'll continue just to add to the conversation. I'll continue what— so Martin ended with different types of private markets that often you don't look at. There are so many of them. They're very idiosyncratic. For example, electricity trading. I think it's a great diversifier in the private market. Mining royalties or any intellectual property royalties, I think, it's a different source. Water rights. You’ve also got different types of focus on GP minority investments. Also, there's some demographic play with Millennials and so there's a lot of opportunities from the different types of private markets. What I would also mention is a bit to what Ash mentioned, but I think, instead, start at looking multi‑strategies, multi‑manager platforms as well. I think that's also a very interesting and good diversifier. Also another one, the art market. Nobody thinks about that but it's also a very different type of private markets. There's a lot of ways if you open and you get that trust with the committee to look into different types, there's a great way to diversify.
Caroline: Ash, final thoughts?
Ash Yes, just maybe I'll segue off what Mark was saying because Mark, and throughout the conversation, has mentioned a lot of more specialized sectors. I think one of the things to keep in mind, I don't think it should change your allocations but it could potentially change your manager selection, one of the things to keep in mind is the size of the private markets and the capital headed towards it has grown tremendously. There are pockets, whether it's sectors, specialties, or geographies where there is a tremendous amount of dry powder sitting there from the fundraising that occurred before the current slowdown. Up until the mid part of 2022, the fundraising was still going very, very strong, and for various reasons, the deployment of that capital has been slower than normal.
As you think about certain sectors, and I don't mean to pick on it but I'll say it because it's the obvious one, the big bio sector, there's a tremendous amount of backed‑up capital if you look at the North American big bio sector. You should think about that from your manager selection perspective if you are going to go into a sector or allocate to a sector where there's going to be a lot of competition for, at present, at least, very few deals.
Caroline: All right, so lots to keep in mind and an absolutely terrific discussion with excellent comments here today. I'd like to say a huge thanks to all of our panelists here today and thanks to everyone for joining us for our inaugural Breakfast Club round table. Terrific. Thanks very much, all of you. I'm going to say keep an eye out for upcoming Canadian Leadership Congress Breakfast Clubs and Monday minutes by subscribing to our newsletter and visiting leadershipcongress.ca or following Canadian Leadership Congress on LinkedIn. You'll get updates about all our events, virtual and in‑person, and we look forward to seeing you again soon. Thanks, everyone.
Breakfast Club sessions are available to senior decision-makers within Canadian pension funds who are currently subscribed to the CLC Newsletter.
Access to the Breakfast Club provides you the link to view at your leisure or share with your team.
Access to the Breakfast Club provides you the link to view at your leisure or share with your team.
Martin Belanger
Director, Investments | University of Western Ontario
Director, Investments | University of Western Ontario
Martin is Director, Investments at Western University, where he oversees the University’s Retirement Plans and Operating and Endowment Fund. He has more than 25 years of experience in the financial industry and has been with the University since July 2006. His responsibilities include monitoring the University’s external investment managers, implementing governance policies, developing asset allocation and risk management strategies and reporting to the governing bodies of the University.
He holds a master's degree in finance from HEC Montreal, is a CFA charterholder, a CAIA charterholder, a certified financial planner (CFP®), and is a fellow of both the Canadian Institute of Actuaries and the Society of Actuaries.
He holds a master's degree in finance from HEC Montreal, is a CFA charterholder, a CAIA charterholder, a certified financial planner (CFP®), and is a fellow of both the Canadian Institute of Actuaries and the Society of Actuaries.
Marc Gauthier
University Treasurer and Chief Investment Officer | Concordia University
University Treasurer and Chief Investment Officer | Concordia University
Mr. Gauthier is responsible for the oversight of the University’s and its related entities’ financial
position, which are segregated through five distinct portfolios; Benefits (Pension Plan, Group Insurance
Plans, Supplementary Retirement Plans and Post Retirement/Employment Benefits), Investments
(Pension Fund and Foundations), Corporate Risks (Insurance, self-insurance and ERM programs), Capital
Budget (Capital investments and Fixed Assets) and Financing. He has been employed by Concordia
University for 31 years; his responsibilities have also included such roles as Executive Director, Finance
and Business Operations, Director of Finance and Restricted Funds and prior as a senior financial analyst
and accountant.
Mr. Gauthier obtained his CMA and graduated from Finance and Accounting at Concordia University as well as from Queen’s Executive Program in General Management.
Mr. Gauthier obtained his CMA and graduated from Finance and Accounting at Concordia University as well as from Queen’s Executive Program in General Management.
Ash Lawrence
Senior Vice-President and Head of AGF Private Capital | AGF Investments Inc.
Senior Vice-President and Head of AGF Private Capital | AGF Investments Inc.
Ash Lawrence joined AGF as Head of AGF Private Capital, the firm’s private markets business, in February 2022. He is a seasoned private markets leader with a wide breadth of expertise in investments and portfolio management across sectors. Ash brings the right combination of strategic thinking, deep experience and strong relationships to drive the growth of AGF Private Capital, a key pillar of the firm’s growth strategy.
Ash has approximately 20 years of private markets experience, including 16 years with Brookfield Asset Management working on real estate investments and portfolio management in North America and Brazil. He most recently led the firm’s Canadian real estate business. Prior to that, he worked at a real estate company managing development strategies and the financing of municipal infrastructure projects. He also worked as an engineering consultant, developing infrastructure and transportation solutions for private and public sector clients.
Ash earned an MBA from the Rotman School of Management and a Bachelor of Applied Science, Civil Engineering, from the University of Waterloo.
Ash has approximately 20 years of private markets experience, including 16 years with Brookfield Asset Management working on real estate investments and portfolio management in North America and Brazil. He most recently led the firm’s Canadian real estate business. Prior to that, he worked at a real estate company managing development strategies and the financing of municipal infrastructure projects. He also worked as an engineering consultant, developing infrastructure and transportation solutions for private and public sector clients.
Ash earned an MBA from the Rotman School of Management and a Bachelor of Applied Science, Civil Engineering, from the University of Waterloo.
Taylor Servais
Director, Investments | University of Ottawa
Director, Investments | University of Ottawa
Taylor oversees the University of Ottawa's 30% real assets allocation for the Endowment and Pension Fund. He previously spent 7 years at CMHC Pension Fund overseeing their real estate portfolio, which covered Canada, the U.S., Europe and the U.K. During his time at CMHC, Taylor also obtained exposure to private equity, private debt, and agriculture.
He is a proud graduate from the University of Ottawa where he was a varsity athlete with the Gee‑Gees football team.
He is a proud graduate from the University of Ottawa where he was a varsity athlete with the Gee‑Gees football team.
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FEATURED TOPIC
The Future of Energy in a Net Zero World
The Future of Energy in a Net Zero World
AIR DATE
October 24, 2022 | 12:00 PM, EDT
October 24, 2022 | 12:00 PM, EDT
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DISCUSSION HIGHLIGHTS
While the global energy transition has given rise to new technologies and sectors focused on carbon reduction, it has also created a good deal of uncertainty for investors, particularly in countries like Canada where the energy industry plays a significant economic role. In this Monday Minute, we will look at the role policy can have in supporting the sectors and technologies that will help the world achieve Net Zero. We also dig into the data and how investors can identify real gamechangers — and avoid greenwashing.
While the global energy transition has given rise to new technologies and sectors focused on carbon reduction, it has also created a good deal of uncertainty for investors, particularly in countries like Canada where the energy industry plays a significant economic role. In this Monday Minute, we will look at the role policy can have in supporting the sectors and technologies that will help the world achieve Net Zero. We also dig into the data and how investors can identify real gamechangers — and avoid greenwashing.
DOWNLOADABLE RESOURCES
Listed Infrastructure Offers Breadth and Liquidity
FEATURED TOPIC
The Yale Model Revisited: Private Markets and Canadian Endowments
The Yale Model Revisited: Private Markets and Canadian Endowments
AIR DATE
June 21, 2023 | 10:30 AM, EDT
June 21, 2023 | 10:30 AM, EDT
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If you have any questions regarding access, email us.
DISCUSSION HIGHLIGHTS
Made popular by the long-term CIO of the Yale Endowment, David Swensen, the so-called “Yale” or “Endowment” Model has traditionally leaned on private assets to generate the income needed by universities to grow. We gathered together a panel of experts over breakfast to check in on the role private markets are playing today at Canada’s top university endowments.
This inaugural CLC Breakfast Club will address key questions endowment investors have about private markets, portfolio diversification, and some of the challenges and opportunities that lie ahead in today’s rising rate environment.
Made popular by the long-term CIO of the Yale Endowment, David Swensen, the so-called “Yale” or “Endowment” Model has traditionally leaned on private assets to generate the income needed by universities to grow. We gathered together a panel of experts over breakfast to check in on the role private markets are playing today at Canada’s top university endowments.
This inaugural CLC Breakfast Club will address key questions endowment investors have about private markets, portfolio diversification, and some of the challenges and opportunities that lie ahead in today’s rising rate environment.
Darcie James Maxwell
Head of Canadian Operations, Data and Platform Solutions,
BNY Mellon and CIBC Mellon
Head of Canadian Operations, Data and Platform Solutions,
BNY Mellon and CIBC Mellon
About Darcie
