Canada Pension Is Backing Fledgling Hedge Funds

Canada’s biggest pension plan aims to back as many as four fledgling hedge funds a year at a time when investors are balking at high fees and disappointing returns from the industry’s biggest managers.

Canada Pension Plan Investment Board has made initial investments of as much as $250 million each in five startups and young hedge funds under its Emerging Managers Program in the past two years, according to Poul Winslow, Toronto-based head of thematic investing and external portfolio management. While the pension fund has allocated to external hedge funds for almost a decade, it rarely invested in managers with a track record of less than a year before the start of the program in October 2015, he said in a telephone interview.

Backing Future Winners

CPPIB hedge fund seeding and acceleration deals

Source: CPPIB

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The Canadian investor, which has C$337 billion ($261 billion) in assets, is getting into promising hedge funds earlier in their life cycles to secure the ability to invest more as they expand. The move reflects a growing realization that smaller managers can access a different set of investment opportunities while being flexible on fees and other terms. It’s also a symbolic shift from a focus on industry behemoths, who have taken a lion’s share of investor assets even as returns from many high-profile managers have been lackluster in recent years.

“There is some argument that early-stage managers have a different return profile, something that can diversify our investments in mature funds,” said Winslow. “With early-stage investments, you can negotiate better fees, revenue share, capacity and transparency terms with the managers.”

Globally, hedge fund managers overseeing at least $5 billion attracted $166.1 billion of additional capital since the start of 2009, while smaller peers saw $13.2 billion of net outflows, according to data from Hedge Fund Research Inc. Funds larger than $1 billion gained an average of 6.1 percent in 2017, while those smaller than $250 million were up 9.7 percent, according to an eVestment report in January.

Crowding Into the Giants

Firms managing more than $5 billion took bulk of global hedge fund assets

Source: HFR

Estimated data at year-end 2017

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California Public Employees’ Retirement System, the largest U.S. public pension fund, decided in 2014 to divest its entire $4 billion hedge fund holdings, partly citing the inability to expand such investments in a way that could justify costs. Investors have also pushed hedge funds to change the way they charge fees to better align investor and manager interests.

CPPIB has produced an annualized real investment return of 5.7 percent in the past 10 years, according to a February quarterly update. It has farmed out C$75 billion to 160 external hedge- and private-equity funds by March 2017 to help diversify investments, said Winslow.

Its emerging managers program, led by London-based Pete McConnon, typically commits $150 million to $250 million of seed capital each to hedge fund startups for two or three years in exchange for a cut of their fee revenue and the ability to invest more later, said Winslow. It also participates in what it calls “acceleration” deals, where it provides a similar amount of money to managers that have typically been operating for fewer than three years and oversee less than $250 million of assets, he said.

CPPIB seeks to stay with successful managers after the initial lockup periods end, using the emerging managers program as a way to expand its investments in mature managers, Winslow said. It has given additional capital to several funds in the program, he added. That sets it apart from other hedge fund seeders that raise money for private-equity-like funds and often reinvest their money somewhere else once the initial lockups end.

Ovata, the Hong Kong-based startup it backed, is led by James Chen, who previously ran the Asian equities team at Michael Platt’s BlueCrest Capital Management. It started trading on Dec. 1 with more than $200 million. His team, which trades Asian stocks, includes members of his former BlueCrest team.