Investors’ appetite for private assets is great right now. Mark Machin’s concern is what could happen if some of those investors need to find cash.
The chief executive of Canada Pension Plan Investment Board - which, like many other global giants, competes for private equity and infrastructure deals – says he is often asked what could trigger the next financial crisis or stress point in the markets. His answer: he worries about what might unfold if major institutions, having locked up large sums in long-term, illiquid investments, need to raise money quickly, as happened in the 2008-09 crisis.
They would likely sell things that are quick and easy to dispose of, namely the publicly traded stocks held by many smaller institutions and individual investors. And that would place rapid downward pressure on their prices.
“If you think about the incredible appetite for private investing around the world, and talk to the investors in private-equity funds, most of them want to increase their exposure to private equity – at a time when there’s [US]$3-trillion invested in private equity right now, by far a record,” Mr. Machin said. “At some point, a lot of funds need to pay their obligations or countries need money from their sovereign funds in moments of economic stress, and everything’s locked up … It’s very difficult to get out of that stuff in a reasonable time frame. So you have to sell the liquid stuff.”
Investors in private-equity funds wait for years for the funds’ managers to invest, own and then sell their assets to realize their return. The fund managers decide when proceeds are distributed; investor attempts to get out early come with punitive fees or are simply not allowed.
Similarly, major investors can partner with others or go on their own to buy major pieces of real estate or infrastructure, such as toll roads or airports. You can’t just hit the “sell” button on a computer and cash those investments out. CPPIB makes these types of investments through its own staff and through partnerships with external investment firms.
Mr. Machin says that with fast-moving markets and algorithmic trading that quickly executes sell orders at the first hint of a pricing problem, the potential for a “flash crash” style event remains meaningful, with small examples occurring in the past year or two. “Everything’s bounced back, so it’s not a fundamental issue today, but it gives you a little glimpse of what could happen when you hit a real requirement for liquidity. It’s not a prediction, it’s something we’re keeping a very close eye on, and I hope all the funds that have loaded up on these private assets are keeping an eye on their liquidity.”
Mr. Machin’s comments to The Globe and Mail came Thursday as the pension fund released its results for the quarter ended Dec. 31.
CPPIB has about one-third of its investments in public equities, so the market tumult of the calendar fourth quarter took its toll on the fund. CPPIB reported a quarterly return of just 1.1 per cent after costs, which represented profit of $4-billion. Pension benefit payments exceeded contributions by $3.8-billion, so total assets increased by just $200-million, to $368.5-billion.
For the first nine months of CPPIB’s fiscal year (which ends in March), the plan has posted a 3.6-per-cent return after costs. The plan’s 10-year return was 10 per cent and its five-year return was 11 per cent.
David Milstead