John Graham – Evolution of the Canadian Model at CPPIB (EP.465)

26:23We don't compete with the GPs. The private equity space is such a well-developed, large, mature market, and the partnership model works really well. Our private equity professionals have a great career and a super fascinating role, but they are solving for something slightly different than a GP. So we're eyes wide open that our compensation system, while people are paid in the Canadian model, fair, they aren't paid like they would be at a general partner or a hedge fund. And so ensure that the strategy that we run doesn't put us in a situation where we're fundamentally disadvantaged. How does that look outside of private equity and the corollaries of real estate infrastructures and public markets on the equity side or fixed income?

27:04It's a challenge we have. And as markets become super hot and then sometimes not super hot and they ebb and flow. Take credit. Credits become really hot. And our credit group was a little bit more direct than our private equity group. And they still do follow somewhat of a partnership model. And so that puts stress into the system. We always try to be competitive, as competitive as we can, knowing that it's sometimes we're just not. I think people have an incredible career at CPP Investments. The senior people have an opportunity to be on a platform that has incredible breadth, scale, reputation, brand.

27:41For people with creativity, for people who want to innovate, it's incredibly motivating. For young people entering the investing space, you'll see tons of reps, tons of opportunities. But there's some people who really do want to have that opportunity to work at a general partner. And I say, God bless them. One of the things I have also a firm believer of at CPP Investments is once a CPP-IB-er, always a CPP-IB-er. And so we've really tried to cultivate the alumni network. We're only 2 ,000 people. Not everyone will spend their whole career here, but I want everybody to always feel like they're part of the CPP-IB family.

28:16In the situations where you've decided that you couldn't compete effectively internally, what does that look like, both the decision process and then the process of finding who you want to partner with externally? The process is generally dictated by returns and realized returns. It's interesting because at the end of the day, you need to allocate to those programs you think you're going to make money in the future, not just in the past. I'm always asking the teams two questions. How did you make money? And how are you going to make money? It might not be the same answer. There's a tendency in attribution and in all the great analytics people do it for it to always be backward looking.

28:57Now, the first clue that you're not going to make money going forward is usually that you didn't make money historically. But there are cases where you may want to scale back because you just are watching a decay in performance and you know that freight train is coming at you. And so you have to make the difficult decision. What we often try to do is move people around and put them into other groups. We typically have had focused groups that are external allocators. In the hedge fund world, it's our external portfolio management group, and that's a focus group. And they really allocate to external managers.

29:27And on the private equity side, we have a funds group that allocates to external. It's rarely commingled within the group that they're doing funds and direct. There are some instances, but they're usually separate groups. So the funds team, the external team, if we did want them to expand, we would give them that mandate to expand and then they would go off and find the managers. There's this interesting dichotomy between talking about how you want that cross fertilization of your internal teams improving and this separate team going out with external managers. How have you thought about the crossover and potential value creation between what you can learn from the external managers you selected and your internal teams?

30:09One thing I would say when I talk about the East-West connectivity is exactly that. It is exactly taking the knowledge that is embedded in that funds team and driving it through the organization. Not only providing an access to opportunities, but also an access to knowledge, an access to information. Obviously, partnering with external managers, we focus on the net returns, but we do pay fees and carry. And we have an expectation of partnership that we will learn things just about macro, that we will learn things about geopolitics. That's part of the reason we do it. You work with the best around the world.

30:44I will spend a lot of time with the leaders of these firms, not going through their portfolio, but trying to understand how they're thinking about, I said, geopolitics, how they're thinking about the macro environment, how they're thinking these big megatrends in the industry. So that's a real focus of mine is the expectation that these teams that are external portfolio management team and our funds team, that they are diffusing the knowledge and the information through the rest of the organization. It's hard though. It's really hard. We're going to take a quick break in the action to tell you about SRS Aquium.

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32:02Learn more at srsaquium.com. That's s-r-s-a-c-q-u-i-o-m.com. And now, back to the show. When you look at that two-by-two matrix today, what types of strategies fill the box of active external? Active external, on the public side, a lot of the quant strategies, they have some macro strategies. They do have some equity strategies in there. A lot of the strategies there, we may run some very small kind of programs on the side of it, but those are really where we're looking to the external managers. Coming back to the private equity model, I'm a big believer. It's worked really well. Partner with the best private equity managers and then do co-investing and co-underwriting with them.

32:48So that's what I meant by it starts to blur a little bit in private equity. That fund's Portfolio is like the sun and the rest of the department rotates around it. When you bring this all together in the portfolio approach for CPB, you have this total funds management approach, slightly different from asset allocation model. What's your way of thinking about how that works? We are solving for the highest total return at the total portfolio. And the total portfolio approach is solving for that. It's very consistent with trying to maximize the total return at the total portfolio level. We're not just giving out an asset allocation and a bunch of benchmarks and managing active risk against it and trying to maximize the information.

33:31We are actually trying to maximize a total return at a given level of risk over the long run. One of the challenges is we execute through a series of strategies, private and public, decisions get made bottom up, and we can get collection of idiosyncratic portfolios. And then we blend them all together and see what we got, knowing that it's looking past the very simple asset class labels, looking what we have from a geography perspective, looking what we have from an asset class perspective. And I know where the team thinks a lot about is how do we actually then have an optimal total portfolio and that we have the right exposures in the total portfolio.

34:09We have the right allocations in the total portfolio. We still have a mechanism to get the alpha through security selection, but then we have an ability to manage the total portfolio. so we have the right exposures we want. How do you think about the process of moving capital around? You have teams, internal, selective managers, external, and it's a large portfolio. Things change in the markets. I describe it as a supertanker in that it's very hard to be nimble with a$700 plus billion portfolio. What we need to do is build a portfolio that is resilient through a broad range of macroeconomic conditions.

34:44When it sees something it doesn't like, it just hits it. and runs it over. We can't really move it that quickly. One of the messages I do try to deliver internally and having experienced this for the past 20 years, every asset class will have its moment in the sun. Every geography will have its moment in the sun. It'll also have its moment in the shade. And you can't kill a program every time it goes into the shade or you won't have anything after so many years. So it is expected that capital may not always be uniform into a given area. There's a big cultural aspect to it on how to think about capital coming in and out.

35:17We build internal teams. We have people, it's their livelihoods, and they want to do transactions. And they were hired to do transactions. It's a very reasonable expectation. So moving capital around is a big cultural component to it. Where I see it working really well would be within the department. So credit. Credit is, they're really good at moving capital around. We're saying we think structured credit is more attractive than corporate credit. We think European credit or Asian credit is more attractive than North American credit. so we're going to move capital around. They're incented to do that because they're incented at the credit portfolio level.

35:52So it's a lever they have to get more carrots. Within our real assets, between energy, infrastructure, and real estate, an ability for them to think about where they're seeing the best value within that. When you start to cross between asset classes, it's a little bit more challenging, but there is a opportunity for larger opportunities where you might be able to move capital in. Just to add to the challenge, you've also expanded offices globally. What have been the challenges in making that work? We have a handful of offices outside of Toronto. And again, this was a choice. We made a choice to open offices because we believe it'll lead to higher net returns for the portfolio.

36:29The reason we believe that is it will give us access to markets, give us access to specifically the best partners and the best opportunities in those markets. that from even a risk management perspective, if you're going to build a reasonably sized portfolio in India, you should have feet on the ground in India. Flying in and out is often not a recipe for success. So if we're going to commit, we'll commit and we'll have an office. We have the offices to get differentiated access. It's not to get beta. We can get beta from screens in Toronto. We can get beta through swaps and ETFs. We need alpha.

37:06We open the offices to get alpha, to get local knowledge, local relationships, local opportunities. It's not just about doing transactions in the country. It's about doing transactions that will ultimately add alpha. I think our footprint is very much a differentiator. I think it's a real asset we have, but one has to go into it eyes wide open. When we move into specifically a geography, our reputation at CBP Investments as a long-term partnership-driven organization, we're getting married to the geography. We're committing to it. We can't come in and out. So we better have a lot of conviction that we're going to be able to scale that and we'll be able to get differentiated opportunities.

37:46And we also will bring in some people from other offices often to set it up. So similar to the asset classes, we put in a fixed cost, needs to be fed. So you have to be comfortable that you're going to have to feed it pretty much all the time at some level and then have that optionality to accelerate in when things look really attractive. So the more reps you get in any investment opportunity set, the more likely you are that something along the way won't work. As you've expanded geographically into different offices, how have you thought about measuring success and what period of time would cause you to reverse a decision that you fully intended was going to be for long term?

38:25This is something we have been spending quite a bit of time on. And when we do launch a new strategy, when we launch a new initiative, is at the beginning, trying to be very deliberate on what is the range of reasonableness. Because we all know that if we say we're going to do a review in two, three years to see how it's working, there's probably going to be some revisionist history on what exactly we're trying to do. Probably going to be some new fact pattern on what the metrics of success will be, which is totally expected. It's also very hard in this business that there is a range of outcomes.

38:59Something could be working and you still haven't made money on it. So we have these quantitative range of reasonableness, that this is the range of outcomes that we would actually expect. If it's outside of that, then it should really generate question. We actually have it for almost all our programs. When something goes out of the range of reasonableness, saying that either we're super good at this or we're not, and we should have a discussion about it. We do try to pre-wire that discussion in three years, if we're going to make a go, no go, what's the decision criteria going to be? Put them down on paper now, not in two years, in 11 months as to what the decision criteria are going to be.

39:34How have you thought about your participation over time in emerging markets? Emerging markets have always been a pretty big part of the CPP investment portfolio. And recently we have scaled back over the past few years, we actually scaled back our allocation to emerging markets. It's still reasonably large compared to many funds. I think we're about 15%, but it's not as large as it once was. And a lot of our appetite for emerging markets historically was a larger appetite for China than we have today. And now you can debate whether the world's second largest economy should be fitting into the emerging market bucket.

40:09Because again, back to looking through just the asset class labels, we had an appetite for a allocation into the world's second largest economy. In general, all the reasons people like emerging markets of growth and convergence, the rationale people get for emerging markets. So we've been investing in it. We have an office in Sao Paulo, an office in Hong Kong, and an office in Mumbai. So we've also been reasonably active. From a alpha perspective, the teams have done great. The beta returns probably haven't been exactly what people wanted over the past few years. They seem to be turning around a little bit now at this point in time.

40:41So we right-sized what we wanted for the portfolio. When you have an overriding objective of trying to get the highest net return with a given level of risk, there are all these decisions that you can imagine would lean people to incrementally taking more risk. How do you manage that tension? We are risk targeters. So we can't build a portfolio and then just lever it up to beat a benchmark. That comes down to really discipline, build the best portfolio we can, the most diversified portfolio we can. And then we do use some leverage to tailor the risk in the portfolio. We're big believers in diversification.

41:22Diversification is an act of humility. We do want to be diversified across geographies, across asset classes. We continue to be a believer in diversification, despite the fact that being invested in a handful of stock in the U.S. equity markets would have been the best choice over the past 10 years. We continue to believe that going forward, we should be diversified. One of the long-held strengths of the Canadian model has been the governance structure that allows the delegated authority for you and the team to go about investing. There have been a couple incidents over the last few years where something in the governance structure and one of the plans looked like, from the outside at least, it was going awry.

42:01I'd love to hear how you've thought about continuing to maintain a strong governance structure once it was set up that was very conducive for successful investing. One thing that I know I firmly believe in and the rest of the CPP investments management and board believes in is we need to execute on the mandate as written in the CPP-IB Act. It's not ours to apply a modern interpretation to. It's our job to maintain fidelity and discipline to the the reforms that happened in 1997 to create CPP investments. And that says to maximize return without undue risk of loss. It creates a governance construct where we are independent with respect to investment decision-making.

42:46So we don't have government involvement with respect to investment decision-making. We also have a professional board of directors, a board of directors that is largely composed of X very senior business professionals from across Canada. It has been our experience that we operate with independence and we don't have political interference in our decision-making. That's a fact. And I've been there for 18 years and that's how it's operated. But we also take the perspective that we need to be accountable. And we have really important stakeholders across the country. CPP Investments is a provincial federal construct.

43:21One of the best examples of the provinces and the federal government coming together to solve a problem. We have stewards that are the provincial finance ministers and the federal finance minister, and they're really important stakeholders. And they care deeply about the plan and they take their role very seriously. So we spend a lot of time on stakeholder management. That doesn't mean we have influence in our investment decision making, but we understand that these are important stakeholders. And at the end of the day, the organization needs to be accountable for the decisions it makes, for the money it spends, and delivering on what's in the CPP-IB Act.

43:58With respect to governance, you've got to know who your stakeholders are. And you're going to have to spend time with them, a lot of time with them. I think about stakeholders for us are being, for me in my role, I've got the employees, the board, the stewards, and the 22 million Canadians that rely on the plan. And so you have to do stakeholder management. And even though you may be independent, ignore a stakeholder at your own peril. I'd love to ask you about two very topical areas that have changed over time. One is climate investing and the other, of course, AI. Climate that used to be a couple of years ago, tip of the tongue for everyone, has receded a little bit in interest.

44:42how have you gone about thinking about the importance of the climate in your investment process? Yeah, it's a great question. And the short answer is nothing's changed and nothing's changed in our investment process. And even getting back to our governance construct is we have a sole fiduciary mandate. We're about value, not values. We don't do concessionary capital. We don't do impact funds. We're about value. We're about returns. So we continue to think it's important to incorporate climate considerations, right now specifically physical risk, into portfolio construction and security selection.

45:21And we ask every team to think through it. Just think about the impact on the insurance markets with physical risk and how that's impacting the value of certain assets and whether we think that's being priced properly in the market. We continue to invest in renewable energy around the world. We continue to see it as a interesting investment opportunity where it needs to stand on its own two feet. If it can only exist because of some type of subsidy, then we shouldn't invest in it. But the economics make a lot of sense in places around the world. And so we continue to invest in it. We also continue to invest in oil and gas.

45:57And we have a big oil and gas portfolio. The world, from our perspective, is going through an energy addition, not necessarily an energy transition. And I think AI is really amplifying that in that we need more energy. And we should look to add sources of energy that are reliable, safe, and ideally green. But we also invest in oil and gas. And we recently announced a transaction with LNG. For us, what has been really important is let's just say what we're doing. Let's just focus on returns, focus on value, not values, and we'll be okay. How have you thought about AI, both use cases internally and then investment opportunities externally?

46:38Like most companies, we're spending a lot of time on it. I would describe where we are is that trying to build a literacy and a fluency in the organization. We've given everybody in the organization all the tools. We have given them training and given them the expectation that we want everybody to be literate. We want everybody to be incorporated into their daily work. And I think we're seeing great examples of productivity at the individual level. Challenge now is that top down. What do we think could be a little bit transformative to the business? Are there certain areas where we think it could have a bigger impact than others?

47:11We're using it in the investment committee. We're doing all the, I think all the right things and now challenging ourselves a little bit on the top down. It's always that fine balance, right? A thousand flowers blooming, giving people the tools or doing super cool things. At some point, you got to have some way to herd it all together and see what it all adds up to. That's somebody we'll probably hit diminishing returns. So really committed to it internally, really focused on it. On the investing side, we obviously have exposure in the portfolio. We have invested in a lot of the big AI companies and we have exposure to them.

47:45Net though, we don't have as much AI exposure as the broader public markets. And that's a challenge from a relative performance perspective, but that's a deliberate decision we're making. Not that we don't think this is a transformative technology, not that we don't think that it could change the world, but we are a little bit concerned about the potential concentration risk in the portfolio. And thinking about who we are and what our mandate is, we're not a wealth maximizing vehicle. There's times when a pension plan and a personal account may deviate, and this might be one of those times where we're thinking about over the 75-year time horizon.

48:19If we don't get it exactly right, it's okay because we're not going to imperil the fund by not being exposed at the market cap weighted level. If we're a little bit under though, it's going to hurt our relative performance. But this is a case we're getting back to who we are and what we're solving for. I think it's just important that we're going into this eyes wide open. Why many institutional investors around the world right now on a quote unquote relative basis can't keep up because they don't want to concentrate at the same level into the market. And I don't know, the market could be right.

48:47I ask the teams all the time. I get lots of different answers. A technology can change the world and still be overvalued. You mentioned using AI in the investment committee. How do you do that? We can train the models on all of our historical investment recommendations and such, and then can ask the model to ask questions. We can do that. We can get the model to ask questions and just to prep or people will use to summarize it. personally. Today, I found it interesting. Not all that, I haven't been super impressed, I guess, by the quality of the questions, but that's okay. Because part of the value, I think it makes the investment committee pick up their game a little bit.

49:24Because we can put the memo into the model and get 10 questions in about one minute. And so you can ask the investment committee members, and whatever we paid for that license is hundreds of dollars. And so we can ask the investment committee members, you better have a question better than these 10? Because we got these questions in one minute and you're bringing 20 years of experience. I think it actually will help with the efficiency and the quality. I think we still got to look to the experienced investors for having that intuition. What are some of the risks and maybe particularly contrarian risks that you're worried about in the portfolio?

50:00I think we are worried about a lot of the same things as other people. I think we have a lot of the same concerns, equity fixed income correlations. The institutional model is built on fixed income being a diversifier. The way we run the portfolio and the total portfolio approach, there's a lot of fixed income in there. So we think a lot about that equity fixed income correlation. That's been one of the take it to the bank correlations over the years for institutional investors. For Canadian investors, the U.S. dollar. and one of the take it to the bank behaviors we've had is the u.s dollar strengthening against the canadian dollar in periods of stress and that's provided a lot of diversification into the portfolio we've witnessed some times over the past year where it didn't behave exactly that way and we have largely not hedged our currencies we view them as diversifying assets so while others might be more active in hedging.

50:57We haven't been as active. We still believe it's a diversifier. We think there's a tendency to think of things as black and white. Something goes from reserve currency to not. And there's a lot of gray in between those two, but it's something we're thinking a lot about. These are the things that really move the portfolio, how we think about currencies and how we think about some of these fixed income equity correlations. As you see things that are that important, potentially changing, what actions do you take differently from where you've been positioned leading into it. Yeah. And maybe it gets back to the super tanker analogy, because we don't move quickly.

51:36And even on things like this, we don't move quickly. And how many times have we heard in our career that this time it's different? And then it turns out it's not. We spend a lot of time and money on moving portfolios around to just round trip back to where they were at some point. We actually try to be quite disciplined and maybe almost programmatic in how some of these get evaluated and move into the portfolio. We would not look at it and then overnight flip the portfolio dramatically based on currency. What you would see with us, and maybe this is incrementalism, maybe it has its own challenges, is things will slowly move.

52:13allocations, you'll start to see them clicking down over time. Our China allocation went from about 12 to seven, but we didn't go 12 to seven. We slowly moved it down from 12 to seven. As you look out over the next couple of years, having been in the seat for several, how do you think about continuing to make the imprint that you want onto CPPIB? I always say I work at the pleasure of the board. And for as long as they allow me to be in this seat. And as I think about the role and I think about CPP investments, we need to be here 75 years from now. We can't fail. 22 million people rely on the plan, but we can't be complacent and we can't be a victim of like creative destruction in the market.

53:00So we have to create this like risk-taking at the grassroots level and this experimentation and risk-taking at the grassroots level with stability at the global level. I think it's one of the great challenges we have. And one of the ways that I think about it, and we talk about as a senior team, is because we have to be here 75 years from now, we're not a founder culture. We're almost the exact opposite of a founder culture. Our job is to put in place an organization that in many ways will be able to operate independently of the people who are there in the past. We can't become totally dependent on a few people.

53:39So it's not the right word, but we have to institutionalize because we have to be there in 10 years, there in 15 years, there in 20 years. And so I think that also that mentality of singing, we're not a founder culture of a little bit of the discipline of when we make choices, we're not making a choice for us. We're making a choice for the people who are in these seats, because the one inevitable future we know is we won't be in these seats forever. And there should be, if we've done our jobs, right, dozens of people in these seats in the future, and we need to make choices for them. And we need to be in some ways forgotten to history at some point.

54:15And that's how we think about it is it can't be a cult of personality, which is interesting because investing is a people business. It can be very anchored into individuals. So how do you really think about the business of investing and creating an institution that invests that isn't so dependent necessarily on the individuals. John, I want to make sure I get a chance to ask you a couple of closing questions. Sure. What's your first paid job and what'd you learn from it? My first paid job was I worked at a gas station. And what did I learn from it? I learned that people will try to rob you. It's important to lock the door at 9 p.m.

54:53And it's important to put the extra cash in the safe. But that is what I learned from that job. And I have carried that to this day. There are bad guys out there. What's the best advice you've ever received? It was a mentor who said, you're a hard charging, pace setting person. And when people ask you to do something, you're going to say yes, because that's going to be your instinct is just to say yes. You're going to always have lots of balls in the air and somebody is going to ask you to put another ball in the air and you're going to say yes. And eventually one of those balls is going to fall and you're going to see it as a failure and they're going to see it as a failure.

55:25But the failure was putting that ball in the air the first time. So you will need to learn to say no in your career. What's your biggest investment pet peeve? One of my biggest investment pet peeves is a belief, a tendency that you can diligence a bad investment into a good investment. That if you just do enough diligence and keep working at it, that you can figure out a way to make it work. You get too committed early on. Maybe you fall victim to a familiarity bias and you just convince yourself that you can do it as opposed to just saying no early. Just saying no, life's too short and we got to step away.

56:05In credit, I would see it. And look, some people have been very successful at it and have done it well. I've also seen many examples where individuals convince themselves they can structure a bad opportunity into a good opportunity. and you end up spending an incredible amount of time. And in the end, you still have a structured turd. What life lesson have you learned that you wish you knew a lot earlier in life? A slight variation on that question is one of the things I wish I knew when I came into this role, slight variation on the question, if that's okay, is sometimes stop and enjoy the moment.

56:41These roles, this career, this industry, it's amazing. And it provides incredible opportunity. And you get to do incredible things. You get to meet incredible people. But you're so focused on the next thing that you never stop and just marinate in the situation and just enjoy it. I've been trying to do more of that, of sometimes just stop and reflect on how fortunate you are and what an amazing opportunity this is. John, last one. If the next five years are a chapter in your life, what's that chapter about? The CPP Investments book needs to be a really big book. It needs to be a really, really long book.

57:16Trilogy, it needs to have hundreds of chapters. We're still in the early chapters because we're only 25 years old. So what's the next chapter about? It's actually about setting up the chapter after it. There's no conclusion to that chapter. It is a chapter in a long story. It's not the last chapter. And what we have to do at CPP Investments is ensure that the next chapter starts out from a position of strength. Well, John, thanks so much for taking the time. Thank you. It was great. Thank you. Thanks for listening to the show. To learn more, hop on our website at capitalallocators.com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more.

58:04Have a good one and see you next time. All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions and securities discussed on this podcast.