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10 years later: Money Management

Quebec fund creates a new game plan

Michael Sabia said some changes were direct responses to the financial crisis.

Just about everything changed in response to shifting environment

Modifications in portfolio construction and risk management were only a part of broader changes resulting from the global financial crisis that were made at the Caisse de Depot et Placement du Quebec, Montreal.

"We changed the fundamentals of how we go about investing, (made) changes in investment philosophy, investment style," said Michael Sabia, president and CEO at Caisse, which managed C$308.3 billion ($233.6 billion) for Quebec pension and other provincial funds as of June 30. "There has been a change in investment ... philosophy, a change in portfolio construction and asset allocation, and a change in risk management."

The philosophical change in investing has three elements, Mr. Sabia said in an interview. Those are:

  • More focus on long-term performance, with a shift to more illiquid investments.
  • A focus on assets that Mr. Sabia said were "rooted in the real economy — not financial engineering, not heavy use of derivative products, but real companies, real real estate, real infrastructure, etc. Things rooted in the real economy that people use every day."
  • A focus on fundamentals-oriented investing, "understanding the assets we invest in at the operating level, going beyond (profit and loss), beyond the balance sheet, beyond the spreadsheet but into the operations themselves," Mr. Sabia said. "That reflects a belief we have that operations is the only true source of value creation over the long term."

While Mr. Sabia said some of these philosophical changes were part of how he saw things when he joined Caisse in 2009, they were more a reaction to the global financial crisis. Before the crisis, he said, "we were a highly quantitative investor, highly focused on financial engineering. Those are all the things that kind of exploded … If it was about alphabet soup, we were invested in it. And the alphabet soup blew up in 2008, the first part of 2009 — and we decided alphabet soup wasn't such a good idea."

In terms of portfolio construction and asset allocation post-crisis, Caisse moved more of its assets to illiquid strategies — infrastructure, real estate, private equity and credit — from traditional assets. In 2010, Caisse was 30% illiquid; today, Caisse is 48% in those strategies, he said.

Other changes include reducing traditional fixed income and making the manager's investment portfolio more global, Mr. Sabia said. "We've substantially reduced our traditional fixed-income portfolio invested in rates and government bonds, which has gone down from 37% (of assets) to 30%," he said. "From a geographic allocation point of view, (we are) prioritizing to make our portfolio more global. Canada, for instance, in 2010 was 59% of our portfolio; today, it's 38% now. The U.S. has gone from 18% to about 30% and emerging markets has gone up from 4% to about 12%. So there's been a significant change in our geographic allocation as well."

Caisse's approach to risk management, targeting the use of more sophisticated tools, more than doubling risk management staff, and embedding risk management into the entire investment process, reflects the "three dimensions of change" the firm went through post-crisis, Mr. Sabia said.

"One (was) a significant effort to build and adopt much more sophisticated tools to develop risk management, sophisticated (value at risk) capability, simulation of stress testing, which we do a lot," Mr. Sabia said. "Second, the risk management group has substantially increased in size from 20 to 50 today.

"Third and most important, we changed risk management's role in the investment process. So now the risk management team works in conjunction with all our investment teams from the very beginning of looking at an investment opportunity. They're part of the investment team itself. We have people who are now specialized and work with the public equity team, the private equity team, the infrastructure team, the real estate team. To use a military analogy, they're embedded in the team."

Such start-to-finish involvement of risk management staff "creates the right type of investment dynamic in an investment team between investors who typically are interested in doing something and risk people whose job it is to say, "Yeah, but are you sure?'" Mr. Sabia said. "We want to create that dynamic from the very beginning of the process and have them work jointly."

Mr. Sabia said that while he joined the Caisse after the financial crisis, in 2009, "from what I've heard, risk was kind of an afterthought. One of the big lessons of the crisis was that risk better not be an afterthought. That's a big change."

Another change regarding risk post-crisis is the focus on absolute risk and not active risk, he said. "The industry had this ridiculous preoccupation with active risk, which as you know is just the differentiation of where you are vs. where an index is," Mr. Sabia said. "That's an absurd idea because it assumes there's something intrinsically important or interesting in how an index has performed. One of the things, certainly in our minds from a risk point of view, is we don't even track active risk any more. All we care about is absolute risk."

While the crisis had a massive effect on how Caisse manages money, Mr. Sabia said the move to more illiquid investing would have been made anyway, but "not to the same degree."

"I think we still would have wanted to increase our exposure to less liquid assets because their characteristics, if chosen right, will be relatively less volatile than liquid assets, and that volatility is still apparent in a lot of public markets," Mr. Sabia said. "We would have probably done the shift, but not as marked a shift as it actually was."