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Quebec’s Caisse restructures fixed-income portfolio

Split between credit, liquidity allows more focus on illiquid assets

James B. McMullan, senior vice president, Caisse d
James B. McMullan looked for new or unused investment areas to address Caisse clients’ long-term needs.

Caisse de Depot et Placement du Quebec diversified its C$89.5 billion ($70.8 billion) fixed-income allocation to focus more on return generation, specifically in private credit and specialty finance.

Montreal-based Caisse, which manages C$270.7 billion in Quebec public pension and other assets, in January split its fixed-income allocation, 33% of total assets, to a C$43.5 billion credit portfolio, which targets higher returns, and a C$37.6 billion rates portfolio to provide client liquidity, said James B. McMullan, senior vice president, corporate credit. The remainder is in other fixed-income investments.

"The issue we've been grappling over the past couple of years has been diminished overall returns," said Mr. McMullan. "We asked if there was a different way to think about our portfolios. We looked for other unused, new segments on the investment spectrum to take into account our clients' long-term needs. We used to have one basic fixed-income portfolio, largely corporates, but in the last eight to 10 years, we were allowed to invest in private opportunities."

While the rates portfolio consists mostly of government securities like U.S. Treasuries and Canadian government bonds with little or no risk, the credit portfolio has four divisions, or "pillars," Mr. McMullan said:

Corporate credit (includes ​ private debt);

Specialty finance (focuses on asset-backed securities like infrastructure debt);

Real estate debt; and

Sovereign credit (mostly government credit in countries with higher risk, like emerging markets in Latin America and Eastern Europe).

Caisse does not break out asset amounts for each pillar, but Mr. McMullan said the largest in terms of assets is corporate credit.

Canadian private credit management is mostly handled directly by Caisse staff in Montreal, but partnerships with private debt managers are used for foreign investments, Mr. McMullan said.

Outside of Canada

To facilitate finding those partnerships, Caisse is looking to hire executives and analysts to work outside of Canada. In June, Robert Hetu, former managing director at Credit Suisse AG and leader of the investment bank's corporate lending group, was hired as vice president and head of U.S. private debt, based in New York. Mr. McMullan said he expects to hire an analyst to join Mr. Hetu as well as an executive to work out of Caisse's London office, although no timetable has been set.

"The pillars all look at new territories, new segments in which we can invest," Mr. McMullan said. "One way we do that is through partnerships. To find those partnerships, we need good people. The idea over time is to have a few people locally to manage the relationships, to have boots on the ground."

Caisse executives have not stood idly by in the meantime. Among its specialty finance investments, it entered into a joint venture announced in June with GE Capital Aviation Services, focusing on aircraft leasing and financing. Caisse will invest $2 billion over four years while GE Capital Aviation Services will administer the platform.

"It's a remarkable opportunity," Mr. McMullan said. "It's newer-generation aircraft. There's an active secondary market for newer planes. The venture has a predictable cash-flow model with good capital protection. The planes hold their value over time. On paper, it looks like a bond. When you deconstruct the investment, you can make an airplane look like a bond."

The joint venture, which will be based in Ireland, speaks to Caisse's global reach, Mr. McMullan said.

Domestically, Caisse in April invested C$1.9 billion in debt and equity to help Canadian engineering firm SNC-Lavelin Group Inc. finance its acquisition of WS Atkins PLC, a U.K.-based design, engineering and project management consulting firm. Of the Caisse investment, C$1.5 billion will be a loan secured by SNC-Lavelin's interest in the operation of the Highway 407 Electronic Toll Route around metropolitan Toronto; the remaining C$400 million will be in equity financing.

"Over the past 10 years, we've built a pretty good (specialty finance) practice in Canada, and now we're developing a capability in the States as well," Mr. McMullan said. "We've created a new credit portfolio with the blessing to find fixed- income-like products that generate predictable cash flows."

While it is too soon for Caisse to have seen the benefits of the fixed-income portfolio restructuring, Mr. McMullan said he's looking to expand the credit portfolio in the next four to five years. "We're in baby steps now, but we want to see what further opportunities there are in this," he said. "We'd consider putting more assets into more definitive things in corporate credit, with a focus on Europe, and specialty finance, which would be North America-focused but with maybe a bit of a global slant."

Liquidity in rates portfolio

While investments in Caisse's credit portfolio are illiquid, Caisse provides liquidity to its clients through its rates portfolio. Also, the nature of the relationship between Caisse and its clients is close, Mr. McMullan said. Sudden liquidity needs "presuppose the need for money for clients, but generally we have a good view of the cash-flow needs of our clients," he said. "Can there be some accident? Sure. But our rates portfolio gives duration for clients but also serves as a liquidity pool. Treasuries and Canadian government bonds can be liquidated quickly that could be needed for cash or a shifting asset allocation. Our buffer portfolio is our rates portfolio."

In addition, Caisse's role as money manager for pension funds and other provincial asset pools means it can concentrate on returns. "Our focus is on assets, not liabilities," Mr. McMullan said. The responsibility for establishing asset allocations to meet liability needs rests with Caisse clients, he said. Caisse does have a client service team that will work with the pension funds and their investment consultants to create the optimal asset allocation to meet their liability needs, he added.

Mr. McMullan said clients generally have been pleased with Caisse's fixed-income strategy. "The client has a certain number of funds they can invest in," he said. "They cannot pick and choose investments within one of those funds. But we take into account all client comments that they contribute to our portfolio creation. We have active, ongoing consultation with our clients through their investment committees."