Heard from AIMA Canada Investor Forum 2018

Institutional investors in Canada are reputed to number among the most sophisticated in the world. “The Canadian model” is described as an investment approach based on continuous learning and innovation, as well as with a focus on principled based investing. Castle Hall was pleased to attend AIMA Canada’s Investor Forum in Toronto to find out what allocators and asset managers are talking about now in light of expectations for the alternative investment industry to nearly double in the next 5 years.

Broad themes:

• Outstanding managers stand out. Asset managers have several opportunities to differentiate themselves as attractive to institutional investors. While retail investors are not expected to have the ability to dig deeply in due diligence, asset managers have the ability to build a good reputation with institutional investors as well as with the platforms offering distribution to a broader selection of strategies. Many themes are applicable across the board, whether the discussion is about hedge funds or privates.
• Embedded fees: this is by no means a new topic for discussion, but it continues to rank high. A fund’s expense ratio - and a manager’s general approach to expense pass throughs that dampen performance - helps investors determine which asset managers are good stewards. This is of particular interest where strategies that are heavily reliant on data and technology are seeing such costs increase exponentially: who should bear such costs? You, as the investor, or the asset manager, as the cost of doing business?
• Alignment of interest: investors want evidence of skin in the game. Conceptually, we can also understand that principals of an asset management firm running a highly specialized strategy may not want to put a large portion of their personal eggs into a single basket, even if it is their own, and especially if subject to a long lock up. However, if an asset manager is unwilling to put up a significant amount of capital at risk in their own strategy, why should anyone else?
• Performance contribution: Asset managers’ returns are scrutinized at a broader portfolio level, where investors are focusing on exactly how a given investment contributes to the overall portfolio return.

ESG:

• Broad and proxy: It seems everyone is talking about Environmental, Social, and Governance issues these days. ESG, which came up in several panels, is said to be becoming a proxy for a wide range of considerations.
• Manager differentiation: Investors are currently looking carefully at these areas and considering how to marry ESG factors with financial and operational analysis to in order to differentiate managers within the same strategy class.
• Measuring impact: It’s still early days for talk of ranking: indeed, many are grappling with how exactly to define what constitutes a “good corporate citizen”, trying to define common terminology, how to interpret findings, and then how to quantify and measure impact. How many levels can or should be examined: the asset manager, the asset manager’s investment targets / portfolio companies.
• ESG as a tool: For now, investors are not necessarily looking to “pin” managers, but there is certainly a growing desire to figure out how to measure a manager’s alignment with broader ESG endeavours. ESG is currently being deployed as another tool in the investment selection process, and not necessarily a constraint.
• Where are North American asset managers? While it is recognized that North American asset managers in general, particularly hedge funds, have been behind the curve in their own internal and investment approach to ESG, they are quickly closing the gap.

Privates:

• The Liquidity premium as a “complexity premium”. Asset managers investing in private transactions are becoming increasingly complex.
• Investors with the flexibility to make direct investments in private transactions have a keen interest in being able to make impact with positive changes.
• Secondaries as an investment class are no longer “distress” investments: they have become well institutionalized over the past decade. They are for the nimble investors who have the ability to act quickly. Interestingly, investors are also starting to see GPs looking to exert increasing control over the tender process for secondary transactions, with corresponding LPA provisions starting to be observed.
• Infrastructure: investors in real assets are moving away from “bucket” classifications and towards “characteristics”, since investments may look partly like one thing and partly like another. For example, how do you classify laundry service at a hospital: is this infrastructure? Or, is an investment in a data center private equity or infrastructure?
• Jurisdictional considerations: some have sticky legal ramifications regarding ownership. Investors need to understand these issues and how to structure investments upfront, including with JV or other structures, so that an investment can be exited as expected at the end of its horizon.
• Private debt: investors don’t want private debt GPs to sacrifice on the covenants since these will often prove themselves as the differentiator. The target portfolio companies / borrowers are looking for financing, and thus may not be as focused on the covenants as the GP should be: when covenants are breached, the power goes to the lender. Interestingly, it may be easier to get tighter covenants (minimum EBITDA, fixed charge coverage, etc.) in emerging markets where recovery rates may be better. It was observed that some GPs investing in developed markets are using leverage in order to meet return hurdles.
• A concern is an increasing observance of leverage applied at the portfolio level rather than just at the portfolio company level.

Final thoughts:

• The human element: A presentation by Dr. Mark Baldwin “Dr. Enigma” of the Enigma Machine used for coding and deciphering German military signals in World War Two reminds us of the important human element which was the key to ultimately breaking the codes. Yes, as we look forward: blockchain will be transformational, crypto will be transformational. Disruptive technologies and ESG factors are changing the way we look at the world and investments, but there is always the human element. While the talent of the future is expected to draw greatly from those who are currently gaining education and expertise in data science, the deployment of any given strategy is still ultimately based on human ideas and the codification of a logical thought process. Interpretation and measurement are still based on logical, human decision making.

Thanks to the organizers and sponsors for a very successful event!