Article Global Public Investor 2019

Stephane Etroy: Leveraging long-term equity

Private Equity London,
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Interest rates have remained low for the better part of the past decade in most advanced economies. For public institutional investors, this has provided both opportunities and challenges. Cheap financing facilitates investment in costly infrastructures, which are needed around the globe because of demographic and economic growth or due to years of neglect and underfunding by local governments. But low interest rates are also an issue for pension fund administrators that traditionally relied heavily on fixed income portfolios, whose performance is closely aligned with official benchmark rates.

“Our focus has shifted to sustainable long-term revenue growth, operational improvement and governance.”

The Caisse de dépôt et placement du Québec manages funds primarily for public and parapublic pension and insurance plans in Quebec. It is one of Canada’s leading institutional fund managers and invests in major financial markets, private equity, infrastructure, real estate and private debt. Our home market is a mature economy with a limited investment market compared to global markets. The US and Europe offer scale and opportunities to invest in leading companies. Their sophisticated financial markets generate intense competition for investment opportunities. Our globalization strategy also targets a limited number of emerging markets into which capital is deployed gradually and patiently alongside our local partners.

Long-term strategy for long-term objectives 

We have no material reason to focus on yearly returns; our actuarial obligations are predictable and therefore require a return on investment over decades, not years. This long-term outlook enables CDPQ to hold steady through industry cycles and adapt properly to new technologies. The development of a new product, service, process, software or brand is often slow and tedious. For entrepreneurs, frequent changes in private equity owners are distracting to the management team and costly in terms of transaction costs.

A long-term investment strategy helps to conclude successfully transactions with companies that require substantial investment, but whose growth strategy is planned over many years. There is considerable value to be found in innovation, research and development. Most businesses have not integrated all the existing technologies that could benefit them substantially. This process often disturbs long-established practices and falls into regulatory grey zones. It is a long-term endeavour. This approach requires a different way of thinking. CDPQ’s international private equity division is more akin to an industrial investor than a financial one. Our focus is not ‘multiple arbitrage’ (increasing returns through playing the difference between entry and exit valuation earnings multiples). Nor is financial engineering (using debt leverage to increase equity returns) at the centre of our portfolio management strategy. The impact of the two over a 10-year holding period is marginal. Our focus is more sustainable long-term revenue growth, operational improvement and governance. As an active minority investor, CDPQ negotiates governance in line with our level of ownership.

The intent is not to manage the company, but to influence positively the management team and co-investors. Consequently, our operating partners are key members of the international private equity team. They manage the portfolio, interact with chief executives and boards, leverage CDPQ’s global network and steer value creation initiatives. This heightened level of commitment toward invested companies and the sustained involvement it requires brought CDPQ to develop a businessowner mindset.

This approach cannot be applied to all types of businesses. A successful globalisation strategy depends on choosing wisely which locations to focus on for deployment. Similarly, a successful private equity strategy depends on choosing wisely in which sector and industry to invest. Considering that CDPQ’s depositors need stable, steady returns on their funds, the international private equity team focuses on business driven by macro trends in health, technologies, financial services and clean industry. In a competitive market, an investor must differentiate itself. Capital is a commodity. At CDPQ, differentiating ourselves means providing sustained support to business founders, entrepreneurs, management teams and equity partners over the long-term. This is how our international private equity team intends to thrive and create value during the next decade.

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