CPPIB head raises red flags about low-qual­ity bonds


The head of the Canada Pen­sion Plan In­vest­ment Board is sound­ing a note of con­cern as high de­mand for cor­po­rate debt has cre­ated lower-qual­ity bonds that are riskier for in­vestors in the event of an eco­nomic down­turn. In­vestors’ de­sire for cor­po­rate debt – bonds com­pa­nies is­sue to raise funds and that of­fer higher in­ter­est rates, or yield, than safer, gov­ern­ment-is­sued se­cu­ri­ties – en­ables firms to de­ter­mine for them­selves whether the in­vestors get paid first if it has to de­fault, and to use a more lib­eral debtto-earn­ings ra­tio to as­sess per­for­mance. Th­ese com­pa­nies might not be able to is­sue debt un­der tougher stan­dards.

“We’re very cau­tious on the loos­en­ing of credit,” CPPIB chief ex­ec­u­tive Mark Machin said, in de­scrib­ing the high de­mand for debt that has al­lowed this. “This de­te­ri­o­ra­tion of … stan­dards is some­thing that could be­come a con­cern.”

McKin­sey & Co. part­ner Su­san Lund noted in a June ar­ti­cle that since 2007, the amount of cor­po­rate bonds out­stand­ing from non-fi­nan­cial com­pa­nies has nearly tripled, to US$11.7-tril­lion and their share of global GDP has dou­bled.

“The buildup in … cor­po­rate debt is a good ex­am­ple of a new risk that’s emerg­ing in the fi­nan­cial sys­tem,” for­mer U.S. Fed­eral Re­serve chair Janet Yellen said on Wed­nes­day at the Bloomberg New Econ­omy

Fo­rum in Sin­ga­pore. Ms. Yellen said the United States has im­proved since the fi­nan­cial cri­sis in mon­i­tor­ing risks be­yond the big banks, but “it’s un­clear that we ac­tu­ally, at least in the United

States, have ap­pro­pri­ate tools to deal with th­ese emerg­ing risks.”

CPPIB can be hurt from this en­vi­ron­ment, or it could ben­e­fit by is­su­ing high-yield debt it­self to fi­nance the pur­chase of com­pa­nies. Reuters has re­ported the pen­sion fund is part of a four-mem­ber con­sor­tium bid­ding to ac­quire alu­minum prod­ucts maker Ar­conic Inc., which has pub­licly traded stock and debt worth more than US$15bil­lion. Large ac­qui­si­tions that re­quire mul­ti­ple big bid­ders – the part­ners are said to be Black­stone Group LP, Car­lyle Group LP and Onex Corp. – fell out of favour af­ter the fi­nan­cial cri­sis. (Mr. Machin de­clined to com­ment on Fri­day about a po­ten­tial Ar­conic trans­ac­tion.)

CPPIB is not as wor­ried if it is in that type of po­si­tion in a deal, Mr. Machin says, but stan­dards are “some­thing we’ve been con­cerned about as buy­ers of debt,” and the CEO has had re­cent con­ver­sa­tions re­cently on the topic with his head of credit.

He said that when CPPIB buys debt, it looks closely at the stan­dards out­lined in the debt doc­u­ments com­pa­nies is­sue with their bonds. “You have to get into the weeds in the terms of th­ese loans,” Mr. Machin said.

Mr. Machin’s com­ments came in an in­ter­view with The Globe and Mail upon Fri­day’s re­lease of the fund’s fi­nan­cial re­sults for its sec­ond quar­ter, ended Sept. 30. The CPPIB port­fo­lio posted a 0.6-per-cent re­turn for the quar­ter once fees and costs are re­moved, as a fall­ing Cana­dian dol­lar was the main head­wind, he said.

The port­fo­lio recorded 10-year and five-year an­nu­al­ized re­turns of 9.1 per cent and 12.1 per cent, re­spec­tively, net of costs.

The plan’s net as­sets were $368.3-bil­lion at Sept. 30, com­pared with $366.6-bil­lion at June 30. The $1.7-bil­lion in­crease in as­sets con­sisted of $2.3-bil­lion in net in­come less $0.6-bil­lion in net cash out­flows for ben­e­fits.

This de­te­ri­o­ra­tion of … stan­dards is some­thing that could be­come a con­cern.


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