BUSINESS

Looking forward to retirement

Pension funds back corporate takeovers

ANDREW WILLIS March 27 1995
BUSINESS

Looking forward to retirement

Pension funds back corporate takeovers

ANDREW WILLIS March 27 1995

Looking forward to retirement

BUSINESS

Pension funds back corporate takeovers

Canadian pension funds are not what they used to be—and neither are the people who run them. Until quite recently, pension-fund managers sat quietly on the rim of financial markets, clipping coupons and trading stocks and bonds. Now, however, a new breed of money manager is stepping into the spotlight and taking a starring role in high-stakes, sometimes controversial merchant banking deals. Wallace McCain, for one, can attest to the power of these deal makers. His $ 1.2-billion takeover bid for Maple Leaf Foods Inc. includes $150 million of his own money, plus a $150-million

investment by the Ontario Teachers’ Pension Plan Board. “To be honest, I raised the money so easily that it scared me,” McCain told Maclean’s last week. “The people I talked to asked me lots of questions and I guess they were satisfied with the answers.”

McCain’s alliance with the Ontario teachers’ pension fund—which has assets of $35 billion—means that the retirement income of more than 203,000 teachers in the province may soon be closely tied to sales of Maple Leaf luncheon meats and hot dogs. The takeover bid will be decided by April 20 and the pension fund could hold up to 46 per cent

of Maple Leaf if that bid is successful. But Ontario’s teachers are not alone—other private sector funds are also playing the takeover game to eam a better return on their investments. Their ultimate goal is to meet the retirement income needs of a rapidly aging baby boom generation in Canada, at the same time as federal and provincial coffers are shrinking and the established social safety net frays. According to a recent report from the Office of the Superintendent of Financial Institutions, the Canada Pension Plan will run out of money by the year 2015 unless additional contributions are made.

Pension funds are also on the trail of such innovative investment ideas because they are required to invest their billions in Canada’s relatively small, illiquid and undiversified markets. Keith Ambachtsheer, president of pension fund consultant Keith P. Ambachtsheer & Associates, says, “This is a tremendously positive development, both for plan members who get an extra return for being at the table, and for the economy, which needs this type of investing.”

The bulk of a private sector pension income depends on the skill of the money manager investing the funds. A typical Ontario teacher earning $50,000, for example, contributes $4,000 a year towards what will eventually be

‘A $200-million investment isn’t a huge transaction for a fund our size’

a $35,000 annual pension, indexed to inflation. The average teacher collects a pension for 25 years. Claude Lamoureux, president and chief executive of the Ontario teachers’ pension plan, explains that the $4,000 contribution only covers about 30 per cent of the pension’s eventual cost—the remainder must come from the return on investments. “We run this fund as a business, aimed at meeting the needs of Ontario’s teachers,” said Lamoureux. ‘We’re large investors in a relatively small Canadian market, so we also look for investment opportunities in companies that aren’t in the market.”

At the Ontario teachers’ pension plan the deal maker is 45-year-old vice-president of merchant banking George Engman. Anywhere from 300 to 500 deals a year cross Engman’s desk, and he pursues two or three of them as investments. In addition to backing Wallace McCain’s bid for Maple Leaf, Engman has also spearheaded the fund’s 49-percent partnership in Steve Stavro’s £ takeover of Maple Leaf Gardens g Ltd., as well as the 1993 purchase of i Niagara-region winemaker T. G. 8 Bright & Co. Ltd. Another arm of I the teachers’ fund is part of a bid for H beleaguered real estate company Cadillac Fairview Inc. of Toronto, and is also offering $188 million for a stake in the Cadillac Fairview-owned office towers that make up the Toronto Dominion Centre and Vancouver’s Pacific Centre.

To date, Engman’s record includes more winners than losers. The value of his $400million portfolio at the teachers’ fund rose about 15 per cent in 1994, outperforming last year’s flat showing by the Toronto Stock Exchange index of 300 stocks. Engman, who is a native of England, came to Canada in 1975 and did an MBA at Toronto’s York University before working at investment management posts that included the Abu Dhabi Investment Authority. His performance earned him $240,000 in salary and bonuses in 1993.

Still, the pension fund industry’s overall track record on investing in takeovers reflects the risks as well as the rewards of branching out. Among the most aggressive Canadian funds is the $47-billion Caisse de dépôt et placement du Québec, which manages the pension and auto insurance funds of Quebecers. The caisse’s overall 1993 performance was a below-average 19.7-per-cent return— this year’s results are expected by monthend—and the fund has drawn criticism for losing money on takeovers such as the Univa (now Provigo Inc.) grocery chain, where the caisse is a 37-per-cent shareholder. However,

the risk of any one deal going sour is offset by the enormous size of pension fund assets. Ontario Teachers’ Lamoureux says, “While I don’t want to pretend that we are unconcerned, a $200-million investment isn’t a huge transaction for a fund of our size.”

For Canadian entrepreneurs, the aggressive new stance of the pension funds is a welcome development. “The pension funds are the only equity investors who are taking the long view,” says Larry Stevenson, president of SmithBooks, whose proposed purchase of Coles bookstores from Southam Inc. will be financed by Canadian General Capital Ltd., a Toronto-based company controlled by the $6.8-billion Ontario Hydro pension plan and the $8-billion Hospitals of Ontario pension plan. Stevenson also had the pension funds’ backing for the $21.5-million purchase of SmithBooks from Federal Industries Ltd. in 1994. He says these funds commit their money for four to seven years, while conventional sources of money such as banks and venture

capital funds typically come with a two-to-fouryear term. Stevenson adds, “The pension funds are strategic in their thinking. When the banks were shying away from the retail sector, the pension funds saw an opportunity to buy at the bottom of the cycle.”

Pension funds are also proving to be guardian angels for emerging Canadian companies. At Ontario Hydro’s pension plan, two of the nine professionals running the fund are spreading about $130 million of development money to emerging companies in areas like medicine and technology. James Wilbee, executive director of the Ontario Hydro pension plan, says, “If we do venture capital right, we’ll see much higher returns than in stocks and bonds.”

For their part, investment industry experts say that, in the future, an increasing amount of takeover and venture capital financing will come from Canadian pension funds as more players enter the field and funds pour in from baby boomers hitting their peak earning and saving years. For example, the $22-billion retirement savings of B.C. civil servants recently began to shift from staid bond investments into the stock market, although B.C. superannuation commissioner John Cook says, ‘We’re just getting our feet wet,” and there are no immediate plans to jump into takeover battles.

According to Phillip Doherty, who left an established career as a partner in accounting firm KPMG to become president of Canadian General Capital in 1991, that trend will continue to gain momentum. Doherty says returns on risk capital that are expected to average more than 20 per cent annually over time will attract pension funds, and he adds: “I’m a bit surprised that more funds haven’t already done it.”

But money from the pension funds is not just pennies from heaven—it also comes with strings attached. Quebec’s caisse has led a movement by pension funds to make executives and corporate directors more directly accountable for their decisions. As part of that initiative, institutional investors are already playing a stronger role on corporate boards by sitting on them. With a $150-million investment in the Maple Leaf Foods takeover, for example, the Ontario teachers’ fund acquires the right to name three of 13 company directors.

In the past, a pension fund would have simply sold its shares in a company if it was disappointed with its performance or its management. But that passive approach is increasingly impractical when a fund’s investment stakes are so large and, in a relatively small Canadian stock market, difficult to sell without driving down the share price. Investors who are willing to throw their weight around are a new experience for Canadian managers, and fireworks are inevitable. Peter Bentley, chief executive of Vancouver-based Canfor Corp., says institutions like the pension funds were vocal in expressing their views on issues that arose during his company’s unsuccessful takeover bid last December for Slocan Forest Products Ltd. Lamoureux says, “We don’t want to be activist just for the sake of it, but if we see a board underperforming, we will discuss the issues with them.”

The ongoing search for better returns has also made Canada’s pension funds massive users of financial derivatives in the past few years. This is a sensitive subject in the wake of the collapse of Barings PLC in late February, largely because of derivative investing. But pension fund managers insist that using these controversial financial instruments, which base their price on the value of other securities such as bonds, stocks or currencies, helps to diversify risk and to protect retirees’ savings from unanticipated movements in the market. Just as they have led the pack in merchant banking investments, the Ontario teachers’ fund is also one of Canada’s largest end-users of derivatives. They deploy those instruments to lessen the interest-rate risk that comes from holding $15.7 billion in Ontario bonds left over from the days when the provincial government ran the fund. But Lamoureux says, “One of our consultants compared derivatives to drugs: there’s Aspirin, valium and cocaine. We only take Aspirin.” And for Canadian pensioners such assurances are a welcome painkiller.

ANDREW WILLIS