Why, Where and How? CPP Investments' Heather Tobin on Building One of the World's Largest Hedge Fund Portfolios

Heather Tobin · CPP Investments

Market-neutral hedge fund strategies isolate pure manager alpha and add genuine diversification.

Long-only strategies like infrastructure or private equity bundle market beta and manager alpha into one return stream. A market-neutral strategy uses matched long and short positions that cancel out market exposure, leaving the return from manager skill, which is pure alpha. Because these returns are independent of broad market factors that drive the rest of the portfolio, they add genuine diversification.

“A market neutral strategy isolates the two. So a matched long and a short position effectively cancel out market exposure, and what's left is the return from manager skill, which is really pure alpha.”at 9:47

Heather Tobin · CPP Investments

Higher rates, volatility and dispersion ended the post-GFC alpha winter for hedge funds; setup favorable.

The hedge fund industry is larger, more institutional and more competitive than ever, but she still finds the opportunity set compelling. Over the last several years the environment of higher rates, elevated volatility and wider dispersion has been very conducive to alpha generation, and these conditions effectively ended the post-GFC alpha winter for these programs. She concludes the setup for skilled managers in this segment of the market remains very favorable.

“The environment's been very conducive to alpha generation, especially over the last several years as we've been living in a... An environment with higher rates, elevated volatility, and wider dispersion.”at 12:05

Heather Tobin · CPP Investments

Multi-manager platforms hold 10-15% of hedge fund AUM but draw outsized flows and talent.

Large multi-manager platforms represent roughly 10 to 15% of industry AUM but take an increasingly disproportionate share of flows and talent. They allocate across hundreds of independent PM teams within explicit risk limits and centralize capital allocation, financing, liquidity, execution, technology and risk management. Done well, this creates platform alpha through better capital efficiency, disciplined construction and centralized risk management, and the consolidation of capital, talent and systems lets platforms develop differentiated edge.

“So large multi manager firms now represent roughly 10 to 15% of industry AUM, but they are an increasingly greater disproportionate amount of flows and of talent.”at 12:44

Heather Tobin · CPP Investments

Expense pass-through to investors has added fee pressure; higher fees need proof of superior net returns.

Platforms deliver their strengths at a cost. The expense pass-through model, where managers charge investors directly for data, technology and talent, has added fee pressure across the industry. Investors must judge when higher fees and potentially longer-duration capital are justified by superior net return potential. CPP focuses on net returns and on the share of gross alpha it pays away, and alignment matters: the strongest platforms have management and employees invested on the same cost structure as investors.

“The expense pass through model where managers are flowing costs for data, technology, and talent directly onto investors has really added fee pressure to the industry.”at 14:01

Heather Tobin · CPP Investments

Top hedge fund managers are closing or capping capacity, making access more competitive for CPP.

Increasingly the top-performing managers are closed or capacity-constrained. The best managers are proactive in protecting their capacity and edge, and understand the challenges of scaling further. This makes it more competitive for CPP to keep growing its program and gain access to these exposures.

“increasingly the top performing managers are closed or capacity constrained.”at 15:26

Heather Tobin · CPP Investments

Gap between top and bottom quartile hedge fund managers has widened, making selection more important.

Increasingly, the dispersion between top- and bottom-quartile performing managers has widened. Underlying the scale-driven changes in the industry, manager selection has therefore become increasingly important to returns.

“increasingly, the dispersion between top and bottom quartile performing managers has widened.”at 15:52

Heather Tobin · CPP Investments

CPP is increasing its hedge fund allocation because market-neutral programs have done well through cycles.

CPP expects its balancing portfolio to deliver the needed beta exposures and wants the active portfolio to focus on alpha. Market-neutral strategies, accessed mainly through external hedge fund managers, are central to that alpha role. Over the last few years, these programs in aggregate have continued to perform very well through cycles, which is why CPP is placing increasing weight on growing its exposure.

“you can see why we're placing an increasing weight on growing our exposure to to that program because over the last few years, we know through cycles, these programs in aggregate continue to do very well.”at 18:32

Heather Tobin · CPP Investments

Skilled investment talent, not capital, is the scarce resource in the hedge fund ecosystem.

CPP maps talent continuously, tracking the top PMs across strategies, who trained them and how they execute, rather than relying only on backtests. Managers are increasingly launching alpha-capture programs externally, and platforms want continued access to talent. Talent is the scarce component, not capital flowing into the ecosystem, which is why CPP also runs an emerging managers program to access talent early in its life cycle.

“talent is really the scarcity here. It's really the skill that's really the scarce component. It's not really capacity into the ecosystem...”at 21:49

Heather Tobin · CPP Investments

Best hedge fund managers are extending liquidity terms beyond quarterly to fund investment in talent and technology.

Typical terms have been quarterly liquidity with gates around 25%, but terms are evolving for the best managers. Capacity constraints and platforms' need to make strategic investments in talent, technology and systems push the best managers to extend liquidity duration for timeline visibility. CPP must judge whether that extended duration is justified by the potential for superior net return.

“The very best managers are looking to extend that duration of liquidity so they have more timeline visibility over which they can make those types of investments.”at 32:26

Heather Tobin · CPP Investments

Hedge fund business models are fragile; quarterly liquidity creates tension as scaling pressure builds.

Industry liquidity has historically been on a quarterly gate cycle. That is a good disciplining feature and keeps incentives aligned, but it creates considerable tension when there is strong pressure to scale capacity. CPP therefore aims to be a supportive, aligned partner to the best managers, and extending liquidity duration is a key advantage it can offer where it has high conviction.

“So, you know, hedge fund models themselves are fragile.”at 33:37

Heather Tobin · CPP Investments

Externally run hedge fund strategies are costly, so CPP builds them internally and sees a golden age for absolute return.

Heather says that allocating to hedge fund strategies externally is expensive, and CPP works to align fees with performance expectations. Its internal team, which runs systematic strategies, helps manage CPP's overall cost profile, so CPP builds in-house what would be too operationally complex or costly to build otherwise. She says the internal team also benefits other departments that run factor-based implementation. She agrees with the view of Tony Ocelof of Davidson Kempner that absolute return strategies are in a golden age.

“...allocating to these strategies externally are expensive. They come with a cost.”at 36:33

Heather Tobin · CPP Investments

Volatility is rising in the hedge fund ecosystem, with more correlated shocks and deleveraging events.

CPP is seeing much more volatility in the ecosystem and more correlated shocks and deleveraging events, which are stressing different parts of the market. Despite these tests, the portfolio has proven resilient, which she credits to disciplined underwriting and portfolio construction, and she says diversification is an act of humility.

“But, of course, you know, we're seeing a lot more volatility in the ecosystem, and we're seeing a lot more correlated shocks and deleveraging events that are definitely stressing different parts of the market.”at 35:49

Simon Brewer · The Money Maze Podcast

Canada looks unusually well placed in a period of strong soft and hard commodities.

Simon argues that the current period is interesting for soft commodities (agricultural) and hard commodities (metals and hydrocarbons), and that Canada is unusually well placed to benefit. He frames this as a possible investment committee view rather than a firm conclusion. He also says he has been deploying his own money into Canadian oil and resource equities for some time, which backs the view with a position.

“Canada is unusually well placed.”at 37:30

Heather Tobin · CPP Investments

CPP is high conviction and well overweight Canada, with over $120B invested domestically.

CPP Investments is high conviction on Canada and has over $120 billion invested domestically. She cites Canada's stability of government and regulatory environment, its energy and critical minerals endowment, its institutional investors and its banking ecosystem as reasons. She says the policy initiatives announced at the Canadian Investment Summit that week are exciting. Canada's share of global GDP and global market cap is well below its weight in the CPP portfolio, so CPP is well overweight Canada.

“we are high conviction Canada. We have over a $120,000,000,000 invested here domestically.”at 38:17

Simon Brewer · The Money Maze Podcast

Passive equity strategies now carry heavy concentration and possibly unexpected risks.

Simon says passive equity strategies now hold a lot of concentration in the market, with risks that may be unexpected. He concludes that how an investor constructs a portfolio across different return streams becomes more important as a result. He gives no quantified evidence.

“the passive strategies are now in... In the equity markets are now encompassing quite a lot of concentration and maybe unexpected risks.”at 45:03