Colin: The best performing sectors right now are retail and office. And so, nobody would have guessed that.
Justin: Welcome to TDAM Talks, a podcast from TD Asset Management. I'm Justin Flowerday, the chief investment officer of TD Asset Management. And I'm joined today by Colin Lynch, the head of private markets at TD Asset Management. And today we're going to be discussing all things private markets. Welcome, Colin!
Colin: Great to be here.
Justin: It's been quite the year. Lots of volatility in markets, lots of interest rate volatility, lots of policy uncertainty. How have private markets held up thus far this year and what surprised you?
Colin: It's a great question. It's been a busy year overall; private markets have held up well. I think we've held up well for a couple reasons. One, we've been through a lot, not just this year, but over the last six years. And if you look at what's happened around the world, physical shut down the space, significant inflation, interest rate hikes, geopolitical tension around the world a lot.
Colin: But in the private markets and especially where we have played, is really in the realm of essential services to society that need to continue to provide their function despite all of the geopolitics. So, we still need our power, and our renewable platforms have performed quite well, actually, because we need more and more power. We still need goods, whether it's tables or cars, they still have to be transported.
And so therefore, our ports have also performed relatively well. And even in spaces like real estate, we still need to work someplace, live someplace and get our goods somehow. And so those spaces continue to perform. And so overall, yes, it's been an incredible environment. But what we own in the broad industries across credit or in the mortgage space or in the real estate or in the infrastructure space have actually been not just resilient, have been actually quite strong performers writ large throughout this period.
Justin: That's terrific. You know, maybe I'll take a step way back. I think a lot of people are familiar or with times private markets in portfolio today and our offerings, I'm not sure everyone has an understanding of the roots. Can you spend a little bit of time walking us through where we came from, the roots of this offering?
Colin: Yeah, it's an incredible story. Uh, the Maple eight, these are the largest government owned, backed, sponsored pension investors. Uh, and they are known around the world. Well, it was effectively the Maple nine and we were the ninth. We were. We began 40 years ago, nearly 40 years ago, as the Investment Management Corporation of Saskatchewan. We were owned by the government.
And then a couple of years later, we were spun out of the government that we were part of the Department of Finance, and we were owned then by 20 pension plans. And those two steps in the story are really critical because from day one, we've had always the perspective of serving a multi-asset class portfolio. We only exist in order to add value, which means reducing risk, improving returns relative to a multi-asset class portfolio.
And the second part of that is when we were owned by 20 pension plans, those 20 pension plans would not stand for whether it's a lot of the fees that we see broadly throughout the industry. So, these are whether it's acquisition, disposition, financing fees, promoters, etc. and they wouldn't stand for a lot of the ego inflation that you see in the industry.
So, in the private market space, you see a lot of firms that are run by large of them life personalities, where you have to really look at whether it's about the individual running, founding that firm or about the service of the firm to investors. And from day one for us, it was very, very clear. Yeah. And that ethos now permeates to this day and we haven't changed.
And so that orientation of being investor first that everybody says that, but at the end of the day, that's how we were created. That's how we governed, that's how we ran these portfolios and continued to run because it is part of our DNA.
Justin: So founded by clients, not necessarily founded to build products for clients, correct? Exactly. Terrific. You know, it's interesting. Within the world of privates, we talk about underlying assets, and I think you were hinting towards this in your previous comments. The structures are also very important. And when I'm talking structures, I mean, you know, for infrastructure, open ended versus closed.
Yes. Maybe talk a little bit about structure. And, you know, we obviously have an open-ended structure in infrastructure. Maybe describe what that means to investors.
Colin: Yeah, it's a great point because it's a subject of a lot of intrigue in the industry historically private market offerings. And when I say historically last 60 years have been principally close ended. And that means that you commit to a strategy, you're locked in for a period of time. Usually, it's at least a decade. There's a couple of years where the manager has an opportunity to invest your capital.
There's usually 5 to 7 years where they do a bunch of work and then a couple of years where they look to sell. There're a couple problems, I'd say with that structure. Problem One is when you're investing is essential, whether it's properties, companies, and credit capabilities that play a long-term role for society. That long term role doesn't necessarily correspond with the 252 dynamic that I just described.
Second is when you're looking to serve investors. So, if you're a pension plan, if your endowment, your foundation, your horizon is not, again, two, five, two-year horizon is I have long term needs that I need to serve. Hmm. Third is, at the end of the day, income is what really creates value. Put differently cash flow and the closer.
Justin: And you're saying income from the underlying properties, the underlying investments, the assets … generation from then it creates the value for the underlying assets.
Colin: That's right. And so, in the closer model you have, you acquire, you do a bunch of work, and you sell. You can almost push that and say you buy and then you flip to somebody. And if a long term value comes from income and the growth of their income over time, the open ended model where you're looking to acquire and hold things for 20 years produces a better ability, in my view, of investing, doing a lot of what we call asset management work that creates and grows that income over time and provides better service to the ultimate investor who's looking again at how does this investment help me generate more income for my pensioners, for
my beneficiaries? And so, we believe the open-ended model works better. No models. Perfect opening model requires a lot of governance, a lot of policy, and a lot of operational capability to run and we have built that over 40 years. But we believe at the end of the day, for investors, it does a better job.
Justin: Yeah, you know, it's interesting when you think about your platform and teams, private markets platform, many different sub asset classes, we can't we don't have time to run through them all in this podcast but maybe you've heard it talk about a couple. Let's talk about real estate and infrastructure.
Colin: Sure.
Justin: I talk about some developments and some major themes that have been taking place in those two sub asset classes this year.
Colin: Yeah, absolutely. If we start with real estate, I like to describe real estate as particularly over the last five years, the four-letter word of portfolios. It has been really challenged by, you know, all the way back to physical shut down the space. And within real estate there was another four-letter word within the real estate portfolios. Initially that was retail.
And you go back all the way to 2016. We were worried about the death of retail, the rise of ecommerce, then COVID shut down retail and it was the least can debate whether it's office or retail, but it was the least important of the spaces you fast forward to today. The best performing sectors right now are retail and office.
And so that says a couple things that says A these spaces are essential as we thought be that says we have cycles in real estate, just like many other asset classes in the broad economy. And so, we are going through one as we speak. And if you look at Fundamentals office and all the return to office mandates, that's a big driver.
More people are in the office. We need more retail space. If you look at the shopping malls that we own in Canada, across all of our major centers, we have the highest foot traffic that we've ever seen, and we are having the highest spend per customer that we've ever seen.
Justin: Incredible.
Colin: And so, nobody would have guessed that, yeah, three or four years ago. And so, I'm as optimistic about the office now. And that's not just because we have some great crystal balls. But when you look around the world at other office markets, they are performing much stronger than we are in Canada.
As has the return to office story is a complete. We obviously have had the wave of employees who have gone back to work, you know, from zero days to two days to three days. In some cases, four and five days. Is that story complete or is there another leg to it?
Yeah, it's not complete. When you have the announcements, you have a lag period by which, okay, we announced, but in six months and 12 months we actually begin doing. Yeah. And then in order to begin doing you need to get space. We've seen amongst the insurance companies and financial institutions there is still a scramble for space going on as we speak to be able to accommodate not only the growth that these institutions have had, but the return to office mandates.
If you look at municipal, provincial or federal in the U.S. state governments who have implemented office mandates, Ontario's have five days the federal government submits a 3 to 4 days same dynamic. And so that continues and will continue, at least for the next year or two, to say nothing of all the other different companies that then support these larger companies.
Justin: Right. Let let's move on to infrastructure for a moment. I mean, infrastructure itself has changed over time. You have the traditional components of infrastructure that we talked about 30, 40, 50 years ago, bridges and toll roads and all that. We now have renewable power. We now have digital infrastructure, we've got air, physical infrastructure. Maybe talk a little bit about the change in infrastructure over time and some of the areas we feel are attractive today.
Colin: Yeah, it's exciting if you set back. Yes, very, very exciting. Not only is there a growth in the asset classes and that will continue to happen, it'll continue to happen for a couple of reasons. One is at the end of the day, most of these spaces were provided by governments. The fiscal capacity governments is frankly gone and so therefore private sector entities worldwide have to step in.
And so that's going on. And so, you continue to see whether we're talking about health care or social infrastructure like housing, which health care part of but housing or the growth of transportation and the growth, for instance, airports and privatization thereof, et cetera. Then you layer on digital and the dramatic growth in AI, and that creates not just a new sector within the broader sector, i.e. digital and then data centers and fiber towers, etc.
But it creates a dramatic growth in energy demand. Yeah. And so, there's been a lot of debate about energy, conventional energy, renewable energy. We need all of the above. We need more of all of the above in order to satisfy the significant growth. And it's not just what I just said, but if you think about the whole world, more and more people are entering the middle class and that means more and more devices, more and more connectivity, and that is powering things while beyond even the decarbonization vision that we also see.
And that creates dramatic growth in needs for energy as well.
Justin: It's always a bit murky when you think about private markets. One of the things that's a little bit different is that with public securities, you have all the available publicly available financial data. You can read a whole bunch of things about the industry, individual underlying assets through, you know, public reports in KS, all that stuff with private, it's a little different.
So maybe to bring it to life a little bit more, maybe we'll walk through a couple of assets. The ones we have as of a recent transaction that could be interesting. And then we have an older transaction which is playing out in the portfolio quite nicely. Start with either arc or the digital infrastructure, the cell tower infrastructure we just purchased in Europe and tied it into some existing assets.
Colin: Yeah, so I like to say some of these assets hide in plain sight because literally we, we rely on them to you use in our daily lives arc rabbit should craft is based in Sweden it is operates wind farms so part of renewable energy though we are expanding that to multiple forms of renewable energy and then there's a new vertical.
So, think we call this interim into power. So, you get lots of wind and generate the wind. The wind farm operators create power, but you might have different weather conditions that mean that not a lot of wind is generated. You can add batteries to that and store some of that power and then provide it in different conditions. And so, you are even out the power production.
So, we added that to the platform. If you step all the way back, Rabbit should craft is a company that we effectively help create through a series of tuck in acquisitions and we have. And so that's a lot. But effectively a different way of saying what I just said is we have assembled marquee assets across multiple countries in Northern Europe extending all the way to Ireland.
We have created a management team, inclusive of all the regulators, three dynamics and marketing and etc. and we have built this team over time. We found this transaction. To your point on the public markets in a bilateral way, which means that we got on the plane, we met with the previous owners, and we negotiated out a transaction.
Justin: So, this wasn't a public auction where you had a whole bunch of different bidders. It was bilateral.
Colin: And that's really important because at the end of the day, you source opportunities that other people don't know about and then you are able to negotiate your acquisition of the opportunity that works for both parties. For us, that's able to pay lower rates in a particular way, but it might work for the seller because we can do a quick transaction, we can do it in an easy way, we keep it out of the general sort of press, etc. So, there's reasons why it works for both.
For us, that's a good part of our value creation, but it is not the majority, right? The majority of that value creation comes with assembling best in class talent, doing additional talking acquisitions that grow that scale, that helps reduce the operating costs, and then we can add revenue streams through multiple sources of power. You add in the batteries as well, and we create a scale entity that provides even more essential power.
Yeah, and to that point, the acquisition that we just completed Sure. Is along that line 6600 towers that provides essential telecommunications across Belgium and the Netherlands. There too, that was not what we call a jump ball or an auction process. That was a bilateral negotiation, and we had to move at speed. So, we did something that would normally take six months and we did it in four weeks because there was a unique opportunity for us to step in with our expertise and with our capital to not just acquire an entity, but to combine that entity with a second entity and create a scale player with material market share, providing essential services to a number of operators in both the Netherlands and Belgium. Interesting. So, it's an exciting recent transaction that we just announced, and it is, as a had described, a real watershed moment for the strategy.
Justin: Fantastic. I mean, as you're describing that, one of the things that comes to mind is you mentioned timing and you had to move quickly. Part of this is you have liquidity in the fund to source to fund future purchases. You need to sell other assets to do that. You have new money coming into the fund. This creates liquidity challenges for a manager.
I think one of the things that is less understood is generally, you know, there's a less liquid nature to this asset class. And I wanted to talk about infrastructure for a second. I mean, the same goes with real estate. You're getting paid because you can't sell in the middle of the day at a very kind of narrow bidder spread.
You need to get in line and potentially wait, you know, a week, a month, a few months in order to sell and buy. Tell us about that liquidity premium. Yeah. And what are the major drivers of that premium?
Colin: Absolutely. It's a great point. The private markets are private markets. And so, I don't think the industry has done as good enough a job as it should in making that point, which is less liquid by definition. And I think that's an important point. And we saw that especially in the private credit world and particularly with individual investors.
Yeah. However, the flip side is true. We get.
Justin: Paid you get paid for that.
Colin: Because of that. And so, whether it is somebody looking to borrow money that again, does not want to hit the news that wants a quick transaction because there's unique situations they may have, whether it's a family dynamic or company dynamic or the like. And we can provide that quicker. But at a premium, the private or private, that word has a nice word for it.
Uniqueness, premium, right? And we measure that. And over time it's between 75 and 80 bps. Yeah. And that's material. It's real. So, on the equity side, the same is we are able to step into a transaction at a price that might be lower than what we would pay if it was a broad, broadly known, broadly marketed process.
But the flip side is true. If we are going to sell something, we want to make sure that we capture top value in that sale, which means likely we're running a broad process and that takes time to run that broad process. And so almost by definition it is less liquid. If I circle all the way back to your point about closed and open-ended funds somewhere, foreclose and the peers are forced to sell because the timeline has run out.
Right? The fund they have to liquidate. Yeah, for a variety of different reasons. And therefore, they have to sell at a price that's not optimal. And we have benefited from that over time where we have bought things from closed ended funds and generated good returns because of that dynamic. And so, the flexibility of an open-ended fund allows us to manage what we sell, when and how to enable us to ensure that we are more likely to get an optimum price on the sale.
Justin: Yeah, I mean, look, the numbers speak for themselves and in a I think your argument is played out and returns over you know several years. It's interesting you see you describe the liquidity premium and that plays out in the returns the other offs then it's an offset. The enhancement is well risk adjusted. Yes. So, you're getting better returns for less volatility.
That's right. Maybe you will explain a little bit about the less volatile nature of the return path.
Colin: Yeah. Part of that is because you have a wider selection of investment opportunities. So, in the real estate space, only a small sliver of that space trades in the public markets. If you look at highest quality properties in whether it's capital cities or major metropolis, we call them coastal cities, they are owned by private sector players, which means that that spectrum of highest quality, which tends to be lower volatility, is held in private hands.
Yeah. If you look at the infrastructure space, entire broad swaths of that space do not trade publicly, right? So, whether it's ports or airports or of the renewable companies, etc. And so that means that not just is a quality that is also an opportunity set. BRAWNER And those two factors are really essential in terms of your standard deviation of a portfolio.
These assets do perform differently because, again, they're essential as well. And so, the lights have to be on. And so almost by intuitive definition, then there is a bit lower volatility because things may happen in the world, but we still need a place to live. Yeah, and we still need to move around the city. Yeah. And we still need to use our, our, our kitchen, you know, and cook things using electricity.
And so those three factors are very essential. There is a bit of a quality spectrum difference and there's a broadness in terms of, you know, sub asset classes that aren't publicly available. And the three together help to reduce that volatility and the interaction with the other classes in the portfolio, asset classes in a portfolio.
Justin: I mean, clearly a lot of complexity as a very, very interesting asset class. But, you know, if you're allocating one of the one of the things that's difficult, what questions do you ask? So maybe we can just leave the listeners with if you're thinking about allocating a manager, maybe what's one question to ask?
And then just one principle to remember as you're engaging in this asset class, if you're a new investor.
Colin: Yeah, you made that really tough because it's one question and there's a whole bunch. I would say the core question you want to understand is how does your private markets manager ensure that they are fully aligned to you as the investor? So how do they feel the downs and how do they feel the ups and that go to the fees, that goes to the governance, the record of that sort of operational infrastructure behind them and then obviously things like how do they perform?
Yeah, but you know, the core question is to the point I mentioned right at the outset, is it about them? Mm hmm. And the leadership and the founder and what they are building for their purposes or is it about putting the investor's needs number one. Right. And reflecting that in everything they do. Yeah. From how they invest to whether that's the time frames that they look at, it's also where they invest the governance behind how they invest and how they treat you as an investor.
To me, if I were to boil it down, yeah, that's what I would be really focused on. Yeah.
Justin: Thank you, Colin. Clearly, we didn't get to delve into all the different aspects of your business. We have private debt; we have a global private credit offering. We have a mortgages offering. We'll save that for the next conversation. But thank you very much for being here.
Colin: It was great to be here.
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