Global Capital Markets The Search for Value

Market Context and Pressure:

• Global pension funds and endowments face pressure to meet return targets despite "ratcheted down" assumptions; most large US and European funds still target 7%–7.5%.
• Norway's sovereign wealth fund is considering lowering its objective from 4% to 3%, while Japan holds ~$20 trillion in assets accepting a zero rate of return.
• The stage group opposes accepting zero returns, aiming to generate substantial rates through active management.

Gordon Thompson (BC Pension Fund - $130B AUM):

• Return Targets: Actuaries cite 6.25%–6.5% as a "home run," with the next decade deemed more difficult due to market valuations and low growth.
• Investment Strategy:
  • Growth: Prioritizing India (demographics, reforms) and Africa (long-term horizon, 10–30 years), while remaining cautious on China except for specific consumer sectors.
  • Distress: Actively investing in distressed Brazilian infrastructure assets made available by political turmoil.
  • Fees: Aggressively challenging the "2 and 20" fee structure when returns are 8%–12%; reducing fees by increasing internal management to ~50% (rising) from lower Canadian peers.
• Liquidity Advantage: Maintains positive cash flow ($2B+ annually), avoiding fire sales during crises and allowing deployment of "illiquidity premium."
• Manager Selection: Prioritizes partner integrity, transparency, and alignment of interest (e.g., managers co-investing real cash) over asset selection alone.

Larry Robbins (Arena Capital) & Lawrence Golub (Golub Capital):

• Larry Robbins (Short-Duration High Yield):
  • Targets a neglected ~$1 trillion market segment (5-year duration or less) within the $2.6 trillion high-yield universe.
  • Returns/Volatility: Generates 5%–7% annual returns with 50–70% of the index's volatility, prioritizing capital preservation over duration risk.
  • Risk Management: Argues rating agencies fail to adjust ratings for short-term bonds; prefers predictable short-term credit risk over 10-year interest rate risk.
• Lawrence Golub (Middle Market Lending):
  • Market Size: Targets the $10 trillion US middle market (approx. 1/3 of US GDP) via non-bank lending, as bank lending has declined >80% due to regulation and compensation structures.
  • Performance: Revenue/profit growth in this sector is double that of large caps/GDP; unleveraged net returns of 6%–8%, rising to 11%–13% with 2:1 leverage.
  • Operating Model: Operates as an "operating business" with heavy back-office/IT infrastructure (125 loan ops staff) to manage risk, charging fees less than 1/3 of bank overheads.
  • Credit Discipline: Avoids energy; compensates deal-makers based on long-term fund profits rather than quarterly mark-to-market to prevent risky behavior.

Omar Choudhry (Emerged Markets/Private Equity):

• Investment Thesis: Focuses on "rough neighborhoods" (Sub-Saharan Africa, Latin America, MENA, Asia) expecting 2/3 of global growth over the next 20 years; targets 1.7 billion people entering the middle class.
• Risk Mitigation:
  • Micro vs. Macro: Treats risks as manageable micro-issues (partners, alignment) rather than unmanageable macro risks.
  • Local Presence: Requires "boots on the ground" to navigate local nuances and legal systems; assumes 6%–7% annual currency devaluation.
  • Defensive Sectors: Focuses on essential consumption (healthcare, education, food) resilient to political instability.
• Case Study (Turkey): Invested >$1B over 15 years in defensive sectors (hospitals, dairy); exited a hospital business (IHH) valued at ~$15B; lost money on a luxury yacht venture due to hubris.
• Future Opportunity: Identifying Indonesia as a potential high-growth market similar to China's previous decade.

Cross-Cutting Themes:

• Distressed Opportunities: Crises (Brazil, financial crisis, Turkey coup) create access to premium assets at discounted prices for funds with dry powder.
• Alignment of Interest: Successful management requires partners to co-invest capital and align incentives with long-term fund performance, not just short-term fees.
• Governance Debate: Canadian pension funds maintain high independence from government, serving as a model for US funds seeking to reduce political interference.
• Credit Covenants: Emphasis on strong covenants and structural protections in debt deals to provide upside and downside protection, often ignored in high-spread markets.

Forward-Looking Statements:

• Golub Capital: Plans to grow AUM by 50%–80% over 3–4 years while maintaining credit discipline and limiting market share to <6%.
• BC Pension Fund: Anticipates significantly higher effort required to generate returns over the next decade compared to the previous decade.
• Arena Capital: Focuses on avoiding "strikes" (major losses) rather than chasing home runs to secure favorable long-term returns.
• Omar: Believes "stepping off the curb" (inaction) is a risk; continuing to invest in emerging markets is necessary despite volatility.