Private Equity and Venture Capital: Term V

TERM V
Private Equity and Venture Capital
Case: Canada Pension Plan Investment Board
Submitted to: Prof. BB Chakrabarti

Submitted By: Group 19
Atindra Saha – MBA06034

Jitesh Thakur – MBA06073
Abhishek Singh – MBA06197
Case: Canada Pension Plan Investment Board
a) Does CPPIB have a clear investment strategy? How would you characterize it? How similar
or different is it from Yale’s?
Answer:
Yes, CPPIB has a clear investment strategy. It used a "total portfolio approach" to
optimize portfolio risk and return. It initially pursued a passive investment strategy until
2005, after which it adopted a value-added approach. The reference portfolio consisted of
a combination of 65% equity (10% Canadian and 55% foreign) and 35% debt (30%
Canadian Nominal debt and 5% hedged foreign government bonds). Active investment
has been introduced to enhance the reference portfolio through "Better Beta" and
"Enhanced Alpha". CPPIB avoided external intermediaries by building in-house expertise
and did not invest through the fund of funds. Aggressive investments were made only if
the risk and return profile was improved and the passive portfolio could be sold to fund
the investment. This is called "straight substitution".
b) To what extent is CPPIB saving money by investing directly? If it were instead to invest in
traditional private partnerships through funds-of-funds, how much better would the private
equity partnerships need to be to justify their fees? Compare CPPIB’s approach with the
alternative of investing through a fund-of-funds. In analyzing this question, you may wish to
assume that:
1) CPPIB invests $1 billion over three years into direct deals:

i) These funds are invested 1/3rd. each year.
ii) It pays no fees or carried interest on these transactions.
iii) The cost of compensation and fees associated with the investment is
approximately 1.5% of the amount invested, incurred at the time of the deals.
2) It could alternatively invest this capital in funds-of-funds:
i) The funds are typically drawn down in three equal tranches, 1/3rd. at the time
of the original investment, 1/3rd. one year later and 1/3rd. two years later.
ii) The private equity funds typically charge a management fee of 1.5% and a
carried interest of 20% of capital gains.
iii) The funds-of- funds typically charge a management fee of 1% and a carried
interest of 5% of capital gains.
3) Assume the return on these investments is 2.5 times (before fees) in five years.
i) 15% is a reasonable discount rate for low beta levered companies.
Answer:
Investment(Total) 10000,00,000.00
Annual 3333,33,333.33
Fees
Year 1 3333,33,333.33 50,00,000.000
Year 2 6666,66,666.67 100,00,000.000
Year 3 10000,00,000.00 150,00,000.000
Total 10000,00,000.00 300,00,000.000
Annual Return 20.11%
Private Equity
Management Fees Performance Fees
Year 1 3333,33,333.33 50,00,000.000 134,08,295.60
Year 2 6666,66,666.67 100,00,000.000 268,16,591.20
Year 3 6666,66,666.67 100,00,000.000 268,16,591.20
Year 4 10000,00,000.00 150,00,000.000 402,24,886.80
Total 10000,00,000.00 400,00,000.000 1072,66,364.790
Fund of Funds
Management Fees Performance Fees
Year 1 3333,33,333.33 33,33,333.333 33,52,073.90
Year 2 6666,66,666.67 66,66,666.667 67,04,147.80
Year 3 6666,66,666.67 66,66,666.667 67,04,147.80
Year 4 10000,00,000.00 100,00,000.000 100,56,221.70
Total 10000,00,000.00 266,66,666.667 268,16,591.198
c) If you were another LP in a fund with CPPIB and you see CPPIB co-investing alongside the
General Partner (GP), how would you react?
Answer:
Co-investment and co-sponsoring inevitably lead to tensions between partners. CPPIB is
a fund with enormous financial influence. If the LP has the influence of the CPPIB, he
can partner with or outperform the CPPIB. If not, the LP needs to focus on that
investment and be aware of the partnership's funding and holding structure.
d) What risks and challenges does CPPIB’s strategy pose? How might it backfire? People are an
essential part of private investing. How does CPPIB recruit and retain its investment staff?
What challenges does it face?
Answer:
The CPPIB has been very active in setting higher goals in itself. As a result, has become
Canada's largest pension fund. The challenge was to maintain relevance as the fund as a
whole grew. As the size of transactions grew, it became more difficult for CPPIBs to
find opportunities to meet their needs. If this continues, the share of private investment
groups in the fund will decline.
The CPPIB was able to attract talent because of its business model and culture. They
weren't top players, but they paid market-based rewards with Carry. The reward
consisted of basic salary, STIP and LTIP. There were many other initiatives that helped
CPPIB maintain its talent, such as creating VP posts.
The challenge for the CPPIB was to provide employees with the right career development
and opportunities while becoming a more mature company.

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TERM V

Private Equity and Venture Capital

Case: Canada Pension Plan Investment Board

Submitted to: Prof. BB Chakrabarti

Atindra Saha – MBA06034

1) CPPIB invests $1 billion over three years into direct deals:

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