In recent weeks, Trusted Insight detailed Mark Canavan’s use of mitigation banking to reap double-digit returns and restore damaged environments in the United States as senior portfolio manager at the New Mexico Educational Retirement Board. Trusted Insight followed up with a piece chronicling Canavan’s discovery that the world economy was on the brink of collapse in late 2006 and how he derisked the New Mexico Treasury Office’s portfolio (his previous employer) in the nick of time.
With those experiences (and his broader career) in hindsight, we asked Canavan about the current state of the markets and how he has positioned the real assets portfolio to mitigate risk while generate the best-possible returns over the near and long term.
Canavan was recently named on Trusted Insight’s Top 30 LPs Investing In Real Estate & Real Assets, and he graciously spoke with us on November 4, 2016.
Trusted Insight: What do you make of the current market situation?
Mark Canavan: It really scares me.
Over a year ago at a conference, I brought up the fact that at the Treasurer's Office, if I wanted to sell everything, it was a few keystrokes. You're out. Now, at ERB, we're in these long-term vehicles.
The panel moderator asked, "What are you going to do?"
I said in front of the whole room, "If I could, I'd sell, but I'm long all this stuff. This is not easy to get out of." I'm very conflicted about that. I've talked to my CIO about building a cash position. I haven't done it yet.
I'm concerned that this is a policy market. It is not driven by economics. This market is driven by policy, specifically interest rate policy, monetary policy. That's what's keeping the market up.
You saw it last summer when the Fed said, "We're going to increase rates." Markets started tanking overnight based on that news. So the Fed said, "Okay, maybe not now." And, the market recovered a little bit.
My call at the Treasurer's Office was based on boatloads of anecdotal experience, and my looking at a situation going, "Wow, this looks just like back then, except worse." Right now, I don't have any anecdotal roadmap to tell me what goes from here, and it scares me.
I know for sure we will be deleveraging our economy and the world's economy for a mind-numbingly long period of time. Early in the financial crisis I was telling people, "We're Japan, man. We'll be trying to re-inflate ourselves out of this for decades." That, to me, is the best case scenario. I'm really worried about deflation.
Bridgewater’s research would say, "This is a beautiful deleveraging. It will happen over time, and they've got the right balance of government spending and pumping money into the economy." And, I hope they're right.
The problem with what they've done with the economy: how they structured the bailout and how they structured saving the economy, in my opinion, was totally wrong. What they've done is stratified socio-economic classes. We're locked in. Social mobility between classes now just went way down, and the middle class is going to continue getting pinched.
Because they've stratified the economy, the rate of return on normal publicly traded investments is going to be low. Stock markets are not going to provide the performance they did during the 80s or 90s. It's not going to have the historical eight or nine percent rate of return. Bonds aren't going to deliver for sure, and even the private equity markets have gotten pretty compressed.
Trusted Insight: You’ve discussed how mitigation banking has worked out for your portfolio. Besides that, how does your market outlook translate into investment strategy? How do you approach your portfolio when you must take both an inherently long-term perspective, but also meet annual payout requirements?
Mark Canavan: I'm glad you brought that up, and I hate you for bringing that up too, because it's really prescient.
Real Estate
This is why my real estate fund really just knocks the cover off all of our benchmarks. A few good decisions can make for a good decade.
What that means for my investment decisions right now is I backed off of core real estate. It's been my mantra. I don't want to do core real estate, because cap rates just got so low.
Should I be wrong about deflation and should there be inflation, you don't want to be in low-interest rate, long duration, compressed risk premia real estate when interest rates start going back up. That's a really bad day.
We've done a lot of value add. We're building and selling to core players, and we're still heavy in distressed debt. Gosh, at one point, I can't remember what percentage of my portfolio was distressed debt, but we were heavily overweight. I think we had 40 percent distressed debt at one point.
This is why my real estate fund really just knocks the cover off all of our benchmarks. A few good decisions can make for a good decade.
Cash
In real estate, we're just trying to be as defensive as we possibly can within the kind of structure we have. I warmed up my CIO to the idea of selling out of some profitable positions to just build cash. We purposefully have an allocation to REITs for just such purposes. So we can be more flexible moving in or out of the market. When we do reduce exposure, it will be by selling down our REIT exposure.
At the Treasurer's office, all we really did was not continue to buy, right? I hate to make light of what I did. It's not like I shorted the market and went, "Whoa, I really know what's going on." I knew what was going on, but it’s not like I had to make a judgement call on longer term assets--particularly limited partnership structured funds where you are going to take a hair cut. But, at ERB it’s a different proposition. I want to be defensive here. I want to build cash. I don't want to do core for sure.
Agriculture
I'm spending more time on agriculture now. Prices have sold off recently, yet demographics favor it over the long term. If we do have inflation, agriculture will act as an inflation hedge, and if we go deflationary, it’s defensive. After all, people always have to eat.
Whether you go deflationary or hyper inflationary, there are a lot of things you don’t need to buy. I don't have to buy another DVD, or download. I don't have to buy another gig on the cloud. There's all kinds of things I don't have to have, but I still have to eat.
Infrastructure
Infrastructure, same thing. We stopped doing core infrastructure a long time ago. We want to build stuff and sell it to the mega funds. If there's anything I know about the securities world: when there's a huge pile of cash needing to be invested and a bunch of sheep running into a market, which is the situation in infrastructure right now, you want to sell into that. You don't want to be one of those sheep.
There's these huge monolithic funds chasing infrastructure assets that are already overvalued, at very low interest rates and in a historically low interest rate environment. I'd rather sell into that crowd.
I was on a panel with a guy from a huge fund manager. He goes, "Well, Mark, I hate to argue with you, but we have $12 billion of capital invested with us that says your opinion is wrong." And I said, "That's the crowd I want to sell to." It was kind of funny.
That's the strategy we're doing here. We're not necessarily always building something to sell to core, but we're not doing flat out core. Well, that's not true. We recently just did a flat out core infrastructure deal, but it's got a 10 percent coupon. It's a regulated utility in New Zealand, high stability, good regulatory environment, and a great coupon. I'll take that all day long.
Water
Lastly, while we may be looking for ways to reduce our real estate exposure, we are seeking ways to increase exposure to water-related investments – water rich farmland or ranchland, water rights, water efficiency, water filtration, water transfers, fallowing programs, water quality programs. Our mitigation banking program touches on water quality and watershed natural filtration ecosystems. Then our infrastructure program gives us exposure to water utilities and desalination. Lastly, we have a water rich property investment that incorporates several themes – water transfers, water efficiency, conservation strategies and fallowing. Still though, we are looking for ways to increase our exposure to water.
To learn more about real estate & real assets investing, click here to view the complete list of Top 30 LPs Investing In Real Estate & Real Assets.
With those experiences (and his broader career) in hindsight, we asked Canavan about the current state of the markets and how he has positioned the real assets portfolio to mitigate risk while generate the best-possible returns over the near and long term.
Canavan was recently named on Trusted Insight’s Top 30 LPs Investing In Real Estate & Real Assets, and he graciously spoke with us on November 4, 2016.
Trusted Insight: What do you make of the current market situation?
Mark Canavan: It really scares me.
Over a year ago at a conference, I brought up the fact that at the Treasurer's Office, if I wanted to sell everything, it was a few keystrokes. You're out. Now, at ERB, we're in these long-term vehicles.
Right now, I don't have any anecdotal roadmap to tell me what goes from here, and it scares me.
The panel moderator asked, "What are you going to do?"
I said in front of the whole room, "If I could, I'd sell, but I'm long all this stuff. This is not easy to get out of." I'm very conflicted about that. I've talked to my CIO about building a cash position. I haven't done it yet.
I'm concerned that this is a policy market. It is not driven by economics. This market is driven by policy, specifically interest rate policy, monetary policy. That's what's keeping the market up.
You saw it last summer when the Fed said, "We're going to increase rates." Markets started tanking overnight based on that news. So the Fed said, "Okay, maybe not now." And, the market recovered a little bit.
My call at the Treasurer's Office was based on boatloads of anecdotal experience, and my looking at a situation going, "Wow, this looks just like back then, except worse." Right now, I don't have any anecdotal roadmap to tell me what goes from here, and it scares me.
I know for sure we will be deleveraging our economy and the world's economy for a mind-numbingly long period of time. Early in the financial crisis I was telling people, "We're Japan, man. We'll be trying to re-inflate ourselves out of this for decades." That, to me, is the best case scenario. I'm really worried about deflation.
Bridgewater’s research would say, "This is a beautiful deleveraging. It will happen over time, and they've got the right balance of government spending and pumping money into the economy." And, I hope they're right.
The problem with what they've done with the economy: how they structured the bailout and how they structured saving the economy, in my opinion, was totally wrong. What they've done is stratified socio-economic classes. We're locked in. Social mobility between classes now just went way down, and the middle class is going to continue getting pinched.
Because they've stratified the economy, the rate of return on normal publicly traded investments is going to be low. Stock markets are not going to provide the performance they did during the 80s or 90s. It's not going to have the historical eight or nine percent rate of return. Bonds aren't going to deliver for sure, and even the private equity markets have gotten pretty compressed.
Trusted Insight: You’ve discussed how mitigation banking has worked out for your portfolio. Besides that, how does your market outlook translate into investment strategy? How do you approach your portfolio when you must take both an inherently long-term perspective, but also meet annual payout requirements?
Mark Canavan: I'm glad you brought that up, and I hate you for bringing that up too, because it's really prescient.
What that means for my investment decisions right now is I backed off of core real estate. It's been my mantra. I don't want to do core real estate, because cap rates just got so low.
This is why my real estate fund really just knocks the cover off all of our benchmarks. A few good decisions can make for a good decade.
Should I be wrong about deflation and should there be inflation, you don't want to be in low-interest rate, long duration, compressed risk premia real estate when interest rates start going back up. That's a really bad day.
We've done a lot of value add. We're building and selling to core players, and we're still heavy in distressed debt. Gosh, at one point, I can't remember what percentage of my portfolio was distressed debt, but we were heavily overweight. I think we had 40 percent distressed debt at one point.
This is why my real estate fund really just knocks the cover off all of our benchmarks. A few good decisions can make for a good decade.
In real estate, we're just trying to be as defensive as we possibly can within the kind of structure we have. I warmed up my CIO to the idea of selling out of some profitable positions to just build cash. We purposefully have an allocation to REITs for just such purposes. So we can be more flexible moving in or out of the market. When we do reduce exposure, it will be by selling down our REIT exposure.
At the Treasurer's office, all we really did was not continue to buy, right? I hate to make light of what I did. It's not like I shorted the market and went, "Whoa, I really know what's going on." I knew what was going on, but it’s not like I had to make a judgement call on longer term assets--particularly limited partnership structured funds where you are going to take a hair cut. But, at ERB it’s a different proposition. I want to be defensive here. I want to build cash. I don't want to do core for sure.
I'm spending more time on agriculture now. Prices have sold off recently, yet demographics favor it over the long term. If we do have inflation, agriculture will act as an inflation hedge, and if we go deflationary, it’s defensive. After all, people always have to eat.
You don't want to be one of those sheep.A colleague told me this little factoid: on a relative basis during the Depression, the one thing that actually didn't go down was almond paste. It was used in a host of baked goods, candies and flavoring--everything from penny candies to high-end cakes. Bottom line is food is highly defensive. Obviously, you still have to buy at the right price. And, it is important to have low-to-no leverage.
Whether you go deflationary or hyper inflationary, there are a lot of things you don’t need to buy. I don't have to buy another DVD, or download. I don't have to buy another gig on the cloud. There's all kinds of things I don't have to have, but I still have to eat.
Infrastructure, same thing. We stopped doing core infrastructure a long time ago. We want to build stuff and sell it to the mega funds. If there's anything I know about the securities world: when there's a huge pile of cash needing to be invested and a bunch of sheep running into a market, which is the situation in infrastructure right now, you want to sell into that. You don't want to be one of those sheep.
There's these huge monolithic funds chasing infrastructure assets that are already overvalued, at very low interest rates and in a historically low interest rate environment. I'd rather sell into that crowd.
I was on a panel with a guy from a huge fund manager. He goes, "Well, Mark, I hate to argue with you, but we have $12 billion of capital invested with us that says your opinion is wrong." And I said, "That's the crowd I want to sell to." It was kind of funny.
That's the strategy we're doing here. We're not necessarily always building something to sell to core, but we're not doing flat out core. Well, that's not true. We recently just did a flat out core infrastructure deal, but it's got a 10 percent coupon. It's a regulated utility in New Zealand, high stability, good regulatory environment, and a great coupon. I'll take that all day long.
Lastly, while we may be looking for ways to reduce our real estate exposure, we are seeking ways to increase exposure to water-related investments – water rich farmland or ranchland, water rights, water efficiency, water filtration, water transfers, fallowing programs, water quality programs. Our mitigation banking program touches on water quality and watershed natural filtration ecosystems. Then our infrastructure program gives us exposure to water utilities and desalination. Lastly, we have a water rich property investment that incorporates several themes – water transfers, water efficiency, conservation strategies and fallowing. Still though, we are looking for ways to increase our exposure to water.
To learn more about real estate & real assets investing, click here to view the complete list of Top 30 LPs Investing In Real Estate & Real Assets.