Friday Letter Canada's underloved, outperforming GP's

Canadian fund managers have been chalking up impressive performance numbers – an achievement they must trumpet loudly to attract more foreign LPs.  

We strapped on our snow boots and headed to Toronto last week to learn first-hand how Canadian fund managers and institutional investors were viewing their market and future opportunities.  A gripe that came up over and over again from GPs was that they felt they have sometimes been overlooked by non-Canadian LPs.

That is perhaps explained by the fact that some investors lump Canada in with the US in a “North American” allocation bucket, and then tend to fill that bucket with commitments to firms in the US, which has a much older industry and many more fund managers.

In 2009 foreign commitments to Canadian funds accounted for only 31 percent of fundraising totals, down from 58 percent the prior year, according to Thomson Reuters data released late last year.

GPs in any market face challenges securing new relationship; as LPs made clear at a recent conference, going forward, only groups that can consistently hit benchmarks and outperform peers would receive support.

But what is on the side of many Canadian GPs, is they have been doing just that. Canada’s private equity and mezzanine funds had achieved a net return of 14.2 percent over a 10-year period, according to the aforementioned Thomson Reuters data released by the Canadian Private Equity & Venture Capital Association. That compares to a figure of 4.6 percent for buyout funds in the US over the same period (US mezzanine funds were counted separately, achieving net returns of 2.9 percent). European private equity funds, meanwhile, recorded an 11.9 percent net return over the same period.

The aggregate fund performance success – albeit for a smaller, younger universe of fund managers compared to the US and Europe – is complemented by macroeconomic indicators.  Though many Canadian funds invest in international portfolio companies as well as domestic ones, it’s worth noting that the Canadian economy has outperformed the rest of the G7 countries in recent years, with a 1.7 percent growth rate from 2000 to 2009. The most recent International Monetary Fund forecast predicted Canadian GDP growth would come in at 3.6 percent in 2011, while the US was expected to grow its GDP by 2.4 percent and Europe by 1.6 percent.

It’s also worth noting that as a percentage of GDP, private equity investment levels in Canada remain low compared to other markets – the figure is on par with India’s 0.3 percent, which compares to 0.7 percent in the US and 0.56 percent in the UK, according to World Bank data included in a CVCA report. The oft-repeated fear of too much money chasing too few deals doesn’t, therefore, pertain to Canada, the CVCA points out.

It is now up to Canadian GPs to make these points – loudly, clearly, repeatedly – to international investors. Last year, some Canadian fund managers did indeed “spread their wings”, as one GP told us, flying around the world to meet with LPs in other geographies. But even more will need to take to the skies.

For as the country’s domestic pensions continue to reduce external fund commitments in favour of direct investments, Canadian fund managers need the support of foreign LPs now more than ever.

PS – Look for PEI’s in-depth special report on the Canadian private equity industry in the March issue of Private Equity International.