The Pension Fund Beating Private Equity

Even as the economy slid into the recession, Jim Leech was making private equity deals. In 2008 he picked up a Chilean utility. Last year he bought a $211 million stake in U.K.'s Bristol International Airport. Now Leech is making a hostile bid for Australian toll-road operator Transurban Group, offering $6.2 billion. If consummated, the deal will be the largest buyout since the credit markets collapsed nearly three years ago.

There are a couple of reasons Leech never had to step away from the negotiating table. He doesn't have to rely on borrowed money, and he doesn't have to court investors. He has plenty—almost 300,000, in fact. They are the teachers of the Canadian province of Ontario, and as CEO of their $83 billion pension fund, Leech is charged with protecting their retirements. That sets him apart from rival dealmakers at Kohlberg Kravis & Roberts (KFN), Blackstone (BX), and Carlyle Group.

Most public pension funds, such as California Public Employees' Retirement System (CalPERS), have outside money managers pick their investments. The Ontario Teachers' Pension Plan does much of its private equity investing directly. It has bought or picked up stakes in almost 300 companies over the past two decades. Simmons Bedding, the General Nutrition Centers vitamin chain, and the Toronto Maple Leafs hockey team all belong in part to the educators of Ontario. The teachers paid cash for Aquilex Holdings, an industrial cleaning company, just weeks after the fall of Lehman Brothers in late 2008. "Even when other private equity firms were on the sidelines, we were there," says Leech.

Leech's strategy of keeping leverage in check and holding assets for the long haul has kept the fund competitive with the big boys of private equity. Since its inception in 1990, Ontario Teachers' private equity arm has earned 19.6% a year, in line with top firms. In 2008 the private equity group lost 13%, vs. nearly twice that for the average buyout fund. (Some 40% of its private equity assets are managed by outside investment firms, including many of the same ones it teams up with to make deals.) Ontario Teachers', which also holds stocks, bonds, real estate, and other alternative assets, made a bad bet on fixed income in 2008 and was down 18%. That made it the fund's worst year, but it still topped CalPERS, which lost 26%.

Ontario Teachers' success may eventually change the shape of private equity investing. Other pension funds are beginning to invest on their own. Ontario Teachers' partner on the Trans-urban deal is the Canada Pension Plan Investment Board. "We operate more like Goldman Sachs Asset Management" than a pension fund, says Mark Wiseman, who left Ontario Teachers' to help Canada Pension Plan develop a private equity strategy. Dutch civil service pension fund ABP owns a portfolio of companies, including Imagem Music Group, the music publisher. Australian pension funds are buying up bridges, toll roads, and other infrastructure.


Direct investment may also become more attractive to pension funds in the U.S., where state and federal authorities are investigating relationships between big pension funds and their outside money managers. Private investment firms paid at least $125 million to middlemen to help win lucrative contracts from CalPERS, according to a report by the pension fund. "The motivations to go direct are higher than they've ever been," says Colin Blaydon, director of the Center for Private Equity & Entrepreneurship at Dartmouth College's Tuck School of Business. "It's a much cleaner structure with less potential for conflicts." Says CalPERS spokesman Brad Pacheco: "CalPERS has acted quickly, adopting a strict policy to require disclosure about placement fees and sponsoring a bill that would end contingency fee arrangements."

Ontario Teachers' began dabbling in private equity in 1990, just one year after KKR's landmark leveraged buyout of RJR Nabisco. Back then, the pension fund was invested entirely in low-yielding Canadian bonds and was having a hard time making high enough returns.

Claude Lamoureux, then the fund's CEO, decided to try operating more like a Wall Street money manager. The pension fund's first buyout, in 1991, was a bust. It paid $15.75 million for White Rose Crafts & Nursery Sales and planned to expand the business. Within a year the company filed for bankruptcy, and Ontario Teachers' lost its investment.

The failed acquisition is immortalized at the pension fund's headquarters on the northern outskirts of Toronto. Four vertical four-foot-high metal sheets listing Ontario Teachers' deals hang on what is called the Wall of Fame and Shame in a conference room. "We could've said, 'Well, we drilled a dry hole' and ditched the do-it-yourself private equity plan, says Leech, the 62-year-old former banking and energy executive who joined the pension fund in 2001. "The amazing part is that there is a wall at all after that experience."

Today a team of 50 in-house money managers, whose paychecks compare to those of Wall Streeters, considers potential investments. The fund made a push into emerging markets in 2005, launching with a crash course for managers dubbed Project Atlantis. The managers took 10-day trips to Turkey, Brazil, and South Africa, meeting with government officials, financiers, and business owners. At a cocktail party in 2006 they chatted with Eike Batista, the Brazilian billionaire. One year later Ontario Teachers' bought a 15% stake in one of his mining companies, LLX Logística.

In 2007, Leech and his successor as head of private equity, Erol Uzumeri, reorganized the group by industry specialties. The structure helps Ontario Teachers' assess potential deals a long time before companies become available. Three years ago the financial- services team began to study the insurance business. It met with top executives and dissected the operations of large insurers, including American International Group (AIG). So when AIG's Canadian mortgage business became available after the U.S. government bailout in late 2008, the team knew that it was interested. After the pension fund spent a year working on the acquisition, the AIG acquisition was announced on Jan. 5.

Like many private equity owners, Ontario Teachers' operates like a mini conglomerate. The acquisition of Simmons Bedding for $760 million in January, made along with Ares Management (ARCC), fit nicely with another Ontario Teachers' holding, National Bedding, maker of Serta mattresses. When Leech was considering buying GNC in 2007, he called executives at the real estate developer Cadillac Fairview, which the fund had bought in 1999. Leech says he asked whether Cadillac Fairview wanted GNC in its malls and whether the vitamin retailer paid its bills on time. "They have a good outlook on how to run the business, and they're not engulfed in the day-to-day," says GNC Chief Executive Joseph Fortunato. "They've been a pretty ideal owner."

Cadillac Fairview has paired up with the pension fund's Maple Leaf Sports & Entertainment unit to build a multi-use development that includes the Maple Leafs' arena. Maple Leaf Square, a $500 million, 1.8 million-square-foot project, will feature a boutique hotel, condominiums, and a retail area. Ian Clarke, Maple Leaf Sports' executive vice-president in charge of business development, hopes to meld the excitement of game day—a giant high-definition screen will show games live in the plaza outside the arena—with shopping.


As with private equity firms, Ontario Teachers' has made moves it regrets. In 2007 it put together an investor group, including Merrill Lynch's (MER) buyout unit, to make a $43 billion bid for BCE, Canada's largest telephone company. The deal immediately began to unravel, and Ontario Teachers' and its partners ultimately walked away, citing an auditor's report that BCE would end up insolvent because of the debt it would have had to take on. BCE and the would-be acquirers are now fighting over a $1.1 billion breakup fee. "It was a product of a euphoric time," says Leech.

That Ontario Teachers' wasn't destroyed by the froth leading up to the financial collapse goes back to the biggest difference between Ontario Teachers' and traditional private equity firms: their investors. The managers are constantly reminded of whose money they are looking after. Retired teachers often stop by the headquarters to pick up their benefit checks; executives talk about extended family members who are pensioners. With retirees soon to equal active fund participants, dealmaking and returns will become more critical. "We have to look at an investment strategy that responds to the situation," says Leech. "It's just the math."

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