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Over the past several years, Ed Cass has seen first-hand how labour issues, political tensions and technological change have impacted asset prices. In this conversation, he reflects on the rapid advancement of AI, the Fed pivot, and why the current investment landscape is unlike any we’ve seen before.
How have recent geopolitical tensions challenged your investing process?
Ed Cass: Well, for the last three or four decades, countries largely worked together with a similar agenda within a rules-based international order. And one of the things we’re all struggling with now is whether we’re on the verge of a breakdown of that order—and what that will mean for investors. A different emphasis on industrial policy or security policy for instance, can have big implications on how the overall economic system functions.
This is a relatively new thing, at least in terms of our economic experience, and it’s tough to gauge it. We don’t have great economic data going back over six centuries, say, when there was a lot of geopolitical conflict that you could express in terms of impact on asset prices. That’s in essence, our challenge now.
How has this changed your thinking as a long-term investor?
Ed Cass: One of the big assumptions we make when we look at asset prices globally is the convergence of economies over time. Emerging economies will gradually increase their GDP per capita, they’ll open their markets and capital flows will become more global. If you believe in that, then there’s a pretty strong forward connection between GDP and the size of investment universe. And when we think about diversification and asset allocation, the size of the investment universe 10 or 20 years out is one of our starting points.
Arguably, some of the things we’re seeing globally right now could challenge that convergence path. If China doesn’t have the same objective goals as the U.S., Europe and developed countries, if it puts more emphasis on social goals than purely economic ones, does that impact the rate of convergence of markets over time? That’s probably the biggest implication for us in terms of how we think about where we’re going as an investor.
Right now we’re looking at what we thought five to 10 years ago in terms of where GDP per capita would be in China and India. Are they on the same convergence path or are they starting to deviate from that? And if so, what does that mean in terms of our future allocation of assets?
How do you go about building a portfolio that’s resilient to these kinds of shifts?
Ed Cass: You just have to continually challenge the beliefs you had when you went in. I think that’s a trap that a lot of people have fallen into over the years and it’s one we try to protect ourselves against.
We examine our beliefs, and we try to set the criteria for when we’re going to change our mind up front, as opposed to in the moment. In the moment, it’s always very hard to be objective. That’s where a lot of people have lost their way over the years.
So interest rates…
Ed Cass: One of my favourite subjects.
The Fed’s hinting at rate cuts. Markets expect the Fed to cut even faster than it’s hinting. How does that change things in terms of opportunity?
Ed Cass: So this gets to the heart of a basic point we don’t always appreciate. It’s not what happens in the economy that matters, it’s what happens in the economy relative to what’s embedded in asset prices. All else being equal, if you said interest rates in the U.S. were going to go down by 300 basis points over the next year, it should be really good for asset prices. It lowers the cost of funding, it lowers the discount rate, it’s arguably a boost to earnings through the lower interest charge.
But the market already has six easings priced in over the course of the next year. So you need eight easings, 10 easings to be beneficial to asset prices. Looked at through that lens, you say, well, the bar for investing in risky assets is pretty high because the inflation process has been sticky at times. That’s a long way of saying that when you think about interest rates, you’ve probably seen most of the easy money made.
How would you characterize the current transition to AI?
Ed Cass: Well for us, the question is, how is the technology going to be used and what’s the implication for asset prices? Part of the problem is it’s just really hard to tell—given what we know about AI right now—to say who’s going to win in the future. We don’t know the future capabilities. We don’t know what the business model is going to be. We don’t know who the winners and losers are going to be from a proprietary versus open AI standpoint.
So we’re back in that land where we’re going to have to make assumptions. One of the things we’ve been doing is, again, trying to set up the criteria. What are we assuming in terms of who the winners and losers are going to be? How do we think that’s going to flow through in terms of economics? How do we think that’s going to flow through in terms of asset prices? Then we try and compare our assumptions against what we see.
The hype over the last 12 months has been exponential.
Ed Cass: Although the underlying technological building blocks that enable AI (e.g. AI models and accelerated computing systems) have been advancing on an exponential trajectory, I’m not convinced the impact has been exponential. A lot of CEOs told me six months ago they were going to replace 10,000 workers, 20,000 workers and save billions of dollars in terms of operating costs. But we really haven’t seen that come through in the data yet.
There’s an active debate about how fast companies can adopt AI—and whether it’s going to be as fast as what’s embedded within asset prices. The prevalent view is that barriers to adoption are much lower with AI than they were with past technologies. People have talked about adoption cycles getting faster and faster, but when we look back over history, that wasn’t generally the case with respect to big transformative technologies.
If you want to rewire your manufacturing process for AI, it’s not a question of just dropping AI down on the floor. You’ve got to rewire the floor. You’ve got to lay out a huge capital-intensive budget to design a new factory. It’s not just a simple drop down of code.
Do you think we’re in an AI bubble?
Ed Cass: Depends how you define a bubble. Certainly, the stocks are aggressively priced, and some will have to do a lot to hit what’s embedded within that pricing.
We’ve taken a look at the lead up to the internet bubble and it looks really similar to where we are one year into AI. With the internet bubble, that process lasted three or four years. With AI, we’re only one year in. So, we have a long way to go before extrapolating from where we are now to where we were then. Asset prices and Magnificent Seven stock prices are aggressive, but they’re priced nowhere near as aggressively as stocks were priced in the late 1990s.
Do you think AI can replicate human reasoning in the investing process?
Ed Cass: We’ll have to wait to see. The biggest impact we’ve seen from AI so far is an increase in efficiency—not an epiphany in terms of outcomes. It’s helped people perform their jobs quicker and faster. It’s allowed people to allocate more of their time to interesting problems, as opposed to mundane ones. But the causal reasoning isn’t there yet within generative AI to provide an entirely different answer.
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Offshore wind at scale. That was the draw when CPP Investments bought its 24.5% stake in Hohe See and Albatros in 2018.
Located about 100 km off the coast of Germany’s North Sea, the wind farms were still under construction at the time. But by early 2020, development was complete and they were pushing some 2.5 million-megawatt hours of electricity into the grid—enough to power 700,000 households per year.
Then the world changed. The war in Ukraine laid bare the European Union’s heavy dependence on Russian energy—the superpower supplied 45% of total EU gas imports in 2021—prompting member states to re-evaluate their energy supply chains. As forest fires and other extreme weather events grew more frequent, regulators began to place a more urgent focus on decarbonization. Notably, Washington’s landmark Inflation Reduction Act, containing generous subsidies for clean energy industries, was signed. And Europe soon answered with its own Green Deal Industrial plan.
In just five years, the universe of investors for renewable energy widened dramatically—and for CPP Investments, the opportunity to crystalize returns through an exit became clear.
“The appetite for renewable energy assets certainly increased given greater urgency on both energy transition and energy security,” said Barry Liang, a senior associate on the deal.
Ultimately a buyer was found close to home. In Canada’s Enbridge Inc. Already a joint venture partner with 24.9% of the assets (alongside German utility and majority owner EnBW with 51%)—Enbridge purchased CPP Investments’ stake in 2023. And CPP Investments netted $374 million in net proceeds after costs, delivering returns well above original expectations.
Alongside growing demand, Liang credits the strong return to three key points: investing early in the renewables development cycle; a lower than budgeted construction capital expenditure; and a favourable debt raise earlier on.
The transaction demonstrates that investing in the long term doesn’t always mean holding an asset long-term. But in another sense, it’s good example of how long-term thinking continues to pay off. Having identified decarbonization and renewable energy as a long-term trend, CPP Investments established an early footprint in the space.
Further growth will be financed by a variety of means including partnerships, securing additional financing at the project level and selling down de-risked assets.
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Five Minutes with Michel Leduc
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“Challenge your beliefs”: Investing in times of geopolitical turbulence
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{:}{:fr}
De l’éolien en mer à grande échelle. C’est ce qui était prévu lorsque Investissements RPC a acquis une participation de 24,5 % dans Hohe See et Albatros en 2018.
Les deux parcs éoliens, situés à environ 100 km au large des côtes allemandes de la mer du Nord, étaient encore en construction à ce moment-là. Mais au début de 2020, les travaux préparatoires étaient terminés et les sites injectaient quelque 2,5 millions de mégawattheures d’électricité dans le réseau, soit suffisamment pour alimenter 700 000 foyers.
Puis le monde a basculé. La guerre en Ukraine a mis au jour la forte dépendance de l’Union européenne à l’égard de l’énergie russe (la superpuissance a fourni 45 % du total des importations de gaz de l’UE en 2021) ce qui a incité les États membres à réévaluer leurs chaînes d’approvisionnement en énergie. Face à la recrudescence de feux de forêt et autres phénomènes météorologiques extrêmes, les pouvoirs publics ont commencé à accorder une attention plus urgente à la décarbonation. En particulier, Washington a promulgué une loi historique visant la réduction de l’inflation (IRA, Inflation Reduction Act), qui accorde de généreuses subventions aux secteurs de l’énergie propre. L’Europe a alors rapidement répliqué avec son propre plan en faveur de l’industrie : le Pacte vert européen.
En seulement cinq ans, l’univers des investisseurs dans les énergies renouvelables s’est considérablement élargi — et pour Investissements RPC, il est devenu évident qu’il était possible de cristalliser les rendements par une sortie.
« L’appétit pour les actifs liés à l’énergie renouvelable a certainement augmenté en raison de l’urgence accrue de la transition énergétique et de la sécurité énergétique », a déclaré Barry Liang, adjoint principal sur la transaction.
Au final, un acquéreur a été trouvé à proximité : Enbridge Inc. au Canada. Déjà partenaire de la coentreprise à hauteur de 24,9 % des actifs (avec EnBW, une société allemande de services aux collectivités, actionnaire majoritaire avec 51 %), Enbridge a acheté la participation d’Investissements RPC en 2023. Investissements RPC a alors réalisé un produit net de 374 millions de dollars après déduction des frais, ce qui a donné des rendements nettement supérieurs aux attentes initiales.
Outre l’accroissement de la demande, Barry Liang attribue ce solide rendement à trois éléments clés : un investissement réalisé tôt dans le cycle de développement des énergies renouvelables; des dépenses d’investissement inférieures au budget de construction; et un accroissement favorable de la dette à un stade plus précoce que prévu.
L’opération prouve que l’investissement de long terme ne signifie pas toujours qu’il faut détenir un actif à long terme. Mais dans un autre sens, elle illustre bien que la vision à long terme continue de porter ses fruits. Après avoir identifié une tendance à long terme dans la décarbonation et l’énergie renouvelable, Investissements RPC s’est établi dans le secteur de manière précoce.
La poursuite de la croissance sera financée par divers moyens : en faisant appel à des partenaires, en obtenant un financement supplémentaire à l’échelon des projets et en vendant des actifs une fois le risque réduit.
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ShareTweetShare
Five Minutes with Michel Leduc
Michel Leduc, Global Head of Public Affairs and Communications, explores evolving industrial policy, concentration risks, and why investors
Video
January 31, 2024
“Challenge your beliefs”: Investing in times of geopolitical turbulence
Over the past several years, Ed Cass has seen first-hand how labour issues, political tensions and technological change have impacted asset
Article
January 31, 2024
Who will win the global AI race?
Artificial Intelligence (AI) has the potential to revolutionize the way the global economy works and how many businesses generate profits.
Article
January 31, 2024
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