Canadian pension funds will be increasing their direct investing into the hundreds of billions of dollars over the next decade. It is obvious that given the fiscal difficulties of all levels of government and the need for better service delivery, governments should create the conditions for domestic pension fund investment in infrastructure, commercial assets (government enterprises), and public markets (e.g., energy, water, transportation) that are relied on by citizens. This would be a win-win situation.
The Globe recently reported the Ministry of Finance’s interest in Canadian pension fund infrastructure, real estate, and private equity investment abroad (collectively termed direct investment). As I have written previously, Canadian funds have developed tremendous expertise in managing such investments efficiently and profitably and thus have become the focus of foreign study and accolades.
But first, Canadian funds need the government to create these domestic investment opportunities. Sadly, this is rarely discussed. Canada’s underutilized assets and public utilities present an opportunity for Canadian funds and therefore the millions of citizens who rely on them. A mutually beneficial special relationship should be formed.
There are three characteristics needed to achieve this.
Arm’s length from politics: Canadian funds have become successful because of good, independent governance that has allowed them to pay market rates for top talent and to invest freely, unfettered by political whims. The heads of both the CPPIB and Quebec’s Caisse made it clear that pension funds should not be used to bail out domestic companies during the last Quebec provincial election. Pension funds exist to achieve a risk adjusted return that will sustain millions of retirees and not to engage in transitory political and economic development projects.
Assets and markets to invest in: A recent OECD report argued that “Canada’s pension funds are major infrastructure investors in the global context, but most of the capital goes overseas.” The reason: a lack of domestic projects or assets available for investment. Provinces continue to hold on to government businesses (such as the LCBO) even if doing so makes little policy or financial sense. Beyond commercial assets, governments need to create markets with large investment opportunities in areas badly in need of transformation, such as water and wastewater, electricity and transportation infrastructure. Until this is done, pension funds will have to look abroad for good investment opportunities.
Well-regulated markets: Institutional investors invest abroad because these investments are governed by regulatory regimes that have an independent mandate from government, not just in theory and intention, but in law and in practice. These entities are focused solely on the effective performance of infrastructure and the needs of its consumers – not broader public policy concerns or episodic fiscal considerations, community or labour-relations issues. The Ontario energy sector is emblematic of what not to do to attract private investment. A recent C.D. Howe report shows how damaging transient and politically driven policy choices have been for the Ontario energy sector, resulting in substantially higher electricity prices and underinvestment in crucial energy assets.
If we are able to create these three characteristics, encouraging pension funds’ investment locally, the funds themselves will benefit in two key ways.
Managing domestic political risk: If domestic funds continue to invest in foreign assets while domestic infrastructure and public markets fail, a capital repatriation argument could become popular (as has occasionally happened in Quebec). From the standpoint of managing domestic political risk, it is better to create domestic deal flow with appropriate risk adjusted returns now than wait for a political backlash.
Domestic assets: Clearly, Canadian assets are not up for sale and Canadian public markets are not structured to allow for easy investment. In contrast, Australian funds have found significant opportunities in their own country because of the creation of Australian investment opportunities and policies (such as asset recycling) that have considerably advantaged Australian superannuation funds in the pursuit of quality Australian assets. Canadian funds are competing for assets all over the world. Creating deal flow for domestic assets would create significant opportunities with beneficial return and risk profiles. In addition, Canadian funds are looking to pool with or manage the direct investments of other funds. By becoming the conduit for foreign institutional capital into Canadian public assets and markets, Canadian funds could continue to position themselves as world leaders in direct investing, while guiding billions of dollars in capital into Canadian projects and public markets.
There is an opportunity for mutual benefit. Canadian governments and pension funds should realize the potential objectives they can achieve together. Governments have long been trying to divine a way to inject private sector rigour and politically “safe” capital into public assets. What better way than through the funds that seek to provide secure retirements for millions of Canadian citizen? Pension funds need investments with the right scale, cash flow and risk-adjusted returns that many public assets and markets provide. Both need to come together to craft a public policy framework guiding a special relationship that would benefit government, taxpayers, and pensioners alike.
J.C. Bourque is a business strategy consultant in Toronto.