It's a Canadian success story that has garnered little attention at home, but a strong following abroad: the performance of the country's biggest public sector pension funds.
Big public sector pension funds in Canada are outperforming their U.S. peers, and money managers around the world are taking note.
One key to the funds' performance: Over the past decade, most have shifted management of a larger proportion of their funds in-house to both boost returns, and to avoid paying hefty fees charged by outside money managers.
A Globe and Mail review of average annual returns of major public sector pension funds in Canada and the United States suggests that the new model is paying dividends for Canadian funds through improved performance by internal managers.
The review shows Canada's nine largest public pension funds earned an average annual return of 5.5 per cent over the past 10 years while data from eight top U.S. public pension funds shows an average annual return of 3.2 per cent in the same period.
But better performance comes at a cost.
With top investment professionals moving to public sector pension funds, salary levels have soared.
A decade ago, many funds were largely staffed with civil servants and professional administrators - much the way many major U.S funds are still managed.
The heads of all major U.S. pension funds make a fraction of the income of Canada's pension fund leaders, in some cases earning just one-twentieth of Canadian pay levels.
"You get what you pay for - there's no doubt in my mind," said Kristopher McDaniel, editor of New York-based ai5000, a magazine aimed at major asset fund managers.
Mr. McDaniel is among the industry watchers who argue that Canada's internal management model for public sector funds is generating the stronger returns.
"If you look at the stats of returns in America, the funds that have the worst returns are always the public pension funds, compared to corporate pension funds and endowments and foundations," he said. "One thing that correlates to that is investment manager pay."
Many public sector pension funds are run as part of the state civil service, typically part of a state treasurer's or controller's office. Even funds with a more independent management structure are still part of the civil service and have boards of directors that include elected politicians or top state bureaucrats.
Better managers, bigger salaries
The rapid evolution that has occurred at many major Canadian funds has attracted a chorus of complaints about the climbing pay levels for managers. Critics say the Canadian pension executives don't need outsized private-sector paycheques to manage public money, and should not be allowed to impose their Bay Street salary expectations on unwitting plan members.
David Denison, the 57-year-old Bay Street veteran who now heads the Canada Pension Plan Investment Board, earned $3-million in fiscal 2009 to manage Canada's largest pension plan with assets totalling $124-billion. That's considerably less than the $4.2-million he earned in fiscal 2008.
Anne Stausboll, by comparison, is paid about one-tenth that amount to run the California Public Employees' Retirement System, which is the largest pension plan in the United States with assets of $205-billion. Ms. Stausboll, 53, earned a base salary of $270,000 (U.S.) and received a bonus of $49,208 for half a year's work in fiscal 2009 as the fund's newly appointed CEO.
Last year, politicians from all parties in the House of Commons voted to support a non-binding motion tabled by the New Democrats, calling on the federal government to claw back bonuses paid to Mr. Denison and other CPPIB executives. The bonuses were left untouched, with Finance Minister Jim Flaherty arguing he did not have authority to interfere in the autonomous organization.
NDP Deputy Leader Thomas Mulcair has also led opposition last year to bonus payments for executives at the Public Sector Pension Investment Board, which manages $34-billion of pension money for federal government workers. In fiscal 2009, ended March 31, PSPIB chief executive officer Gordon Fyfe saw his pay climb 11 per cent to $1.4-million even as the PSPIB lost 22.7 per cent of its value in the market crash.
Despite the higher salary costs in Canada, internal management has been a bigger advantage than it has been a cost, said pension specialist Keith Ambachtsheer, director of the International Centre for Pension Management at the University of Toronto.
But the results talk
Research shows internal teams not only save money by cutting high external money management fees, but also perform better as investors because they are more closely aligned to the mission of the pension fund, he said. According to data from CEM Benchmarking, internal management improves returns by 0.5 per cent annually over external management, Mr. Ambachtsheer said.
"Canada is now leading the world in terms of design and operation of these organizations," he said.
To put the difference between the big Canadian and U.S. funds' returns perspective, consider the longer-range picture: one percentage point of better return each year translates into 20 per cent more income when the money is compounded over a 20-year span, and two percentage points boosts income by more than 40 per cent over a 20-year span.
Research suggests cost savings from internal management are greatest in areas such as private equity and infrastructure investing, where outside managers typically charge the most for money management. Private equity funds, for example, routinely charge pension funds an annual fee equal to 2 per cent of their invested assets, plus collect an additional 20 per cent of all gains earned above a base threshold amount.
Mr. Denison said at a fund like his with more than $100-billion to invest, these "2 and 20" external management fees are so high that external managers are used primarily in targeted niche areas where CPP staff cannot duplicate the expertise.
"It is a factor of 10 times more expensive to do it externally versus internally," he said. "But doing it internally means the compensation elements show up in our statements as such, while doing it externally means people don't focus on it."
In fiscal 2009, CALPERS paid $1.5-billion (U.S.) to external fund managers, consultants and private equity investment partners.
CPPIB, by comparison, paid outside investment managers, consultants and other professionals just over $400-million (Canadian), most of it fees to private equity investment partners.
The Ontario Teachers Pension Plan, which has the longest track record in Canada for internalizing investment functions, paid even lower external management and consulting fees in 2008, totalling $188-million on total assets of $87-billion.
Teachers CEO Jim Leech said good outside managers cost about 5 to 6 per cent per year on assets under management - or $5 to $6 on each $100 invested - while internal investment costs (excluding commissions and fees for external managers) are .0015 per cent. That means internal management costs about 15 cents on each $100 invested.
"It is significantly less expensive for the plan," Mr. Leech said.
A shift in Alberta
At the new Alberta Investment Management Corp. (AIMCO), created in 2008 as an arm's length manager of $70-billion in investment and pension assets for the Alberta government, CEO Leo de Bever has begun the process of shifting investing in-house, bring the internal management model to the new organization.
In his first year on the job, Mr. de Bever said he trimmed external management costs from $175-million to $150-million, and said the number is heading down toward $100-million.
AIMCO had 150 different external managers when he began - about 50 of them managing private equity funds - and is down to about 75 now.
But the flip side, he said, is that he has to be able to pay top people to work in-house to replace the outside managers.
"I can't hire experts that have commercial alternatives on a civil service salary," he said.
Canada's internal management model began in 1990 with the creation of the Ontario Teachers Pension Plan. Former CEO Claude Lamoureux said that when he was approached about taking the top job, he insisted on having an independent board free of political influence, corporate job titles, and compensation plans with incentives similar to those in the private sector.
"You can be penny wise and pound foolish," Mr. Lamoureux says of the compensation debate. The success of Teachers has helped encourage the spread of the internal management model.
But major U.S. funds have long-established practices that make wholesale change hard to achieve. Unlike Canada - where many of the largest public sector pension funds have been launched or retooled in the past two decades - the U.S. has not had many "green field" opportunities to build new structures.
Mr. McDaniel in New York said he believes changing U.S. public plans to bring money management in-house - at higher salaries - would likely be too radical to survive the confrontational U.S. political climate.
"There would be a huge uproar, especially in the California budget situation," he predicts.
This article has been corrected from an earlier version.