At first glance, the Canada Pension Plan looks like a model for a government-created retirement fund. The portfolio is growing, returns have looked strong and the plan is now among the 10 largest of its kind in the world.
But as it approaches $220-billion in assets, the CPP’s investment arm, the Canada Pension Plan Investment Board, is taking on more risk than ever. The CPPIB has moved into a host of far-flung private investments such as Chinese real estate, high-yield debt, speculative energy plays and even a deal with the organization that runs Formula One car racing. Sources say it has also faced an internal struggle over investment strategy that has contributed to the departure of several key executives.
As the fund moves farther away from safe holdings, like government bonds and blue-chip stocks, the ramifications could be significant for 18 million Canadians who depend on the CPP for retirement benefits. In the past four years, the CPPIB has rapidly expanded its private investment portfolio from $30-billion in 2010 to $88.5-billion today. And earning exceptional returns on these investments can be challenging.
“In my 15 years as a professional investor, this is by far the most difficult market” for private assets, CPPIB chief executive officer Mark Wiseman said in an interview.
In a sign the new strategy isn’t paying off just yet, the CPPIB has failed to beat its own internal benchmarks two years in a row, falling short by $350-million – and in four of the past six years, amounting to $1.9-billion worth of total underperformance.
Much like a mutual fund, CPPIB’s success cannot be judged on annual returns alone. The pension fund must also be assessed on its ability to beat the market. Almost any fund manager can earn 10 per cent when the market is up 15 per cent, but real value, or alpha, as it is known on Bay Street, comes from going above and beyond. Because the market is so hard to beat, surpassing it by even the smallest of margins is touted as a success.
Even if the underperformance seems small for such a large fund, failing to consistently beat the benchmark can have far-reaching implications. It would undermine the shift toward more high-risk assets and it could hold back overall returns. And considering that the CPP is expected to grow to $500-billion by 2030, any misstep on the investment strategy could be costly.
Such a scenario can be confusing. To the average person, the fund’s annual performance looks impressive. The CPPIB has roughly doubled the size of the fund in the past 10 years to $219-billion and its 16.5-per-cent return last year suggests the portfolio is humming. The fund has also become a major player on the world stage, opening offices in four countries and participating in several foreign transactions, and CPPIB executives are regularly invited to elite gatherings such as the World Economic Forum in Davos, Switzerland.
But the CPPIB has undergone a substantial transformation. A decade ago, executives lobbied hard to shift away from solely investing in passive investments, such as federal and provincial bonds that that pay low, safe returns. The goal: To take on riskier but potentially higher-paying strategies, such as investing in private companies and real estate. Ottawa ultimately gave CPPIB the green light, but required that the fund find ways to determine if the extra risk was worth it.
To help track its performance under the new strategy, the CPPIB created a “reference portfolio” – a low-cost, basic basket of global public market investments it could otherwise invest in. Each year, CPPIB’s returns are compared with this portfolio. When the returns fall short, it means Canadians would have been better off avoiding the riskier investments, the same way a retail investor might fare better by investing in an exchange-traded fund that tracks the simple S&P/TSX composite index instead of picking and choosing between companies.
The CPPIB must now prove that taking on the extra risk was worth it in the long run. And it has to do that just as the environment for these kinds of investments has become much more competitive as many other pension funds, private equity firms and sovereign wealth funds seek to do the same thing.
All this extra attention on private equity has put more pressure on the CPPIB’s far larger public investments arm, which buys and sells publicly-traded stocks and bonds as well commodities, currencies and interest rates. Returns here have to be good to compensate for any shortfall on the private side. The trouble is, this division, which comprises 60 per cent of the fund’s assets, hit a series of road bumps in recent years, such as infighting over investment strategy.