To start righting the ship, CPPIB launched a major strategic review last year, tackling everything from organizational structure to compensation. After some soul-searching, the pension fund is out to prove to Canadians that they will be adequately compensated for the extra risk added to their retirement funds.
Investment strategy strife
To truly appreciate the current conundrum, it helps to have a good grasp on the past.
The Canada Pension Plan has existed since the mid-1960s, but the program was revamped in 1997 when federal and provincial governments realized its demographic assumptions were outdated. To correct course, politicians forced Canadians to put more of their paycheques into the plan, sending the value of funds under management soaring. The government also created the CPPIB to start dabbling in investments beyond government bonds.
Almost a decade later, the CPP was overhauled again when management adopted a much more aggressive strategy to earn even higher returns. In the years since, CPPIB has invested in assets such as Sydney office towers and it has also completed a host of high-profile deals such as buying U.S. reinsurer Wilton Re for $1.8-billion (U.S.), forming a $250-million joint venture with China Vanke in Shanghai to invest in Chinese residential real estate and acquiring a portfolio of Saskatchewan farmland for $128-million (Canadian).
But it was deep in the board’s public markets division, which manages a $131-billion portfolio, where problems first surfaced a few years ago.
Because the public markets division is so large, it employs myriad investing strategies. Such diversity can sound like a good idea, but its practical implementation doesn’t always pan out. “The problem with the public markets group,” said a former employee, “is that they’re in so many different strategies that it’s very difficult for all the stars to align so that every group is making money.”
With so many strategies at play, it can be hard to pinpoint those that have worked and those that don’t. But in its simplest form: if one makes $3-million, another loses $4-million, and a third returns $1-million, the net effect is no gain.
There has also been a deep divide between the public markets group’s two dominant investing themes – quantitative versus fundamental analysis.
Many fund veterans, including recently departed chief investment strategist Don Raymond, were steadfast quantitative investors, which means they deployed money based on things like probability distributions and standard deviations. A quantitative portfolio manager may arrange an investment mix based on certain assets’ correlations to one another.
As CPPIB’s portfolio expanded, however, its fundamental investing team – which conducts research to forecast future cash flows and pores over corporate financial statements – grew bigger and very quickly housed a large group of people who had a different view of the market. These folks did not care much about what the statistics said.
In an interview, Mr. Wiseman acknowledged it was a marriage that could not work. “It’s like getting [people] who speak two different languages and asking them to go write a novel,” he said. “It just becomes really, really difficult.”
Other units within the public markets division also had to be overhauled after they each underperformed their benchmarks by hundreds of millions of dollars, according to two different sources familiar with the fund. CPPIB would not verify the amounts, saying it only reports results at a very high level.
Mr. Wiseman acknowledged problems in two particular units: the global corporate securities group, or GCS, which primarily played with long and short positions, and the global tactical asset allocation team, or GTAA, which invests based on macroeconomic themes, such as a euro zone recovery or an emerging-markets slump. The first group needed to fine tune its strategy, he said, while the second suffered from bad leadership.
Another problem was determining annual compensation for long-term investment strategies.
Because CPPIB has such a lengthy investment horizon – 75 years in some cases –both GCS and GTAA tried to use it to their advantage, sometimes placing trades that required them to hold securities for two to five years. (Most money managers in the private sector have a time horizon of less than two years.) At CPPIB, a portfolio manager might purchase Spanish securities in the middle of the European debt crisis, assuming the euro zone will eventually get its act together, even if it takes three or four years to reap the benefits.