He also acknowledged that private equity isn’t a sure bet – especially not in this competitive market when assets are sometimes purchased at big premiums. “It’s really hard to get right. It’s a tough, competitive business.” Jaw-dropping returns are getting harder to come by now that university endowment funds and sovereign wealth funds have all moved into this terrain. “This industry has matured. It’s always harder to get superior returns when there’s a lot of money chasing deals,” Mr. Wiseman said.
Private assets also pose a valuation problem – they are incredibly hard to value until they are sold. Because there are only so many power and water utilities up for sale at one time, it can take time to find comparable transactions. In financial circles, then, the valuation process is sometimes called “marking to myth,” and the problem is so widespread that Keith Ambachtsheer, a renowned pension expert who runs the Rotman International Centre for Pension Management at the University of Toronto, is devoting much of his research to analyzing the issue.
Back to the glory days
While it can seem like CPPIB’s task is daunting, the reality is far from it. The country’s largest pension fund is still pumping out positive returns, and it is complying with its most crucial guideline.
Every three years, Canada’s chief actuary calculates the returns CPPIB must generate to meet its long-term pension obligations. The last time the review was conducted, it showed the fund must generate a 4-per-cent real rate of return each year – or 4 per cent after adjusting for inflation. Over the past 10 years CPPIB’s annual real rate of return is 5.1 per cent.
As for the internal benchmark, CPPIB has proven it can beat it. Early on the fund generated a lot of alpha, and those gains have contributed to total positive “value-add” of $3-billion since CPPIB adopted its more aggressive approach and created the reference portfolio in 2006. Now management must prove that it can get back to the glory days.
Mr. Wiseman stressed there is no need to worry. Because 40 per cent of CPPIB’s portfolio is invested in private assets, he argued that the fund is at an inherent disadvantage when public stock and bond markets are hot, like they are right now, because private assets take much longer to reprice. “Just keeping up to the reference portfolio in a bull market is unbelievably good,” he said.
In the private asset portfolio, Mr. Wiseman said CPPIB has the luxury of being “steadfastly patient.” Because the fund doesn’t have to return money to investors every five to seven years, as private funds do, it can wait for good opportunities.
And overall CPPIB also has some wiggle room. The fund benefits from net inflows until 2023, meaning its members’ contributions amount to more than its annual payouts until then.
However, the net inflows can serve as a double-edged sword. Whereas Ontario Teachers’ Pension Plan can’t afford to make investment mistakes because it currently pays out more than it brings in every year, CPPIB can arguably hide behind its sizable contributions. The pension plan also has less stakeholder engagement than rival funds. OTPP, for instance, holds quarterly meetings with the Ontario Teachers’ Federation, according to Rhonda Kimberly-Young, the union’s secretary-treasurer.
“We really rely on the integrity of the people on the board and we rely on the competence and vigilance and transparency of the people who are on the staff to do a good job, [because] they don’t have a stakeholder looking over their shoulder,” said Mr. Hamilton of the C.D. Howe Institute.
Mr. Wiseman shrugs off such worries, arguing that the board is vigilant. Just because missteps happened does not mean management has had, or will have, a free ride. “Not making a mistake means you’re not building your business, you’re not taking enough risk,” he said.
But he also understands the severity of the situation, and pledged to prevent the same drama from unfolding again. “Making the same mistake twice? That’s unconscionable,” he said.
Even if CPP’s future is much smoother, there still is no guarantee that the active management strategy will pay off, something other massive pension funds are wrestling with. While Singapore’s GIC sovereign wealth fund has adopted a similar approach, Norway’s $850-billion wealth fund is debating whether it should move farther away from passive investments.
“It’s human nature for people not to invest passively,” Mr. Hamilton said. “They all want to try to do better [than the market].” The problem is that the time frame required to assess the merits of an active approach can take decades – time during which billions of dollars can be made or wasted. “At this point, it really is an experiment,” he said.