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The investment arm of Canada Pension Plan is struggling to post returns that keep pace with frothy stock markets, forcing the fund – and its rivals – to debate investment portfolio weightings amid a bull run that could keep raging.

Canada Pension Plan Investment Board reported a 16.4-per-cent return over the first three quarters of its current fiscal year, which runs from April 1, 2020, to March 31, 2021.

The fund’s internal benchmark, known as the reference portfolio, measures its performance against the wider market. It is 85-per-cent weighted to returns from the S&P Global LargeMidCap Index, and it delivered a 46-per-cent gain over the same period. The remaining 15 per cent of CPPIB’s benchmark is weighted to the FTSE Canada All Government Index, which tracks bonds and delivered a 3-per-cent return over the same nine months.

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Altogether, it means that for the current fiscal year, CPPIB is delivering less than half the return that can be achieved by passively investing in stocks and bonds. This could significantly dent the firm’s outperformance since its inception, which amounted to $52.6-billion at the end of the previous fiscal year. The Federal Reserve and the Bank of Canada have both pledged to keep interest rates extremely low until 2023, which could continue to fuel the stock market’s rally.

The situation is not unique to CPPIB, which is Canada’s largest pension fund with $476-billion in assets. Equity markets have been hot for a while, and it is hard for pension funds to keep up because they have diversified into a number of alternative asset classes such as real estate and private debt over the years. These assets do not change in value as quickly as a raging market.

However, CPPIB is particularly affected because the fund changed the constitution of its internal benchmark over the past five years to give it even more exposure to large and mid-cap equities. In fiscal 2015, bonds comprised 35 per cent of its reference portfolio’s weightings, more than double the current portion.

By comparison, Teachers uses 30 different indices to make its internal benchmark, and they track everything from equities to commodities.

The timing of CPPIB’s fiscal year is also having an outsized impact at the moment. After the pandemic erupted, stock markets largely hit their bottom in late March last year, which means they started gaining around the start of CPPIB’s fiscal year. When markets are this hot for an entire year, it’s tough for a large fund with a diversified investment portfolio to catch up.

“We’re not market timers,” Michel Leduc, CPPIB’s senior managing director and global head of public affairs and communications, said in an interview. While frothy markets have put the fund in a position of playing catch up on returns this year, he added that CPPIB uses a long-term investment horizon and its diversified portfolio is designed to outperform over this time frame. “Does [the current rally] change our conviction? Absolutely not.”

In 2020, this asset mix helped CPPIB beat its benchmark. At the end of that third quarter, the fund, like this year, was also underperforming its benchmark. But then stock markets tanked from mid-February to late March, helping CPPIB post a positive return of $23-billion relative to the benchmark.

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Mr. Leduc also said that despite the current divide between investment returns and the benchmark, CPPIB has still delivered a 16-per-cent gain this year. “Ultimately, that’s fantastic for the fund,” he said.

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