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Would it be smart to make a voluntary contribution to the CPP?

Information regarding the Canadian Pension Plan is displayed of the service Canada website in 2012.

Sean Kilpatrick/The Canadian Press

As you head off to the lake this summer, give a thought to the pension experts who are sharpening their pencils – and perhaps scratching their heads – over Ottawa's sketchy idea to let Canadians make voluntary contributions to the Canada Pension Plan on top of what is deducted from their paycheques.

Voluntary contributions might be treated like a defined-contribution pension plan, where return on investment depends on market performance. The CPP, in contrast, is set up like a defined-benefit plan. Given that the CPP fund returned 18.3 per cent for the fiscal year ended March 31 – the highest since it was created it 1999 – an investment in it looks enticing.

"I think it's a good idea," says Fred Vettese, chief actuary of consulting firm Morneau Shepell, about the government's proposal, which would help boost their retirement savings. "Would I invest my money? I think I would."

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While the CPP fund has lagged some low-cost mutual funds over the past decade, it could outperform long term because of its move to diversify, Mr. Vettese says. "I'm confident it is going to do well in future."

What can you realistically hope to get for your extra contributions to the CPP? And how does the CPP investment board invest Canadians' savings?

Not long ago, the CPP fund invested only in government bonds. By the late 1990s it was becoming clear the program would not be sustainable with such modest returns, so the federal government raised contributions and set up the CPP Investment Board with the goal of generating higher returns. As the managers moved into stocks, the CPP came to resemble a big, global balanced fund.

In the 2008 financial panic, the CPP fund took a big hit, falling by 18.6 per cent in its fiscal year ended March 31, 2009. Pension fund managers everywhere sought ways to protect their plan holders from the markets' wild swings, turning to so-called alternative investments – stakes in privately held companies, known as private equity, as well as real estate and infrastructure.

By the fiscal year ended March 31, 2015, a full 40 per cent of the CPP's $264.8-billion in assets were in alternative investments, with about 60 per cent in marketable securities. By region, the fund had 38 per cent of its assets in U.S. holdings, compared with 24 per cent in Canada.

Arguably, this shift will lessen risk, although alternative investments such as toll roads, bridges and ports do have drawbacks in that they can be difficult to value. Will the board's active investment style win out over a passive, couch potato portfolio of stocks and bonds?

"Our five- and 10-year returns show that our active investment strategy is on track," a spokesperson for the board said in an e-mail. The fund's 10-year rate of return is 6.2 per cent after subtracting inflation, comfortably above the 4-per-cent real rate needed to sustain the fund for the next 75 years. Ideally, the balanced fund portion – the couch potato portfolio – will keep the fund solvent. The rest is all gravy.

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As the fund grows, it is elbowing out competitors for ever larger deals. While most of its investments are partnerships, it has shown it is not afraid to buy an entire business. Last month, it beat out some of the largest takeover firms in the world – including Apollo Global Management LLC and KKR & Co. – paying an eyebrow-raising $12-billion (U.S.) for General Electric Co.'s private-equity lending business.

The fund already has a unit that lends to big businesses, so the GE unit "was an excellent complement to our existing portfolio of assets," a CPPIB spokesperson said in an e-mail. The acquisition allowed the board to secure the leading U.S. middle-market lender "in one fell swoop."

Rivals are throwing up their hands.

"We are incapable of competing against the CPPs of the world," Edmund Truell, chairman of the London Pensions Fund Authority, told The Wall Street Journal in December. "They come and say, 'I will have the whole project, the whole bridge, the whole airport.'" The fund's advantages include its long horizon and the scale and certainty of its funding.

So what kind of returns can Canadians expect on their voluntary CPP contributions?

"Actuaries estimate the best return we can expect over the next 25 years is going to be in the range of 6 per cent," Mr. Vettese says. Stock prices are more than triple what they were six years ago, which helped boost the fund's returns. "What are the odds they're going to triple again?" he asks rhetorically.

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A bigger reason to expect modest returns is the dim outlook for the bond market. With interest rates bumping along the bottom, CPP managers can't expect much from bonds for the foreseeable future. "Interest rates are either going to stay where they are, in which case they'll get a low return, or go up, causing capital losses," Mr. Vettese says. The yield on the 10-year Canada bond is about 1.7 per cent.

In the end, any disconnect between the CPPIB's strategy and potential voluntary investors might have to do with the time frame. The board's approach to investing is appropriate because of the size of the fund, its very long horizon and "the fact that risk is pooled not only across millions of contributors, but through multiple generations," the board says in its e-mail. People thinking of making voluntary contributions to the CPP fund may well have a shorter time horizon.

The CPP fund's asset mix as of March 31:

Foreign developed market equities (includes private equity) – 37 per cent

Bonds and money market – 26.1 per cent

Real estate – 11.5 per cent

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Canadian equities – 7.3 per cent

Other debt – 6.5 per cent

Emerging market equities – 5.9 per cent

Infrastructure – 5.7 per cent

Total: 100 per cent

Some recent CPP investments:

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  • Cattle grazing land in Australia
  • Toronto highrise apartment buildings
  • Information technology park in India
  • Shopping mall in Spain
  • Shopping mall in South Korea
  • German real estate
  • British mobile telephone operator
  • Big U.S. software firm
  • British ports
  • Hong Kong broadband company
  • London student housing
  • Australian toll tunnel
  • Mixed-use real estate development in China
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