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To read the latest annual report from the Canada Pension Plan Investment Board, you’d think everything was going just swell. For the fiscal year ending March 31, crowed a press release accompanying the report, the CPP fund “returned 20.4% net of all costs, the highest return since inception.”

You had to read way, way down into the press release – and even further into the report itself – to find the bad news. The fund may have gained 20 per cent, but markets generally – as measured by the bundle of indexes in the fund’s self-assigned benchmark, known as the “reference portfolio” – were up more than 30 per cent. (As it happened, the start of the fund’s fiscal year coincided with the markets’ pandemic-induced lows, from which they have since rebounded.)

The real story, then, is that the fund underperformed the market averages by about 10 percentage points. Or in other words, its high-priced managers did about 10 percentage points worse than they would have, according to the laws of probability, if they had just flung the proverbial darts at the stock listings.

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Or no, that’s not the real story. The real story is that in 15 years of trying to beat the market, ever since the CPPIB adopted its current “active management” investment strategy, the fund has more or less tracked level with it. Some years it beats the reference portfolio, some years it lags. On average, it’s currently running about a half a percentage point a year ahead.

That’s “net of all costs,” of course. But that’s the point. Whatever gains the CPPIB might have hoped to achieve from the switch to active management – picking individual stocks and other investments, rather than buying the market as a whole – have been almost entirely wiped out by the massive increase in costs it has incurred in the attempt: from less than $4-million in 2000, the year the CPP first started investing in the markets, to more than $4.4-billion last year.

At the outset, the fund had just five employees; today, it has close to 2,000. Its first chief executive officer, John MacNaughton, earned a little more than $600,000 in salary, bonuses and benefits in his first full year; today, the average compensation for its top five executives is in excess of $3.5 million.

All told, the fund has spent nearly $30-billion since 2006 in its quest for above-market returns. It calculates its portfolio, at $497-billion, is about $28-billion larger than it would have been had it stuck to its previous “passive-management” strategy. But another year like the last one, and even that slim margin is in jeopardy.

Actually, that’s better than most active managers do. Year in, year out, between two-thirds and three-quarters of active fund managers underperform their respective indexes, net of costs; over longer time frames, nearly all do. The reason isn’t that they are all stupid; most of them are pretty smart. But over time, on average, they’re no smarter than all the other smart money managers.

Essentially, they battle each other to a draw: On average, the average manager does about as well as the market average. The reason so many of them end up behind the market, in net terms, is costs – that, and the cash reserve managers typically keep on hand in order to be able to take advantage of market “opportunities.”

Yet even the meagre advantage the CPP has claimed has to be viewed with some skepticism. For starters, is the reference portfolio a good proxy for the fund in terms of risk? In recent years, the fund has increased the ratio of equities to bonds in the reference portfolio from a relatively safe 65:35 to a highly aggressive 85:15. But the fund’s actual portfolio risk is far harder to gauge.

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That’s because it has plunged so heavily into assets that aren’t traded on public markets: private equities and “real assets” such as shopping malls and infrastructure projects. These two highly illiquid asset classes now make up nearly half (48 per cent) of the fund’s total investments, up from less than a third a decade ago.

Was any of this necessary? Probably the fund had to take on more risk to achieve its investment objectives, given today’s low interest rates: The only way to buy more yield is with more risk, after all. But it didn’t have to invest in Bolivian water treatment plants to do that. By its own admission, it could have done so at a fraction of the cost, just by adjusting the ratio of equities to bonds in a portfolio of index funds.

Will this massive, and massively costly, bet with the country’s pensions pay off in the long run, as claimed? Who can say? But by then today’s CPPIB managers will have retired with their millions. The next generation, as usual, will be left to pick up the pieces.

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