The Canada Pension Plan Fund delivered the strongest annual return since its inception, but its managers are turning increasingly cautious on asset valuations following a six-year bull market in stocks and the rising likelihood of interest rate hikes in the year ahead.
"We're generally bullish on the economy, but that doesn't necessarily mean we are bullish on asset prices," said Mark Wiseman, chief executive officer of the Canada Pension Plan Investment Board.
He said the $265-billion fund – the investment arm of the Canada Pension Plan – is selectively selling assets, pointing to the sale of its stake in U.S. cable operator Suddenlink, announced this week.
"It doesn't mean that we don't see opportunities, but we're being really, really picky right now," Mr. Wiseman said.
The fund delivered a return of 18.3 per cent in its 2015 fiscal year ended March 31, after accounting for all costs, for a net gain of $40.6-billion in investment income.
The return, in both percentage and dollar terms, far exceeded anything the fund has delivered previously during the six-year economic expansion that followed the global financial crisis of 2008 and 2009.
The return also beat the fund's internal benchmark, or a reference portfolio, after underperforming for two successive years.
"It was really a year when we were firing on all cylinders," Mr. Wiseman said.
All of the fund's holdings – public equity markets, bonds, private assets and real estate – contributed to the growth. The Canadian dollar's decline against the U.S. dollar and a number of other currencies also fuelled some of the gains, since the CPP Fund does not hedge its currency exposure.
The fund's 10-year annualized return, which its managers believe better reflects the CPP's long-term horizon than a single year's performance, rose to 6.2 per cent after factoring in inflation, hitting a record high that is considerably above the 4-per-cent bar that is necessary to sustain the fund.
The CPP Fund has undergone extensive changes over the past decade as it moved away from its traditional base of government bonds to a far more eclectic mix of assets – from British ports, to an Australian road tunnel, to a Hong Kong broadband service provider – designed to boost returns and provide a more diversified portfolio.
Private and public equities now account for more than 50 per cent of fund assets, up from just 5 per cent in 2000.
Geographically, it has a bigger exposure to U.S. assets than Canadian, and has also accumulated substantial holdings in Europe, Asia and Latin America. It opened offices in Mumbai and Luxembourg in 2015, adding to international offices in New York, Sao Paulo, London and Hong Kong.
Its managers expect that diversification across assets and geographies will act as a cushion during market downturns, and give the fund a better shot at outperforming its benchmark – a feat that managers say is exceptionally difficult during bull markets.
Mr. Wiseman said the fund has ample liquidity to take advantage of buying opportunities should they arise during a downturn, especially if rival managers shy away.
"In spite of the quality of our returns over the last few years, they've actually been some of the more difficult investment environments for us because our comparative advantages – when everybody has capital, when everybody is flush, when there's lots of liquidity in the market – are less distinctive than in times of dislocation," he said.
Mr. Wiseman said it is impossible to completely insulate the fund from an unexpected increase in interest rates.
"But we are carefully monitoring that risk in the portfolio and taking steps to mitigate it, including in some cases selling assets that we believe have a disproportionately higher exposure to an increase in interest rates," he said, pointing to lower-quality real estate assets as an example.
Editor's note: A version of the graphic below, previously published online, grouped the Canada Pension Plan Fund's Japan and Australia assets as part of the Other category, rather than the Asia category. The graphic has been corrected.