Skip to main content

Private equity offers the opportunity to make big returns, particularly with interest rates low, but it’s also risky business.Ryan Remiorz/The Canadian Press

Major public-sector pension plans are criss-crossing the globe looking to buy private companies in key strategic sectors. And while each deal is being justified on its various financial and tactical merits, the broader result is a significant ratcheting up of potential risks as pension plans become owners of hundreds of companies in a diverse array of industries.

The Canada Pension Plan Investment Board, Canada's largest pension manager, is one of the funds announcing a constant stream of deals.

In recent months, it has purchased a technology park in India, a giant U.S. private-equity loan portfolio, a retail mall in South Korea, a shopping centre in Spain, a port operator in Britain, retail real estate holdings in Germany and a broadband Internet provider in Hong Kong.

Other Canadian pension funds are also bulging with cash and negotiating investment deals in an extended era of low interest rates where plain-vanilla bonds cannot hope to generate adequate returns to pay promised pensions.

The global shift in investment strategy is worrying the international Organization for Economic Co-operation and Development (OECD), which issued a business outlook Wednesday to warn about the risks inherent in "an excessive search for yield" by pension plans and insurers as they search for new ways to earn returns. The OECD didn't point fingers at any particular countries, but the themes look familiar to anyone watching Canadian pension investment trends.

OECD Secretary-General Angel Gurria said a strange "risk puzzle" is emerging in the global business world. Companies and organizations in the investment and finance sectors are taking on more risk as they search for better-yielding assets, he notes, while companies in other sectors worry about excessive risk in a volatile economic environment and are sitting on trillions of dollars in cash while eschewing most major investments, including those that would improve productivity.

"Why do so many people managing listed companies that carry out a large portion of the world's capital formation see so much risk on the horizon while so many major players in the financial markets apparently see so little risk?" Mr. Gurria asked in a commentary issued with the new business outlook report. "Someone will inevitably be proved wrong. How do we avoid a crisis when this happens?"

There is no easy answer to that question, especially in a world where the axis of the global economy is shifting toward developing countries with less regulatory oversight, and the global financial industry has grown so interconnected that a small local problem can spin into a broad systemic risk.

For insurers in a country such as Canada, there is discipline in the capital requirements imposed on the industry by regulators. Higher-risk profiles require higher capital reserves, which add to business costs. For pension funds, however, the risk profile of individual investments held by the pension plan is largely a matter of internal analysis, while regulators focus primarily on overall solvency valuations.

The OECD isn't suggesting pension plans should abandon the investment strategy, and notes there are opportunities for economies to benefit from them. If pension funds invest in infrastructure development, for example, they can directly improve a region's productivity and economic growth.

But the OECD says there should be more available data about pension investment portfolios that would make it clear whether the pension sector is taking excessive risks. It urges regulators "to remain vigilant" and to consider how well pension plans are protecting themselves in the event that low interest rates are a long-term condition.

Pension funds typically say they are prudently selecting stable investments in sectors such as real estate and infrastructure that pay out a steady stream of cash, matching the long-term funding requirements of pension obligations. They say the strategy reduces rather than increases risk, and that other traditional investments could be even more volatile.

It sounds reasonable if it unfolds perfectly, but some funds are inevitably going to do a better job than others in implementing the strategy. The problem is that it's difficult to assess which is which in the short-term, and the OECD warns it could be a tragic lesson to learn if things go badly in the longer term.

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe