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Streetwise Why public pensions can’t afford to skimp on pay

The logo of the Canadian Pension Plan Investment Board (CPPIB), pictured in their Toronto office August 5, 2010.

Mark Blinch/Reuters

Pay is always a flashpoint at public pension plans. That's taxpayers' money, after all, going to compensate the people looking after our pensions – and cash that is paid to pension managers isn't there for pensioners.

It is a lot of money, by any measure. Pension plans compete for talent with private equity firms, mutual funds, endowments, family offices, investment banks and numerous other places where people with good financial brains can find work. So setting compensation at something close to market rates is going to lead to paycheques that would be largely unimaginable for most of us, never mind the people actually receiving a monthly pension cheque.

Periodically, it leads to a real blowup. When Canada Pension Plan Investment Board paid bonuses during the financial crisis, there were calls in Parliament for the government to step in and claw back the money.

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These days, with markets on the rise and the economy a little more healthy, the focus on pay has diminished. But a reader wrote to say he had seen a posting for a portfolio manager at CPPIB with a $250,000 base salary, plus bonus, in all likelihood leading to pay of $500,000 a year or more. The reader questioned whether that is money well spent, saying that "in a private company that is totally fine," but that "in a public pension fund, that seems outrageous and highly suspect." It's even moreso in an environment where Canadians may well be asked to put more money into the CPPIB, the reader argued.

I haven't seen the job posting, but it sure sounds in the ballpark. Based on the 2013 annual report, the average CPPIB employee took home compensation of about $350,000. Portfolio managers would likely be higher than that.

So, is it outrageous?

Emotionally, perhaps. Logically, no.

According to the most recent figures, CPPIB runs $193-billion. If, by paying sub-market rates, CPPIB doesn't get the best people and its performance suffers by even one tenth of a percentage point, the opportunity cost there is $193-million in lost investment returns.

By 2032, when the actuarial forecasts say the CPPIB will oversee half a trillion dollars, a lost tenth of a percentage point will be worth $500-million.

And the reverse is also true, that any additional performance from having better people will add hundreds of millions of dollars to the pension fund.

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At the moment, annual staff costs at CPPIB run in the $300-million range. If you cut them in half, you would save $150-million. But if you lose even a bit of investment performance, given the scale of CPPIB, you could end up being worse off.

There are some reasons that people will take a bit of a discount to work at CPPIB. For one, it's big and can do cool stuff like large private equity deals and run complex strategies. That's fun, and attractive. Another perk is that there is no fundraising, a part of the business that many people in money management abhor. But in general, top talent commands top rates.

Unless you can find some rare people who want to work at CPPIB for a lot less than market rates, but can still perform at the top level, paying cheaply at CPPIB risks being penny wise and pound foolish.

As an investor in CPPIB, I want them to pay whatever it takes to get that extra return. Because the math works in our favour.

Or at least, it should. The caveat is that you still have to spend the pay money wisely, on the right people and generate the returns.

What is curious is that one thing that should work in favour of pensioners – scale – is not yet doing so. As the fund grows, the cost of running each dollar should drop. Those staff costs should be spread over more assets, dropping the ratio of management expenses to assets.

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As blogger (and longtime CPPIB critic) Mark McQueen has noted, CPPIB is not as economical as you might think. That should lead to a lower management expense ratio (MER). At CPPIB, not so much.

Mr. McQueen notes that some of that comes from CPPIB shifting from passive management to internal active management, requiring more people.

Some of that is also likely due to CPPIB getting to the size now where it can handle the rapidly growing volume of assets that is going to come in the next few years. Costs go up relatively faster than assets at a time like that. That MER ought to come down when the contributions pour in.

So in principle, yes, pay up to get the performance. There is no point choosing to run an active strategy and then cheaping out and doing it badly.

But in practice , make sure that the people you are paying are driving the returns, and keep an eye on that MER.

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