Created in 1997 as part of a plan to revive the health of the ailing Canada Pension Plan (CPP), the Canada Pension Plan Investment Board (CPP IB) has gone from strength to strength. Andrew Sheen talks to senior vice president John Ilkiw
The chief actuary of Canada recently gave it a clean bill of health, commenting that the plan was robust, with contributions remaining below the 9.9% legislated rate. Pleased with the fund's performance over the past year, the actuary estimated the CAN$121bn fund was set to more than double in value to $250bn in a decade. Given that in 2000, the fund had a total market value of $44.5bn, the rise of the CPPIB can only be described as meteoric.
A different approach to investment
One of the things that differentiates the approach of the CPPIB from many other pension schemes is that it doesn't 'set' a target for returns, although it is expected to make 4.2% a year to remain sustainable over the 75-year time horizon envisaged by the actuary.
Ilkiw explained: "The 4.2% [projected real rate of return] is kind of our reference point - it's nice to target that, but really the markets determine what you're going to earn and we think it's a reasonable objective for the fund."
The board also has a unique approach to asset allocation. A 'reference' portfolio was introduced in April 2001 to provide a financial yardstick against which all other investments must be measured. The theoretical portfolio was designed to be a low cost, low complexity model, composed of 65% equities and 35% debt, which can be invested through tracker funds.
Ilkiw said: "Our objective as managers is to improve upon what we call the 'no brainer' strategy. We make risk return decisions relative to that 65/35."
Unlike many other investment plans, the CPPIB does not actively pursue 'set' asset allocations. For example, the board doesn't have targeted exposures to private equity, or real estate, but every investment decision must prove its worth against both the reference portfolio and the current asset mix by providing additional returns net of the costs. As Ilkiw said: "Everything has to compete."
He explained the advantages of the approach: "It gives us greater flexibility to chase where the best returns are - we're not forced to pursue assets that are going down in price just because we have some sort of pre-determined allocation."
Being a 'pay-as-you-go' plan, the CPPIB is only ever about 20% funded. This also allows the fund to actively seek high levels of riskadjusted return, without resorting to heavy exposures to bonds to cover future liabilities. Indeed, Ilkiw stated that were the CPPIB to engage on a risk mitigating strategy using 100% bonds, it would be "guaranteed" to under-perform the 4.2% real rate of return needed.
There are some curious omissions in the CPPIB investment portfolio. The plan has no exposure to hedge funds, however, it does use many of the investment strategies employed by hedge funds - long/ short strategies being one example -as standard. Ilkiw explained that the CPPIB was wary of the risks inherent in trusting large sums of money to opaque institutions.
"The big problem with hedge funds is you can't see what's going on inside there, so it makes them risky. We know what we like and what we don't, and we like transparency," he said.
One of the largest single changes to affect the CPPIB was the repeal of the Foreign Property Rule (FPR) in 2005. The FPR effectively handcuffed Canadian investors - especially pension funds - by mandating that not more than 30% of a fund could be invested outside of the country. While intended to reduce the volatility of the Canadian dollar and promote internal investment, critics of the FPR had commented that having 70% of a plan's assets invested in a single country would leave it prone to weaknesses in the market.
It was a view that Ilkiw wholeheartedly subscribed to: "You cannot self-insure - so the risk you have is that the Canadian economy may not be doing as well as projected. If all of your assets are invested in Canada, when Canada's going down, your assets are going down too."
Currently, the CPPIB has about 45% of its assets outside of Canada and $67.2bn invested within its borders. Ilkiw said in the future the CPPIB wanted to invest further outside of the country, but had been constrained by certain assets that were difficult to dispose of.
The CPPIB has just over 7.2% in infrastructure and real estate and 8.1% in private equity. Thanks to its size, it is able to bypass fund of fund investment vehicles and invest directly. Ilkiw said the CPPIB disliked fund of fund arrangements because the level of fees charged made it uneconomical to participate. He added that the CPPIB liked to be an active participant in the investments it enters into.
Geographically, the majority of the CPPIB's private equity, infrastructure or real estate investments tend to be situated in Canada or the US, where the CPPIB has greater knowledge and insight into the markets and can profit by being the lead investor. Outside of North America - the CPPIB has a limited a real estate, infrastructure and private equity portfolio in the UK and Western Europe - the board prefers to benefit from the expertise of fund managers. At present, about two thirds of the CPPIB's private equity investments are in funds, with the remaining third invested directly. As with many of the CPPIB's other investments, individual opportunities are assessed on their ability to provide a good level of risk-adjusted returns.
Ilkiw explained the rationale for trusting external fund managers rather than remaining in-house for select investments: "The worst thing you can do is think you're smarter than you actually are, and that you have more expertise than you actually do, because you'll get your head handed to you."
Private equity and other illiquid assets do, however, pose some problems in so far as they can be difficult to evaluate: "As the individual most responsible for risk management at the fund, [one] of the practical issues that I face is that as we get into more illiquid private market investments, how do you price the risks and the securities of investments that don't trade on a day by day basis? They might be risky, but because they don't trade, you don't know whether they're gong up and down in value."
On the impact of the sub-prime fiasco and associated credit crunch, Ilkiw remained sanguine: "Asset values have fallen across the board and we're not immune to that - we've been exposed to that like everybody else, but I wouldn't say we've been negatively impacted any more than anybody else in the market."
The CPPIB has been at the forefront of incorporating environmental, social and governance (ESG) concerns into its investment portfolio. Ilkiw pointed out the fund was a key player in the United Nations Principles for Responsible Investing (UN PRI) and had been taking socially responsible investing seriously for five years.
The ESG team is integrated into the public markets investment team and is actively investigating a more specific ESG investment strategy. "We're doing a couple of pilot programmes that just focus in on ESG - funds and strategies that just focus in on finding those companies that are highly rated on ESG issues," said Ilkiw.
However, he added that there were limits to the pursuit of social responsibility: "We're certainly comfortable taking the forefront and explaining why we're doing it. But we would not pursue a strategy that actually had a net loss in expected returns - it has to be value added."
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