The leading edge of Canada's baby boom is turning 65. Just don't expect their pension plans to blow out the candles. (THE CANADIAN PRESS/Ryan Remiorz) Photo: Postmedia News file It is increasingly widely recognized that there is something very amiss at the Canada Pension Plan Investment Board. What began in 1999 as a lean, tightly controlled fund to invest surplus contributions to the plan has since become a costly monument to empire-building and bloat.
The Fraser Institute is the latest to notice. As the institute reports in a new study, far from the bargain advertised to the public, the CPPIB is now running up costs in excess of $2 billion annually, or more than one per cent of its assets — a fact obscured by the board’s opaque annual reports, which list “operating costs” separately from “external management fees” and “transaction costs,” as if all three were not costs of investment, to be deducted from the returns to the fund’s beneficiaries, the pensioners of Canada (outside Quebec; the Quebec Pension Plan’s funds are managed by the Caisse de Dépot et Placement du Québec.)
The institute also correctly notes the CPPIB’s costs have been “skyrocketing” in recent years. External management fees, in particular, paid to private fund managers who invest on the CPP’s behalf, have shot from $25 million in fiscal 2007 to $947 million in 2014 (the board’s fiscal year ends March 31) — nearly twice the board’s reported operating costs of $576 million, themselves up more than five-fold in the same period. But that’s just the half of it.
CEO of the Canada Pension Plan Investment Board, Mark Wiseman, poses for a photo in this file photo. (Tom Hicken for National Post)
To be sure, the fiscal 2007 reference point is well chosen. That was the year the CPPIB shifted decisively into its “active management” investing strategy — that is, one in which managers make bets on individual stocks and other assets in hopes of earning above-average returns — after several years in which it had largely stuck to its original “passive” investing mandate, where the objective is simply to track the broad averages. (Though as early as 2000 this constraint was being loosened, to the evident delight of the CPPIB’s managers.)
Equally, there’s no doubt that that is the primary reason for the fund’s soaring costs. As the CPPIB says in its 2007 annual report, the shift in strategy meant “the need for investment professionals with the requisite active management skills and experience has increased markedly,” forcing the board into a global bidding war for the sort of “specialized investment talent” this implied.
But to really get a grip on the increase in personnel costs this has entailed, you have to go back before 2007, to the early years of the CPPIB’s mandate. Even before 2007 the board had been on an extended internal hiring spree, growing from five employees in 2000 to 164 in 2006. Today it has more than 1,000. More striking still has been the growth in compensation for senior managers: from $220,000, on average, in 2000, to $1.56 million in 2007, to $3.3 million in 2014.
Has this extraordinary executive bounty been associated with a similar increase in returns to the fund? Hardly. Even looking at the simple rate of return (net of costs), the fund earned slightly less on average after 2007 than before.
But you can’t look at a fund’s returns in isolation. They make sense only in comparison with the market averages. The fund’s managers can no more be blamed for the catastrophic losses in fiscal 2009, the year of the global financial crisis, than they can be credited with the prodigious 16.2 per cent return last year, when markets were flying. As I’ve written before, when compared with the board’s “reference portfolio,” a composite of the averages in each of the major asset classes, the record is mediocre at best: It beat the benchmark in four years, lost to it in four.
But even here the comparison is misleading. The reference portfolio is made up of publicly traded assets: stock markets and the like. But in recent years the CPPIB, like other pension funds, has plunged heavily into private equity — illiquid assets like infrastructure or unlisted companies, which now make up more than 40 per cent of its portfolio. These are inherently riskier investments, as the board acknowledges — that’s why they pay higher returns, or are supposed to. On a risk-adjusted basis, then, the fund is very likely underperforming.
This is not a criticism of the fund’s management. It is simply a reflection of what is by now also widely recognized, among those without a vested interest in denying it: Active management is a crock. To consistently beat the market within a given asset class, a fund manager must not only be smart and well-informed, he must be consistently smarter and better-informed than all the other smart and well-informed managers out there, all of whom are trying to do the same. That’s vanishingly unlikely. To earn above-average returns, you have to take on above-average risk. There’s no free lunch, in investing as elsewhere.
Who knows? Maybe the fund’s bet on private equity, and the high-priced investment talent that goes with it, will pay off. As the board likes to explain, interminably (another measure of bloat: the CPPIB’s annual reports are now five times longer than they were a decade ago), as a public pension fund it can afford to invest on much longer time horizons than other investors; the returns to private equity are hard to measure in the short term; etc., etc. So it’s always possible we’ll find, decades from now, that it was all worth it. Or perhaps we won’t. But by then the managers will have made off with their millions, either way.
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