It’s official: Canadians would have an extra聽$42.7 billion in our national pension plan, had CPP Investments聽鈥 Canada鈥檚 national pension plan investment arm 鈥 followed a simple passive investment strategy and bought low-cost stock and bond index funds instead of trying to outsmart the market.
CPP Investments boasts eight offices across the globe, more than 2,000 talented employees, performance-based compensation, executives earning millions of dollars,聽aggressive international tax planning, tax exemptions on Canadian investments, partnerships with several of the聽world鈥檚 most prestigious private equity firms and hedge funds, and oversight by a professional board of directors including some of Canada鈥檚 most celebrated business executives.
And yet. Not only did CPP Investments underperform the benchmark it created for itself over the past year, it also underperformed over the past 5 years, the past 10 years, and since the inception of active management in 2006.
This past year (fiscal 2024) was especially brutal. CPP Investments underperformed its reference portfolio 鈥 a mix of 85 per cent global stocks and 15 per cent Canadian bonds 鈥 by almost 12 percentage points.
The monetary value of this miss is equivalent to a huge loss of $64.1 billion. It also resulted in the fact that all the added value (beyond its benchmark) ever created due to CPP Investments鈥 active management style was completely wiped out.
‘An unusual year for global capital markets’
In a letter to Canadian contributors and beneficiaries, John Graham, CEO of CPP Investments, explained that this past year鈥檚 poor results were due to 鈥渁n unusual year for global capital markets鈥 in which the 鈥淯.S. stock market 鈥 soared to new heights, fuelled largely by technology stocks.鈥
You see, CPP Investments decided to play the game of active management, confident in its ability to outperform a benchmark it self-created. When things went well (for example in fiscal 2023) it boasted on the first page of its annual report how it beat its reference portfolio. Graham went further, saying: 鈥淭hese gains 鈥 were the result of our active management strategy, which enabled us to outperform most major indexes.鈥
But this year, after the huge miss, Graham is complaining that the benchmark misbehaved (鈥渁n unusual year.鈥)
Michel Leduc, global head of public affairs and communications at CPP Investments, played down the role of the benchmark. 鈥淭he Reference Portfolio is predominantly how we communicate our market risk appetite. That portfolio is heavily concentrated in a handful of companies, belonging to one specific sector and based in the United States,鈥 he wrote in an email statement.
Indeed, the S&P Global LargeMidCap index CPP uses in its reference portfolio has become more concentrated over the past few years, and the top 10 companies now comprise 22.4% of the index. Yet, it is still a well-diversified portfolio, representing more than 3,500 companies in 48 different countries.
Leduc says that 鈥渋t would be highly imprudent to anchor the CPP to such dangerous levels of concentration,鈥 meaning it would be dangerous to actually invest in the index it uses as a benchmark.聽
Worse聽performance than an ETF portfolio
Portfolio managers at the聽聽might disagree. They decided聽decades ago to invest like a passive, ultra low-cost index fund, putting 70 per cent in stocks and 30 per cent in bonds. Their largest equity positions are now 鈥楾he Magnificent 7鈥 (Microsoft, Apple, Alphabet, etc.) and they don鈥檛 find it “dangerous,” even with a portfolio almost four times the size of CPP. There’s no reason why CPP couldn’t do the same.聽
CPP Investments has made it clear it favours active over passive investing and it is true that its portfolio is more diversified. It has decided to invest less than the market weight in large-cap companies such as Meta, Tesla and Nvidia, and it has diversified across additional asset classes, including infrastructure, credit, private equity, real estate and more.
But since this diversification generally reduces the risk of the fund below its targeted level, CPP Investments is using leverage (borrowing of funds) to re-risk the fund to its targeted level of risk.
At the end of this exercise, since CPP Investments is taking as much risk as its reference portfolio, it鈥檚 only logical that it should be measured against its benchmark return, just like any other fund or portfolio manager.
I agree that CPP Investments may have just had a bad year. All funds do, sooner or later, and it may well bounce back and out perform the index next year, and for years to come.
But this year at least, it looks like Canadians have paid an awful lot of money to get slightly worse聽performance than a Couch Potato or passive ETF portfolio could have delivered over the long term without a team of portfolio managers and all the expenses that come with it.
Billions in expenses
This past year CPP Investments paid more than $6.3 billion just in borrowing costs on top of $1.6 billion in operating expenses (personnel and general and administrative) and $4.3 billion in investment-related expenses.
Altogether, the Funds鈥 annual expense ratio (total expenses divided by assets) stands at 1.94 per cent (194 basis points). Had CPP Investments outsourced its entire operations to 鈥 the pioneer of passive investing 鈥 it would have paid a fraction of that, only 0.03 per cent (3 basis points), on its entire portfolio.
Leduc reminds us that CPP Investments is: 鈥淎mong the leading 25 pension funds 鈥 around the world鈥 and that 鈥渇or multiple years, it ranked first or second in investment performance.鈥
That is correct.
But what Leduc doesn鈥檛 mention is that CPP鈥檚 asset allocation is one of the riskiest in the industry, as it goes heavier on stocks, which can be more volatile than most other assets. For example, PSPIB, Canada鈥檚 public employees鈥 pension, has a much more conservative benchmark of 59% equity and 41% bonds. For a fair comparison, CPP Investments should present its risk-adjusted returns.
In a recent interview, Harmen van Wijnen, the president of ABP 鈥 the Netherlands鈥 largest pension fund with $750 billion in assets 鈥 admitted聽that 鈥渢he added value of active investing is zero for us because we are such a large investor.鈥 Moving forward, ABP decided to index 80% of its funds.
This is an excellent lesson for CPP Investments. Twenty-five years after it was established, and with a superior financial position 鈥 Canada鈥檚 Chief Actuary concluded that the CPP is financially sustainable for at least the next 75 years 鈥 CPP Investments needs to recognize that it鈥檚 simply too big and complex to beat the market.
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