CPP equity debut a good thing for markets

Canadian Pension Plan Investment Board managers control one of the largest pools of investment capital in the country. Despite concerns, the board says CPP is a viable source of retirement income for Canadians for years to come. What is interesting, and perhaps not as well known, are the growth prospects for the fund, and the footprint it could have on markets in the future.

A common misconception held by many is that the CPP is in trouble and might not be around when the time comes to retire. This is not true, says Donald Raymond, vice-president of public market investments at the CPP Investment Board. “Most Canadians are not aware of the reforms of the late nineties.”

The CPP Investment Board is a relatively new entity in the Canadian marketplace. The Crown corporation, created by an Act of Parliament in December 1997, has a mandate to manage CPP contribution surpluses and generate sufficient investment returns to fund future benefits.

At the same time the board was created, provinces and the federal government agreed to increase the size of CPP contributions in stages to the current 9.9% in order to make up the shortfall, and relaxed the rules to allow equity investments. In diversifying the fund’s assets, managers may in the future invest as much as 30% of total CPP assets in a combination of private equity, real estate and infrastructure.

Before these changes were conceived, numbers from the Office of the Superintendent of Financial Institutions indicated the plan would be bankrupt by 2015. Today, the chief actuary of Canada predicts the fund will be financially sound for the next 75 years. For now, contributions alone are expected to be sufficient to fund benefits until the year 2021. Eventually, 80% of benefits will come from employee contributions, while the remaining 20% will be generated from investment income. The chief actuary says the CPPIB needs to generate 4% returns above inflation annually to sustain the plan over the long term. “The board believes it can generate 4.5% real returns. That is our target,” says John Cappelletti, CPPIB manager of communications.

On Monday, Raymond told members of the Toronto Society of Financial Analysts that the CPP is the second fastest growing pool of capital in the world after the Norwegian Government Petroleum Fund. “The CPP Investment Board is destined to manage one of the world’s largest pension funds,” he says. “It’s difficult to verify, but to our knowledge, the CPP Investment Board is managing the second largest growing pool of capital in the world.” Canada Pension Plan assets are expected to reach approximately $190 billion in the next 10 years.

The pension fund’s portfolio of cash and bonds held by the federal government are also being transferred to the care of the CPP Investment Board. The portfolio of 20-year term bonds, the assets that were originally lent to the federal and provincial governments at preferred rates, will have completely matured by 2033.

It remains to be seen what effect this new huge pool of capital will have on equity markets. Like other large investment managers, the fund is subject to foreign content rules forcing it to invest most of its assets in the Canadian market. “The Canadian market is really quite small,” says John Gilfoyle, investment consulting practice leader for Western markets at Watson Wyatt Canada. “It makes it difficult for them to invest. Many of the large investors have similar issues.”

Rather than voting with their feet and selling their shares, large investment managers are increasingly focusing on good governance. Already the CPPIB is joining the fray and weighing in on Canadian shareholder deals.

“I think it’ll be very positive,” says Don Reed, president and CEO at Franklin Templeton Investments. With one more buyer providing capital for companies, he says the CPP’s entry into the market will be positive for stock prices. “It gives Canadians the opportunity to participate in the Canadian economy. It’s another source of capital. I think it’s a very good thing.”

In 2004, the CPPIB hired their first external managers and appointed David Denison, president of Fidelity Investments Canada, to replace John MacNaughton as president and CEO. Denison takes over the top spot on Monday. Fidelity is still in the process of finding Denison’s replacement.

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com