Canada's Top 10 Pensions in Big Trouble?

Zane Schwartz of The Logic reports Canada’s 10 biggest pension funds have lost an estimated $104 billion in public equity amid market chaos:

When the S&P 500 closed at a record high on February 19, Canada’s major pension plans, with more than a quarter of their investments in stocks, were in a comfortable position in spite of the looming coronavirus pandemic.

Five weeks later, Canada’s 10 largest pension funds — upon which millions of Canadians are relying for retirement—have lost an estimated $104 billion, according to an analysis by The Logic.

But not all pensions are created equal, and while some—including the country’s largest, the Canada Pension Plan Investment Board (CPPIB)—have high exposure to public markets, others have managed to mostly skirt the crash that has seen the S&P 500 lose roughly US$8 trillion this year.

Canada’s 10 largest pension funds have an average of 27 per cent of their assets invested in the public markets, based on an analysis of each firm’s disclosed asset allocation when last reporting their finances. With a combined $1.7 trillion in assets, they have more than $500 billion invested in public equity markets.

It’s not just public equity that can impact the health of pensions. They are also vulnerable to swings in other asset classes, such as fixed income, private equity, real estate and infrastructure, areas that have also taken a hit in the crisis. Mortgage applications in the U.S. dropped 29.4 per cent last week and capital from seed-stage funding has decreased about 22 per cent globally since January. Currency fluctuations are also a risk, particularly the Canadian-to-U.S.-dollar exchange, which has dropped about 30 per cent since its 2011 high.

While all 10 funds are long-term investors with diversified portfolios, some are more susceptible to market swings than others.

British Columbia Investment Management Corporation (BCI), which manages funds for over 2.3 million people, is the most exposed to public equity, which represents 41 per cent of its $153.4 billion in assets. Asked to comment on The Logic’s estimate it has lost about $8.5 billion in public equities since it last reported, external communications manager Ben O’Hara-Byrne said the fund was looking for long-term returns.

“BCI had been anticipating and prepared for a market downturn by defensively positioning and diversifying our clients’ portfolios,” said O’Hara-Byrne.

CPPIB had $140.8 billion invested in public equity as of Dec. 31, 2019, or about 27 per cent of its portfolio. It declined to share how much it had in public equity after the market drop. “The Fund is not immune to occasional, severe drops in the value of stocks. Indeed, of course, the current situation is impacting the Fund,” said Michel Leduc, global head of communications.

“The Fund is demonstrating significant resilience relative to much sharper drops observed in public equity markets globally.”

The Caisse de dépôt et placement du Québec has the second-largest dollar amount invested in public equity: $116.9 billion, representing 34 per cent of its assets.

“The world and the markets are obviously facing challenging times,” said Maxime Chagnon, head of global media relations. “We are monitoring our portfolio and various asset classes very closely in this exceptional situation.”

Not all of the big 10 pension funds are so exposed to public equity. The Ontario Teachers’ Pension Plan’s public equity holdings comprised just 10 per cent of its assets, according to its most recent financial report. Asked for comment, Teachers’ said that its 2019 results will be reported next week.

“Teachers’ is a more mature plan when you compare it to their peers. Their population is older. Their pensioner-to-active ratio is shrinking. They’re very much looking to manage risk within a different tolerance,” said Andrew Whale, a principal at consulting firm Mercer Canada.

OPTrust, which manages a defined benefit plan for over 96,000 public-sector workers in Ontario, had the least exposure to public equity, at just six per cent.

“Many pension plans around the world tend to have an over-concentration to the equity risk factor. We are very focused on trying to deliver on our pension promise with the lowest risk possible,” James Davis, OPTrust’s chief investment officer, told The Logic, adding that its portfolio is fully funded.

The Alberta Investment Management Corporation’s (AIMCo) public equity holdings made up $41.5 billion when it last reported for the year ended March 31, 2019—36 per cent of the pension’s total holdings. AIMCo said it would report more recent numbers in mid-April.

“The recent volatility in investment markets and decline in economic activity as a result of the COVID-19 pandemic is truly unprecedented,” said Dénes Németh, AIMCo’s corporate communication director.

“This has created significant challenges for institutional investment, but adherence to prudent management of our clients’ portfolios, coupled with the long-term investment horizon of our clients and a broadly diversified portfolio both in terms of asset classes and geographies, will allow our clients to weather the market downturn, as we have on their behalf in the past.”

In recent years, Canada’s top pension plans have been widely heralded as global leaders for both their stability and rapid increase in assets. In 2017, the World Bank Group commissioned a report on Canadian pensions to help pension funds in emerging economies model their systems. In November 2019, five Canadian pension funds were ranked among the top 100 global asset managers.

“Canada’s major pensions really are world-class,” said Whale. “They’re set up to report for decades to come, and are set up to get through this kind of short-term volatility.”

“It’s a big loss for such a short period of time. The major pensions are being hammered from all sides right now. Public equities are dropping at the same time government bond yields are at an all time low,” said Whale.

Mercer Canada’s pension health index ended February at 103 per cent, which means pensions were slightly overfunded, with more money than obligations. That’s dropped to 88 per cent as of March 20.

That’s light years ahead of the U.S., whose largest fund, the California Public Employees’ Retirement System (CalPERS), has a funding ratio of 70.1 percent, according to the Center for Retirement Research. CalPERS reported last week that it had lost about US$67 billion in market value since January.

When a pension is underfunded, one of three things can happen: employers, workers or both can make more contributions; the pensions can cut benefits; or the fund can earn a higher return on its remaining investments.

For funds that aren’t over-leveraged in public equities, this is a time that can also create value.

“I think taking the opportunity to add modestly to our equity holdings now is the right thing to do,” said OPTrust’s Davis. “But we’re looking at it across all asset classes. And so, my private markets teams have a lot of dry powder, as well, and they’re in a position to be able to add as opportunities present themselves.”

The first thing that went through my mind after reading this article is: "OMG! Ben O’Hara-Byrne was a high school classmate of mine!" (great guy).

Last time I saw Ben was on CTV News covering major news stories so I'm glad he's over at BCI now handling communications. Stay safe Ben, hope you and everyone at BCI are doing well.

Now, let me get to this article which was published in "The Logic" and then the National Post picked it up because that newspaper loves slamming Canada's large public pensions.

Canadian pensions getting clobbered by coronavirus? You don't say, eh?

Let me be clear here folks, the great coronavirus unwinding is slamming everyone except for short sellers preparing for a market crash.

No pension fund is immune to what is going on in these markets.

Yesterday, I covered how Norway's giant sovereign wealth fund is getting clobbered because its asset mix is 65% global stocks, 30% bonds and roughly 5% real estate (listed and unlisted).

I stated the following:

I've repeatedly said that Norway has a giant beta problem. Beta is great on the way up, like last year when Norway's Fund soared 20%, but it really bites you hard on the way down, like Q1 2020 which will be one of the worst the Fund ever experiences (we shall see, it's not over yet).

Let me be more specific, Norway takes on too much public equity risk which exposes the fund to too much volatility. Who cares? It has a long-term focus and can absorb all this volatility.

True, but it can and should do a lot more to deliver more consistent and higher risk-adjusted returns over the long run.

Let me give you an example. Look at CPPIB's asset mix as at March 31, 2019:

Even though it's a year old, it hasn't changed much. Just like Norway's Fund, the CPP Fund also takes equity risk, lots of it, but it spreads it more evenly between private (24%) and public equities (33%).

More importantly, it invests and co-invests with top private equity partners all over the world, ensuring great long-term performance and significantly reducing its fee drag.

It also invests in infrastructure, real estate and private debt all over the world, further diversifying its portfolio.

Now, don't get me wrong, CPPIB and other Canadian pensions aren't immune to what is going on out there with this pandemic. Private equity, real estate and infrastructure investments are getting hit too.

For example, CPPIB owns 50% of Highway 407 and it will take a hit from the fact that this toll road won't generate the toll revenue over the next few months. OTPP owns major stakes in European airports, it too will get hit on these infrastructure investments over the short run.

Longer term, however, these investments will generate significant cash flows and even if they are marked down temporarily, they will bounce back.

The same thing for real estate and private equity investments. Of course they aren't immune and even if they're not marked to market, they too will experience significant losses, but over the long run, they will bounce back.

Earlier this week, I covered how Canadian pensions are staying the course, taking a long-term view on their investments, diversifying across public and private markets all over the world and doing as many direct deals as possible (primarily through co-investments).

Mark Machin, CEO of CPPIB, updated Canadians stating CPP Fund is built for the long haul, and he ended on this note:

Over the past 21 years, we’ve grown the CPP Fund from $36.9 billion to $420.4 billion; and the most recent report by the Chief Actuary of Canada, released in December 2019, states the Fund continues to be sustainable for more than 75 years. This performance was made possible by the diverse skills, deep expertise, and network of relationships we’ve built over the years.

We don’t yet know the full impact of COVID-19. It will continue to affect the global economy and like other global investors, we will not be immune. We believe strongly, however, that our long-term investing view, our deep bench of talent and expertise, and our highly-diversified portfolio will continue to serve the Canadians who depend on us for the safety of their retirements. To all 20 million Canadians who participate in the CPP – it is with kindness to one another and confidence in the systems in place, like the CPP, that we will endure.

Now, it's important to note that CPP Fund will typically underperform its Reference Portfolio (made up of 85% global equity/15% nominal bonds issued by Canadian governments for CPP base; for the additional CPP account, CPP Investments has adopted a Reference Portfolio of 50% global equity/50% nominal bonds issued by Canadian governments.) when stocks are soaring but outperform it when stocks are sinking.

This is because 55% of its portfolio is made up of private equity, real estate, infrastructure and private debt. Again, these asset classes are not immune to the crisis but they're not marked to market and over the long run, they will perform well and deliver more consistent returns.

The article above is terrible for a lot of reasons. CPPIB, CDPQ, PSP, BCI and AIMCo are pension funds, not pension plans like HOOPP, OTPP, OMERS and OPTrust.

BCI is a pension fund and is only recently ramping up its direct PE deals so it's not fair to make big assertions on their asset mix and losses. There's no doubt they're more exposed to public equities but they have been more defensive and are moving to allocate more to private markets.

I hate when people compare Canada's large pensions as if they are all the same, they're not. They have different liabilities, maturities, asset mixes, foreign exchange hedging policies, etc. 

Pension plans have a lot more bonds in their asset mix because they're matching assets with liabilities very closely. Their focus is on asset-liability matching, not maximizing returns without taking undue risks (it's an important nuance).

Bearing this in mind, it doesn't shock me if these large Canadian pension plans do a bit better than large Canadian pension funds when stock markets get hit hard, but who cares? Over the long run, every large Canadian pension is delivering strong results because they all have great governance.

Also, as HOOPP's retiring CEO Jim Keohane told me earlier this week, as long bond yields approach zero, they too need to start investing more in other asset classes like infrastructure to make their target rate-of-return. 

The important point is Canada's large pensions are in great shape, they will get hit due to cornavirus but are able to weather this storm a lot better than their US counterparts, and they will come out ahead once again three, five and ten years down the road.

CalPERS recently disclosed it lost about $67 billion in market value since January as the coronavirus pandemic roiled global financial markets.

If CalPERS is getting hit, everyone is getting hit. 

But unlike Canada's large pensions, many US state pensions are underfunded or chronically underfunded, and the drop in long bond yields coupled with the market rout will place many of them in a very precarious position.

Canadian pensions are well funded, a few are overfunded, so they can absorb these shocks a lot better and are able to take advantage of market dislocations a lot quicker (their governance and the fact that they can leverage their balance sheet also helps them be a lot more aggressive and nimble when needed).

Now, let me be clear, there's no Canadian pension which will escape the carnage from COVID-19. You can stress test your portfolio for a lot of negative shocks, a pandemic isn't one of them.

Importantly, as I keep telling people, a pandemic is deflationary, it will hit all asset classes, public and private with a vengeance except for nominal bonds, which are pretty much the only hedge against deflation.

But the drop in long bond rates to ultra-low record levels leaves many pensions in a bind, they cannot make their required rate-of-return investing in long bonds so they need to take intelligent risks across public and private markets and manage their costs a lot better.

Lastly, I believe COVID-19 is a wake-up call for global policymakers, the entire world was ill-prepared for it and we need to do a much better job preparing for the next pandemic.

Pensions losses will eventually be made up, lives lost won't so please stop focusing on negative articles on Canada's pensions which are among the best in the world and start listening to medical experts. Stay safe and stay home!!

Below, Finance Minister Bill Morneau and Bank of Canada Governor Stephen Poloz hold a news conference in Ottawa following the central bank's announcement that it is lowering its key interest rate to 0.25% in response to the economic impact of the ongoing COVID-19 (coronavirus) pandemic as well as the decline in global oil prices.

It is worth noting this from the Bank of Canada's announcement:

Today, the Bank is launching two new programs.

First, the Commercial Paper Purchase Program (CPPP) will help to alleviate strains in short-term funding markets and thereby preserve a key source of funding for businesses. Details of the program will be available on the Bank’s web site.

Second, to address strains in the Government of Canada debt market and to enhance the effectiveness of all other actions taken so far, the Bank will begin acquiring Government of Canada securities in the secondary market. Purchases will begin with a minimum of $5 billion per week, across the yield curve. The program will be adjusted as conditions warrant, but will continue until the economic recovery is well underway. The Bank’s balance sheet will expand as a result of these purchases.

Earlier this week, the Fed cut rates to zero and engaged in QE Infinity worried the US commercial mortgage market was on the brink of collapse. The Bank of Canada had no choice but to follow suit.

Second, Michael Purves of Tallbacken Capital Advisors discusses the major market moves this week, and the stress levels that could keep this from being a more sustainable rally.

I've repeatedly warned my readers, temper your enthusiasm, these relief rallies are powerful and give many the false sense of hope, but this isn't over and we will see wild gyrations in markets as negative news on the economic and health front hit us.

Third, Bill Gates, co-founder of the Bill and Melinda Gates Foundation and Microsoft, weighs in on what he thinks the world is learning about pandemics from COVID-19 and what the role of the public and private sector is during circumstances like this. Great insights, listen closely to Gates.