CPP Investments Reviewing its Bond Holdings?

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Saheli Roy Choudhury of CNBC reports that Canada’s massive pension fund is reviewing its bond holdings in light of near zero interest rates, CEO says:

Central banks have slashed interest rates this year in an effort to revive economies ravaged by the fallout from the coronavirus pandemic. But low interest rates are proving to be a challenge for investors, even ones who have long-term, multi-generational views on investments such as Canada’s massive pension fund. 

While the Canada Pension Plan Investment Board’s (CPPIB) long-term game plan hasn’t changed much in light of the virus outbreak, the one thing that’s challenging the fund is the zero-bound, according to Mark Machin, president and CEO. 

“The fact interest rates are now zero-bound – does that change the diversification benefit of bonds in the long term? I think we, like a lot of long-term asset owners, are looking at reviewing that,” he told CNBC’s “Squawk Box Asia” on Wednesday. Machin is an attendee of the Singapore Summit, which is being held virtually this year. 

Zero-bound refers to an expansionary monetary policy tool used by central banks to lower short-term interest rates to zero to stimulate the economy by reducing the cost of borrowing. But for bond investors that would mean they may receive less than their initial investment at maturity despite paying a large premium as bond prices and yields move in opposite directions.  

For example, a week and a half after the U.S. Federal Reserve cut its benchmark rate to near zero in March, yields on both the 1-month and 3-month Treasury bills dipped below zero.

“We have a lot of other fixed income alternative in our portfolio so we have things like infrastructure, power renewables, we have credit exposure, we have hedge fund exposure — we have a lot of other things in that space but that holding government bonds in large size is something that we will continue to examine, whether that’s the right thing to do at the zero-bound,” Machin added. 

CPPIB manages about 434.4 billion Canadian dollars ($329.75 billion) as of June 30 and a bulk of its investments are in North America — around 34% of total assets are allocated in the United States — followed by Asia. 

The fund is heavily invested in both the technology and health-care sectors and continues to invest, according to Machin. Companies in both industries have benefited from a change of consumption and corporate habits due to the pandemic. 

“Digitization is a massive theme across the world, it is being talked about — it’s probably a five to 10 year acceleration across many sectors,” he said. He pointed out how online education has taken off in Asia due to more specialized companies dealing with the changing trends and predicted that adoption would pick up over time in Europe and the U.S. 

Sustainable investing

CPPIB on its website says it factors in environmental, social and governance (ESG) risks and opportunities into its investment analysis and actively engages with companies to promote “improved management of ESG.” 

“We think no company can survive and thrive in the long term if they are not considering their impact on the environment, if they are not considering their impact on the communities they are in, if they are not considering the quality of the governance that they are running their companies with,” Machin said.

So, CPPIB is joining HOOPP and others rethinking the diversification of bonds in a zero-bound world. 

Recall, last week, I spoke with HOOPP's CEO, Jeff Wendling, on its LDI strategy 2.0 amid low interest rates. You can read that comment here. 

Jeff reiterated what his predecessor told me, namely, HOOPP will never invest in negative-yielding instruments so they're looking at slowly ramping up a few things:

  • Infrastructure: HOOPP has been late to embrace infrastructure because they thought the asset class was overvalued for many years. Jeff told me only 25% of their assets are in private markets, "much lower than our peers" (they are closer to 50%). But with bond yields continuing to go lower, they decided to start investing in infrastructure. "We set up a team, we committed $1 billion in two infrastructure funds and will co-invest alongside them in bigger deals but it's still early, so we haven't deployed a lot of that billion dollars yet."
  •  Insurance-linked securities: In addition to infrastructure, it launched an insurance-linked securities (ILS) program. I'm not an expert on this but read a great comment on it from Marsh here. Basically, "ILS is another form of reinsurance available to insurance entities. However, instead of facing a rated balance sheet, the insurance entity faces a fully secure, collateralized form of funding dedicated to a precise risk requiring coverage. Usually the collateral takes the form of highly-rated, highly-liquid investments, such as government gilt funds or pure money market funds. Premium flows are determined by the type of risk and investor appetite."
  • Allocating more to external absolute return managers: HOOPP has prided itself over the years for delivering great risk-adjusted returns in a very cost effective way. They do a lot of absolute return strategies internally but as the size of the Fund approaches $100 billion (they're at $99 billion now), they need to find scalable alpha strategies they can't replicate internally to help them continue delivering great risk-adjusted returns. Jeff confirmed to me they are using Innocap's managed account platform (the same one OTPP and CPP Investments use for their external hedge fund managers) to onboard new hedge fund managers but they are proceeding very selectively and cautiously. I told him I used to allocate to external hedge funds and warned him: "When things go well, it runs like a car in cruise control, but when things start to falter, get ready to hear all sorts of lame excuses as to why they're not performing. Proceed with great caution." He agreed and told me they have smart people internally working on finding good managers offering unique alpha they cannot replicate internally.
  • Taking more concentrated positions in higher yielding equities and bonds: This was an interesting topic, Jeff told me back in March/ April, they moved quickly to buy more Canadian banks at low prices because they were "yielding 7%" and they also gorged on provincial bonds when "spreads widened". He said they're looking to be more opportunistic and more concentrated in public equities. "Traditionally, we invested synthetically in the S&P 500 and the S&P/TSX but we will be adding to our holdings of high yielding securities when opportunities arise. That's what we did with Canadian banks and provincial bonds." 
Now, unlike HOOPP which is a pension plan with huge bond portfolio (50%) which served it well as it implemented an LDI approach over the last 20 years, matching assets with liabilities, CPP Investments doesn't have as large an allocation to government bonds.

As shown below, as at March 31, 2020, CPP Investments had 5.2% of its total portfolio invested in non-marketable government bonds and 18.7% in marketable government bonds:

That 18.7% represents roughly $80 billion and they need to figure out what to do with that money if yields remain zero-bound or go negative.

Luckily, the Fund is mature and has developed expertise in all public and private assets, so they can figure what it needs to be done with their bonds if rates continue going lower.

In the article, CPP Investments' CEO Mark Machin states: 

“We have a lot of other fixed income alternative in our portfolio so we have things like infrastructure, power renewables, we have credit exposure, we have hedge fund exposure — we have a lot of other things in that space but that holding government bonds in large size is something that we will continue to examine, whether that’s the right thing to do at the zero-bound.”

While not a perfect substitute, infrastructure and real estate investments offer yields in between stocks and bonds, but with higher risk. The same goes for private debt, power renewables or hedge funds.

By the way, in my last comment covering Ray Dalio's latest shocking warning, some people interpreted my criticism on some points Ray made on capitalism as me recommending to redeem from Bridgewater's Pure Alpha II Fund.

I made no such recommendation and to be brutally honest, if I was a large investor in Dalio's fund now like CPP Investments and other large Canadian pensions, I'd use this opportunity to deploy more capital with his firm.

When I first invested in Dalio's hedge fund back in 2002, they had just come off a bad year, I spent time on-site talking to their managers to understand what went wrong.

One thing about Bridgewater, they know exactly why they lose money and can adapt quickly to any market.

All this to say, no, I never recommended redeeming from Bridgewater's Pure Alpha II and people who don't read my comments carefully and make these assertions are totally wrong and quite foolish.

I might disagree with Ray on capitalism, US debt, the greenback and China, but that has nothing to do with my call on his flagship fund.

One thing I did post in my last comment was this:

[...] Jeroen Blokland recently posted this on LinkedIn, on how the traditional 60/40 portfolio won't work as well buffering during downturns because bond yields are at ultra-low levels:


I replied:
"Central banks have been systematically screwing pensioners by forcing everyone to take on more risk in search of yield. The result of all this financial repression will be catastrophic for those who don’t have access to a gold-plated defined benefit plan, which is the majority of the global population." 

I stand by those comments, we are entering a period where private and public pensions are at risk, as are the trillions in private savings in 401(k) plans.

When Mark Machin says the diversification of bonds won't be there in an ultra-low-rate environment, it's not that bonds offer no diversification, it's that ultra-low rates will make them more volatile than ever before, and that's not the type of volatility CPP Investments or any pension fund wants to experience. 

There are better alternatives over the long run, that's all. 

And CPP Investments' new CIO, Ed Cass, and the senior managers there are more than capable of finding suitable alternatives.

What else? Nichola Saminather of Reuters reports that Canada pension plan's fossil-fuel investments raise climate risks, study says:

Canada Pension Plan Investment Board (CPPIB), which manages the pensions of 20 million Canadians, is investing billions of dollars in fossil fuel companies, exposing it to significant climate-related risks, research by two universities said on Thursday.

The study was done by Canada Climate Law Initiative (CCLI), a project of the University of British Columbia and Toronto’s York University.

The research acknowledged the progress made by Canada’s biggest pension fund, including the doubling of its renewable energy holdings, but found the board’s continued fossil fuel investments revealed a “troubling incrementalism.”

Six of CPPIB’s 15 private transactions in the past six years were in fossil fuels, and an earlier analysis found the fund has invested in 79 of the world’s top 200 public oil, gas and coal companies.

The energy sector has “the strongest of motives to adapt, have the access to capital to do so and the technology know-how to innovate,” CPPIB spokesman Michel Leduc said. “The idea, through divestment, of starving them of capital, would... likely be harmful or counterproductive.”

The report says globally, climate risk is recognized as a material enterprise risk, impacting supply chains, future cash flows and disrupting business models across industries. CPPIB’s public and private investments raise questions about its ability to cope with sudden or unexpected changes in consumer and investor preferences or in government policy.

CCLI called for the fund, which had C$434 billion in funds under management as of end June, to set “transparent and aggressive” targets for a carbon-neutral portfolio.

Fossil fuel producers and services made up 2.8% of CPPIB’s investments as of March 31, from 4.6% two years earlier. CPPIB CEO Mark Machin told Reuters in May the fund is comfortable with its energy exposure.

I'll try to keep my cool and remain respectful to the Canada Climate Law Initiative (CCLI) and all the tree-hugging granolas who are highly critical of CPP Investments' fossil fuel investments.

These people simply don't know what they're talking about, they are dangerous critics who think the answer for all pensions is to divest from fossil fuel industry altogether.

I can't stand this Al Gore holier-than- thou sanctimonious nonsense! And this is me talking, not CPP Investments!!

I suggest all these environmental zealots stay out of pension investments, period.

Alright, let me regain my composure.

CPP Investments does take ESG investing seriously but that definitely doesn't mean divesting from oil & gas. To do so would be to contravene their fiduciary responsibility which is to maximize returns without taking undue risks.

I suggest all these environmental groups read my recent comments on the rise of constructive capital and Big Oil for the long run.  

If you ask me, at just less than 3% of its total portfolio, I'd say CPP Investments is under-invested in fossil fuel producers. If it were up to me, I'd increase that allocation to 6% and buy companies like Enbridge, Exxon and Chevron, all of which pay a great dividend yield.

I'd better stop there before I receive nasty emails from environmentalists who think they know more about pension investments than me or the folks at CPP Investments.

What these people need to realize is all of Canada's large pensions take climate risk seriously but they also have a fiduciary responsibility to their members and are better off engaging the fossil fuel industry rather than divesting from it.

On that note, Marie-Josée Privyk, Head of ESG and Customer Innovation at Novisto, posted this article on ESG 2.0 on LinkedIn and I liked what she stated: 

"ESG integration has never claimed to be seeking impact - it is seeking better risk-adjusted returns from a more fulsome and granular analysis of all the fundamental factors that contribute to a company’s long-term success, including those that fall in the environmental, social, and governance categories. It does support the notion that companies that manage their material risks and opportunities well make better companies."

Lastly, CPP Investments' former CEO, Mark Wiseman, has been discussing Canadian public policy recently and you should definitely read his comments:

Mark is a smart guy, maybe he will run for office one day.

What else? It looks like Alberta is getting cold feet on APP and my prediction is it won't opt out of the CPP (it would be a very dumb and costly mistake to opt out):

Finally, this October, CPP Investments is holding virtual public meetings to provide an update on the CPP Fund’s performance and answer questions. Register for your region’s meeting here.

Below, the Canada Pension Plan Investment Board is currently reviewing its bond holdings in light of central banks slashing interest rates to nearly zero to cope with the coronavirus fallout, says Mark Machin, president and CEO.

Update: In my original comment, I said CPP Investments had an allocation of 5.2% in government bonds, that was non-marketable Canadian bonds. I thank Eric Wetlaufer for bringing this up to my attention on LinkedIn. My bad, I screwed up and rushed to read the table (and always thought CPP Investments had a smaller allocation to bonds).

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