Addressing Conundrum Of Canada's Lacklustre Capital Investment?

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David Parkinson of the Globe and Mail reports that Sen. Clément Gignac is determined to address ‘conundrum’ of Canada’s lacklustre capital investment:

Clément Gignac – veteran Canadian economist, rookie Canadian senator – says that if Canada is going to meet its economic goals of a green transition, improved productivity and sustained healthy growth, it’s going to need an awful lot of private-sector money to do it.

He knows where we could find a couple of trillion dollars in investment money – from domestic sources, no less. Tapping into it will be the tricky part.

“I doubt that Canada will be able to succeed in energy transition without the participation of pension funds,” he said in an interview last week. “It’s important to understand what policy-makers have to do to interest Canadian pension funds in more Canadian investment.”

Mr. Gignac comes at the problem from an interesting background, both professionally and politically.

The 66-year-old spent decades as one of Canada’s leading private-sector economic voices, first as chief economist at National Bank of Canada and, later, in the same role at insurance group iA Financial. In between, he served as special adviser to then-federal finance minister Jim Flaherty (a Conservative) during the 2008-09 global financial crisis, then as a cabinet minister in the Quebec provincial government of Jean Charest (a provincial Liberal who is now running for the federal Conservative leadership). Prime Minister Justin Trudeau (a Liberal) named Mr. Gignac to the Senate last summer. (In the Senate, Mr. Gignac is aligned with the Progressive Senate Group.)

With nearly a decade to spend applying his economic expertise to government policy before he reaches the Senate’s mandatory retirement age of 75, Mr. Gignac is determined to address the “conundrum,” as he puts it, of Canada’s lacklustre capital investment – which has become a more pressing issue as the country recovers from the COVID-19 pandemic.

“We have to understand that government has done the right thing during the pandemic, but now they need an exit strategy. They need a long-term plan – to restore public finance, but also to foster Canadian GDP [growth] potential,” he said.

“We cannot have a sustainable long-term expansion without the contribution of business investment. I have a concern that the current recovery has really relied on government spending, and real estate.”

Meanwhile, business investment has stagnated. Statistics Canada data show that businesses’ non-residential gross fixed capital formation – essentially, investment in machinery, equipment and physical structures – is essentially flat over the past five years in inflation-adjusted terms, and is 10 per cent below its prepandemic levels.

A report from last fall from a former colleague of Mr. Gignac, National Bank chief economist Stéfane Marion, brought to light the huge potential of Canadian pension funds to fuel much-needed private-sector capital investment in this country – as well as an alarming drift by those funds away from Canada as a destination of choice to invest the massive amounts of Canadian money they oversee.

As of the third quarter of last year (the latest data available from Statistics Canada), the country’s trusteed pension funds held a collective $2.2-trillion in assets, having doubled in the past decade. Yet less than half of those holdings are invested in Canada; a decade ago, the domestic share was 70 per cent.

If pension funds’ domestic holdings were to somehow return to their proportions of a decade ago, it implies an additional $500-billion invested in Canada. That’s the kind of money that might actually make a dent in the country’s massive need for capital, as it faces challenges not only to reignite tepid business investment and generate much-needed productivity growth, but to pay for the daunting costs of a net-zero carbon transition.

“On the fight against climate change alone – to build a net-zero economy by 2050 – Canada will need between $125-billion and $140-billion of investment every year over that period. Today, annual investment in the climate transition is between $15-billion and $25-billion,” the government said in its budget this month. “No one government can close that gap.”

The most glaring shortfall in pension funds’ domestic investment has been in equities. Domestic stocks now make up less than 30 per cent of Canadian funds’ holdings – down from more than 50 per cent a decade ago. This lack of domestic equity investment has almost certainly weighed on business spending – those are funds that otherwise would have fed capacity and productivity growth in the private sector.

“The federal government, with provincial governments, [need] to have a discussion with pension funds about what Canadian policy-makers have to do to create the winning conditions for Canadian pension funds to become more interested in Canadian investment,” Mr. Gignac said. “What exactly is the reason Canadian pension funds have reduced their exposure in Canada so much?”

Coming from Quebec, Mr. Gignac believes there are compelling arguments to having public-sector pension funds take on investment mandates similar to that of the province’s Caisse de dépôt et placement du Québec, whose mandate includes investing in the province’s economic development. However, he’s also a realist, especially when it comes to private-sector pensions.

“Pension funds need independence, I understand that. ... It’s not politicians’ business to manage pension fund money. But it’s politicians’ business to understand why investment in Canada continues to fall short of expectations, and underperform the U.S. If you want to succeed in this [green] transition, it’s important,” he said.

Let me begin by thanking Senator Clément Gignac for sending me this article earlier today.

During 2000-2002, before joining the hedge fund group at CDPQ, I worked for Clément Gignac as an economist at the National Bank and learned a lot working with him, Stéfane Marion and Vincent Lepine.

I'll never forget when the bear market started in 2001, Clément invited us in his office and said this: "We're entering into a bear market and in a bear market, nobody wants to hear from stock analysts touting stocks, they want to understand the economic fundamentals and see how long this pain will last. In a bear market, people listen to economists and we need to produce."

Oh boy, did we ever produce and scored highly on the Brendan Woods survey back then.  

Stéfane Marion and his small team are still producing great economic reports and I would urge all of you to click here to read the report from last fall on why Canada can't afford to bleed capital like this.

We have a lot of problems in this country and I'm not sure anyone in Ottawa really understands the magnitude of these problems because they're more structural than cyclical in nature.

Sure, Clément Gignac gets it, so does Michael Sabia who is the highest ranking civil servant in Ottawa and so does Mark Wiseman who chairs AIMCo's Board and points out ways we can improve public policy:

But many of the politicians I'm listening to across the political spectrum don't really understand the magnitude of the problems our country faces (or they're too afraid to speak up, fearing the repercussions in today's cancel culture).

We just lived through the pandemic. Unprecedented monetary and fiscal policy were warranted but now that we are exiting this stimulus stage, we all need to figure out how to generate long-term sustainable prosperity in this country.

Importantly, you can't spend your way into prosperity, that's a short-term fix. 

You really need to invest massively in key areas to boost productivity growth which will lead to long-term prosperity. 

If we want better standards of living for future generations, we need to address the challenges and opportunities which the transition economy will provide and make sure everyone takes part in it (inclusive growth).

Role of Pension Funds

Clément is right, if Canada is going to meet its economic goals of a green transition, improved productivity and sustained healthy growth, it’s going to need an awful lot of private-sector money to do it:

 “I doubt that Canada will be able to succeed in energy transition without the participation of pension funds,” he said in an interview last week. “It’s important to understand what policy-makers have to do to interest Canadian pension funds in more Canadian investment.”

“On the fight against climate change alone – to build a net-zero economy by 2050 – Canada will need between $125-billion and $140-billion of investment every year over that period. Today, annual investment in the climate transition is between $15-billion and $25-billion,” the government said in its budget this month. “No one government can close that gap.”  

He wants to open the dialogue with large pensions all while respecting their independence:

“The federal government, with provincial governments, [need] to have a discussion with pension funds about what Canadian policy-makers have to do to create the winning conditions for Canadian pension funds to become more interested in Canadian investment,” Mr. Gignac said. “What exactly is the reason Canadian pension funds have reduced their exposure in Canada so much?” 

 “Pension funds need independence, I understand that. ... It’s not politicians’ business to manage pension fund money. But it’s politicians’ business to understand why investment in Canada continues to fall short of expectations, and underperform the U.S. If you want to succeed in this [green] transition, it’s important,” he said.

Now, to be fully transparent, I am helping Clément meet some of the key players in Canada's pension industry and would love to see them participate in Senate hearings to discuss critical themes like improving investment in Canada and improving our retirement system.

He's spot on about federal and provincial governments creating winning conditions for Canadian pension funds to become more interested in Canadian investments.

I gave him the example of infrastructure, a very important long-term asset class. If the federal government did more to partially or fully privatize assets like airports, ports and toll roads, and the Canada Infrastructure Bank did more to attract all investors to these projects, it would be a win-win for everyone.

There's a reason why Canada's large pensions invest massively in Australia and UK's infrastructure, they are getting access to the right scalable deals in these countries.

If they can invest in similar infrastructure deals here, they would, it's that simple.

When it comes to private markets, Canada's large pensions invest and co-invest with the best strategic partners from all over the world, and they're always on the hunt for the best risk-adjusted returns.

That is their mandate, to maximize returns without taking undue risks and to make sure they have enough assets to pay their long dated liabilities.

All this to say there's immense competition when it comes to investing in private equity, venture capital, real estate, infrastructure and timberland and Canadian funds are competing with the best and brightest from all over the world.

And in some cases, they are leading the pack. Look at Brookfield, a global alternative investment powerhouse which manages more assets than CPP Investments, our largest pension fund. 

Everyone wants to emulate Brookfield's success.

But more needs to be done to boost productivity growth and Canada's large pensions are doing their part investing across the capital structure, mostly abroad but here too.

In some cases, like CDPQ, it's directly investing in both private and public companies to boost Quebec's economy.

CDPQ is unique because it has a dual mandate but its Quebec portfolio is a true testament that even very large pension funds can successfully invest in domestic companies.

A while ago, I covered why Peter Letko was calling for a 'sanity check' at Canadian pensions. 

His partner, Daniel Brosseau, was recently quoted in an article in the National Post on how pension regulations have affected Canadians' futures.

Their main beef is the pendulum has swung too far away from Canada and pensions aren't investing enough in Canadian equity markets and that's impacting our shared prosperity:

Pension plans typically turn to indexing, to ensure their pension investment strategies don’t become outliers, Brosseau says: “If Canada represents 4 per cent of all the public equities in the world, they allocate 4 per cent of their investments to Canadian public equities. Canadian pension funds hold 30 per cent of Canadian savings, but that money is benefiting businesses and economies outside of Canada far more than inside it. This does not contribute to creating high quality jobs in Canada for Canadians.”

At the Toronto CFA Society's spring pension conference two weeks ago, Mr. Brosseau pointed out how US, UK and Australian pensions invest a lot more in domestic equities than we do.

I understand perfectly why Peter Letko and Daniel Brosseau are making these points, I just don't fully agree with them and feel like we need to have an open dialogue to really understand what's at stake here. 

My biggest fear is that we are politicizing our large pensions, undermining the very governance foundations which have led to their long-term success. 

It's become open season to blame Canada's large pensions for all that ills this country.

As these pensions become larger and more powerful, it seems like everyone has an opinion as to how they should invest on behalf of their beneficiaries.

And that's something which concerns me.

Yes, let's have a conversation, an open, fruitful and meaningful conversation on the role our large pensions can play to bolster Canada’s lacklustre capital investment.

But let's hear all sides of the story and I'm not saying that Canada's large pensions can't play a more meaningful role,  I just want to listen to the input from many pension experts on this issue.

This is what Senator Clément Gignac is calling for and I stand by him on the need for more dialogue so we can create the winning conditions to attract more capital from domestic and international pension and sovereign wealth funds.

There's a role for Canada's large pensions, to be sure, but we also need to make sure we don't undermine the foundations that have led to their long-term success by politicizing their investments.

That would be wrong, foolish and downright dangerous.

Alright, let me wrap it up there, this is an important topic and one that needs to be discussed further.

Below, Stéfane Marion, chief economist at National Bank of Canada, says Ottawa must "better explain" its ESG transition to help reverse a decline in investment. Watch here if it doesn't load below.

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