Jack Mintz Is Wrong on ESG and Pension Plan Woes
Investors know it has been a tough market so far this year. They can take some solace from the fact that pension funds have also taken a hit in their returns. As of June 30, Canada’s four big public pension funds — CPP Investment Board, Caisse de dépôt et placement du Québec, Ontario Teachers Plan and Ontario Municipal Employees Retirement System (or CPPIB, CDPQ, OTPP and OMERS) — had incurred $53.4 billion in losses. Of the four the Caisse did worst, with a minus 7.9 per cent return on its portfolio (see table).
Pension funds have done well over the years so their recent difficulty is far from being a crisis. On the other hand, governments meddling in financial markets may turn this year’s lackluster results to be repeated down the road.
Pension funds have shifted strongly to long-term investments in private equity, infrastructure, and real estate. Illiquid assets like these provide good returns — they have to in order to cover their higher risk and management costs. Given their tax-exempt status, pension funds load up on target companies by holding debt rather than equity, thus eliminating corporate tax payments and giving them an advantage over taxable rivals in acquisition markets. This distortion costs federal and provincial governments over a billion dollars a year in revenues.
The big four pension plan portfolio losses likely would be much larger if half their portfolios weren’t invested in assets that, unlike publicly traded stocks and bonds, don’t have a constantly observable market price. Thus OTPP’s marketable bonds and equity were down $4 billion but it figures its less liquid assets offset that so its overall portfolio was up. CPPIB thinks its non-marketed assets broke even, with almost all its losses due to stocks and bonds.
Pension fund managers do their best to estimate the fair market values of their non-marketed assets but doing so is hardly an exact science. They rely on discounted cash flows, earnings multiples of comparable companies or valuations provided by a manager. All of us have similar experiences with our homes. Real estate agents and municipal governments use comparables to determine the market value of our house, but it’s all just informed guesswork until the house is actually sold. In a down market, our own assessment of our house’s value may well be an overestimate.That may be true for the pension funds, too, which means their losses would be higher if all their assets had continuously quoted prices. Norway’s government pension fund, which holds most of its assets in marketed securities, last week announced a 14 per cent loss on its US$1.3 trillion portfolio, with all sectors reporting lower values except energy. If it had more untraded assets, it would likely have reported a smaller loss.
Quite apart from current market pressures, pension funds are facing increasing political scrutiny that could limit portfolio returns. For example, the Norwegian fund has excluded investment in companies for environmental, human rights, corruption and nuclear armament concerns. As of June 15, its blacklist included Canada’s top four oil and gas companies for unacceptable GHG emissions, Bombardier for corruption, Barrick Gold for severe environmental damage and Capital Power and TransAlta for coal production. All this despite the fact that as of December 31 it held investments in many oil-related Chinese and Russian companies, such as China Oil Field Services, Gazprom, Sinopec subsidiaries, and LUKOIL. Go figure.
Idiosyncratic political choices can lead to a pushback by employers seeking the best possible returns to cover their employees’ pensions. In a recent letter to Larry Fink’s BlackRock, attorneys-general from 19 Republican states wrote: “The time has come for BlackRock to come clean on whether it actually values our states’ most valuable stakeholders, our current and future retirees, or risk losses even more significant than those caused by BlackRock’s quixotic climate agenda.”
Similar issues are already hitting Canada. The Canadian Association of Pension Supervisory Authorities has issued a draft guideline that would allow ESG factors to be included in investment decisions. But it’s hard to believe that restricting exposure to GHG emissions, setting investment targets for green assets and imposing standards for diversity, executive compensation, labour and cybersecurity won’t affect funds’ bottom lines.
Like the Norwegian pension fund, the Caisse last year announced it will no longer hold shares of oil and gas producers. But such shares have risen by a third this year — a gain Quebec pensioners both present and future have missed out on. For its part, the CPPIB has been careful not to dump Alberta oil and gas shares. If it did, that could be the last straw for Albertans thinking about withdrawing from the CPP in favour of their own Alberta Pension Plan.
At this point, Canada’s pension funds are healthy. We need to keep them that way by not distorting how they earn the best possible returns for their members.
Jack Mintz's article raises some valid points but I don't agree with him on many others, especially his stance against ESG which is part of a wider political backlash these days, putting US public pensions in some GOP states at risk.
He's right that our large pension funds are healthy but fails to appreciate why they're so healthy.
First, pensions exist to make sure they have enough assets to cover their long-dated liabilities. Period.
On that front, all of Canada's large pension funds are delivering the required long-term returns to make sure their contributors and beneficiaries have a sound and fully funded pension plan.
Second, most pension funds, like OTPP, are very transparent about their tax strategy. Note this part:
Similar to an RRSP, pensioners pay taxes when they receive their pension payments and, therefore, Canadian pension funds, including Ontario Teachers', are exempt from tax on investment income in Canada regardless of where it is earned. This mechanism was intentionally designed so that retirement income is only taxed once.
Mintz accuses pension funds of taking advantage of their tax exempt status to "load up on debt" on companies they acquire, giving them an advantage over taxable rivals, claiming this distortion costs over a billion in lost tax revenues every year.
I am not exactly sure what he's referring to here. Pension funds have a right to use their tax advantages but he seems to claim they are an unfair advantage over taxable rivals.
Third, Canada's large pension investment managers have a long investment horizon and other comparative advantages that allow them to invest in private markets and across the capital structure.
This is why over the years, they have increasingly shifted more of their assets into private markets and taken the right approach, going direct and co-investing alongside strategic partners on large transactions to lower fees and boost returns.
The critical point is over the long run (5 to 10 years), the shift into private markets and adopting the right active management approach have delivered significant value-add over their public market benchmarks with less risk.
Mintz fails to explain this properly and instead claims private market valuations are just estimates and if they were continuously priced like bonds and stocks, pension funds would have exhibited bigger losses.
This assertion isn't true for Canada's large pension funds over the long run and even in the short run, like in the first half of the year where stocks and bonds sold off but some private markets came through nicely as inflation hit a 40-year high.
If you look closely at CDPQ's mid-year results as well as those of OMERS which I recently covered, you'll see they generated solid returns in their real estate (10%) and infrastructure portfolios (6% and 5%) during this period, and in OMERS case, their Private Equity portfolio delivered a 7.7% gain while CDPQ had marginal losses (not the same PE approach or objectives).
In addition to Infrastructure, OTPP's investment in commodities allowed it to eke out a positive return during the first half of the year.
Again, this just highlights the benefits of asset class diversification and having the right active management approach which have helped these large pension funds deliver relatively decent returns during a difficult time where stocks and bonds are getting hurt in high inflation environment.
So, Mintz is right, if they only invested in stocks and bonds, they would have suffered bigger losses in the first half like Norway's pension fund and many others, but they're smart enough to have diversified their portfolio and bolster their active management strategies across public and private markets.
This brings me to governance and his claim that ESG will hamper pension funds. Our large pension funds operate at arms-length from the government but they do track regulatory and consumer trends to determine where the world is heading and they need to take into account long-term risks to their portfolio, especially climate change.
They also take diversity, equity and inclusion and governance issues very seriously and report to their clients/ members and listen to their concerns.
Most of them have committed to net zero by 2050 or earlier and while their approaches differ, they are all looking at the risks and opportunities of climate change and have incorporated ESG considerations in their responsible investing approach and provide annual updates in a formal report.
This integration of ESG is deeply embedded in their investment process and it has only enhanced their returns, not detracted from them.
Mintz is arguing that ESG screens are detrimental to long-term returns (opposite is true) and doesn't understand why ESG considerations are important to all of Canada's large pension funds when he writes: "...it’s hard to believe that restricting exposure to GHG emissions, setting investment targets for green assets and imposing standards for diversity, executive compensation, labour and cybersecurity won’t affect funds’ bottom lines."
It's actually not hard to see how they add to the bottom line if you think long term and realize the added value responsible investing brings to their investment process.
Luckily, Canada's large pension funds are all very serious about these initiatives. They take responsible investing seriously and they understand ESG considerations absolutely matter over the long run because the world is changing, the climate is changing, regulations are changing and geopolitical and socioeconomic concerns are on the rise. Consumers and investors are demanding change and companies either respond or risk becoming obsolete.
What else? Not surprisingly, Mintz takes a swipe at CDPQ for exiting out of oil & gas, stating it cost Quebec pensioners.
But as CDPQ CEO Charles Emond stated a couple of weeks ago, exiting out of oil & gas was done at a profit and they made billions investing in renewable energy and natural gas over the last 2-3 years:
"I would not like there to be an impression in the population that there have been losses [by selling our oil assets]", affirmed Mr. Emond, in reaction to an article in La Presse which amounted to nearly a billion dollars the money that the CDPQ could have collected if it had waited longer before disposing of the majority of these titles. “We sold at a profit,” he insisted, explaining that there was no perfect time to do so.
“We got six billion dollars of return, over a period of two to three years, in renewable energies and two billion dollars with natural gas, which is a transition energy source”, also underlined Mr. Emond to justify the strategy of the Quebec institution.
We can argue about whether divesting out of oil & gas is the right approach (most do not divest, preferring engagement) but it doesn't mean that CDPQ is wrong. It has decided to take its own approach as part of its climate strategy and knows full well it still needs to deliver the requisite long-term returns investing elsewhere.
Unfortunately, in Quebec, this decision is being politicized for all the wrong reasons (see here and see the FTQ's response here).
What else? Mintz claims if CPP Investments divests it "could be the last straw for Albertans thinking about withdrawing from the CPP in favour of their own Alberta Pension Plan."
This is ridiculous. CPP Investments didn't divest out of oil & gas because of political considerations or fearing it will lose Alberta's CPP contributions. Like other large Canadian pension funds, it simply prefers engagement as it focuses on the risks and opportunities in the transition to net zero.
Its CEO, John Graham, is on record stating they don’t believe in blanket divestment: “We’ve taken the position that we invest in the entire energy ecosystem, and we do not pursue a path of blanket divestment.”
Moreover, he has stated the path to net zero “won’t be linear,” there will be risks and opportunities along the way.
I recommend my readers take a look at CPP Investments' sustainable investing approach to appreciate how the Fund is addressing the risks and opportunities of climate change.
It's not alone, all of Canada's large pensions take sustainable investing very seriously and have charted their own path to net zero through various initiatives. They are committed to use their capital and influence to make this a better world, and deliver on their pension promise while doing so.There is a reason why Canada's large pension funds are considered to be among the best in the world and why they are leaders in responsible investing.
The two go hand in hand and being a responsible investor means actively worrying about what can impact long-term returns of your pension assets.
Lastly, I agree with Mintz that Canada’s pension funds are healthy and we need to keep them that way, but given his biased views, he fails to fully appreciate why they're healthy and what that means.
It simply means letting them operate at arm's length from the government and not politicizing their investment decisions. It doesn't mean they should abandon responsible investing and neglect long-term risks and opportunities posed by climate change and other factors.
Below, CPP Investments President & CEO, John Graham, spoke at the Canadian Club Toronto about the Fund’s F2022 results, as well as their approach to investing in the energy evolution and how diversity & inclusion plays into the Fund’s strategy (late June).
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