Will Finance Canada Reinstate Foreign Content Limits For Pensions?

Ryan Tumilty of Post Media reports pensions push back on Liberal government pressure to invest more in Canada:

The Liberal government’s plan to try to get Canadian pension plans to direct more investment in Canada has led to warnings about risking pension returns for political purposes.

In this week’s fall economic update, the government made it clear would like to see more of the trillions of dollars pensions have under management spent at home, although it has not made any moves to require it.

“Canada is one of the safest and most attractive investment destinations in the world — whether it is for the clean economy and major infrastructure projects, or new housing, or supporting our innovative companies,” reads the fall economic statement. “The federal government believes that continued domestic investments by Canada’s pension funds have the potential to boost Canada’s economy and create good careers for people across the country.”

The statement said government would work with pensions to find and encourage more investments in Canada. The Liberal government also said that it will now require pension funds to publicly disclose their asset mix by jurisdiction.

It also suggested it might lift the restriction that prevents pensions from owning more than 30 per cent of a given corporation, but only for Canadian firms.

“The whole concern is that if our own pension plans don’t invest in our backyard, is that sending a wrong signal to international investors,” said Mahmood Nanji, a fellow at the Ivey School of Business and former associate deputy minister at the Ontario Ministry of Finance. “I suspect the government is hearing this pressure and hence this proposal.”

Canadian investments abroad have grown dramatically since 2015 relative to foreign investment in Canada. In 2014, about $100 billion more was being invested abroad by Canadians than by foreign investors here, Statistics Canada data show. By 2022, the difference had grown to $726 billion.

The government only has direct influence over federally regulated pension plans, with many of Canada’s largest plans overseen by provinces.

The proposal is just a suggestion and Nanji said he doubts the government would ever go further when it comes to pensions, because of the risk to upsetting returns.

“I don’t think (Finance Minister) Chrystia Freeland or anybody in the federal government would ever suggest mandating any of this stuff. I think it’s more of a sort of gentle nudge.”

Evan Siddall, the chief executive officer of Alberta Investment Management Corp., (AIMCo) which manages several of the province’s pensions, said the Liberals’ move is a mistake because it pushes pensions away from their current core mandate focused on higher returns.

“This so-called ‘dual mandate’ would be confusing and would dilute our fiduciary obligation to deliver safe, secure and growing pension investments for the people we serve. Inherently, it asks pensioners to foot the bill for Ottawa’s failure to promote Canadian economic growth and productivity,” he said in an opinion piece in the Globe and Mail.

He said pressure to invest more in Canada is a bad investment strategy and one they do not intend to follow.

“AIMCo does not believe we need to increase our investments in Canada. While our public disclosure makes clear we invest nearly half of our clients’ portfolios domestically, AIMCo must be free to seek investment opportunities by achieving the portfolio benefits of global diversification.”

The largest federally regulated pension by far is the Canada Pension Plan currently, which has $576 billion in assets, with 14 per cent of that invested in Canada. The CPP has a bigger share of its investments in the U.S., Europe and the Asia Pacific region than it has at home.

Michel Leduc, the plan’s global head of communications, said the plan’s investments in Canada, while smaller than other parts of the world, is still significant.

“Canada is, and will continue to be, a core market for us. While Canada represents less than three per cent of the world’s equity market capitalization, 14 per cent of the CPP Fund invested in the Canadian market, representing $83 billion,” he said in an email. “That our portfolio is, by relative standards, overweight in Canada reflects our deep understanding of and conviction in the Canadian economy and investment landscape.”

Leduc said Canada has become more attractive in recent years, but they have to strike a balance.

“Increasing geopolitical risks over the last half decade have heightened the relative position of stable investment markets such as Canada, even as we continue to think and invest over multiple decades. The attractiveness of the Canadian market as a destination for our capital will continue to be balanced with the risks of investing too much of the CPP Fund in the same country that generates 100 per cent of our contribution inflows.”

It's Monday, I had a chance to discuss all this "invest more in Canada" with someone who understands Ottawa and the way Crown corporations are governed very well.

First, a brief recap of last week's comments on this topic:

Alright, on to the discussion I had with this governance expert who understands extremely well what is at stake.

He told me straight out while he understands the concerns of Canada's Maple 8, "the reality is Finance Canada holds enormous power over them, a lot more than they think."

He added: "They've been hiding behind their independent governance model for years now to justify outrageous compensation packages, especially at the senior levels, but if they continue being arrogant, they're going to be slapped with legislation that forces them to invest more in Canada and curbs their compensation."

I pressed him on this and why he feels so.

"Basically these pension fund managers are acting as if they run their own personal investment shop. But as you have stated many times, they're managing money from captive clients, Canadians, and even if some are not officially Crown corporations like CPP Investments or PSP Investments, they better not forget they have a huge responsibility to their members who live in Canada."

I agreed but said isn't their first responsibility to invest the contributions in the best interest of all their active and retired members, maximizing returns without taking undue risks, investing across public and private markets all over the world?

Unimpressed, he replied: "What the hell does that even mean? Canada is a safe country, liabilities are in Canadian dollars, the minute they start investing in foreign countries, they take on currency risk and typically lose a bundle there."

I didn't exactly agree with him because most of the investments are done in the United States and most of the large pension funds are long US dollars and do not hedge that currency, which has proven a very wise strategy.

He told me even US investments expose these pension funds to currency risk and it's not a given the greenback will always outperform the loonie.

More importantly, however, he was peeved with the fact that Canadian equities represent 3% of MSCI Global Index: "Who cares? What a dumb way of looking at how much you should invest domestically."

He went on: "The only Canadian pension fund CEO that really understood his dual mandate and took it seriously was Michael Sabia. Michael not only invested in Quebec, he was 100% committed to the REM project and he believes pension funds have a role for economic development of the country, and they can make great money doing so."

I reminded him that the CEO of CDPQ has a dual mandate which others do not have and that the Caisse had a checkered history investing in Quebec prior to Michael's arrival.

He responded: "No doubt, it was the Wild West at Quebec Inc, people writing cheques to their buddies in Quebec and Michael cleaned all that up. Not sure if it's headed back to the old days with Charles Emond, I hope not, but the point is the Quebec portfolio is extremely profitable."

He went on: "People forget the role of Quebec saving bonds that helped spur companies like Air Transat and Couche Tard get off the ground."

I said the startup business is inherently risky which he agreed: "No doubt, 90% of the companies you invest in will turn out to be major flops but you hope the 10% that do well perform exceptionally well."

I asked him if he thinks the Maple 8 should have a dual mandate like CDPQ. "Maybe not explicitly but implicitly, yes, they should invest here first and even though Freeland can't force CPP Investments to do so, she can force PSP Investments to do so."

As far as Letko Brosseau's reaction, he said this: "I agree with them, the pendulum has swung way too much to foreign investments and risky geographies. They've toned it down however because if you ask me, publicly listed Canadian companies are starving for cash and our pension funds should invest more capital in them as well as in private equity, venture cap, infrastructure, real estate and private debt."

I told him from my experience investing in hedge funds, there just aren't many that can compete with US or UK funds and apart from Brookfield and a couple of other Canadian private market funds, there's not much going on in Canada.

He agrees that there may be limited choice and he also stated that when allocating money domestically, transparency is a must to avoid any perception of corruption or kickbacks.

What else? He agrees with me that infrastructure is where the big opportunities lie to invest in Canada but for this to happen, "our politicians need to get their heads out of their behind and start privatizing assets."

But he was very clear about one thing: "Don't assume Freeland is powerless. She has tremendous power and she will use it. If Canadian pension fund executives keep hiding behind their independent governance model, Finance Canada will pass a law limiting foreign content investments. Don't be surprised if this happens."

I told him I sure hope not because that will limit their degrees of freedom to invest where they see the best opportunities all over the world.

He ended on this ominous note: "Leo, you know pensions, I know Ottawa and how Crown corps function and are expected to function. I'm telling you something has to give here and it's in the best interest of the country and economy. Despite the fear mongering from Maple 8 execs, there's no reason whatsoever why investing more in Canada cannot be a win, win, win for all parties and for the country."

As good as that sounds, I'm still not convinced but it's clear that we need a long discussion on all these issues and Canadian pension funds need to take part in them. 

Alright, let me wrap it up there, if you have anything to add, please email me at LKolivakis@gmail.com.

Below, Brendan Caldwell, president and CEO of Caldwell Investment Management, joins BNN Bloomberg to share his insights on the Canadian banking sector in anticipation of major banks' upcoming earnings announcements. He notes that consumer mortgage refinancing and higher interest rates are leading him to favor U.S. banks over Canadian ones.

My take: the Canadian economy is in deep trouble. By this time next year, I expect Canada's mighty banks will be pleading with the Bank of Canada to slash rates by chunks of 100 basis points. It's going to get really ugly next year as the US and global economy also fall into recession.

Will Canada's pension funds come to the rescue? Probably not but there will be more pressure on them to invest more in Canada. 

Update: Daniel Brosseau of LetkoBrosseau Global Investment Management sent me this after reading this post:

The Banks and Insurance companies are subject to regulations that discourage foreign investment but do not proscribe it. We do not think that we need to go back to the 10, 20 and 30% ITA limits. A regulation of pension funds inspired by Bank and Insurance company regulations could suffice. But in any event, all this needs to be discussed. What cannot be accepted is disregard of the feedback loop that domestic investments trigger. Everything must be done purposefully and not haphazardly.

I thank Daniel for sharing his thoughts and agree with him that everything needs to be discussed openly to clearly understand the consequences of investing or not investing more in Canada.

To be clear, I'm not a proponent of reinstating the foreign content limits but according to my sources, it is being discussed at the highest levels of Finance Canada.

Another well-informed person who doesn't want to be publicly quoted sent me their thoughts on all this:

I know something about Crown corps. I used to run one. Your unnamed source is wrong. In particular, only PSP among the Maple 8 comes under federal jurisdiction. 

If Chrystia tries to legislate pension fund regulation over provincial entities, after losing their fight over Bill C-69 at the Supreme Court, she will be overwhelmed with resistance.

I thank them for sharing this and do think the federal government needs to proceed cautiously here despite what the unnamed source told me (they may have the power but it will be challenged).