Canada's $2-Trillion Pension Giants Struggling With Trump's Policies
Ontario Teachers’ Pension Plan Board chief executive Jo Taylor and his investing team usually rely on a lot of real-world data when determining where to allocate billions of dollars of investment money on behalf of retirees. But United States President Donald Trump’s flurry of edicts that threaten to upend global trade and geopolitical alliances makes it hard to know what data points they should even be looking at.
“The predictability of what we’re investing in is lower,” Taylor said as pension teams across the country dig into drafting and assessing potential scenarios for a year that, given the prospect of multiple pockets of economic and geopolitical unrest, could be very different from those that came before it. “Looking forward and trying to predict the future is more challenging.”
Globally invested pensions such as Teachers’, particularly those with large exposure to North America, are acknowledging that investment risks are rising as predictability falls, and the uncertainty is not simply tied to a particular region, sector or asset class like it sometimes is.
Trump exporting risk
The policies and rhetoric of the U.S. administration under Trump — including threats of escalating trade tariffs, threats to annex Greenland, the Panama Canal and Canada, and warnings about withdrawing traditional military support from European allies that don’t meet North Atlantic Treaty Organization (NATO) funding targets — are essentially exporting risk to governments and companies around the world.
This, combined with uncertainty of what he will say from day to day and his ever-changing tariff policies, complicates decision-making at globally invested pensions like the eight largest ones in Canada, which together manage nearly $2.4 trillion to fund the retirements of millions of Canadians.
“It’s hard to predict Mr. Trump,” is the blunt assessment of Charles Emond, chief executive of Caisse de dépôt et placement du Québec.
Pension managers typically assess risk and asset allocation by using models, underpinned by data, to test their portfolios and reveal what would happen against possible and plausible scenarios. Sebastien Betermier, an associate professor of finance at McGill University’s Desautels Faculty of Management, said they then assign probabilities to each outcome.
The problem now is that things are changing very fast — often from one day to the next — and the movements being contemplated by the models are far more extreme and wide-ranging than they have been in the past.
“These scenarios capture regime shifts that are complex and hard to model quantitatively,” Betermier said, adding that pension managers must rely on a certain amount of “narrative building” in the absence of hard facts and figures about how things will play out economically and geopolitically.
What pension professionals can see is that the U.S. equity markets that helped propel returns into the high-single and even low-double-digit returns over the past year or more may no longer reliably do so. Both the benchmark S&P 500 and the Nasdaq composite, often viewed as a stand-in for the tech sector, slid into correction territory in March.
Geopolitical risks rising
There are other less clear yet rising risks pointing to the potential for a global recession, Steven Riddiough, an associate professor of finance at the University of Toronto, said. The escalating trade wars already enveloping North America, Mexico, China, the United Kingdom and Europe threaten to slow growth across the board, he said.
But these conventional sources of risk in economic and market systems do not even paint the full picture for global investing entities, which are vulnerable to an often-overlooked source that can cause major disruptions: geopolitics.
“Countries and firms are seeing their exposure to geopolitical risk change in real time. Many countries — especially in Europe — now feel far more vulnerable as the U.S. creates uncertainty around its explicit and implicit international commitments,” Riddiough said. “In effect, the U.S. is exporting risk to foreign governments and firms through these policy shifts, rapidly altering the risk profile of investors’ portfolios.”
In Trump’s first term as president, he repeatedly said the U.S. might pull out of NATO. Since he took office again in January, he has wielded a different threat by targeting specific nations in the 32-country alliance that don’t pay what he thinks is their fair share of the costs to defend them.
This threat is being acutely felt in Europe, which has relied on the U.S. as the primary guarantor for security since shortly after the Second World War, as have many other countries. The position taken by Trump and the White House on NATO-hopeful Ukraine, including a public confrontation with President Volodymyr Zelenskyy that suggested the U.S. may no longer help push back on Russia’s invasion, sent fears through nearby NATO member countries such as Poland and raised questions about whether an attack on one NATO member will continue to be viewed by the U.S. as an attack on them all.
Such challenges to nearly 80-year-old international understandings — not to mention Canada suddenly being declared by Trump to be an enemy rather than a partner in trade — are forcing pension managers to undertake far more complex reviews than usual and face tough decisions across a number of portfolios.
The situation is also challenging a key element of what has made large, globally invested pensions such as Canada’s so-called Maple 8 group so successful: diversification. By spreading investments, from equities to infrastructure, across public and private assets and buying in a variety of countries, they reduce the downside risk of something going wrong with a particular asset class or in a particular country or region.
However, with geopolitical upheaval spreading across jurisdictions and threatening to penalize multiple sectors and asset classes, there could be widespread repricing of risk, which would send investors fleeing to safer assets in what’s known as a “risk-off” scenario.
“In extreme risk-off scenarios, it’s like everyone rushing for the exits in a burning theatre,” said Riddiough, whose resumé includes a consulting stint with the Canada Pension Plan Investment Board on global tactical asset allocation.
“In those moments, assets that normally move independently start selling off in unison. In the most extreme case, if everything sells off in exactly the same way, then it doesn’t really matter how many assets you hold; it’s as if you only own one.”
Canadian pension managers have increased investments in private assets over the past decade or more in part to avoid getting caught in such scenarios. Because assets such as real estate, private equity and infrastructure don’t trade frequently or in as volatile a manner as public markets, they can preserve value — and mask elevated risk — even when public markets plummet.
However, new approaches to valuing private assets are threatening to close this gap, which can also make these less liquid assets difficult to exit in times of crisis due to large gaps between what sellers and buyers think the assets are worth — as happened with commercial real estate after the COVID-19 pandemic spurred a surge in remote work and office building vacancies skyrocketed.
“It’s increasingly difficult to hide the elevated risk by overweighting private markets because many firms are building tools, using data and AI, to quantify private market risk in real time,” said Kenneth Kroner, an economist and finance professional who spent two decades at investment company BlackRock Inc., where he oversaw multi-asset strategies and systemic active equities as a senior managing director and member of the global executive committee.
“In a few years, the true risk of private investing will be quantified and well-understood. In the meantime, I think most sophisticated boards … aren’t fooled one bit,” he said. “If I were a portfolio manager (at one of Canada’s big pensions), I’d emphasize to my board (and) clients that risk is elevated even though the data might not currently say so.”
Still, the Edmonton-born Kroner, who was a director at Alberta Investment Management Corp. (AIMCo) for seven years until a government-led shakeup resulted in his departure along with the rest of the board last year, said he doesn’t think Canadian pensions should be making any sudden moves in the way they invest in response to Trump.
Pension managers should focus on their advantage, which is long-term investing. Today, that’s clearer than at any time in my career
Kenneth Kroner, economist and finance professionalInstead, he said, they should be scrutinizing everything that is happening and modelling what the consequences are likely to be in order to focus on what will survive in the years well beyond his presidency and invest based on that.
“I would study and understand those risks now,” he said. “But I wouldn’t invest for those risks until I believe that they’ll be a reality in 10 years’ time.”
Long-term view
For example, pension professionals should be asking themselves what trade policy will look like in a decade, rather than simply looking at what Trump is proposing now, Kroner said. Another key question is where innovation will be strongest at that point, if not the U.S. There is also the question of how shifting alliances today are likely to alter geopolitical order beyond the lifetimes of current country leaders.
Some will try to profit from the “noise” around Trump, including his shifting rhetoric on tariffs and threats to bring economic harm to Canada to get what he wants on issues including trade and NATO funding, but he said he would not advise pensions to try to pick short-term winners and losers.
“The noise level is just too high to make informed bets along these lines; leave those bets to naive investors,” he said, adding that the investment horizon of pension funds gives their managers the option to set a different course. “Pension managers should focus on their advantage, which is long-term investing. Today, that’s clearer than at any time in my career.”
This means closely scrutinizing the impact of the fast-shifting geopolitical order, which has the potential to crimp growth and long-term returns.
“The (traditional) U.S. axis has the potential to split into two further axes: those aligned with the U.S. and those not,” he said.
The isolationist path of the U.S. is raising questions about whether economic growth can continue at the clip that has been helping pension returns over the last decade or more. Even the U.S. Federal Reserve reduced its outlook for gross domestic product (GDP) growth to 1.7 per cent from 2.1 per cent, while inflation is forecast to grow and interest rate cuts could be off the table this year.
After Teachers’ turned in an annual return of 9.4 per cent for 2024, Taylor said his team had begun to assess whether the U.S. can continue to provide the fund with the same level of risk-adjusted returns to justify adding to the $99 billion invested there.
“The question is, how much more do we want to build on top of that versus other parts of the world?” he said.
Kroner said portfolio managers considering how to play the evolving situation should move away from investing in traditional global indexes such as MSCI World and All Country World indexes, which provide exposure to a broad basket of large and mid-cap stocks in developed countries and emerging markets, and instead create new indexes that reflect the shifts and splintering of alliances and trade.
He said pensions should also focus on higher-growth segments of the market that prioritize innovation.
“To overcome the growth deficit, one should invest heavily in markets where innovation is best supported,” he said. “Arguably, that’s what we’ve done for decades, but that might no longer be the U.S., like it has been historically.”
Kroner said pension managers should be the repricing the risk of investing in Europe, particularly countries in the NATO alliance.
“No matter how you slice it, the risk of investing in NATO countries is elevated and will remain so for a few years,” he said.
In one scenario, pension managers could reprice the risk of NATO countries as a whole, taking the view that Trump’s stance will affect them all negatively. In another, the risk for investments in counties most likely to feel threats from Russia if U.S. support wanes, such as Poland, could be repriced.
In either scenario, Kroner said, assets should be reallocated to countries outside NATO based on the changing risk-reward calculus.
“The risk is a broad geopolitical risk,” he said, adding that he favours the first scenario. “The alternative is to go through all the NATO countries and come up with a personal view of the Trump impact on each individual country, and that’d be a challenging exercise to get right.”
Homegrown challenges
Some “homeshoring” — reallocating investment to a pension fund’s home market — is an obvious strategy, he said, though this is potentially a difficult one for large Canadian pension funds whose managers have complained for years that large, private infrastructure investments — from toll roads to airports — aren’t made available to them.
They have also pushed back on pressure to invest more in Canadian companies via stock markets due to concerns it would lead to overconcentration in their home market and a reduction in long-term returns generated through diversification.
After Teachers’ reported its latest annual results in March, Taylor reiterated the former.
“We’ve stated for a while that we have a strong desire to try to invest more in Canada in larger assets,” he said.
Another alternative would be for the pension giants to shift investments away from NATO countries to similar economies, such as Latin America and Asia, Kroner said.
“What I would do is move some percentage away from NATO (countries), say, five per cent,” he said. “Half of that would come home and half would go to a LatAm index and an Asia index.”
Within Asia, China presents its own risks for pension managers, though growth is not the primary concern.
“Investments in the China axis are extremely risky because of the very high risk that they become stranded assets,” Kroner said. “I’d recommend that institutional investors either avoid investing in this axis, or at least keep their allocations to something less than cap-weight” — a less risky way to invest in a basket of assets in an index.
The Canada Pension Plan Investment Board has significant investments in China, but its exposure, once representing more than 10 per cent of assets, has been declining since 2021 and the fund has committed resources and attention to other countries in the Asia-Pacific region.
Teachers’ and others in the Maple 8, including the Caisse and British Columbia Investment Management Corp., paused direct investments in China in 2023 and Teachers’ plans to close its Hong Kong office this year while targeting a doubling of investments in India over the next five years.
Concerns about China came to the fore a couple of years ago amid government and regulatory crackdowns on tech businesses, but the world was still more or less perceived to be under the steady hand of the U.S.
With that in the rearview mirror, Kroner said institutional investors should be preparing for some pretty bad outcomes, including wars.
“But,” he said, “nothing has changed on this front since Trump, in that investors should always prepare for bad outcomes” through good risk management and scenario analysis that look at what could happen to a portfolio in very bad scenarios.
“The only difference this time is that Trump has made some of these negative scenarios pretty easy to envision,” he said.
As Wall Street closes out its worst quarter since 2022, every large fund (not just pension funds) is trying the navigate the noise from Trump's tariffs.
It's a big problem and while the inclination is to shift away from the US to domestic or ex-US assets, I do agree with Kenneth Kroner, AIMCo's former Chair (featured above), it would be wise to resist making impulsive decisions based on the latest news.
The truth is nobody knows where Trump is headed with these tariffs.
Moreover, I have my doubts that his own administration knows.
All I know is Trump 2.0 is off to a terrible start and if it's one thing you need to remember about Trump is he's incredibly vain and will likely fold on tariffs when the going gets tough.
In that regard, he's highly predictable.
In fact, last week, when he caught wind that Canada and the EU were coordinating a response, he showed his cards by panicking and stating the will significantly increase tariffs if that were the case.
That is telling but it shows you Trump doesn't really want to start a tariff war.
The good news is by the end of the week, we will know where his administration stands on tariffs.
The bad news is they might go through with these tariffs in the near term as a form of negotiation and that will wreak havoc on global markets and possibly send the global economy including the US into a recession.
More bad news might also come in the form of US economic data that confirms a recession has arrived.
This week we get the ISM tomorrow and then the big jobs report on Friday.
Thus far, the market is in RISK OFF mode and rates are creeping higher as investors price in stagflation.
I don't get carried away with short-term movements but it's clear growth and hyper growth stocks are bearing the brunt of this policy uncertainty.
Still, I noticed stocks came back strong today, especially growth stocks which were selling off hard at the open.
This tells me the market is sniffing out lenient tariffs but we are also closing out a bad quarter, portfolio rebalancing is helping cushion the blow and adds to volatility.
Whatever happens the rest of the year is anyone's guess.
Will stagflation prevail? Are we headed for a long tariff war which causes a global economic recession?
Again, nobody really knows, all long-term investors can do is diversify and be ready to seize opportunities as they present themselves.
Below, Scott Wren, Wells Fargo Investment Institute Senior Global Market Strategist, and Victoria Greene, G Squared Private Wealth CIO, joins 'Closing Bell Overtime' to talk the impact of tariffs on the market.
Next, Doug Rediker, founder and managing partner of International Capital Strategies, says the Trump tariff plan is fraught with uncertainty and Wednesday's announcement likely will bring only some clarity.
Third, Chris Verrone, Strategas Research Partners chief market strategist, joins 'Closing Bell' to discuss markets, making sense of the sector rotation and more.
Lastly, Joseph LaVorgna, SMBC Nikko Securities America chief economist and former Trump Economic advisor, and Mark Zandi, Moody’s Analytics chief economist, joins 'Closing Bell Overtime' to talk the impact of tariffs on the economy.
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