Canada’s government acknowledges that the significant investments they seek in Canadian businesses and infrastructure must come mostly from the private sector. But in fact for decades, the country’s pension funds have been considerably reducing their domestic investments, a trend the feds and regulation are being taken to task for.
Tony Loffreda, independent senator from Quebec and former vice chairman of RBC Wealth Management, on May 12 asked the government’s representative in the Senate, Marc Gold, what the feds could do to incentivize Canada’s pension funds to invest more in Canada “without necessarily regulating free enterprise.”
“If pension funds were to inject billions of dollars into our Canadian companies at a greater rate, it would have the potential of increasing productivity and growth, accelerating innovation and technology, fuelling competition, and attracting further investments—and perhaps more importantly—help raise the standard of living Canadians,” Loffreda said during question period.
Gold’s response to Loffreda specifically referred to the Canada Pension Plan Investment Board (CPPIB)—which manages Canada’s largest pension fund, with $550.4 billion in assets as of Dec. 31, 2021—as an independent body that makes its own decisions.
“The CPPIB operates at arm’s length from both federal and provincial governments,” he said.
The CPPIB’s 2021 annual report showed that in 2006, 64 percent of its assets were invested in Canada and the remaining 36 percent invested globally. But by 2021, the mix had changed to 15.7 percent in Canada and 84.3 percent globally.
According to the CPPIB’s 2021 annual report, the weighting of Canadian equities in its portfolio is effectively determined by a global equity index, and “because we do not make a separate allocation to Canadian equities, … As of March 31, 2021, this weighting was approximately 2.8 percent.”
The CPPIB added that the actual percentage allocated to Canadian equities will likely be higher due to the advantage of having greater knowledge of and access to its home country.
Loffreda emphasized that “I really think the government needs to properly assess the situation, find out why Canadian pension funds are reluctant to invest, and what winning policies can be implemented, while respecting the idea of free markets.”
Downward Trend
In a report published in April, global investment firm LetkoBrosseau and Associates Inc. elaborated on Canadian pension funds’ allocation to Canadian public equities that had declined from close to 80 percent in 1990 to barely 10 percent by 2020.
Canadian equities represent about 3–4 percent of the world’s equity markets.
“Americans invest 75 percent in their own economy, should Canadians make do with 3 percent and leave it to others to forge their future or should they also invest 75 percent in Canada?” stated the LetkoBrosseau report.
The firm, which has over 30 years’ experience managing pension assets, pointed to some of the pitfalls of investing internationally, such as currency fluctuations, taxation, and political and legal risks.
The report outlined some of the reasons for the trend, singling out regulation.
“Plan sponsors are reacting in very predictable ways to their regulatory environment and the only way to change this behaviour is to change the environment,” LetkoBrosseau said.
It said regulation has over-emphasized short-term fluctuations in asset values, resulting in a shorter investment time horizon for pension fund assets. In contrast, pension savings, which represent 30 percent of Canadian savings, are typically invested for the long term and are meant to be managed such that they can take more risk to earn greater rewards.
A shorter investment horizon for pension funds, however, translates into buying bonds and some real estate, which typically carry less risk or volatility; however, those assets usually have lower yields than stocks.
“Several issues … have risen in importance as a result of the shortening of the investment horizon that has been imposed on pension funds by changes to regulations,” according to LetkoBrosseau.
This issue of the decline in investments in Canadian public equities by Canadian pension plans was also brought to the fore last November in a Financial Post sponsored content story.
Daniel Brosseau, president of LetkoBrosseau, elaborated on the flaw of basing historical performance for various asset classes to project future returns and then investing accordingly, which results in a minimal allocation to Canadian equities, due to being deemed riskier than stocks of smaller U.S. companies.
Brosseau offered a solution. “Regulators just need to allow pension liabilities to be discounted at a slightly higher rate when backed by Canadian equities. Pension fund investment allocations would then change suddenly and completely.”
The value of pension liabilities would thus be assessed lower if backed by Canadian equities, and pension funds would invest more in them to get closer to closing the gap between liabilities and assets.
Some of the other problems with Canadian pension plans, according to LetkoBrosseau, are that they are investing more in private markets than public ones, increasing investments in low-return assets with higher volatility instead of the other way around, and they are investing more like index funds instead of actively managed ones.
Drumming Up Investment
The need for more investment in Canada was made clear in the federal budget, especially given the government’s focus on building a net-zero economy by 2050. The feds said Canada will need between $125 billion and $140 billion of investment a year to reach that goal.
Budget 2022 announced the creation of a Canada Growth Fund (CGF), a new public investment vehicle, that will operate at arms-length from the government—much like the CPPIB—“to attract substantial private sector investment.”
The CGF will be allocated $15 billion of funding over the next five years and will aim to attract at least $3 of private capital for every dollar it invests.
Furthermore, the Investing in Canada Infrastructure Program has earmarked $33.5 billion over the next 11 years for public infrastructure across the country.
