In early February, members of Northland Wealth attended a roundtable luncheon hosted by the C.D. Howe Institute to hear from Mark Machin, the President and CEO of the Canada Pension Plan Investment Board (“CPPIB”). This presentation was informative as we were the only wealth manager in attendance. It is Northland’s access to, and conversations with, the world’s leading institutional investors such as CPPIB and Yale Endowment Plan, that allows us to understand and utilize best practices in risk and portfolio management for the families we serve.
CPP is Canada’s national retirement plan. It traces its roots back to the 1960s when the government used employee and employer contributions to purchase Canadian government debt. Upon review in the late 1990s, the plan was deemed to be unsustainable and in order to meet its future pension obligations to Canadians significant changes to the plan would need to be made. These included the gradual increase in the contribution rate and the formation of the Canada Pension Plan Investment Board in 1999. The board’s role was to steer the investment decision only in non-marketable government bonds. It was not until the creation of the CPPIB that the plan was diversified into other asset classes such as equities, but even then it only invested on a passive basis.
While Mr. Machin highlighted CPPIB’s strategy in a changing world, he also stressed the importance of educating Canadians about the history of CPPIB, its mandate, and its ultimate purpose. Mr. Machin emphasized the board’s need to be transparent and accountable to the Canadian public it serves. The pension is meant to act as a mandatory savings plan made possible by contributions during Canadians’ working years.
In 2006 CPPIB embarked on its current mandate, which is to achieve a “maximum rate of return without undue risk of loss” by pursuing actively managed investment strategies. This change in approach was made in order to help achieve the real rate of return required to sustain the plan, which the Chief Actuary of Canada pegged at 3.9% in 2013 over a timeframe of 75 years. In other words, CPP requires a return of almost 4% per year greater than Consumer Price Index (“CPI”). This would also be known as an absolute rate of return target of CPI + 3.9%. The ability to invest over decades combined with utilizing an absolute return approach is one of the key advantages that CPP shares with families of significant wealth. Although CPPIB’s new investment approach was heavily influenced by the success of the Yale Model, which had been employed at the Yale university endowment since the late 1980s, CPPIB is still considered ahead of its time, as this strategy is now endorsed by other pension programs, large endowments and sovereign wealth funds.
It was not a simple flip of a switch that allowed CPPIB to pivot from passive investment management to active management in 2006. This change required extensive planning and development in order to create a model that would achieve its long term goals. It was determined that active management would need to maximize returns above those achieved through a passive strategy, while also compensating for the increased fees and illiquidity. To do so, the board built in-house teams to take advantage of the entire investment universe rather than simply employing external managers. In fact, it is estimated that by doing so CPPIB incurs only one tenth of the cost by investing through its own in-house investment teams. This is not to say that the board does not employ external managers, it does, but typically the fees paid are performance based. As the pension portfolio outperforms its benchmarks, it decreases the need for contributions by the Canadian public. The ability of the fund to meet or exceed its long term performance requirements serves as a multi-generational benefit to Canadians.
It is with this long investment horizon that Mr. Machin stressed the importance of educating the public about CPPIB and its mandate, as in order to earn trust from future benefactors the pension must be transparent in both good and bad times. Of course, there will be times when returns deviate away from the 3.9% real return target. However, by taking a dynamic approach, CPPIB can pursue value-added strategies that will enable it to achieve returns while providing stability to the plan and its beneficiaries. At Northland Wealth, we embrace this philosophy and adapt these best practices and strategies to our clients’ portfolios in a common sense way.