Globe and Mail columnist Andrew Coyne wrote a pretty tough piece recently on the lack-lustre performance and high expenses of the Canada Pension Plan Investment Board.
The CPPIB, which manages almost $500 billion in Canada Pension Plan assets, reported its “strongest ever” net return of 20.4% for the year ending March 31, 2021. As Coyne notes, the return sounds good until you dig into the CPPIB annual report. There, you discover that a basket of indexes used by the CPPIB to benchmark itself returned 30.4% for the year.
In pursuing its active investment management strategies, the CPPIB ran up over $4.4 billion in direct and indirect operating expenses, including $2.7 billion paid to outside money managers. By comparison, the Caisse de dépôt et placement du Québec, which manages $366 billion in Quebec Pension Plan and other public assets, incurred $757 million in operating expenses and external management fees in the year to Dec. 31, 2020.
The CPPIB has almost 2,000 employees and nine offices in cities around the world. Average total annual compensation for its top five executives was over $3.5 million in fiscal 2020.
High expenses are nothing new at the CPPIB. A few years ago, PWL Research Director Raymond Kerzérho looked at the performance of the eight largest pension fund managers in Canada. In 2017-2018, CPPIB had by far the highest expense ratio at 0.97% of assets, while the Caisse had the lowest at just 0.22%.
Of course, the last year has been anything but normal. But looking back to 2006 when CPPIB abandoned a passive investment approach in favour of trying to beat the markets with active strategies, it has added excess returns of $28.4 billion after costs.
According to the Coyne’s calculations, that comes to about 0.5% of return per year on average above the CPPIB’s benchmark, which is composed of a passive portfolio made up of 15% bonds and 85% in stocks.
However, it’s hard to know how much risk was taken to achieve those returns because a large share of the CPPIB’s portfolio is invested in illiquid alternative investments like private equity, real estate and infrastructure. Is the benchmark—itself quite a risky mix—a good gauge of risk in the portfolio?
At any rate, half a percentage point of excess annual return per year is not a lot considering how much has been paid for salaries, far-flung offices and outside managers. It’s a common theme in the investment world—when excess returns are generated, they often go to pay the excessively high fees of the administrators and money managers, not the clients.
By coincidence, the CPPIB brought out its results just a couple of weeks after the death of investing giant David Swensen. As Chief Investment Officer at the US$31-billion Yale Endowment since 1985, Swensen developed what has come to be known as the Yale Model of investing.
He achieved remarkable results through his expertise in asset allocation and by adding alternative investments that are not well correlated with the stock market. This allowed the endowment to increase its equity allocation while reducing its reliance on bonds for safety.
Many other endowments (and other institutional investors) have emulated Swensen’s approach at Yale, but most have fallen well short of replicating his results.
As discussed in a report by my PWL colleagues James Parkyn, François Doyon La Rochelle and Raymond Kerzérho, U.S. endowments have struggled to match equity/bond index returns, despite having sophisticated management teams and access to the best investment managers, consultants and technology money can buy.
First, paying high fees doesn’t lead to higher returns, even for the most sophisticated investors in the world with access to unlimited resources.
Second, considering the evidence, it’s worth asking whether you need to go into illiquid private equity, infrastructure and other alternative investments when a low-cost passive portfolio of stocks and bonds does a better job.
