That in-house focus allows Canadian pensions to invest in assets that traditionally are more expensive to manage, including real estate infrastructure and commodity-related assets. The total allocated to these real assets was 18%, double what others do.
While ESG has been on the minds of many investment managers and the subject of news coverage, we noted one unusual element of recent discussion. According to Axios, “Marcie Frost, CEO of CalPERS [said] that America’s largest pension fund is ready to buy or become the majority owner of a company within the next ‘two to three years. That's an atypical move for a U.S. pension fund, but in line with how Frost now wants to mimic the Canadian model....’”[1] Why would an American pension CEO be following, let alone interested in mimicking, the Canadian pension funds? We dug in and found that the Canadian pension system has been attracting attention from a variety of sources.
What is the Canadian model what do Advisors need to know about it to advise their institutional clients? Over the last few years, Canada’s pension funds have been drawing attention from investment policy analysts. Libertarian think tank Reason compared Canada’s system to the US pension funds and noted a few sharp differences. “Canada’s federal and provincial public pension plans tend to be much better funded than U.S. state and local pensions. Canadian pensions investments have also largely outperformed U.S pension investments in the last two decades. Preliminary analysis reveals that key differences in investment strategy, cost-sharing, and risk appetite are the reason for Canada’s success.”[2] Apparently, the assumptions on return drive a good deal of the difference. According to their article. “The median assumed rate of return for state and local pension plans in the United States is roughly 7.25%. The average assumed return for the Canadian plans listed above is 4.7%.” Some US pension plans also have higher targets for alternative investments, like private equity, than their Canadian counterparts. Those two differences result in shortages to US pension plans and increased volatility. The Canadian approach aims for efficiency and reduced volatility to reduce costs and resource use.
McGill College Research paper that outlined the differences between the two countries pension plans noted three main elements of the Canadian approach that drove better results. “We find that a central factor driving this success is the implementation of a three-pillar business model that consists of i) managing assets in-house to reduce costs, ii) redeploying resources to investment teams for each asset class, and iii) channeling capital toward growth assets that increase portfolio efficiency and hedge liability risks.”[3]
The history of the Canadian pension system’s unique approach begins with the Ontario Teachers’ Pension Plan’s (OTPP) creation in early 1990.[4] That plan’s success reshaped other pension plans in Canada. A few unusual elements were key to its achievements: OTPP set a high disclosure standard for itself; it created incentives for its in-house investment advisors; it created a risk budgeting protocol; and it invested in real estate and corporations. Those investments in corporations became so successful that by 2012 the magazine The Economist labeled the Canadian pension systems as “Maple Revolutionaries.”[5] “They have taken part in six of the top 100 leveraged buyouts in history. They have won the attention both of Wall Street firms, which consider them rivals, and institutional investors, which aspire to be like them.”
The key takeaway for advisors about the increasing attention to the Canadian model involves the sharp focus on internal investment costs. “On average, Canadian pensions manage 52 percent of their assets in-house, compared with 23 percent for funds outside the country.” That in-house focus allows Canadian pensions to invest in assets that traditionally are more expensive to manage, including real estate infrastructure and commodity-related assets. The total allocated to these real assets was 18%, double what others do.[6]
If CalPERS’ Frost’s comments regarding investing in real assets and corporations catch the attention of plan sponsors considering their options for increasing participant’s retirement savings success. And some corporations are considering adding annuities to their benefits - both individually and as a trust.[7] Lastly, we’ve noted a rise in domestic manufacturing and a potential rise in Union organizing in the US over the last few years. Those rising union memberships may increase scrutiny on pensions. All of which may continue to keep the Canadian model in the spotlight.
[1] https://www.axios.com/2023/05/11/calpers-ceo-marcie-frost-esg
[2] https://reason.org/commentary/what-u-s-pension-plans-can-learn-from-canadian-pension-funds
[4] https://kpa-advisory.com/userfiles/Ambachtsheer_JPM_article_April_2021_1.pdf
[5] https://www.economist.com/finance-and-economics/2012/03/03/maple-revolutionaries
[7] https://www.plansponsor.com/dated-thinking-may-holding-back-annuities
These articles are prepared for general purposes and are not intended to provide advice or encourage specific behavior. Before taking any action, Advisors and Plan Sponsors should consult with their compliance, finance and legal teams.
Before leaping into the unknown, we recommend a thorough examination of your plan. Because we are experts in the field, we know the marketplace and know what your existing vendor is capable of offering. Through this examination, we can help you optimize the service you receive.
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