Investing for the CPP in challenging times

With over $500 billion in assets, the fund supporting the Canada Pension Plan is a significant player in the investment world. Inflation, climate change and other factors have presented some interesting challenges as of late. Joining us to discuss the approach taken by CPP Investments during these uncertain times is Geoffrey Rubin, Senior Managing Director & Chief Investment Strategist.


Fievoli: Welcome to Seeing Beyond Risk, a podcast series from the Canadian Institute of Actuaries. I’m Chris Fievoli, Staff Actuary, Communications and Public Affairs, at the CIA.

The most recent Canada Pension Plan (CPP) actuarial report reaffirmed the financial soundness of the CPP for the next 75 years, and one of the key components underlying the stability of this plan is the CPP investment fund.

And joining us today to discuss some of the challenges associated with managing this fund is Jeffrey Rubin, Senior Managing Director and Chief Investment Strategist for CPP Investments.

Thanks very much for coming on the podcast today.

Rubin: Well, thank you for having me.

Fievoli: This is a pretty significant fund. The net assets managed by CPP Investments is now over $500 billion. Can you share with us some of the challenges that are associated with managing a portfolio of that size?

Rubin: I think it might be useful to talk a little bit about the structure of the Canada Pension Plan and the Canada Pension Plan Investment Board (CPPIB), which is the entity I work with that invests the excess of contributions above what is required for contemporaneous benefits.

The Canada Pension Plan itself has been around since 1965 and is a partially funded pension plan – that’s important for thinking about how we are going to invest those excess proceeds. This was true until about the last five years, in which the CPP itself was amended to include an increment – what’s called the “additional CPP” (ACPP) – which is a fully funded increment.

So even though there is a single Canada Pension Plan, it’s comprised of two distinct parts: the base, which is a partially funded plan, and the additional CPP, which is a fully funded increment.

We invest the excess of contributions over benefits for the single CPP, but we do so with an eye towards these two distinct elements. Of the $550 billion or so of assets that we have and that we are managing within the CPPIB, the preponderance are associated with the base CPP – the original, partially funded plan. A small but growing piece of that total portfolio is invested in the half of the additional CPP, which is fully funded, as I described.

Because of those differences in the funded targets for those two pieces, the investment target for those two is going to be distinct. In particular, for the base CPP, we maintain a higher risk target for the investments associated with the base CPP, and it will deliver correspondingly higher returns over time.

For the additional CPP, the fully funded increments, we have a lower risk target and anticipate there will be lower returns over time. So the challenges of managing our fund are compounded by the fact that we have this interesting distinction of investing on behalf of two distinct parts of the Canada Pension Plan.

In terms of our size and the challenges that come with managing a large fund, first, there are opportunities within investment markets that might be really attractive on a risk-adjusted return basis but are simply too small for us to meaningfully participate in. The investments that we make need to move the needle, so to speak, and some very attractive opportunities just don’t meet those criteria.

I think a second aspect of that is, in some markets, if we were to participate at our size, we might actually impact or move the markets in ways that would degrade the risk-adjusted returns that we would generate.

Another issue with running a large fund is that we broadly need to be globally diversified and exposed to elements and drivers of economic prosperity and growth around the globe. That’s a challenge that we need to take on.

I would say the following, which is, in addition to the challenges faced by size, there are opportunities. And it’s important for us to think about how we can invest in ways where our size is an advantage, where we can invest in opportunities that few other investors have the size or the means to invest in that might create outsized risk-adjusted returns for us.

So, while there are challenges, and part of the challenge is on the investment side and part of the challenge is on the organizational side – in order to invest a fund of this magnitude, we have to have a well-developed organization and team based around the world – those challenges, we think, can be redeemed by opportunities to invest in size and scale where few others can.

Well, let’s turn to everybody’s favorite topic now, and that’s inflation. As we all know, that wreaks havoc on a lot of things, particularly benefit plans, especially those that have an element of indexation.

I’m just wondering, has the CPPIB needed to do any repositioning in response to the recent spike in inflation? And if so, what have you done?

The impact of inflation is important both for the performance of our investment portfolios as well as the assessed sustainability of the plan itself, upon whose behalf we invest. As I mentioned earlier, these two distinct elements of the Canada Pension Plan, the base and additional CPP, have different levels of target funding, and as such are going to have very different exposure to inflation.

It turns out the base CPP is actually quite insensitive to the level of inflation, and that has to do with the combination of both indexed benefits as well as an expectation of rising wages and contributions into the plan in the face of broad inflation.

The additional CPP is much more exposed to inflation, so that rise in inflation does have a negative impact on the funded status of the ACPP in the way you describe. When we think about our investment portfolio, we want to think both about the absolute performance of the fund as well as its ability to help the Canada Pension Plan meet its obligations over time.

In terms of investment performance, rising and unanchored inflation is really problematic for nearly all assets and asset types. It is very difficult in a regime of high and uncertain inflation and corresponding high-risk premia to maintain the level of returns that the market’s been accustomed to over the last 10 to 15 years.

So, at some level, inflation is a problem, and it is a problem everywhere. It’s very difficult to build a portfolio that is entirely immune from those kinds of impacts. But there are opportunities.

In particular, we invest significantly in real assets. This is commercial real estate, infrastructure and sustainable energy power generation, all of which have some degree of ability to pass through inflation and maintain a level of revenues and profits that is somewhat resilient to a rise in inflation.

Those kinds of investments, along with things like inflation, linked bonds and commodities investments, do help us maintain a degree of return in the face of rising and unstable inflation. But it can only do so partially.

This is definitely an environment in which we, along with most, if not all, large institutional investors are going to face significant headwinds in terms of generating risk-adjusted returns.

Fievoli: OK, interesting. Let’s turn to another topic that a lot of actuaries have taken an interest in, and that’s climate change.

I’m curious how climate change has affected the choice of investments that CPPIB has made in terms of balancing the best returns versus investing perhaps in something that’s more climate friendly.

How do you strike that balance?

Rubin: Clearly an important element of our investment strategies and the specific investments that we make, but we do our best to frame the climate change risk exposure as a part of our pursuit of risk-adjusted returns, as opposed to something that runs contrary to our pursuit of those risk-adjusted returns.

We have done substantial work over the last decade to incorporate all risks – financial risks, market risks, and climate and ESG risks – into the consideration of the investments that we make.

We want to make sure that we are compensated for all the risks that we take, and it’s a very clear there are investments in certain companies or in certain sectors where the risk of profound climate change and the uncertainty that induces is going to be higher.

We want to be very clear as to what those risks are and be sure that we’re investing in ways that we can deliver the outsized performance and returns that we seek while being very clear and mindful of the risks, including the climate change risk.

I think of two examples in our portfolio where there is not a trade off, per se, but a deep consideration of impact of climate change risk.

The first is our sustainable energies portfolio. We have renewable power generation around the globe in a portfolio that includes solar and includes wind, both onshore and offshore, and is an investment that we believe is underwritten to perform and deliver returns using expected outturns of economic and regulatory policy.

But it’s also, we believe, well positioned to perform with even additional vigour in the case of the kinds of climate change risk that we see the global economies and financial markets exposed to.

A second example would be the green energy bonds that we issue. We can raise financing in a rate superior to what we would otherwise issue, so long as we ensure those proceeds are being used in investments in projects that have the kind of carbon footprint required for those asset classes.

In both cases, we are not foregoing risk adjustment returns in order to address climate change considerations. In fact, we are incorporating those climate change risk considerations into the underwriting and pursuing them because we believe they will help contribute to an outperforming portfolio.

Fievoli: Great. Let’s keep going on that risk management theme. Looking back over the last couple of decades, what have we had?

We’ve seen the financial crisis in 2008, we saw the September 11 attacks and the aftermath of those, the bursting of the .com bubble. This year, a war in Europe, and in the last two years, the economic shocks and the aftereffects that were associated with the global pandemic.

So knowing that actuaries have a natural interest in risk management, I’d be curious to know what processes CPPIB follows to try to anticipate and possibly mitigate the effects of the next big event, whatever it is, and what could that possibly look like?

Rubin: It sure seems that once-in-a-generation events are happening quite frequently, and we need to really anticipate what that means for the portfolios we design and deliver.

We have a group we call the Scenario Analysis Working Group that draws upon professionals across the organization to work on these very problems and to think about both the likelihood and potential severity of any number of events that might prevail.

I’m just looking at the report of the team most recently produced, and there are seven high-, about eight medium- and a handful of low-impact risk exposures that this team was tracking around the globe, and it’s the collection of geopolitical and economic risk exposures that I think most folks are thinking through today, and we too are doing the work to build out our understanding and awareness of these kinds of risks and exposures.

We do this work, and we do this work to really maintain that situational awareness of where things can go wrong – where they can go wrong in the economy, where they can go wrong in policy circles or geopolitics, and we think about their impact on the resiliency of our portfolio.

But when I think about the way that we position ourselves to succeed in the face of these events, that’s the first element. The first element is resiliency.

It is not so much about predicting which of these events will transpire, but about using them to understand the performance of our portfolio in the face of any, so we can ensure we are as effectively diversified and prepared for a surprise of any type, whether it is on that list that I mentioned to you or not.

So making sure that we have a very resilient portfolio is quite important as a foundational element of our risk preparation.

A second element of that is ensuring sufficient liquidity. We need to ensure we have the liquidity to meet all obligations, near term and long term, in the face of any of these kinds of downturns, and we do quite a bit of work to test the adequacy of our liquidity position under any number of possible circumstances to ensure that we are always in a position to meet those obligations and continue operating in ways that we have laid out. So liquidity adequacy, I would say is the strong second pillar of our approach to managing risk.

And there is a third pillar, which is our governance and organizational preparation for these downturns. We have a Financial Crisis Working Team that runs drills and tabletop exercises and is well positioned through that work to respond and be prepared to act in the face of whatever the next surprise might be.

And this kind of preparation governance goes all the way up through our management. We want to be really well equipped to contend with, to respond to and to react, and to ensure that we maintain continuity of our investment strategies through these events.

The single most damaging thing that could happen to organizations like ours is to go through an event in which the governance is ill equipped or unprepared to handle those outturns, and as a result, loses will and commitment in the midst of the crisis.

I think most, if not all, of the examples of institutions that have really had a difficult time are those that lose their conviction near the bottom of a downturn and effectively unwind or stop out their strategies. To me, that is mostly a failing of governance.

It’s mostly a failing of the ability to adequately build the processes and the procedures and the culture and the mindset around what downturns might look and feel like, and to ensure that the organization is really well prepared to meet those challenges as they arise, maintain their awareness through them, have the processes to contend with the demands and needs that come up, but always with an eye towards the consistency and conviction of approach that is set out in advance.

Those are the three elements of risk management that we focus on.

Fievoli: That’s great. Let’s wrap up with one final question.

I was wondering if there’s anything you’ve learned from your experience at CPPIB that you could share with actuaries as they advise sponsors of smaller pension plans when they’re making their investment choices and trying to manage their own risks.

Rubin: I think that notion of being very clear as to what your aims and objectives are as an organization, the constraints you face as an organization, and what you’re trying to accomplish is so critically important no matter the size of the organization or the approach that’s taken.

I think organizations that are very clear as to whether they are seeking to offset a liability, or manage to a particular return target, or manage to outperform their peers, it’s only with that very clear understanding what you’re trying to accomplish that you can then subsequently set up your investment strategies to deliver against that.

I think what we talked about in terms of building real commitment and resiliency in your governance and ensuring that the strategy you choose is one that you can maintain through cycles and over time, I think is really important.

In the spirit of working from big to small, I think the fundamental questions of risk target, so the fundamental level of risk that the organization will maintain, the choice of investment strategy – is it going to be an all-domestic strategy or include international? – the access to the types of partners with whom you will invest, these are the biggest decisions.

And while we don’t necessarily revisit them with great frequency, I think those are the ones that over time have the greatest impact on the performance of the organization.

I think, often, the elements of investment strategy that are more contemporaneous, that happen more frequently, are exactly those that have the least amount of impact on overall performance over time.

So if I were to think about one recommendation for funds of all sizes, it’s know thyself and be very clear as to what it is you’re trying to accomplish. And within that, make sure you set up your investment strategies and governance to answer the big questions first and maintain that kind of conviction through cycles and through downturns, through the events we talked about, to deliver the best possible performance over longer horizons.

Fievoli: OK, that’s a lot of interesting information. Thank you very much for joining us today.

Rubin: I really appreciate you having me.

Fievoli: We now have over 100 episodes in our podcast series going back over the last three years, so we encourage everybody to subscribe, and you can do so through whatever platform you use to get your podcasts.

And we’d also like to hear from you. So, if you have any suggestions or episode ideas, you can send them to podcasts@cia-ica.ca. As well, we’re always looking for content to include on our Seeing Beyond Risk blog. So, if you have some ideas you would like to share, you can contact us at seeingbeyondrisk@cia-ica.ca.

And we’ve recently launched a new site covering all of the exciting changes we’re making to the CIA qualification requirements. And you can check that out at https://education.cia-ica.ca/.

Until next time, I’m Chris Fievoli, and thank you for tuning in to Seeing Beyond Risk.

This transcript has been edited for clarity.

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