CDPQ Reports Solid Year of Progress Despite Missing Return Target

Caisse de dépôt et placement du Québec (CDPQ) released its 2019 annual report on Tuesday, highlighting investment performance slumped by global market volatility, and progress in several key initiatives, including environmental, social, and governance (ESG) investing, exposure to international markets, and portfolio diversity.

The CAD $340.1 billion ($251 billion) fund reported a global return in 2019 of 10.4%, missing its benchmark by about 1.6%, and noted that its portfolio is being “tested” by the COVID-19 crisis. Returns for the eight principal depositors ranged from 9.5% to 10.8%.

The fund appointed a new chief executive officer, Charles Emond, to replace the departure of his predecessor Michael Sabia, earlier this year.

“To perform in a competitive environment, you need to have the best talent, both here and around the world. This will be even more important in the next decade, as the global economy suddenly lost steam and CDPQ’s portfolio is tested. Our organization has the teams to take on this challenge under the leadership of Charles Emond as president and chief executive officer,” said Robert Tessier, chairman of CDPQ’s Board of Directors.

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The fund’s five- and 10-year performance clocked in at 8.1% and 9.2%, respectively.

Besides return performance, CDPQ is focused on gaining additional portfolio exposure to international markets. Over the past year it has upped its allocations to the United States, Brazil, Colombia, and other “key growth markets,” increasing its exposure by 2% for the year, surmounting to 66% by year-end. Its international exposure in 2009 was 36%.

Additionally, the fund is focused on increasing its allocations to holdings that promote ESG concerns, as well as investing in its own local Quebec community.

CDPQ added $6.9 billion in investments tailored to climate change-mitigating assets in 2019, continued its proactive leadership in “green” endeavors by co-founding Net-Zero Alliance, and reduced its carbon intensity by 21% since 2017. It has committed to reducing it by an aggregate 25% by 2025.

The fund is also working up to build its roster of low-liquidity assets, and had transacted more than CAD $26 billion into asset classes that provide this attribute (real estate, private equity, and infrastructure) across international markets to achieve this.

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This year’s market downturn could end up being the death knell for struggling public pension plans which, after failing to replenish their funded levels in the decade since the financial crisis, might not survive to see the next decade.

“Given that the aggregate funded status of public plans has remained virtually unchanged since the last financial crisis, this downturn is a serious step backwards in their funding progress,” said a report from the Center for Retirement Research at Boston College and the Center for State and Local Government Excellence.

The report said that if the markets maintain their current level, most public pension plans will close out fiscal 2020 with negative annual investment returns, reduced asset values, lower funded ratios, and higher actuarial costs.

Although projections suggest that plan finances will continue to deteriorate in the aftermath of the downturn, the report says that plans “on the whole” should persevere and maintain sufficient assets from which to pay benefits. However, this does not include plans with extremely low funded ratios, some of which face an increased risk of depleting their assets and the high cost of “pay-go funding” if they do, the report said.

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To determine how plans might manage in the wake of the downturn, the report used projections from 2020 to 2025 under two possible market scenarios. The first scenario assumes markets remain at current levels until June 2021 and then steadily climb to their previous peak by 2023. And, from that point on, plans would achieve their assumed rate of return of approximately 7.2%. The second scenario assumes a more pessimistic forecast with markets remaining at current levels until June 2021 but taking longer to recover, with markets not reaching their previous peak until 2025.

Under the first scenario, the aggregate funded status of public plans would decline to 62.7% in 2025, and the actuarially determined contribution would rise to 25.1% of pay. But under the more pessimistic scenario, the funded ratio would fall to 55.5% while required contributions would surge to 29.1% of pay. Additionally, the average ratio of assets to benefits, which is a rough gauge for the health of a trust fund, would decline to 9.4 or 7.9 in 2025 from 11.6 in 2020. This means that, in 2025, public pensions would have assets equal to an estimated eight or nine years of benefits.

The report said plans can maintain asset levels if annual investment returns exceed their cash flow, and that the projections show that cash flows fall to negative 3.8% or negative 4.5% in 2025 from negative 3% of assets.

“Given these relatively attainable thresholds,” the report said, “no plans are projected to exhaust their trust fund within the next five years.”

However, remaining solvent over the next five years isn’t exactly reassuring for pension plans and their decades-long time horizons.

Under a slower market recovery, as in the case of the second scenario, the average estimated funded ratio for the 20 worst-funded plans in the report’s sample would be 38.3% in 2020, falling to 32.2% in 2025, according to the report. And six of the plans—Charleston (West Virginia) Fire, Dallas Police and Fire, Chicago Municipal, Chicago Police, Chicago Teachers, and New Jersey Teachers—would see their funded ratios dwindle to 25% or less.

The average funded ratio for the 20 worst-funded plans is projected to decline to 4.5 in 2025 from 5.9 in 2020, which means that in 2025 they will have assets equal to less than five years of benefits. And Chicago Municipal, Dallas Police and Fire, and New Jersey Teachers would see their asset-to-benefit ratios erode even further to less than two years of benefit payments by 2025.

“These sobering statistics highlight the precarious position of the worst-off plans,” the report said.

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Tags: Center for Retirement Research at Boston College, Center for State and Local Government Excellence, funded level, Funded Ratio, pay-go funding, Public Pension