Can the Canadian Model Be Improved? | Chief Investment Officer

The “Maple-8” Canadian public pension funds are known for many things, such as their use of direct investments and internal management of assets, as well as their globally diverse portfolios.

Many have considered the Canadian model to be the prime pension fund investment model, with many pension funds, including the California Public Employees Retirement System, aiming to replicate some of its features.

The term “Maple-8” refers to the major Canadian public pension funds including, the Canada Pension Plan Investment Board, Public Sector Pension Investment Board, Caisse de depot et placement du Quebec, Alberta Investment Management Corporation, British Columbia Investment Management Corporation, Ontario Teachers’ Pension Plan, Healthcare of Ontario Pension Plan and the Ontario Municipal Employees Retirement System, which collectively manage more than C$1 trillion in assets and have become pioneers of the model, starting in the 1990s, when Canadian public pension funds were woefully underfunded.

But does the model still have a future today? In an academic paper, “On the Sustainability of the Canadian Model,” author Eduard van Gelderen, the CIO of the PSP Investment Board, aims to find out if the Canadian model is still relevant today, and what its future looks like.

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Issues With the Canadian Model

The paper identifies several issues that currently exist within the Canadian model, following interviews with executives from the Maple-8 pension funds who identified some problems that the Maple-8, and the Canadian model might face.

The paper discussed the impact of the expectation that Maple-8 pensions’ will be expected to adopt or have adopted net zero climate impact by 2025 and climate targets. Due to this, these pensions will be de facto impact investors, adopting impact in principle.

The paper notes that some executives voiced concerns that investing in green assets would lead to lower investment returns, conflicting with their fiduciary duty to generate strong investment returns. However, the paper also states there is evidence that green investing also provides strong returns.

The paper also states that the Canadian model is not applicable everywhere, citing evidence that for many emerging markets, the Canadian model does not work. Canada and other developed markets have unique circumstances that are not transferable to emerging markets.

As Baby Boomers retire over the next 20 years, this could put pressure on cash withdrawals from these pension funds, as they have high allocations to alternative investments, thus these funds will have to focus less on alternatives, once a staple of the Canada model to meet pension liabilities.

How the Maple-8 Can Adapt

The paper offers many solutions for the Maple-8 to adapt to their changing environment. First, Van Gelderen suggested that the Maple-8 focus on long-term risk management and avoid taking short-term focus, which could do more harm than good.

Finally, the paper suggested that the Maple-8 adopt new technologies and data processes, noting that many of the pension funds are underutilizing newer technologies in their systems.

“New technologies and advanced analytics make the industry less dependent on historical data alone and provides huge opportunities to determine associations and correlations we were not aware of before,” the paper states. “As such, AI application could be found, amongst others, in alpha-generation, total fund management, risk management, and trading. The task for the Maple 8 is to figure out how they will benefit the most, which is dependent on their specific situation and mandate.”

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Tags: Canada, Canadian Model, Eduard van Gelderen, PSP Investments

University endowments returned an average 7.7% in the one-year period ending June 30, 2023, according to the National Association of College and University Business Officers’ annual study of endowments, made in partnership with asset management firm Commonfund. The 2023 report, a version of which NACUBO has released since 1974, tracked 688 university endowments representing $839.1 billion in assets.

Fiscal year 2023’s return of 7.7% was a strong rebound from 2022’s average return of negative 8%, as tracked by that year’s NACUBO study. These figures pale compared to the impressive 30.6% endowments returned in fiscal 2021.

The median endowment of those in the NACUBO study was $209.1 million, while more than one-third had less than $100 million in assets. University endowments also increased their spending during fiscal 2023, withdrawing $28.4 billion during the period, an increase of 8.4% from fiscal 2022.

Still, both NACUBO and other sources found significant discrepancies between endowments when it comes to their asset allocation and size. Alongside NACUBO, Markov Processes International also released its FY 2023 Ivy League Endowment report card, following the performance of endowments that follow the so-called “Yale Model,” pioneered by late Yale CIO David Swensen.

Weak Alts, Strong Equities

Larger endowments historically tended to outperform smaller ones, but interestingly, the reverse was true in 2023, NACUBO noted. Alternative investment returns were weak across the board in 2023, and larger endowments tend to hold more of these types of investments. Smaller endowments hold more equities in their portfolios.

According to NACUBO, endowments with assets greater than $5 billion returned an average of 2.8% during the fiscal year, while endowments with less than $50 million in assets returned an average of 9.8%. The NACUBO study split respondents into seven cohorts, depending on the size of their endowments. The bottom three size cohorts all returned greater than 8%.

As MPI noted, Ivy League and other elite institutions that have been champions of high allocations to alternatives did not perform as well as their equity-heavy peers. MPI’s Ivy tracker, which follows the eight Ivy League institutions as well as Stanford University and MIT, found that these universities returned an average of 2.1% in fiscal 2023, according to the firm’s FY 2023 Ivy report card report.

“If current trends hold, endowments that have higher allocations to private markets, typically larger or more elite schools with well-resourced endowment offices, could struggle relative to smaller endowments that tend to have simpler portfolios with significant exposure to public equities,” says Michael Markov, MPI’s CEO. “Domestic stocks, especially mega-cap technology stocks embodied by the Magnificent 7, are doing well so far in FY 2024. Though rates have jumped recently, bonds have positive performance fiscal year-to-date, too, so schools with relatively more traditional or vanilla portfolios with higher relative exposure to U.S. public markets look set to outperform yet again—should the current asset class performance hold (a big if).”

Will Alt-Heavy Portfolios Shift to Equities?

Likely not, Markov says. “For multiple reasons, it is unlikely that endowments that are heavily allocated to private markets and alternatives veer from the so called ‘Yale model’ after the challenges of fiscal year 2023,” Markov says. “Our research shows that Ivy and elite endowments are risk takers and their portfolios are not particularly efficient. The pressure on valuations and an environment with broken cash flows, deal-making, and fundraising for private markets could also function as a driver of both performance and allocation levels at the schools that have heavy commitments to private markets. Cash distributions to limited partners fell to 11.2% of funds’ NAVs in 2023, the lowest level since the [global financial crisis] and very far south of the 25% median of the past 25-year period.”

Alternative investors are also coping with underfunded commitments, which are at an all-time high, according to data about dry powder, or the amount of money allocated but not yet committed, which across U.S. private equity reached $1.27 trillion as of November 2023, almost double the figure at year-end 2018. Markov says these unfunded commitments could outpace cash distributions by a factor of 8:1.

“In such a capital squeeze environment, being longer-term investors doesn’t exactly help. Even if no new private equity investments are made, endowments will have to fund capital calls from PE funds that they are already invested with,” Markov concludes. “They have no choice. To meet such obligations, they could sell public equities or other liquid investments at a discount and that’s most likely what they have done lately. Our analysis shows that Ivy liquid allocations shrunk in FY 2023. An alternative is to sell private equity to secondaries even at a bigger discount. Either way they lose. This dynamic is likely why you’re not hearing upbeat quotes from Ivy CIOs.”