The Canadian pension system is considered by many to be one of the best in the world, and the envy of other asset owners. The major Canadian pensions, known colloquially as the “Maple 8” operate on a model which emphasizes internal management of assets and direct investments.
This model has led to these funds’ investments outperforming their peers, and all of them have a significant funding surplus. Combined, these investors manage over $2 trillion in assets for tens of millions of beneficiaries, an impressive feat for a country of fewer than 40 million people.
These funds are very much global investors; however, some Canadian leaders have criticized the pension funds for not investing as much domestically as the do internationally. In March 2024, a letter signed by 90 executives of Canadian companies called for Canadian funds to make more investments domestically.
In April, Stephen Poloz, a former Bank of Canada governor, was appointed as the head of a federal working group that will examine how the government could encourage domestic investing from the country’s pension funds.
The letter, as well Poloz’s position, have contributed to a debate in Canada in whether pension funds should be mandated or encouraged to invest more domestically.
A recent paper from authors Keith Ambachtsheer, Sebastian Betermier and Chris Flynn titled “Should Canada Require its Pension Funds to Invest More Domestically” from the Global Risk Institute addresses concerns over the level of domestic investment by these funds and offers some solutions. However, it warns against government mandates to ensure domestic investments.
“We caution against adopting government policies that mandate Canadian pension funds to invest domestically, as such policies will upset the funds’ risk-return calibrations and expose pension plan members to potential financial losses,” states the paper, which compares the domestic and international pension investing of 157 pensions from the U.S., Canada and the U.K.
The paper warns against having too much market exposure, especially in a time where investors are trending towards more global diversification. “A portfolio with too much invested in one market is more exposed to that market’s performance fluctuations,” the paper states.
This is a point brought up by several pension funds in the country. “While we continue to seek opportunities in Canada, we also need geographical diversity in our investment portfolios because diversification allows you to make sure you don’t have all your eggs in one basket and is, therefore, key for managing risk,” says a spokesperson for the Healthcare of Ontario Pension Plan, a CAD 112 billion ($73 billion) plan which invests more than half of its assets in the country.
This risk is especially high in a country like Canada, where the population is smaller than that of California, and where the economy is smaller than that in Texas. The Canadian economy is also concentrated among three sectors, energy, financials and materials.
The paper argues that there cannot be a lack of capital invested in Canada, because global institutional investors also are investing in the country. “There is no reason to conclude that Canadian companies have less access to capital because Canadian pension funds are investing less domestically,” the authors wrote. “If Canadian funds are investing more abroad, so are the funds from Australia, Europe, the Middle East, Singapore, the UK, and other countries.”
What should be done, the authors suggest, is to determine where the barriers to entry to investing in Canada are: “If Canada is not receiving its share of foreign or domestic capital, then it must have a structural problem that is setting up barriers to investing in Canada.”
Investing In Canada
It is true that Canadian pension funds have been decreasing their investments domestically, however this is true for all geographies that the paper surveys. From 2013 to 2022, Canadian pension investors decreased their allocations to domestic equities to 18% from 33% .
Still, this 18% figure is quite large, when compared to the share that Canadian equities make up global equities. The domestic Canadian equities market makes up roughly 4% of global equities. The size of the Canadian TSX stock exchange is roughly $2.8 trillion, less than the value of one Nivida, or just more than two Metas.
Across the pond, U.K. pensions saw their allocations to domestic equities fall to 18% in 2022 from 34% in 2013, according to the paper, in line with the Canadian plans’ domestic allocations. U.S. pensions saw their allocations to domestic U.S. equities fall to 37% from 49% in the same period. In a separate study of Dutch pension funds, these investors decreased their domestic equity exposure to 13% in 2016 from 37% in 1992.
The paper notes three takeaways, Canadian pensions are disproportionally overallocated to Canadian equities, and that the domestic share of these investments have decreased from 2013 to 2022, however, none of these trends are unique to Canada.
A spokesperson for one Canadian pension fund tells CIO that while the fund is eager to invest more in Canada, investments in the country need to meet the plan’s risk/return needs.
In their fixed income portfolios, Canadian pension funds saw their allocation to domestic fixed income decrease to 88% in 2022 from 96% in 2013. In the U.K., the allocation to domestic fixed income as a total of fixed income portfolios increased during the same period, to 83% from 69%. In the U.S., this figure was virtually unchanged, at 95% in 2022 from 94% in 2013.
Canadian pension funds allocated roughly 7% of their private equity portfolios to domestic investments, 57% of Canadian real estate investments were domestic, and so were 7% of these pensions’ infrastructure investments.
In Australia, these figures were 6%, 61% and 46% respectively. In the U.S., pension funds allocated 68% of their PE portfolios to domestic opportunities, 82% in their real estate portfolios and only 17% to domestic infrastructure.
These variations can be easily explained, most private equity activity happens in the U.S., while both the Australian and U.K. governments monetize their infrastructure assets, Canada does not, and could provide a reason as to why the Canadian pension funds allocate only 7% of their infrastructure portfolios domestically.
In the March letter, Canadian business leaders complained of the decline in allocations to Canadian equities. “Canadian Pension Funds have reduced their holdings of publicly traded Canadian companies from 28% of total assets at the end of 2000 to less than 4% at the end of 2023,” that letter stated.
The papers response, “This statistic is difficult to interpret because it combines two effects: 1) the decline in the stock portfolio’s domestic share discussed in Section I.B, and 2) the rebalancing of the pension funds’ total assets from public investments towards private investments over the past two decades.”
Barriers, and Solutions to Domestic Investing
When it comes to domestic infrastructure investments, the paper notes that a majority of assets with high strategic value for pension funds are owned by the Canadian government as well as public authorities. Domestic infrastructure assets like airports, ports, hydropower generating assets and other public infrastructure assets are not for sale, locking out the country’s pension funds from their ownership.
Canadian pensions are already owners are part owners of a number of airports and other utility companies abroad, such as London Heathrow Airport, in which Quebec’s CDPQ holds a stake, and U.S. marine terminal operator Ports America, which is wholly owned by the Canadian Pension Plan Investment Board.
The paper suggests that solutions could come in the form of monetizing Canadian infrastructure assets, either through privatization, or through public/private partnerships. The 2024 national budget of Canada could open the door to such privatization, the government will release a policy statement on the issue sometime this summer.
Regulatory hurdles also exist for domestic infrastructure investments in Canada. The paper notes that it takes on average 249 days to receive a construction permit in Canada. In the U.S., it took only 80 days, according to 2019 data from the World Doing Business Index. The economic viability of such projects in Canada could come into question, as permitting issues could deter pension funds from engaging in large greenfield projects.
“Government initiatives that reduce the barriers to domestic investing by facilitating access to strategic asset classes will not only retain and attract capital from Canadian pension funds but also bring in additional capital from the much larger pool of foreign investors,” the paper concludes.
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Tags: Canada, CDPQ, Chris Flynn, HOOPP, Keith Ambachtsheer, Maple 8, Pensions, Sebastien Betermier