September 28, 2021

One Big Reason Canadian Plans Are So Well Off: International Investing

Their overseas exposure is expanding, while US funds stay mostly at home.

Reported by Larry Light

Art by Brian Scagnelli

A big part of Canadian public pension plans’ success lies in their international orientation. Compared with their US counterparts, the Canadian plans have vast amounts invested outside their home country, which enhances their diversification and gives them healthy exposure to fast-growing, albeit potentially erratic, developing economies.

In addition to non-domestic holdings, a World Bank study of Canadian plans cited insulation from politics (they aren’t beholden to state or municipal lawmakers, as are US peers) and in-house management (to keep costs down) as key factors in their achievement.

“The Canada model” features the largest concentration of assets in the neighboring giant to the south, but still has major investments scattered across the globe, especially in emerging markets (EMs). Big infrastructure projects are a favorite destination for Canadian pension cash—especially ones with an environmental, social, and governance (ESG) tilt.

This broad-ranging international investing strategy arrangement has a lot going for it, the World Bank study argues. While US markets have outpaced much of the rest of the world lately, that wasn’t always true. And many investment strategists argue that broader bets placed globally, beyond the giant US, will pay off better in the future. In equities, for example, Northern Trust projects that annual returns for the next five years will be 4.3% for the US and 5.3% for EMs, a full percentage point better. (Canadian investments generate estimates that are on par with the EMs, at 5.2%.)

The World Bank report found that the top 10 Canadian pension funds had international assets comprising 77% of their public equities, 28% of fixed income, 85% of private equity, and 74% of real estate.

Canadian public plans are in much better financial shape than their US counterparts. In Canada, almost all of the public plans are fully funded, whereas in the US the figure is only 69%, per Pew Charitable Trusts. Pew, however, does expect the American funded status to shoot up to 84% this year, thanks to larger employer contributions and a buoyant stock market. Still, that will fall short of the benign situation in Canada.

The contrast is most vivid when comparing the holdings of the two nations’ largest public defined benefit (DB) pension plans, whose enormous asset totals dwarf their home-country peers: the California Public Employees’ Retirement System, or CalPERS ($487 billion), and the Canada Pension Plan Investment Board, or CPPIB ($406 billion), both in US dollars. (Technically, the Canadian program’s investment board is separate from the actual pension program and runs the retirement fund’s money.)

As of their most recent reports, CalPERS invests 75.4% of its portfolio in the US, whereas the Canadian board has just 16.6% in its own country. CPPIB, with investments in 56 nations, has offices in New York and San Francisco, as well as in Hong Kong, London, Luxembourg, Mumbai, São Paulo, and Sydney. CalPERS has no foreign outposts.

Other differences: the beneficiaries of these two behemoths. CalPERS furnishes retirement benefits of state and municipal workers. Any Canadian can sign up with the Canada Pension Plan, which is voluntary and supplements the equivalent of the US’s Social Security. The Canadian plan is fully funded, and the California one is not, at 82% of obligations as of fiscal year-end June 30. Nevertheless, by US standards for funded status, CalPERS is near the top.

Pension plans, wherever they’re based, are by their nature patient organizations, as they serve the long-run needs of their beneficiaries. That goes double for Canadian plans. It’s seldom that they get involved with initial public offerings (IPO), for instance, which come with high expectations for large surges at the outset.

“They don’t need an IPO story and are willing to put half a billion dollars and wait for the next 10 to 20 years. They are happy to come last but to a stable and long-term asset story,” said Mahesh Kolli, founder at Greenko Group, backed by sovereign wealth funds GIC of Singapore and Abu Dhabi Investment Authority, in comments to the Mint investing site.

There are a couple of other causes for Canadian plans to have such a strong foreign investment bent. One is that most of them started late, in the 1980s and 1990s, say pension experts. (CPPIB was launched in 1997.) That was the time when developing markets drew attention as hot growth prospects, so this was a fruitful area for the new plans to get into. The second cause is that Canada, even though it has the 10th largest world economy, with a gross domestic product (GDP) of $1.7 trillion, has a limited amount of assets to invest in within its borders.

“We have 4% of the global equity market, so finding investments is more difficult and you must go outside,” said Fred Pye, former national sales manager of Fidelity Investments’ Canadian operation and now CEO and chairman of digital asset manager 3iQ in Toronto. The US, with the world’s largest stock markets, has a $21.5 trillion GDP.

Certainly, a number of US plans also have a robust international presence. In fiscal 2020, the Teacher Retirement System of Texas, or TRS, ($164 billion in assets) held 37.5% of its portfolio in international stocks and bonds. The program opened a London office in 2015. Four of its top 10 holdings are in Asia, with China’s online retailer Alibaba Group coming in as the Texas fund’s largest stock investment.

The Canadian Colossus

For a good snapshot of how Canadian plans go about their overseas forays, let’s take a closer look at CPPIB, whose 20.4% return during the 2021 fiscal year ending March 31 proved to be its best showing since its creation. (It rose 3.5% for the first quarter that concluded June 30.) The benefits of diversifying abroad are clear. Homegrown stock investments did the best most recently. International equities returned a net 29.1% and Canadian stocks were up 40.8%. But the year before, which covered the pandemic downturn, foreign shares were at least in the black, up 1.6%, as Canadian ones dove 12.2%.

A lot of the fund’s public equity investments are in the US (36.9% of its assets, making America the plan’s largest national allocation), with positions in such companies as chip maker Nvidia, credit card provider Mastercard, and railroad Union Pacific. But the case is strong for expanding its allocation in EM nations, CEO John Graham said in recent remarks, reported by Bloomberg. Right now, about a fifth of assets are in EMs including Brazil and India, he said, “despite the humanitarian crisis that’s seen those two countries suffer more COVID-19 deaths than any other besides the US.” Over the next four years, he wants to increase the EM share to a third.

“We were really able to monetize all the effort we put into building this organization with a global footprint over the past 10, 15 years,” the CEO said. “We have the expertise internally on all the different asset classes. It allowed us to navigate through the early days of the pandemic and then turn our mind to being offensive and looking for opportunities.”

Over the past 12 months, Canadian plans have been particularly busy gobbling up assets in India, with CPPIB at the forefront. In June, CPPIB announced it was plugging US$77 million into developing a shopping center in the affluent Alipore, Kolkata, neighborhood in India, as part of a new joint venture with mall operator Phoenix Mills. In April, the Canadian plan invested US$210 million to develop 10.4 million square feet of office space in India, partnered with Indian developer RMZ.

Broad-Based Expansion

Other Canadian funds are energetically expanding their international footprint. Take Caisse de dépôt et placement du Québec (CDPQ), with assets of US$289.6 billion, which in the difficult fiscal year ending in December 2020, logged a 7.7% return. Over two-thirds of its assets are invested internationally. CDPQ’s assets are 32% in Canada and 35% in the US, with 14% in Europe, 12% in the Asia-Pacific region, and 4% in Latin America.

Earlier this month, it announced a US$8 billion deal with local partners to acquire WestConnex in Australia, a 70-kilometer toll road linking Sydney’s west and southwest to the city center, the Sydney Airport, and the Port Botany seaport.

The Ontario Teachers’ Pension Plan (OTPP), with US$180 billion, also did OK in the fiscal year closing last Dec. 31, reporting a net return of 8.6%.

Infrastructure is getting increasing attention from this group. Ontario Teachers’ added to its infra bets this year, buying stakes in the operator of thermal energy systems Enwave Energy in Canada, electricity transmission platform Evoltz Participações in Brazil, and electricity distribution system operator Caruna in Finland. The fund has recently opened up a Singapore office, initially staffed with people from its infrastructure group.

“We have a very global mindset and a great global perspective—we have a global investment committee, we all sit on it, and we evaluate, you know, a toll road in Australia against a toll road in Mexico against a toll road in Europe,” Dale Burgess, senior managing director for infrastructure and natural resources, told the Financial Post. Burgess said he’d like to lift the level of investment in infra to US$33 billion, almost double its current level.

Meanwhile, the plan also has wagers in other asset classes across the globe. It recently announced it is investing US$350 million into performing and distressed private credit in India.

There is a constant flow of foreign corporate acquisitions from Canadian pension programs, sometimes going solo, sometimes with partners from the target’s country, sometimes with Wall Street outfits. The Alberta Investment Management Corporation, or AIMCo, with US$94 billion in assets, just bought Australia’s Lawson Grains. Its co-investor is New Forests, a North Sydney farm and forestry investment manager.

And the Ontario Municipal Employees Retirement System, aka OMERS, (US$90 billion) has teamed up with Goldman Sachs to buy a majority stake in Germany’s Amedes Holding, a provider of medical-diagnostic services including COVID-19 tests.

Canadian pension systems “are the top ones for global real estate, ESG, and infrastructure, and have no problem investing in airports and highways” around the world, 3iQ’s Pye said. “They have a real global vision.”