Monday, October 1, 2012

Good pensions for all? Is this even possible?

I had an interesting chat about pensions with a fellow who thought everyone should be assured a decent pension on retirement. Canadian civil servants have such pensions, why don't all Canadian workers?

It is an excellent question that defies an easy answer. My gut instinct tells me that if every worker in the world saved properly for retirement, all that retirement money would control every decent equity investment on the planet.

Think of the Norwegian Pension Fund, possibly the largest sovereign fund in the world. Just this one fund owns a little more than 1 percent of all global stock.

At one time most public pension systems, the Canada civil service plan among them, met pension demands out of the country's general revenues. In Canada, for those who retired prior to April 1, 2000, this may still hold true. Since that date, the Canadian federal public service pension plan (which includes military pensions) has been an independent pension fund, administered by PSP Investments. It does not pay it’s pensions from government revenues, but makes it’s money by investing in private markets, equities and real estate, just like any other pension plan. (Note: The Reserve Force didn't come under the PSP umbrella until after March 1, 2007.)

Pay-as-you-go plans, also known as unfunded plans, have lost support. Many compare such approaches to Ponzi schemes. This is not to say they are Ponzi schemes but only that they share attributes with the famous con. Both pay off early members of the scheme with money provided by late joiners.

The pay-as-you-go system is not as foolish as it seems at first. In a booming economy with a growing labour pool, an unfunded plan can deliver on its pension promises for many years. But sooner or later many argue such plans must do one or more of the following:

  • raise the contribution level (raise taxes)
  • raise the age of retirement (Think of OAS in Canada — an unfunded plan. In the future, retirement will begin at age 67.)
  • cut payments to pensioners
  • cut benefits from other programs to fund pension liabilities (Rob Peter to pay Paul.)

There is no reason to believe that pension rules cannot be changed, even for those already drawing a pension. Read the following from The New York Times:


Residents of San Diego and San Jose voted overwhelmingly to cut the pension benefits they give city workers. And they did so in a way governments traditionally avoid: moving to cut not just the benefits of future hires, but also those of current city workers, whose pensions generally have much stronger legal protections than those of private-sector workers.

Let's take a closer look at the PSP Investments board. It has $64.5 billion of assets under management as of March 31, 2012. It invests funds for the pension plans of the Public Service, the Canadian Forces, the Royal Canadian Mounted Police and the Reserve Force. A team of 400 professionals manages the diversified global portfolio of stocks, bonds and other fixed-income securities, plus investments in Private Equity, Real Estate, Infrastructure and Renewable Resources.

Investment boards are becoming the preferred approach for managing pension funds and meeting pension obligations in the future. The following are just a few of the investment boards found in Canada.


Will investment boards be able to meet tomorrow's pension demands? The short answer: Maybe. The truth is that no one knows the future. Risk is part of life and risk is inherent in any plan based on investing in the global stock markets.

Among the risks faced by these funds are:

  • market risk
  • liquidity risk
  • leverage risk
  • concentration risk
  • credit and counterparty risk
  • governance risk
  • strategic risk
  • operational risk
  • stakeholder risk
  • legal and regulatory risk
  • reputational risk

The recent returns of many funds have raised doubts. In 2009 the PSP lost almost 7 billion dollars (Cdn.). To put this in perspective, in fiscal year 2012 net investment income was more than one and a quarter billion dollars with net assets surpassing $47 billion. On the downside, the recent return for the fund was only 3 percent. This is not adequate. PSP calculates it needs a real return of at least 4.2 percent.

In recent years, I have beaten the PSP fund but I am a small investor and can move in and out of the market without causing a ripple. Still, with so much money pouring into global markets under the control of thousands of well-managed pension funds, how long until I will be unable to find suitable investments for my personal pension portfolio?

I already compete with the pension investment boards. Take the top ten PSP investments and you have ten of my personal favourites too. But investment boards have interests going much deeper than banks, Reits and resources.

Have you ever taken the 407 toll road north of Toronto and cursed its capitalist owners? Glance in the mirror. If you have a connection to CPP, you have a connection to that highway.

The CPP investment team saw the toll road as a great asset. For one thing, the owners can charge as much as they like, and there is no prospect of new competition. CPP bought 40 percent of the highway at a cost of $4 billion. It has since syndicated part of the stake, reducing its share to 29%.

Or take REITs, a favoured investment of Canadians running their own personal RSP portfolios. CPP in a joint venture with another fund bought real estate from London Life Insurance Co. The move by the CPP Investment Board signals its move to invest 5 percent of its holdings in real estate.

I have something in the order of 15 percent of my retirement funds in REITs around the world. Now I find myself competing with giant investment funds with billions of dollars in their war chests.

Which brings me to the question posed by this post:

Are there enough good investments, even if one is willing to search the whole globe, for all the world's pension funds to find good, high-yielding, homes?