Monday, July 27, 2009

Risky investments

There is an interesting table in the August 17, 2009 issue of Canadian Business that shows the investment returns earned by some of the largest pension plans in Canada. The returns are shockingly poor, particularly considering the amount of expertise hired by these plans to keep everything in order.

The last published one year returns, the 10 year average returns to the last date published and the yield on 10 year Canada bonds for the same period were:

Casse de depot: -25.0%, 3.6%, 4.9%
CPP Investment Board: -18.6%, 4.3%, 5.0%
Ontario Teachers Pension Plan: -18.0%, 6.6%, 4.9%

In a recent article in The Gazette, Alban D'Amours, who was the head of the risk management committee of the Caisse de dépôt et placement du Québec put part of the blame for their loss on tainted non-bank asset-backed commercial paper (ABCP). When asked about these risky assets, he stressed that the Caisse didn't take more risks than what was laid out in its risk policy. But one has to question why any investment at all was made in ABCP and how could a risk management policy for a “public” fund allow this to happen. The questions are the same for all of these plans: who is really bearing the risk of a financial shortfall and, if it’s the public who will have to pay up in the end, how are the potential costs to the public taken into account in the risk policy of the pension plan?

D'Amours, like other managers of the Caisse, refused to shoulder any of the blame for what they call a "perfect storm" that hit the pension fund by surprise. This reminds me of a comment by Warren Buffett, “it’s only when the tide goes out that you learn who’s been swimming naked.”

Here’s the view from actuarial researchers Lawrence N. Bader and Jeremy Gold from their paper, The Case Against Stock in Public Pension Funds:

“Current funding and investment practices are costing taxpayers dearly. We are not directly addressing the losses of the past few years, which we can all hope are temporary, but the poor decision-making that stems from failure to understand the risks of equity investment.”

Essentially, equity or similar investments by these plans involves many risks besides the market risks:

• intergenerational taxpayer conflicts (risk transfers masquerading as risk sharing),
• undercharges to employees’ compensation packages for the value of the pensions,
• employee claims on pension surplus, and
• higher governmental borrowing costs (once new accounting rules bring forth the real plan costs and liabilities).

This may be an opportune time to start dealing with these issues and to make sure the public interest is served in the process. If there are additional costs, which is likely, let’s deal with them now so as a country we can be more competitive for the future.

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