Home Capital Markets Professor Kesselman’s arguments for “Big CPP” don’t hold water

Professor Kesselman’s arguments for “Big CPP” don’t hold water

I’m sure that he means very well, and perhaps he’s well-suited for a life in the political realm as a candidate of the Left, but there is so much that’s wrong with a recent Globe article by Rhys Kesselman regarding the Canada Pension Plan and the alleged benefits of increasing its current promise. I’m concerned that he’s backing the “Big CPP” initiative based upon some flawed research by one of his graduate students. How else could someone so accomplished have such a mis-appreciation of the key principles of the issue he claims to be tackling on our collective behalf.

From his public sinecure at Simon Fraser University, Dr. Kesselman argues that dramatically increasing CPP contributions is not a “job-killing payroll tax”, and that young workers would be “the largest beneficiaries.” He takes particular issue with William Robson’s analysis of the “Big CPP” proposals; for me, I side with the C.D. Howe Institute on this one.

Like so many of the well-meaning people peddling this enhanced CPP concept to Provincial politicians and influential members of the media, Dr. Kesselman starts with the assumption that: 1) investing via the CPP Investment Board will produce better returns than what can be achieved via a private sector manager, 2) the CPPIB is more cost-efficient than investing via private managers or other public sector plans, 3) the promised enhanced benefits “will” be there in 40 years, provided that we employers and workers pay now, and 4) the private sector won’t notice the cost increase that comes with all of the various proposals to expand the Canada Pension Plan. According to Dr. Kesselman, these are all just “misconceptions” on the part of we doubters (see prior post “Is now really such a good time for a new Ontario pension plan?” Oct. 17-13).

Let me take you through Dr. Kesselman’s key arguments, and the reality from Bay Street:

Kesselman: Young workers will be the largest beneficiaries of an enhanced CPP.

This cannot be known, as the nature of investing has no guarantees. It is subject to timing, currency moves, inflation and so forth. This is generally understood, of course, but seems lost in all of the arguments being made by “Big CPP” proponents. In his recent Globe piece, Dr. Kesselman suggests that “young workers…would stand to get the full increase in [Big] CPP benefits.” If he was a mutual fund manager, the regulators would fine Dr. Kesselman for not including the proviso that investing involves “risk”, and that there are no guarantees as to the future performance of the investment in question.

During the period of 1929 to 1954, or 1962 to 1983, for example, the Dow Jones Industrial Average was largely flat. Although middle aged Canadians will have no recollection of those days of dead money, our parents, grandparents and great-grandparents each experienced their own 20-25 year period where the main world market index produced no meaningful return. This was repeated, although for a shorter 13 year period, during our own generation’s investing horizon when the S&P 500 index showed no gain from 1999-2012.

If young workers experience a similar 20 or 25 year horizon of zero equity returns, which might be almost guaranteed based upon the last 100 years of market index tracking — and this happens to coincide with the meaty earning years of their, say, 38 year careers — it seems unlikely that the capital pool will be available to pay the benefits being promised by Dr. Kesselman and the other members of the “Big CPP” echo chamber.

Fans of private equity may argue that value can be created in that asset class, regardless of the performance of the public markets, over that 20 year period; and that vehicles such as the CPPIB are just the avenue for such access. True enough, except that the PE industry as we know it got rolling in the early 1980s, which coincides with the greatest bull run in public market history. It is also true that the worst performance window in the last 20 years of the PE business happen to overlap with the great market crash of 2008-09.

When the public investing climate is tough, as a result of global political strife or economic stagnation, for example, there is no body of evidence to suggest the private markets will merrily sail along. Certainly not one that an academic could point to for proof of the theory.

Kesselman: “Skeptics also question whether the CPP Investment Board can achieve the 4-per-cent annual real rate of return needed for even the existing level of benefits to be sustainable. If any investing entity can achieve this rate of return over the long run, it is more likely the CPPIB than a private pension plan, mutual fund, or private investment manager.”

This is laughable, and undercuts Dr. Kesselman’s credibility on the entire issue.

Through its first 15 years in business, there’s nothing in the CPP Investment Board’s track record that suggests this is true. In fact, the opposite is the case.

A simple review of the Globe and Mail mutual fund database uncovers the simple reality that over the past 10 years, which represents lion’s share of the CPP Investment Board’s investment track record and is a fair representation of relative performance over an extended horizon, dozens of Canadian and international mutual funds have produced returns in excess of the CPP Investment Board’s gross 7.4% 10 year rate of return, as published in its 2013 annual report.

Kesselman: “Unlike private entities, the CPPIB does not need to charge fees and generate profits, and its massive scale and professional staff operate at lower administrative cost than its private counterparts.”

This proposition is just plain silly, as the CPP Investment Board spent approximately $800 million on fund management costs in its last fiscal year. That’s a lot of cabbage to generate a gross return of 10.1% — a return which was below both the CPPIB’s own internal benchmark (meaning the team didn’t add value) and the total return of the S&P 500 index. Once you take into account the $800 million CPPIB spent on internal and external fund managers, it performed well below the broader market.

As much as the CPPIB isn’t out to make a profit per se, its senior management compensation program is richer than anything you’ll see at a mutual fund for a Portfolio Manager with a few billion under administration.

Earlier this year, I revisited my earlier work regarding the cost of managing the investment portfolio of the CPP Investment Board to similar Canadian vehicles, such as Ontario Teachers, Hospitals of Ontario Pension Plan and OMERS (see prior post “Why is CPPIB’s MER higher than its peers?” Jan. 9-13). The CPPIB was the most expensive of the entire bunch, despite having the largest pool of assets under management. Instead of saving Canadians’ money as the CPP grew between 2005 and 2012, it had actually become more expensive to manage each incremental dollar.

According to the Jim Keohane, CEO of HOOPP, this isn’t a surprise, as his former boss wrote in response to a blog in 2011 (see prior post “Does Ontario really need five Pension Plans? part 2” Dec. 15-11):

“…once a fund grows beyond $75 billion in assets the real risk is diseconomies of scale as costs can actually start to go up.”

And even if CPPIB could manage my retirement savings for half of its current MER, I can still find plenty of index fund ETFs to do it still cheaper, even then.

Kesselman: CPPIB “is not constrained by financial returns in the slower-growing Canadian economy.”

None of us are.

There are dozens of North American-based fund companies with investment vehicles that will give me as much exposure to the global economy as I can tolerate. And many will hedge my Canadian dollar investment too, if I want. Unlike the CPPIB, which has taken the decision to not hedge the exposure they are taking to changes in global currency valuations. Changes that have cost us money, to date (see representative prior post “Our $3.4 billion Private Equity currency hit at CPPIB” Feb 18-13).

Kesselman: The CPPIB can take a much longer-term perspective on investment portfolios than any individual investor, on account of pooling the CPP contributions of the entire labour force across all ages. This factor also allows the CPP to be more heavily invested in equities versus lower-return fixed-income assets than a typical worker would be prudently advised in the last 15 years before retirement.

This is a curious statement, since the CPPIB had about half of our capital in assets other than equities as of the end of its most recent fiscal year. The Fixed Income bucket had more than 32% of our capital, while Real Assets had been allocated just over 16%. If, as Dr. Kesselman says, I had 15 years to go before retirement, I doubt my investment advisor would suggest anything more conservative than a split of 50/33/17 between Equities/Bonds/Real Assets.

I could go on, but I think you get the point.

There may be plenty of reasons why “Big CPP” makes sense, but Dr. Kesselman has yet to share them with us. Perhaps, if he was prepared to give up a defined benefit pension plan, such as the one that’s often associated with University faculty jobs (and guaranteed by the taxpayers of British Columbia), and roll it into the “Big CPP”, that would be all the evidence we need that this idea will live up to his promises.

Until then, he should let my investment advisor manage my savings for me.

(disclosure: this post, like all blogs, is an Opinion Piece)

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