A WASTEFUL INVESTMENT
Ontario’s planned pension plan won’t be more efficient than the bumbling CPP
Among the list of arguments advanced for the proposed Ontario Retirement Pension Plan (ORPP), which with the re-election of the Liberal government will now suck up $3.5 billion of Ontarians’ savings every year to invest on their behalf, efficiency was near the top.
Not only are the province’s hapless citizens chronic undersavers, as the recent budget lectured them, but if left to invest unchaperoned they simply would blow it all on things like mutual funds, with their notoriously high management fees. That much is true: people who invest in mutual funds, of the kind that blanket
Nobody earns the same return as the index: there’s always some cost involved.
the airwaves with claims of their superior returns at RSP time, are suckers — of which there are, by one estimate, more than 525,000 added to the population every year.
But the premise that, by forcibly merging everyone’s savings into one big government-sponsored fund, such waste can be avoided, does not necessarily follow. I’ve had a look at several years’ worth of annual reports from the Canada Pension Plan Investment Board (CPPIB), on which the ORPP is to be based (indeed, the government cites the plan as a fallback from its preferred position, of simply expanding the CPP). It was hard slogging: the figures on costs are buried in acres of print near the back. But the picture that emerges is unmistakable, and gives the lie to any claims of savings.
In the last fiscal year (ended March 31), the board incurred costs of about $1.74 billion, or nearly one per cent of the $183.3 billion in assets it started the year with. (The fund now stands at $219 billion.) Of this, about $1 billion was in fees paid to exter- nal managers, who invest on the board’s behalf. Another $200 million or so was in transaction costs — the cost of executing trades and acquiring assets. The rest, nearly $600 million, was in general operating costs. During the past four years, total costs have more than doubled; since fiscal 2007, they are up roughly seven-fold.
The choice of year is significant: in the 2007 fiscal year the board switched from a purely “passive” investing strategy — that is, simply “buying the index,” seeking to replicate the performance of the broad market in each asset class, rather than trying to pick particular stocks or bonds — to “active” management, including a major plunge into private equity and other relatively risky assets, in hopes of earning higher returns than the average. It hasn’t really worked out that way.
In the eight years since it shifted to active management, the CPPIB’s return on investment, net of all costs, has beaten its “reference portfolio” — made up of the indexes for each of the asset classes in which it invests — just four times: 2007, 2008, 2011, and 2012. The other four times it lost. To be sure, in those four good years, it beat the reference portfolio by an average of two percentage points. Add it up, and the board estimates its efforts “added value” to the tune of a cumulative $3 billion, meaning the fund is worth about 1.4 per cent more, eight years later, than it would have been without them. But it spent more than $7.5 billion to do so. And there’s no guarantee even that meagre gain won’t be wiped out next year.
A not inconsiderable part of the bill went in salaries to its senior executives. The seven top managers listed in the annual reports collected an average of $3 million apiece in total compensation last year. (Admittedly that was a good year, but it’s commonly in excess of $2 million.) There’s no need to begrudge them that — they’d probably pull down something comparable in the private sector. But that’s the point: in the private sector, it’s sucker money they’re collecting. Whereas with a compulsory fund like the CPPIB, it’s all of our money.
CPP execs were in the papers boasting of the 16.5 per cent return they earned last year — 16.2 per cent after operating costs. Great: the reference return was 16.4 per cent. That’s the average, meaning it’s the return you could expect to collect, on average, just by picking stocks (and bonds) at random — the proverbial flinging darts at the stock listings, if newspapers still had stock listings. You don’t need to pay people $3 million each to slightly underperform the average. (For example, I would be willing to do it for onethird as much.)
That’s not quite fair. Nobody earns the same return as the index: there’s always some cost involved. But the costs the CPP is incurring are vastly higher than they would be had it stuck with the original passive strategy. My own little portfolio of exchangetraded funds (ETFs), all of them strictly index-based, has an average management expense ratio of 0.19 per cent — less than a quarter the CPP’s.
I don’t mean to suggest the CPP is doing anything wrong, or corrupt. As investment funds go, I’d guess it’s better managed than most. Certainly it hasn’t behaved anywhere near as foolishly as Quebec’s Caisse de dépôt, which lost one-quarter of its value in 2008 after betting heavily on assetbacked commercial paper, nor does it compare with the continuing mess at the Alberta Heritage Savings Trust Fund. It’s only making the same mistake as all the other actively managed funds — or rather the people who invest in them: thinking they can beat the market.
The evidence on this is overwhelming: in any given year, twothirds to three-quarters of actively managed funds get taken to the cleaners by their index. Over a 10-year period, it rises to 90 per cent. Their managers aren’t stupid: they just aren’t any smarter than all the other smart managers out there.
The only way you can beat the market is if you know something everyone else doesn’t — new information, not previously public — and not just once, but routinely. That’s not just hard to do. It’s damn near impossible.
Which is why the smart money buys the index, and leaves the sucker money to do the heavy lifting.
And yet the CPP is spending $1.74 billion a year of your money and mine in the same futile attempt to beat the index. And the Ontario government is about to copy them. Because, God forbid, they leave it up to you. Suckers.