CPPIB asset allocation scorned and defended

Fraser Institute calls real estate, infrastructure and private equity unproven investments
Friday, February 5, 2016
By Barbara Carss

Real estate analysts suggest there’s more ‘tank’ than ‘think’ in the Fraser Institute’s recent characterization of the Canada Pension Plan Investment Board’s (CPPIB) asset allocation strategy. A newly released Fraser Research paper comparing the administrative and investment costs of six public pensions ranks the CPP’s expense ratio as the highest — at 1.07 per cent of its asset value — and ties it, in part, to consultation fees related to alternative asset classes, including real estate, infrastructure and private equity. The report’s authors, Philip Cross and Joel Emes, further argue that these illiquid assets make for an unproven and risky investment strategy.

“The strategy presumes first that these assets are mispriced because they are relatively unknown and infrequently traded, and second that the mispricing of assets is on the low and not the high side,” the economists theorize. “In other words, there is a presumption of market failure in price discovery, which large pension funds can identify and profit from better than other investors such as hedge funds.”

For their part, however, real estate investment specialists provide a more comprehensive set of reasons for their actions and faith in the asset class. Notably, it comes with its own revenue generating capacity, which can be used to fund further investment and protect against inflation — attributes particularly aligned with a pension fund’s defining obligation to pay out to plan members.

“If there is growth and interest rates rise then hard assets can typically increase rents,” says Chris Langstaff, senior vice president, research and strategy, with LaSalle Investment Management. “Real estate is less liquid — you can’t sell it in a day, like a stock — but not completely illiquid. At the same time, large pension funds like CPP have a long-term perspective. Unlike publicly traded companies, they can ignore mark-to-market volatility and focus on building a durable long-term income stream.”

Despite Cross and Emes’ somewhat unique position that CPPIB’s investment strategy is “an experiment in progress, not the execution of a proven strategy”, institutional investors have long relied on real estate for diversification and risk management.

“It’s portfolio theory 101,” observes Michael Brooks, chief executive officer of the Real Property Association of Canada (REALpac).

Scrutiny of CPPIB asset allocation is part of the Fraser Institute’s larger critique of CPP costs, of which investment related expenses are a major portion. While the report concedes “the more expensive plans could justify higher costs if they generated higher investment returns”, Cross and Emes question the current reporting of those returns.

“Many of the investments made by pension plans in infrastructure, real estate and private equity are long-term illiquid investments that are often without a recent reference price. This allows management some discretion in their valuation and it is in management’s interest to maximize these valuations while minimizing the returns on assets in the benchmark group,” they submit.

Regardless, yesterday’s release of the REALpac/IPD Canada Property Index in Toronto revealed a 10-year return of 10.3 per cent on index participants’ directly held standing investments versus 10-year returns of 5.8 per cent on bonds and 4 per cent on equities.

Speaking at an event in conjunction with the index release, CPPIB director Sharm Powell pegged the fund’s real estate holdings at $40-billion or about 14 per cent of total asset value. While the Fraser Research report singles out CPPIB for its purported unproven investment strategy, the five other examined public pension plans — Healthcare of Ontario Pension Plan, Ontario Teachers’ Pension Plan, Ontario Municipal Employees Retirement System, Ontario Pension Board and Ontario Public Service Employees Union Pension Trust — are also represented in the index.

Barbara Carss is editor-in-chief of Canadian Property Management.

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