The head of Canada’s largest pension plan says his fund is ready to take advantage of economic instability.Last week, I made an exception and discussed CPPIB's fiscal Q1 results as assets topped $400 billion CAD.
“We like to be able to take advantage of the opportunities that happen when everyone else is stressed,” Canada Pension Plan Investment Board Chief Executive Officer Mark Machin said in an interview with BNN Bloomberg Tuesday.
“That really should be one of the defining features of funds like ours. We have incredibly stable money, incredible long-term money. So, when other funds are suffering redemptions, or banks are under stress, we can buy assets at prices that come up once in a generation.”
The key, Machin says, is to rigorously stress test portfolios and ensure they’re prepared for absolute worst-case scenarios.
“The really key thing is understanding the risks you’re exposing yourself to, making sure you’re not compounding risks you haven’t thought about,” he said.
“The worst that happened before, the second-worst that happened before – what if both happened at the same time? And, really looking at what could happen and making sure we have sufficient liquidity, sufficient ability to rebalance the portfolio.”
Machin’s comments come as many investors are on edge after the key two-year and 10-year U.S. Treasury yield curve briefly inverted last week, spurring fears of an economic downturn and wild market swings.
He says that investors should be prepared for lower returns ahead, as the rally that began after the 2008 global financial crisis comes to an end.
“This is the challenge for the next 10 years or more, in that yield is going to be really low, or negative and, likely, returns on equities are not going to be what they’ve been since the financial crisis until now,” he said. “We’ve had a fantastic 10, 11 years in recovery since the global financial crisis.
“How much more bonds can go into negative territory, nobody really knows. But, there’s certainly going to be very low yield relative to history for the foreseeable future as economies grow, central banks try and cut rates, [and] put more stimulative policy in place.”
I typically don't cover quarterly or mid-year results for the simple reason that these are massive penions which have a very long investment horizon and long-dated liabilities, so covering their annual results and looking at 5, 10, 15 and 20-year results is what really matters.
Still, a lot of investors are edgy these days so I might cover more recent results in more detail but rest assured, everyone is just fine for now.
I would invite you to listen very carefully to Mark Machin's BNN Bloomberg interview with Amanda Lang here (I also embedded it below).
Machin begins by discussing how the strength of the Canadian dollar was a drag during their fiscal Q1 stating "85% of our assets are outside Canada." He added: "That's a sensible hedge for diversification for the Fund overall. When Canada's economy is doing well, contributions are likely to be stronger over time and when Canada's economy is not doing well, then the international portfolio is a natural hedge for the Fund overall."
It's worth noting that CPPIB doesn't hedge its foreign exchange risk which I think is the right move for a fund of its size for two reasons: 1) Hedging costs money and 2) I'm bullish on the US dollar over the very long run and since a huge chunk of CPPIB's foreign assets (public and private investments) are in the United States, it is better off not to hedge its USD risk over the long run.
In my opinion, as long as the US economy continues to dominate the technology and financial landscape, it's economy will continue to dominate the global economy for many more years even if there are other parts of the world growing at a faster rate.
There's a lot of debate over whether or not to hedge F/X exposure. HOOPP hedges it completely and benefits when the Canadian dollar rallies versus the greenback and other currencies and OTPP put in some hedges to limit foreign currency swings and their effect on their overall portfolio swings but most of Canada's large pensions have adopted CPPIB's approach which is to not hedge their foreign currency exposure.
Machin states over the very long-term currency swings don't matter and says even though 85% of their portfolio is outside Canada, CPPIB "is still massively overweight the Canadian dollar in the context of a global-weighted index where the Canadian economy is less than 3% of the global economy."
He said "they don't stress too much over currency pairs" at any given time but I would argue that they should stress a little more at times and I have the perfect guy in Toronto to help them actually make money on currencies (most Canadian pensions have woefully underperformed in their currency operations over the long run; it's not easy but they keep hiring the wrong people to do a very important job!).
To be fair, even top hedge funds have a hard time making money in currencies and CPPIB and other large Canadian pensions invest huge sums in the very best global macro and quant funds around the world so they do receive some currency alpha from these external managers.
In terms of growth, Machin said Canada is doing relatively well mostly owing to the fact the "digital economy is growing at twice the pace of the overall economy." On this point, you should all read CBRE’s Paul Morassutti's thoughts on why tech will likely be Canada's savior if a recession hits.
On the record amount of negative-yielding credit around the world, Machin stated this:
"This is the challenge for the next 10 years or more in that yields are going to be really low or negative and likely returns on equity are not going to be what they've been since the financial crisis till now. We've had a fantastic 10-11 years in recovery since the global financial crisis, so our returns over 10 years are 10.5% and it's been a great period to own assets. If you owned equities, if you owned bonds, they've all rallied significantly. How much more can bonds go into negative territory, nobody really knows but they're certainly going to be very low-yielding relative to history for the foreseeable future as economies grow, central banks trying to cut rates, put more stimulative policy in place and we are at the end of what Ray Dalio and Bridgewater would call the long-term debt cycle. So we have record amount of debt in the word today, by some measures over 300% debt-to-GDP in the global economy which is a massive number and so that's something that's going to weigh on rates and weigh on the global economy for a long time."He's absolutely right and talked about the limits of QE, how negative debt will impact the financial system and how they're particularly focused on structural issues like demographics given their long investment horizon.
He said "Canada is aging" but so is most of the rest of the world, including Japan, Germany and especially China which has a "massive aging and pension problem...by 2050, there will be over 100 million people over 80 years old in China, which is a phenomenal number which needs supporting with healthcare, pensions, etc. So all of this is going to press on global growth."
He added: "there's not much you can do about demographics other than diversify into different markets that may manage this better or the few markets where the demographics are better" like India, a central focus of CPPIB and other large Canadian pensions.
Machin said India has a massive young population which is why it has a demographic dividend but he cautioned this growth has to be handled correctly given the gender distortions there where it's disproportionately young men and you need jobs for these young men to maintain social stability.
He ended by stating they are very comfortable that CPP will be sustainable over the long-term and explained how the Fund is globally diversified across public and private assets.
He also talked about rigorously stress test portfolios to ensure they’re prepared for absolute worst-case scenarios and being prepared to buy assets that "come up once in a generation".
Interestingly, he once again brought up liquidity risk and how a lot of mature pension plans are taking on more liquidity risk than they can afford, putting a third or more of of their assets into illiquid asset classes. And if a major crisis hits them hard, they will be forced to sell their "liquid assets" at distressed prices or worse still, sell their private holdings too at distressed levels.
In my opinion, it will be particularly brutal for many chronically underfunded US public pensions who are falling short of their targets.
But this will just offer CPPIB and other Canadian pensions more opportunities to snap up great assets at rock bottom prices.
Anyway, take the time to watch this clip of Mark Machin and Amanda Lang below. Great interview, I wish more Canadian pension CEOs would give her and other reporters such in-depth views (I've been toying with the idea of doing 20-minute podcasts not just with CEOs, but CIOs and others).