• Business leaders demand more investment
• Government creates working group
• Pension funds oppose government intervention

Canada’s federal government could heed to pressure to convince pension funds to invest more domestically amid weak polling and concerns about the rising cost of living but is unlikely to impose a mandate, advisors and business executives said.

In early March, a group of 92 business leaders sent an open letter to Canada’s Finance Minister Chrystia Freeland and her provincial counterparts urging them to amend the rules governing pension funds to encourage them to invest in Canada. “We are concerned with the decline in Canadian investments by pension funds and its impact on the Canadian economy,” the letter reads. “It is estimated that the eight largest pension funds in Canada have more invested in China (roughly CAD 88bn) than they do in Canadian public and private equities (roughly CAD 81bn).”

The letter’s political timing could not have been better.

The incumbent Liberal government finds itself trailing its rival, the Conservatives, in most public opinion surveys polls amid lackluster economic growth and a growing frustration over the cost of living. And so, instead of ignoring the letter, the government last month appointed former central bank governor Stephen Poloz to lead a new federal working group to “explore how to catalyze greater domestic investment opportunities for Canadian pension funds.”

Poloz declined to comment, noting he does not want to front-run the consultation process in any way.

The government has also directed state-owned Business Development Bank of Canada, Export Development Canada and Farm Credit Canada to increase their risk appetite to invest more money into small and medium-sized domestic companies.

Risky proposition

Although it is unclear how the federal government could mandate provincial pension funds to invest more in local companies without overstepping provincial governments’ authority, any directive could jeopardize the funds’ returns and ultimately people’s pensions, said Sebastien Betermier, an associate professor of finance at the Desautels Faculty of Management at McGill University.

“Pension contributions exist for one reason and that is to pay pension benefits, not to serve some misguided economic engineering that is as problematic as it is counterproductive,” Michel Leduc, senior managing director, global head of public affairs and communications at Canada Pension Plan Investment Board (CPP Investments), Canada’s largest pension fund manager, wrote in response to the business leaders’ open letter.

Indeed, between 2004 and 2018, Canadian pension funds outperformed their peers on all fronts, including generating greater returns for each unit of volatility risk and hedging their pension liability risks, according to a 2020 paper in the Journal of Portfolio Management co-authored by Betermier. The paper analyzed performance metrics, asset allocation strategies, and cost structures for 250 pension, endowments, and sovereign wealth funds across 11 countries.

The paper concluded that one of the three keys to the success of Canadian pension funds is their investment diversification “that increase portfolio efficiency and hedge against liability risks.”

“The funds have operated by making their own investment decisions around the world… by looking at investments in Canada, the US and beyond,” said Betermier.

In fact, Canadian pension funds are highly regarded among state investment executives from all over the world who are trying to replicate the model, said a former managing director at CPP Investments. “Canadians are extremely proud of their pension funds and that they are independently run,” he added.

“Canada leads the world in pension investing. Despite being only the 38th largest country by population, Canada has the third-largest share of pension wealth. Among the reasons for that success is the pursuit of investment returns and an absence of political interference,” seven former pension fund leaders wrote in a 10 March op-ed.

It was not always this way. In the late 1980s, the precursors to public sector pension funds such as the Ontario Teachers’ Pension Plan (OTPP) and the OPTrust, which administers the Ontario Public Service Employees Union pension plan, were invested entirely in nonmarketable government debt and had no true independence from the government, according to a 2017 World Bank report on the evolution of the Canadian pension model.

That led to poor “investment performance, unclear governance responsibilities and underfunding,” CPP Investments’ Leduc wrote in his letter. “The fact that the CPP was unmistakably headed to insolvency motivated policymakers to act.”

The government’s concern that public sector funds could become an insurmountable fiscal burden prompted it to commission three expert reports whose recommendations led to the transformation of the teachers’ and public servants’ pensions in Ontario intro three professional pension fund managers: OTPP, OPTrust and the Ontario Pension Board, according to the World Bank’s report.

Cries for help

Still, business executives feel pension funds could use a greater share of their massive war chests to support local companies. Other countries already require their pension funds to invest a set amount of money in domestic businesses and projects, said a Canada-based partner at a Big Four firm.

Caisse de depot et placement du Quebec (CDPQ) is the only Canadian pension fund manager that has a dual mandate of seeking the highest returns possible while boosting Quebec’s economy. “This dual mandate brings a DNA… I’m privileged because I don’t have to find a mission for this organization,” CDPQ’s president and CEO Charles Emond told The Globe and Mail’s Rob Magazine.

Canada’s eight largest pension fund managers – known as the ‘Maple 8’ and which include CPP Investments and CDPQ – manage more than CAD 2.2tn (USD 1.6tn) in retirement savings on behalf of more than 27m Canadians, according to a February report by advocacy group Shift Action for Pension Wealth and Planet Health.

“I would love to see that money staying in Canada,” said the CEO of a Canadian mining company.

The mining and oil-and-gas industries have seen their funding options narrow as institutional investors step away from those sectors as part of their environmental, social and governance commitments.

“One of the reasons why Canadian mining companies are looking at investment from Chinese companies and other foreign countries is because there’s such a lack of capital available for the mining industry in Canada,” said the mining company CEO.

In 2022, the federal government required Chinese companies to sell stakes in three Canadian lithium miners: Vancouver-based Power Metals [TSXV:PWM], Calgary-based Lithium Chile [TSXV:LITH] and Vancouver-based Ultra Lithium [TSXV:ULT]. And earlier this month, Solaris Resources, a Vancouver-based critical minerals company, called off its financing deal with China’s Zijin Mining Group [SSE:601899] after failing to receive regulatory approval from Ottawa, which had been vetting the transaction on national security grounds.

Canada’s barriers to Chinese investment, which have increased in recent years due to tensions between the Canadian and Chinese governments, will likely expand to other sectors and remain in place indefinitely, Mergermarket reported in December.

Business leaders would like pension funds to replace the funding lost from Chinese investors, said the partner at the Big Four firm.

However, some believe pension funds already invest more than enough in Canadian companies. “When you look at their investments, they’re disproportionately invested in Canada already relative to the size of the Canadian economy,” said the CEO of a Canadian company backed by CPP Investments.

According to Betermier, from McGill, Canadian pension funds already invest about 20% of their assets under management in publicly listed portfolios in Canada even though Canada represents only 3% of the world’s stock market.

Canadian pension funds also support local companies through private credit, said the managing partner of a Canadian mid-market private credit provider.

Reuters reported in January that CPP Investments will double its overall credit portfolio to about CAD 115bn. British Columbia Investment Management Corporation’s private debt program grew to CAD 15bn at the end of 2023 from CAD 13.5bn in March 2023, the report added.

“It enables us to pick and choose the deals that we want. Pick and choose the risk that we want. The sectors that we know very well,” Thomas Cockburn, senior director, private debt at CDPQ, said at the Mergermarket Private Equity Forum held in New York in April.

The question, however, is deeper than simply whether pension funds can invest more in local companies. “Is it the fact that we have an underlying growth problem? Not being sufficiently appealing to investors?” Betermier asked.

Canadian pension funds reduced their holdings of publicly traded Canadian companies from 28% of total assets at the end of 2000 to less than 4% at the end of 2023, according to the business leaders’ open letter. And the eight largest funds have more invested in China than in Canadian public and private equities, the letter added.