By Emily Holbrook

Pension plans that invest in Canadian assets have a direct effect on the country. Firstly, it fosters a sense of national stability, as investing in domestic enterprises directly contributes to the growth and prosperity of the Canadian economy. By providing capital to local businesses and infrastructure projects, pension plans stimulate employment, innovation, and economic development within the country. Moreover, investing in Canadian assets can offer familiarity and a deeper understanding of local market dynamics, allowing pension plans to make more informed decisions and leverage their expertise to generate favorable returns.

On the other hand, diversifying investments beyond Canada’s borders exposes pension plans to a wider array of opportunities and risks. By venturing into international markets, pension plans gain access to a broader range of asset classes, industries, and geographies. This diversification provides the potential for bigger returns, reduced portfolio volatility and improved risk-adjusted performance. Furthermore, international investments can act as a hedge against domestic economic fluctuations, as they offer exposure to different economic cycles and geopolitical factors.

Over the past several decades, Canadian pension plans have grown their international investments while decreasing their domestic ones. This has created a discourse within the industry around whether such a trend is harmful for the country.

CPPIB’s Stance

So how much are Canadian pension plans investing at home? Canada’s largest plan, Canada Pension Plan (CPP), has a 14% allocation of investments in Canada. The plan invests 36% into U.S. assets and 26% into Asia Pacific assets.

Source: CPPIB

One of the plan’s highlighted investments within its 2023 year-end report was its increase in equity allocation by $570 million to the second tranche of the Tricon Multifamily joint venture, for a total allocation of $1.13 billion. The report notes that, alongside Canada-based Tricon Residential, the joint venture will develop more than 2,000 Class-A purpose-built rental units in the Greater Toronto Area.

Another domestic investment of note is CPP’s commitment of $79 million across Radical Ventures III, an early-stage venture capital fund focused on AI and managed by Radical Ventures. As an anchor investor in Fund II, Frank Switzer, managing director of investor relations for CPP, says the fund “played a lead role in the structuring and formation of what is expected to be one of Canada’s largest VC firms.”

Switzer also notes that the plan does not allocate capital based on geography, but that “global diversification is critical to managing the domestic demographic and economic factors that affect the financial sustainability of the CPP, including an aging population, levels of employment and immigration, and the real rate of growth in earnings on which CPP contributions are based. Foreign investment income provides the only lever to manage these domestic risks.”

Although Canada makes up less than 3% of global GDP, CPPIB has 14% of the fund, or $83 billion, invested there (as of March 31, 2023). While some may view that as a miniscule amount, Switzer notes that for a globally diversified institutional investor, this allocation is a significant portion of the whole portfolio.

Counterpoint

One of the most outspoken opponents of Canadian pension plans investing heavily outside of their home market is Peter Letko, co-founder and senior vice president of Letko, Brosseau & Associates, an investment management firm serving more than 420 institutional investors. Letko points to data from the Pension Investment Association of Canada, which noted that in 2000, investments in Canadian publicly traded stocks represented 28% of total assets held by the country’s defined benefit pension plans. Fast forward to the end of 2021 and that number had plummeted to 4%.

Letko Brosseau invests approximately 40% of client funds within Canada, though it’s important to note that a leading factor in determining that number is client mandates. Even so, Letko voices his pro-Canada stance when it comes to investments.

“We are enthusiastic investors in Canadian stocks,” he says. “We have a nice flow of immigrants into Canada, many of whom come here with skills. Our government is very stable, and we have wonderful natural resources throughout the country. We have a highly respected banking industry and insurance industry — there are really so many fine businesses across all industries here. We have a compounded annual rate of return on our Canadian stocks of almost 15%, versus the benchmark of about 8%.”

Even with its passion for Canadian investments, Letko Brosseau holds a very large emerging market portfolio. Letko acknowledges the positive returns from foreign investments. His concern focuses on the dwindling interest in Canadian equities among the country’s pension plans, even though Canadian equities have performed modestly well.

According to RBC Investor & Treasury Services, the Canadian equities asset class generated positive returns during the first quarter of 2023, with a 4.2% uptick. Similarly, the TSX Composite Index rose by 4.6% over the quarter, with the information technology (+26.5%) and consumer staples (+7.9%) sectors performing particularly well.

Letko feels the reasoning behind Canadian pension plans investing so little domestically is because Canada is only 3% of the Morgan Stanley Global Index, and pension plans tend to follow that type of weighting with their own investments. And while the number-one goal of all pension plans is to earn the highest return possible on its investments, Letko feels the Canadian economy can offer just that.

“Imagine you are a farmer, and you just had a wonderful harvest and you made money,” he says. “You take that money to the bank, and you think about what you might invest in. You might need new equipment. Or you might experiment with another crop, so you invest that money into different seeds. Or you could grow the farm and buy some adjacent land.

“The point is that the farming model says when you do well, you think of ways of reinvesting in the same business that delivered that wealth,” he continues. “You don’t think about taking your money and investing it in Asia. You want to sustain that business that provided such wealth and make it stronger.”

While institutional investing and farming are very different, Letko says the result of not reinvesting profits in endeavors that performed so well is the same: partly foolish and partly harmful. Letko claims it has a negative effect on job opportunities and income within the country. That radiates out to law firms doing IPOs, organizations doing R&D, and elsewhere. There is an economic impact of investing less in Canada.

Whether or not Canadian pension plans invest heavily in Canadian assets, the argument will continue as plan managers work to balance a desire to grow their economy at home while trying to capture the greatest returns possible for plan beneficiaries.

Emily Holbrook serves as owner and head content creator at Red Label Writing LLC, a content studio that collaborates primarily with the insurance and financial services sectors.