seminar on demographic, economic and investment perspectives … · 2020. 12. 15. · cppib’s...

CONFIDENTIAL Copyright © 2012. Canada Pension Plan Investment Board. All rights reserved.

Investments Seminar on Demographic, Economic and Investment Perspectives for Canada

Donald Raymond September 28th, 2012


Contents

1. CPPIB Mandate

2. CPP Reference Portfolio

3. Capital Market Assumptions

4. CPPIB Investment Strategy

5. Investment Results

1


CPPIB Mandate

2


Mandate of the CPP Investment Board

3

Operate at arm’s length

from governments

Have investment-only objectives

Pursue no other policy objectives

Demonstrate a high level of transparency

Our Mandate Our Goal

Maximize investment

returns without undue risk of loss

Help secure the future pensions of

19 million contributors and

beneficiaries

Legislation requires that CPP Investment Board:


Our Governance Foundation

Independence

• Investment decisions made by investment professionals

• Independent professional Board of Directors

• Board selects CEO

• Federal/provincial amending formula

Accountability

• Extensive disclosure

• Annual Report

• Triennial review of CPP/CPPIB

• Special audit provision

• Public meetings

4


Range of Strategic Options

In order to fulfill its mandate, the CPPIB needs to construct a portfolio with sufficient exposures to equities and fixed income to generate required levels of investment returns over the long term.

Two valid and distinct ways of achieving this goal are as follows:

Option 1 Low cost, low complexity

Option 2 “Value-added” approach

More active investing to achieve higher risk-adjusted returns:

• This requires a larger organization with diverse skills and backgrounds along with corresponding systems, policies and procedures.

• This is a more complex organization with a focus on value-added returns and Board oversight is similarly complex.

Valid passive investment option:

• This option requires a small organization primarily focused on portfolio design and passive investment programs through external managers

• A priority would be placed upon cost minimization and Board oversight would be relatively straightforward.

5


Constraints: Stewards’ Risk Tolerance

Expressed via equity exposure:

Exposure greater than 70% is taking undue risk

Exposure less than 50% is unlikely to obtain the returns required to avoid eventual plan adjustment

50% 0% 70%

“It is proposed that CPP funds be prudently invested in a diversified portfolio of securities in the best interest of contributors and beneficiaries . . . consistent with the investment policies of most other pension plans in Canada and the QPP.”

Securing the Canada Pension Plan, February 1997, p. 13

6


CPP Reference Portfolio

7



8

Global equity

Canadian equity

Canadian Gov’t bonds

G7 Gov’t bonds

35% Bonds

65% Equity



9

Reference Portfolio $165.8 bn

= $ 0.166 tn

= 0.27% of Global Market Cap

Global Market $62 tn

As of August 2012


The Reference Portfolio is more than the Total Fund Benchmark

The Reference Portfolio (RP): • represents a viable strategic choice, • is a low cost, long horizon, passive portfolio, and • takes the stewards risk preferences and CPP liability characteristics into account.

Having chosen an active strategy, the RP: • represents the path not taken, and • an appropriate benchmark against which to measure value-added.

We design the RP to minimize Adjustment Risk • The Adjustment Index is the probability that the Minimum Contribution Rate (MCR) exceeds the Legislated Rate (9.9%) • This is driven primarily by the long term economic outcome.

10


CPPIB’s Largest Risks Cannot Be Mitigated Through Asset Allocation

Investment Returns

(default-free rate, equity risk premium, active return, etc.)

Economics

(real wage growth, inflation, etc.)

Demographics

(fertility, longevity, etc.)

Unwanted change in contribution rate

or benefit level: “Adjustment Risk”

CPPIB helps reduce adjustment

risk through its investment decisions

Must be considered when making investment

decisions, but beyond CPPIB control

11


The CPPIB ALM model finds the portfolio which minimizes the Adjustment Index, given

• Estimates of demographic, economic, and market uncertainty • Assumptions reflecting judgment

• Constraints

• The CPPIB ALM is a model of Optimal Dynamic Portfolio Choice under Uncertainty • Central to finance theory since the 1970s, only recently has computer power

reached the point that such models can be used in practice • Carefully implemented and rigorously tested • Externally vetted and reviewed

The CPPIB Asset Liability Model (ALM)

12


Input Scenarios and Assumptions

4 Economic scenarios (SLM) 5 x 4 Market scenarios We determined the optimal portfolio strategy for each of 400 (4 X 20 X 5) scenarios

Indicative Assumptions are BOLD

Indicative OCA Optimistic Pessimistic Real Wage Growth (%) 1.7 1.3 1.7 1.1 Inflation (%) 2 2.3 2.3 2 APV discount rate (%) 4 4 4.5 3.8 Real Liability Growth (%) 2.2 1.8 2.2 1.6

Equity Risk Premia (bps) 275 375 475 575 675

Bond Risk Premia Views (bps) 0 50 100 150

13


For Each Scenario, We Simulate 10,000 Possible Future Paths

9.50%

9.55%

9.60%

9.65%

9.70%

9.75%

9.80%

9.85%

9.90%

9.95%

2000

2006

2012

2018

2024

2030

2036

2042

2048

2054

2060

2066

2072

2078

2084

Min

imum

Con

trib

utio

n R

ate Current

Legislated Rate

Good Outcome Poor Outcome Very Poor Outcome

14


Checking the robustness of our recommendation

Alternative Estimates #1


Best Estimates

Alternative Estimates 400

. . . . . .

Portfolio 1 Portfolio 2 Portfolio 400 Potential RP . . . . . .

Compare Potential RP to

Portfolio 1 under



Portfolio 2 under



Portfolio N under

Alternative Estimates 400

. . .

ALM Model ALM Model ALM Model

Step 1: Determine the optimal portfolio strategy for each of the 400 scenarios Step 2: Run the candidate portfolio strategy in each scenario. Step 3: Since the candidate portfolio is not the optimal strategy the adjustment index will be higher

than that of the optimal portfolio strategy. Step 4: If a candidate portfolio creates only small increases in adjustment index across all

scenarios, then the Potential RP is “nearly optimal” across the range of our estimates – i.e. is Robust.

ALM Model

15


The Adjustment Index is Most Sensitive to the Economic Scenario

Vertical bars represent the range of adjustment risk over 75 years for each economic scenario

Low

Medium

High

Optimistic Indicative OCA Pessimistic

16

Adjustment Risk


Reference Portfolio Summary

The Reference Portfolio is robust, performing well over a variety of economic and demographic scenarios. Economic and demographic factors, not Reference Portfolio design, are the key drivers of CPP sustainability.

17

0%

30%

100%

Canadian Equity

Global Equity

G7 Gov’t Bonds

Canadian Gov’t Bonds

5%

55% 10%


CPPIB Capital Market Assumptions

Approach chosen

18


CPPIB Asset Return Projection Process

19

Return Covariance

Matrix

ICAPM Equilibrium

Returns

Risk-free return + equity premium

Expected Return Views

Market Cap Weights

Black-Litterman Model

Economic and Financial Market

Forecasts

Mixed Expected Returns


Estimating the Equity Premium

We test for long-run relationships between the ex ante premia and macroeconomic factors

Review stylized facts for ex ante and ex post premia

Estimate econometric relationship between ex ante premium and fundamental factors

Ex ante return = (smoothed earnings)/price

Ex ante premium = ex ante return – 10-year real sovereign bond yield

Approach chosen

20


-2

0

2

4

6

8

10

12

14

16

1967Q1 1977Q1 1987Q1 1997Q1 2007Q1 2017Q1 2027Q1 2037Q1

We find evidence of a stable, long-run relationship between the U.S. ex ante premium and core inflation…

Ex Ante Premium

Core CPI Inflation


21


-2

0

2

4

6

8

10

12

14

16

1967Q1 1977Q1 1987Q1 1997Q1 2007Q1 2017Q1 2027Q1 2037Q1

…that implies a future long-horizon premium of around 3%

Ex Ante Premium

Core CPI Inflation

Trend Ex Ante Premium

U.S. Ex ante equity premium is currently positive, but lower than long historical average

Shift to low and stable inflation regime appears to have driven equilibrium premium down

Actual premium is presently above equilibrium level

Results are qualitatively consistent with literature and

OCA AR25 assumptions


22


Rising yields imply weak bond returns over the next 5 years

-4

-2

0

2

4

6

8

10

12

Canadian Bonds G7 Bonds Canadian Equities Foreign Developed Equities

Emerging Market Equities

Reference Portfolio

Expected Return Views (Real)

2012-2017

2017-2022

2022-2032

2032-2042

23

Economic and Financial Market Forecasts Expected Return Views


Expected return forecasts are uncertain, particularly for equities

-5

0

5

10

15

20

Canadian Bonds G7 Bonds Canadian Equities Foreign Developed

Equities

Emerging Market Equities

Reference Portfolio

2012-2017 Real Expected Return Views - 68% Confidence Bands

24

Economic and Financial Market Forecasts 2012 – 2017, 68% Confidence Bands


Real Mixed Expected Returns – 2012 to 2042

0

1

2

3

4

5

6

7

8

9

10

Canadian Bonds G7 Bonds Canadian Equities Foreign Developed Equities Emerging Market Equities

Real Expected Returns

Macroeconomic-Based View

Black-Litterman - Blended

ICAPM Equilibrium

2012-2042

25

Mixed Black-Litterman



Our macroeconomic-based estimates suggest noticeably higher emerging market equity returns than were assumed in AR25

0

1

2

3

4

5

6

7

8

9

Canadian Bonds G7 Bonds Developed Equities Emerging Equities

Long-Horizon Real Steady-State Returns

Expected Return Views AR25

Long Horizon Real Steady-State Returns

26


Macroeconomic model and ICAPM-based estimates both suggest significant emerging market premia relative to the U.S.

-2

-1

0

1

2

3

4

5

6

7

8

9

China Brazil Turkey Peru Russia Chile Colombia India Mexico South Africa

Total Emerging

Long Horizon Equity Returns Relative to U.S.

Macroeconomic View

ICAPM Equilibrium

NA NA NA NA

Long Horizon Equity Returns Relative to U.S.

27



Will emerging market premia fall as emerging market economies become developed?

May take a long time for many emerging economies

China may well approach developed levels by 2040, but most other emerging economies will remain clearly “emerging” for the foreseeable future

Frontier economies will enter the emerging universe even as some emerging economies exit

Developed economies can revert to emerging

Argentina in 20th century Greece?

Approach chosen 0.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

1.00

GDP PPP USD Per Capita Relative to US

China Brazil India Mexico Turkey Chile

Estimating the Emerging Market Premia

28


CPPIB Investment Strategy

29


CPPIB Investment Strategy: Active Management

30

Structural Very long-term investment horizon

Certainty of assets

Size of our portfolio Developed

Total Portfolio Approach

Ability to partner with world-class firms

High performance culture

Maximize value-added relative to the Reference Portfolio

subject to the Active Risk Limit


CPPIB Investment Strategy: Total Portfolio Approach

31

Low Risk High Risk

Low Return

High Return X

Public Equity

X

Distressed Corporate

Bonds

X

Corporate Bonds

X

Government Bonds

X

Treasury Bills



32

Low Risk High Risk

Low Return

High Return

X

Private Equity

X

Public Equity

X

Core Real Estate

X

Regulated Infrastructure

X

Government Bonds



33

Low Risk High Risk

Low Return

High Return

X

Private Equity

X

Public Equity

X

Core Real Estate

X

Regulated Infrastructure

X

Government Bonds


Investment Results

34


CPP Fund Size & Investment Income

35


Annual and 10-Year Rates of Return

36

-1.5

17.6

8.5

15.5 12.9

-0.3

-18.6

14.9 11.9

6.6

-20

-10

0

10

20

%

10-YEAR RETURN

6.2%

F2003 04 05 06 07 08 09 10 11 12


Questions

37

Investments��Seminar on Demographic, Economic and Investment Perspectives for CanadaContentsSlide Number 3Mandate of the CPP Investment BoardOur Governance FoundationRange of Strategic OptionsConstraints: Stewards’ Risk ToleranceSlide Number 8CPP Reference PortfolioCPP Reference PortfolioThe Reference Portfolio is more than the Total Fund BenchmarkCPPIB’s Largest Risks Cannot Be Mitigated Through Asset AllocationThe CPPIB Asset Liability Model (ALM)Input Scenarios and AssumptionsFor Each Scenario, We Simulate 10,000 Possible Future PathsChecking the robustness of our recommendationThe Adjustment Index is Most Sensitive to the Economic ScenarioReference Portfolio SummarySlide Number 19CPPIB Asset Return Projection ProcessEstimating the Equity Premium We find evidence of a stable, long-run relationship between the U.S. ex ante premium and core inflation… …that implies a future long-horizon premium of around 3% Rising yields imply weak bond returns over the next 5 yearsExpected return forecasts are uncertain, particularly for equitiesReal Mixed Expected Returns – 2012 to 2042Our macroeconomic-based estimates suggest noticeably higher emerging market equity returns than were assumed in AR25Macroeconomic model and ICAPM-based estimates both suggest significant emerging market premia relative to the U.S.Will emerging market premia fall as emerging market economies become developed?Slide Number 30CPPIB Investment Strategy: Active ManagementCPPIB Investment Strategy: Total Portfolio ApproachCPPIB Investment Strategy: Total Portfolio ApproachCPPIB Investment Strategy: Total Portfolio ApproachSlide Number 35CPP Fund Size & Investment IncomeAnnual and 10-Year Rates of ReturnSlide Number 38

seminar on demographic, economic and investment perspectives … · 2020. 12. 15. · cppib’s...

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