What we can learn from the pension meltdown

There is one piece of good news in the staggering losses lately reported by Quebec’s Caisse de Dépôt et Placement: it will be hard to blame this one on the feds. In a province where federalism is routinely blamed for everything, where sovereignty is offered up as the cure, not only for the worldwide financial meltdown (“In my opinion, the economic crisis demonstrates the necessity of sovereignty,” Parti Québécois Leader Pauline Marois told her troops at a recent party meeting), but for terrorism, global warming and head lice, this is one fiasco that is clearly and unequivocally de chez nous.

Indeed, the Caisse, which invests on behalf of the Quebec Pension Plan, as well as a grab-bag of other provincial, municipal and private funds, lies at the very heart of the “Quebec Inc.” approach to the economy, an instrument and symbol of the province’s nationalist ambitions all these years. The QPP was the first great triumph in Quebec’s post-Quiet Revolution drive for autonomy, carved out of the nascent Canada Pension Plan in 1963 via the usual mix of nationalist threats and federalist spinelessness.

Yet if the faute du fédérale reflex must be temporarily stifled, do not imagine this points to any sudden outburst of fresh thinking in the province about the Caisse and its role. If that sort of thing were likely, after all, it would have happened long ago. Though it has never before posted the kind of dramatic 25 per cent loss in a single year that has so shocked the political classes of late, in truth the Caisse has been a drag anchor on Quebec’s fortunes since its founding, mired as it was in its mandate to promote the province’s “economic development” (i.e. favour a few well-connected firms at the expense of everyone else) rather than, say, earn a decent return for its beneficiaries. Pierre Arbour’s 1993 book Quebec Inc. and the Temptation of State Capitalism nicely catalogues the Caisse’s many misadventures (Provigo, Brascade, Domtar, etc., etc.), though there have been many more since, leading at last to the Charest government’s 2004 decision to refocus the Caisse on its proper fiduciary responsibilities.

Curiously, it is that very reform that the PQ opposition has seized on as the source of the calamity. It was the pressure to achieve higher returns, the PQ claims, that drove the Caisse to invest so heavily in asset-backed commercial paper (at $12.8 billion, the Caisse held 30 per cent of the entire ABCP market in Canada; more than half of this was later written off) and in foreign-currency hedges, the two biggest contributors to its nearly $40 billion in losses. The Caisse, for its part, while acknowledging the ABCP “mistake,” blames the general collapse of stock markets, especially in the fourth quarter. But neither explanation can account for why the Caisse’s performance was so much worse than that of the CPP (2008 return: -14.4 per cent), or the Ontario municipal employees fund (-15.3 per cent), or indeed the average for all Canadian pension funds (-16 per cent).

Perhaps, in fairness, that is not the question we should be asking. For all the Caisse’s well-publicized woes, none of the pension funds can claim to have done particularly well last year. And while all of them can point to the decline in the markets, that only raises the question: why were they invested so heavily in stocks? I don’t mean to echo the National Post’s Terry Corcoran, who doubts the whole “stocks for the long run” theory of investing. For younger workers, with 30- or 40-year investing horizons, I think the case for stocks and similarly risky investments remains compelling. But for those nearer to retirement age, a very different strategy is in order, placing greater emphasis on preservation of capital. Yet under universal, compulsory pension funds like the CPP or QPP, that option is unavailable to them: the old are exposed to the same risk of ABCP-style “mistakes” as the young, though they have much less ability to absorb them. Yes, their benefits are still guaranteed—for now. But another year like the last one, and some combination of higher contributions and lower benefits will be inescapable.

There’s another problem with the QPP/CPP model. The people who run these funds do not simply invest in stocks. They invest in particular stocks, frequently adjusting their position with the aim of “beating the market.” Yet if there is one thing that is absolutely clear from the economic literature, it is that this is almost impossible to do, or not for more than a year or two. In a typical year, between two-thirds and three-quarters of all such actively managed funds finish behind the market averages—meaning they do rather worse than would be expected had they simply thrown darts at the stock listings. They do so not because they are stupid, but because they are in competition with a lot of other smart investors—to outperform them consistently, they would have to have access to information the others do not—and because, in anticipation of “buying opportunities,” they generally keep some of their portfolio in cash, where it earns nothing.

When the CPP first got into equity investing a few years ago, it was promised that it would simply “buy the index,” thus assuring it could at least do no worse than the market average. Somehow that was forgotten, leaving the CPP free to pursue the same sorts of ill-advised strategies that got the Caisse into so much trouble. At a minimum, then, a return to index investing would seem appropriate. But would it not be better yet if we gave these forced savings back to their rightful owners, and let each invest his lot in the manner appropriate to his situation?