Did CPPIB hit its 4.0% “real return” bogey? part 2

I have you an answer as to the CPPIB’s inflation expectation for the medium term (see prior post “Did CPPIB hit its 4.0% “real return” bogey?” May 19-12): a handy 2% per annum. That’s why they feel good about returning 6.2% nominal over the past 10 years. The true goal is a 4% real return, so 4% plus 2% becomes the bogey at which the CPP is self-sustaining (assuming every other assumption about our population base and economy hangs together).

Now, you can’t blame the team at the CPP Investment Board for coming up with this modest inflation figure. It seems that the CPPIB relies upon Chief Actuary of Canada (via his 25th actuarial report), who in turn is relying upon Bank of Canada Governor Mark Carney:

Price increases, as measured by changes in the Consumer Price Index, tend to fluctuate from
year to year. In 2006, the Bank of Canada and the Government renewed their commitment to
keep inflation between 1% and 3% until the end of 2011. It is assumed that this commitment
will be renewed for another five years following 2011. Therefore, a price increase rate of
2.0% is assumed for years 2010 to 2016. Beginning in 2017, the rate is assumed to uniformly
increase until it reaches an ultimate rate of 2.3% in 2019.

There you have it. As long as Governor Carney’s magic is successful, and the 1-3% inflation range comes out precisely in the middle — at 2% — then the CPPIB team need not do any better than a 6.2% nominal return over a 10 year period. Of course, prior to the financial crisis, inflation was running around 2.3% for the decade. It was only thanks to the 2008 economic meltdown that the 2% annual inflation figure became a realistic one. At one point during 2011 it got as high as 3.7%, and inflation was above 2% each and every month last year.

Should inflation run at 3% for the next few years, CPPIB will need to earn more than 7% to get the 4% real return that’s required so that we don’t suffer from another CPP premium hike. But at least we now know whose shoulders the CPPIB are putting their return figure upon: not the Chief Actuary, but Governor Carney himself.

I can hear it now: “Hey, we were counting on a 2% inflation figure through 2016, but got blindsided….”

MRM