CPP Investment Board underperformed its own benchmark in FY2013

The thing about benchmarks, for a fund manager at least, is that they’re all your investors really have to go on. Once you’ve settled on what the appropriate benchmark is, of course. But, after that, you can’t stop staring at your personal Mendoza Line. As much as top drawer advisory firms such as Russell Investments might tell clients to ignore underperformance provided that the team and strategy you bought into haven’t changed course, institutional clients have a really hard time ignoring negative value add. The sentiment is: if a passive approach earns a higher return, why do I pay your fees?

In 2006, the CPP Investment Board created its own benchmark so that we beneficiaries can know how our CPPIB management team is doing. According to the CPPIB, this is what the Reference Portfolio is meant to accomplish:

– “It serves as a performance benchmark against which the CPP Investment Board’s value-added activities are measured.”
– “The Reference Portfolio represents a low-cost strategic alternative to the actual CPP Fund that would earn sufficient returns over the long term to help sustain the current CPP contribution rate at 9.9 per cent.”
– “The objective of the CPP Investment Board is to create value-added investment returns above and beyond those that the Reference Portfolio would generate. We achieve this by investing in asset classes that diversify risk and enhance returns and by utilizing investment strategies not represented in the Reference Portfolio. As always, in the challenge to add value, the CPP Investment Board adheres strictly to its mandate to maximize returns without undue risk of loss.”
– “The current composition of the Reference Portfolio benchmark is 10 per cent Canadian equities, 55 per cent global equities, 30 per cent Canadian nominal bonds and 5 per cent foreign sovereign bonds.”
-“The composition of the actual CPP Fund will invariably differ from the Reference Portfolio. In the actual portfolio there are no specific allocations to asset classes. Instead, in the pursuit of value-added returns we make investment choices guided by the underlying risk/return characteristics of individual investments rather than by which asset class they represent.”
– “This provides the board of directors, management and CPP stakeholders with an understandable and demanding investment benchmark to evaluate the investment performance of the CPP Investment Board.”

Last Thursday, the CPPIB team released our results for the 2013 fiscal year. The uninquisitive mainstream media appear to have read no further than the first three pages of the six page press release (see prior post “Why so uninquisitive about the CPP Investment Board, ROBers?” Mar. 3-13), and breathlessly reported on an annual return “topping” 10%. Indeed, it was 10.1% on a gross basis before being dragged down by $490 million of internal management costs.

If you read a bit further into the release, you’ll come to the part where CPPIB admits that it failed to hit the return threshold of its own passive reference portfolio. In fact, once you include the cost of all of ever-growing internal team managing our money (see prior post “Why is CPPIB’s MER higher than its peers?” Jan. 9-13), the CPPIB Reference Portfolio outperformed our money by $286 million.

Yep. A 2006-vintage well-structured basket of passive indices and bonds outperformed our active investment leadership at CPPIB for fiscal 2013. In its release, CPPIB went on to say that on a cumulative, long term basis this underperformance is not sustained, and that the active side of the portfolio has added $3.1 billion of value since fiscal 2007. I’d point out that most of the “gains” in our $30 billion plus of private equity investments over the past five years have been and remain merely estimated gains, since the CPPIB’s 140 plus different external PE Managers themselves are called upon to estimate the values of their underlying illiquid private companies.

This underperformance is all the more stark as we started the 2013 fiscal year with just 45% of our capital invested actively. In essence, 2012’s $286 million of negative value add by our investment team arose due to the performance of less than 50% of our invested capital.

This isn’t the first time the CPPIB media team has had to break bad news to us, reticent as they are to disclose anything negative whatsoever. Our private equity portfolio contributed $1 billion of negative value add over the four years ending in 2102 (see pg. 52). Also in fiscal 2012, the CPP annual report advised that the CPPIB Reference Portfolio earned a 4 year return of 3.1% (pg. 41), exceeding the CPP’s actual 5 year return of 2.2% (pg. 39). Why they don’t match the time horizons so that we can perfectly compare the figures I cannot explain.

I’ll add that to the list of questions I’m trying to get answered for you (see prior post “12 questions CPP Investment Board won’t be answering on BNN today” Jan. 17-13).

MRM