Did CPPIB hit its 4.0% "real return" bogey?

The CPP Investment Board’s recent earnings press release was strange, not for what it said, but what went unsaid.

As CEO David Denison hands the reins over to the next generation, some justifiable pride appears to be taken for the recent financial results. For the CPPIB team to be doing their job, the Chief Actuary has assumed that our Fund “will attain an annualized 4.0% real rate of return.”

For those who may have forgotten, a real rate of return takes into account the cost of inflation. As in — a fund’s nominal return minus inflation equals a real rate of return. This little factoid is important for every working Canadian and employer. If the CPPIB team can’t earn a sustainable return of 4% plus inflation, the government has to, once again, increase CPPIB contributions. Which is kind of like a tax increase over which we voters have no say.

According to this week’s CPPIB 2012 fiscal year release:

“We are pleased that our 10-year annualized nominal rate of return of 6.2% is above the 4.0% prospective real rate of return that the Chief Actuary has incorporated in his latest report confirming the sustainability of the CPP…the 10-year return reinforces our confidence in the ability of the Fund’s current portfolio composition and our active investment strategy to generate the returns required to sustain the CPP at its current contribution rate over the longer term.”

Now, let’s think about that for a minute. For the CPPIB to be hitting their 4.0% “real rate of return” target, one has to deduct the 10 year rate of inflation from the CPPIB’s 6.2% “nominal rate of return”. The quote from Mr. Denison describes that he and the team achieved a 6.2% “nominal” return over the past 10 years. And he was “pleased” that it exceeded the target 4.0% “real rate of return”. But for that to be the case, doesn’t that imply that the 10 year inflation figure has to have been below 2.2%? Why not tell us what CPPIB’s real rate of return was? Why are we just reading about the nominal rate of return, when that’s far less relevant?

Over the past 10 years, inflation was certainly bounced around. But has it averaged less than 2.2% during that time frame? If not, then the CPPIB’s 6.2% nominal return hasn’t been sufficient to achieve a 4.0% real rate of return.

According to the Bank of Canada web site, the annualized Consumer Price Index was 2.0% for the month of April, having ranged between 1.9% and 3.7% over the past 12 months. If 2.0% inflation sounds skinny to you, the average CPI rate is actually 3.26% going back to 1915.

Take the CPPIB’s 4.0% real return target (which according to page 21 of the 2012 Annual Report “is an average over the review’s 75-year horizon”), add the long term CPI average of 3.26%, and CPPIB needs to be earning a nominal return of 7.26% per annum. The actual figure of 6.2% over 10 years won’t cut it under that scenario, depending upon what shorter term inflation rate assumptions are being made (see the 75 year horizon for the 4% real return annual target). If the inflation figure is 2.2% or less, we’re golden. If it’s closer to 2.5%, we future pensioners are losing ground each and every day.

And that’s what’s curious. I can’t find that CPI number anywhere in the 136 page CPPIB Annual Report (which may well be a function of my ever-aging eyes). I’ll give them a call when they open for business on Tuesday and see what inflation assumption is being applied. Then we’ll know how we’re doing against the real return target. Will keep you posted.

MRM