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Or sign-in if you have an account.Because of the need for liability matching and risk diversification, pension portfolios will never be entirely invested in public equities, writes Joe Oliver. Photo by Getty Images/iStockphotoWould you choose to generate hundreds of billions of additional dollars for Canadian pensioners over 10 years if doing so would cost you personally $50 million in lost compensation? Few of us are given this choice, but those who are choose personal enrichment. That’s not a surprise, but governments should consider the public policy implications.Subscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman, and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.Subscribe now to read the latest news in your city and across Canada.Exclusive articles from Barbara Shecter, Joe O'Connor, Gabriel Friedman and others.Daily content from Financial Times, the world's leading global business publication.Unlimited online access to read articles from Financial Post, National Post and 15 news sites across Canada with one account.National Post ePaper, an electronic replica of the print edition to view on any device, share and comment on.Daily puzzles, including the New York Times Crossword.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one account.Share your thoughts and join the conversation in the comments.Enjoy additional articles per month.Get email updates from your favourite authors.Create an account or sign in to continue with your reading experience.Access articles from across Canada with one accountShare your thoughts and join the conversation in the commentsEnjoy additional articles per monthGet email updates from your favourite authorsSign In or Create an AccountorPublic pension fund executives who actively manage assets generate returns significantly below what low-cost index ETFs achieve. But if managers primarily invested passively, governments would rightly question their value-added and reward them less handsomely. Moreover, most money managers convince themselves they can beat the averages.Because of the need for liability matching and risk diversification, pension portfolios will never be entirely invested in public equities. Most include bonds, private assets and foreign-exchange hedging, so asset allocation is an important investment decision. For example, public equities represent only 29 per cent of assets under management (AUM) at the Canada Pension Plan Investment Board (CPPIB).Get the latest headlines, breaking news and columns.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Top Stories will soon be in your inbox.We encountered an issue signing you up. Please try againThe opportunity cost of active versus passive management can be gleaned by examining historical performance. Over the past 10 years, the S&P 500 annual return, including reinvestment of dividends, was 14.5 per cent, while the S&P World Index returned 11.22 per cent. That compares to the CPPIB and Public Service Pension (PSP) returns of 8.8 per cent and Quebec’s Caisse de Dépôt at 7.2 per cent. The Ontario Teachers’ Pension Fund attracted a lot of attention recently for its early stake in SpaceX, but over time, that fortuitous investment likely won’t boost the fund’s modest 10-year return of 6.8 per cent much beyond seven per cent.Had CPPIB’s portfolio earned returns comparable to a passive S&P 500 index fund, which represents roughly 40 per cent of global equity market capitalization, it would have accumulated over half a trillion dollars more assets over the past decade. Even if the performance gap had been only two percentage points annually, rather than 5.7 percentage points, the additional return would still have exceeded $150 billion. Passive investing would not have produced superior results using the TSX Index, but since Canadian equities represent only about three per cent of global market capitalization, the TSX is a less relevant benchmark.The direct cost of active management can be very steep. CPPIB employs over 2,000 employees globally, up from 150 in 2006, at a cost of over $1.1 billion. Its total expenses were $5.4 billion, 100 times greater than 20 years ago, although its assets only grew eight-fold over that period — from $101 billion to $793 billion. The average compensation for its top five executives last year was about $5.4 million. In contrast, Vanguard’s S&P 500 ETF has a 0.03-per cent expense ratio, which would total just $238 million for the CPPIB’s AUM.Pension funds invariably claim they’ve outperformed their internally constructed benchmark portfolios, but they do not disclose long-term returns for major asset classes such as private equity. So it is difficult to assess whether the active-management model really adds value compared to ETFs.Several foreign funds pursue a passive management approach, including the Norwegian Sovereign Wealth Fund. Over the past 10 years, it had a public equity return of 10.1 per cent, 1.3 per cent higher than the CPPIB return (although its overall return was lower because it invested a higher proportion of its portfolio in bonds). Its CEO’s compensation was around $1.5 million, compared to the $5-6 million that CEOs of major Canadian actively managed funds make — even though the Norwegian fund oversees $2.2 trillion in assets, much more than any Canadian fund. Active management attracts higher pay, even if results are poorer.It’s not really surprising that pension funds do not match passive investment returns. Achieving that after fees is exceedingly rare. The S&P Indices Versus Active (SPIVA) U.S. Scorecard is a scorekeeper of money managers’ performance and the results are grim. Over 10 years, 98.8 per cent of managers underperformed the TSX Index, 97 per cent underperformed the S&P 500 and 98.7 per cent underperformed the S&P World Index. Over 20 years, the numbers reach 99 per cent.When odds they typically do not beat are so dramatically stacked against them, pension fund executives are hard-pressed to justify pursuing active management. This problem becomes increasingly important as assets grow — and CPPIB forecasts its AUM will be $4.3 trillion by 2050.Although a more passive approach to asset management would have earned beneficiaries billions of dollars more without increasing risk, management won’t change — they are paid too well — nor apparently will their boards. So it is up to the governments or unions who call the shots to confront entrenched interests. After all, they have a fiduciary responsibility to pensioners.Joe Oliver was minister of natural resources and finance in the Harper government. Join the Conversation This website uses cookies to personalize your content (including ads), and allows us to analyze our traffic. Read more about cookies here. By continuing to use our site, you agree to our Terms of Use and Privacy Policy.