Good morning, Mr. Chair and members of the committee.
Thank you for having me here today to speak with you and answer questions regarding the Canada Pension Plan Investment Board and how we are helping ensure that the CPP remains sustainable for future generations.
With me are Michel Leduc, our senior managing director of public affairs and communications, and Ed Cass, our chief investment strategist.
I'm Mark Machin. I joined the CPPIB four and a half years ago as their first president for Asia and then became head of international work in 2013. Prior to that, I worked for Goldman Sachs for 20 years in Europe and Asia. While I'm a new resident of Canada, so far I've had the pleasure of travelling across the country meeting with finance ministers, the stewards of the CPP, and some of our contributors.
I was enormously honoured to be chosen by CPPIB's board of directors to lead such an important professional investment organization with a compelling public purpose. International organizations such as the OECD, the World Bank, the Harvard Business School, and The Economist have all praised the “Canadian model” of pension management due to its strong governance and internal investment management capabilities.
Our governance structure is a careful balance of independence and accountability, enabling professional management of the CPP fund while ensuring that we're accountable to the federal and provincial governments, and ultimately to the Canadian public. We know that contributions are compulsory, so we're motivated to work even harder to earn that trust.
We hold ourselves to an extensive disclosure policy, including quarterly reporting, annual reports, triennial reviews, and special examinations, and we announce all major investments and corporate developments.
It was just over 20 years ago that the Chief Actuary of Canada projected that the CPP would run out of money by 2015 if changes were not made to the management of the CPP. In 1997 the federal and provincial governments addressed this challenge head-on by increasing the contribution rate and creating CPPIB to manage the contributions not required to pay benefits. There was a clear imperative: to expose the fund to capital markets in order to achieve growth objectives.
Since then, CPPIB has been focused on getting the best investment returns possible. Our ten-year rate of return is 7.3%, and our five-year rate of return is 12%. More than half of the assets of the CPP fund today are now the result of investment returns, not contributions. The chief actuary noted in his report last month that over the last three years investment income was 248% higher than anticipated due to the strong investment performance of CPPIB.
Most importantly, the chief actuary reported that the CPP fund would be sustainable for the next 75 years, with an assumed 3.9% net real rate of return after inflation and all expenses. CPPIB's five-year net real rate of return as at September 30, 2016, is 10.5%.
At CPPIB we know we can't take these results for granted. It's a difficult investment climate around the world, and single years can produce very different results. In 2009, we had our worst year ever, losing over 18%, but in 2015, we had our best year ever, with a gain of over 18%. We know we can't focus on the yearly results. Our ability to see past these short-term pressures and pursue the best long-term strategy depends on strong, independent governance and the clarity of our mandate.
With the CPP's risk exposure, including wage growth, demographics, longevity, and economic risks, being highly weighted towards Canada, it's especially important that CPPIB's investments hedge against these risks.
To address these risks, CPPIB is diversifying the fund around the world and across asset classes. Currently, over 80% of the CPP fund's assets are in international jurisdictions and in a variety of asset classes, from private equity, infrastructure, and real estate to public markets.
While we're confident that this is the right strategy, we also know that competing with the largest investment firms around the world to secure the best assets comes with costs.
CPPIB, at approximately $300 billion in assets under management today, is a mid-sized organization competing with global giants. BlackRock, the largest asset manager in the world, has over $5 trillion in assets under management. Closer to home, Sun Life has almost $900 billion. Among global competition, we fall well down the list in size.
To fulfill our long-term investment goals, CPPIB took the decision 10 years ago to pursue an active management strategy that would both maximize returns and create a more resilient, diversified portfolio.
Pursuing an active global strategy was a decision taken very seriously, with considerable analysis. Success depends on sufficient resources to compete and manage risk effectively, and this is important context when looking at our costs. In order to compete, we need expertise and skill as a knowledge-based enterprise. There's no doubt that the winners will be those investment firms with the most talented investment teams and a global footprint to cultivate critical relationships with partners, governments, and others to secure deal flow and manage the risks over time in order to maximize returns and manage risks for our contributors and beneficiaries.
Before concluding, I'd like to address Bill . CPPIB is currently analyzing the legislation to ensure that we are completely ready to implement the amendments that affect us.
With or without reform, the CPP fund is projected to grow significantly in the future, and we're well prepared to manage a larger fund. When we evaluate investment programs, new processes, and supporting technology, we always want to ensure that they can be scaled to take into account increased size. We are very confident that we'll be ready to manage the additional funds.
Bill requires separate and joint financial statements for both the base CPP and additional CPP. While we're working through the details, we will be able to meet this new requirement.
We believe that it's possible to manage the consolidated fund while having regard to the funding and the requirements of the base CPP and the additional CPP. We recognize the additional reliance upon investment income for the additional CPP due to its fully funded nature and therefore a need for a more conservative asset mix for the additional CPP. We will be working closely with the chief actuary, Finance Canada, and provincial governments to ensure that we are meeting the intent of the legislation.
To conclude, in order to successfully achieve our mandate for Canadians, our competitiveness is predicated on capabilities to buy assets that will create enduring value-building growth. It is a deep privilege to serve, and we believe we are on track. Public confidence is critical, and we must continue to work hard to earn that trust every day. We submit that Canadians have reason to be confident as the hard work continues.
My colleagues and I will be pleased to answer your questions.
Thank you, Mr. Chair.
Thank you very much for the question.
On governance, we're governed by a professional board of 12 directors who are appointed and selected based on their financial, business, and other related expertise. They take their governance role extremely seriously and challenge management in that regard.
The governance framework that has been set up for CPPIB, with its accountability to the federal and provincial governments and ultimately to the beneficiaries and contributors, to Canadians, is being held up as a gold standard around the world when we look at our peers around the world and the studies that have been done, whether by the World Bank or The Economist or others. It's a robust governance system, and one that is incredibly important.
We also have disclosure that we think is over and above what any of our peers do. We report quarterly and have done so since inception. We have quite extensive quarterly reporting. We have an extensive annual report, a 130-page annual report, with very detailed disclosure. Then we have a triennial review by the chief actuary, plus the other triennial review that happens. We have the special exam that happens on a regular basis.
There is a series of governance and controls and checks and balances externally, and then internally as well. Disclosure-wise, it's not just the annual report and the quarterlies: every single major investment we make, we disclose, and we have thousands of pages of disclosure on our website. We believe that it's important to be transparent and have good disclosure that everybody can access. Also, every two years, we go out and we have physical meetings in every province where we have a steward. We do a public meeting that is accessible to all Canadians. That's what we do on a biennial basis.
Disclosure and governance are very important. We think they've stood the test of time so far, and we'll continue to look for ways to enhance them.
Mr. Steven MacKinnon: My last—
Gentlemen, welcome to your Parliament, and welcome to your House of Commons committee. It's a great honour for us to welcome you here. You have perhaps not been here for many years, but it's never too late to be good. It's maybe also an indication that you have to be away from the political agenda to do some things, and you have done so well.
Mr. Machin, you arrive in a brand new role as the head of a crown corporation, which is very inspiring for all Canadians.
The board's results in the past 10 years speak for themselves. After making an adjustment for inflation, we can see there was a net growth of 5.6% in 10 years. Also, in the past five years, there has been a return of over 10%. That's what we call a very respectable result. It's an excellent result that benefits all Canadians. The magic number of $300 billion may make our head spin, but it can also serve as an inspiration to continue making progress, as you have done so nicely for many years.
You know that Quebec has an equivalent institution, the Caisse de dépôt et placement. About a year and a half or two years ago, the Caisse de dépôt et placement decided to invest in a municipal infrastructure program, the Montreal public transit system. This surprised many people, but also piqued people's curiosity.
I want to hear your thoughts on this type of investment. I'm not asking for your opinion on the Caisse de dépôt et placement's decision. However, as a manager, do you think the board could make this type of investment? Does it currently have the power to do so?
Thank you for that question. It's a very important question.
I would say on environmental, social, and governance responsibilities that we take them very seriously. We publish an annual report on sustainable investing, which covers all of our policies and how we think about them. This year, we added human rights as an additional focus area of concern.
I can't comment on the specific investment itself. We can revert on the specifics there, but I suspect it's within the passive portfolio, so its probably part of an index. I'll come back and confirm on that.
But what I can say on human rights in particular is that we're involved in a number of initiatives. One that is related would be that we're part of a coalition trying to improve the supply chain of cobalt mining in the Democratic Republic of the Congo. We're working in collaboration to improve the supply chains for electric vehicle companies, the battery companies, and the associated electronics companies that get their cobalt from the Democratic Republic of the Congo. We're concerned about similar practices there and are exerting due pressure to improve those practices and improve supply chains.
That's something that is not exactly answering your question, but it's a similar initiative, and it is an important area for us to focus on.
We take our expenses extremely seriously, because every dollar we spend on expenses is a dollar less for our pensioners. It's important that we minimize them as much as we possibly can.
There are really three elements when we look at costs. The first is the expenses that we pay to external fund managers. That's the bulk of the costs. It's probably about a half of the costs. There, when those fund managers are doing well, they generally end up with higher performance fees. It's a good sign, to some extent, that those fees are going up. At the same time, we negotiate extremely hard with those external fund managers to make sure we minimize the fees as much as we possibly can. We have teams that keep a very close eye on all of those fees and make sure they are kept to a minimum.
We also try to make sure that we maximize the opportunities where we can: invest alongside those funds in a low- or zero-fee basis and therefore average down the fees across those funds. Those funds are generally private equity funds, and there are some public market fund strategies. We only invest in those funds where we believe that it's going to be too challenging or too costly to develop equivalent internal expertise. The more that we can do internally, the better.
For example, earlier, I mentioned our infrastructure investing portfolio. We've invested about $16 billion in infrastructure over the years. If we were to do that externally, through external funds, that would probably cost somewhere between $650 million to $700 million. It costs less than a tenth of that to do that internally, so to the extent that we can develop teams that have capability, then we will do that internally. For external management, we only look for where, net of all of those costs, they could still outperform what we think we could achieve internally. As I say, the two main areas are select public market strategies and private equity.
Then there are also the transaction costs that are driven by the number of private deals we negotiate. Again, the teams spend a lot of time trying to minimize those transaction costs.
Finally, there are the operating costs of operating the offices and employing the people. That runs at about 32 basis points, so far, of cost.
That's where we are today.
Yes. First of all, I want to say thank you for your kind comments on CPPIB's performance so far. We very much appreciate that.
With respect to external management fees, and considering my earlier comments, the external management fees are driven by two major areas. One is our investment in private equity funds, where we have relationships with about 77 external fund managers. Similarly, then, the second area is on the public market funds side, where we have about 57 external portfolio management relationships.
In these two areas, if we believe that it's challenging for us to build sufficient internal expertise, with all the costs involved internally, and we compare that with the external returns and all those costs, if we think we can make more money for our pensioners, more money for the contributors and beneficiaries externally, then we'll make that decision.
On that $1.3 billion, we report all of our results net of all that cost. It's net of all of that cost, so for the pensioners, our 7.3% ten-year return is after all of that cost.
Let me just comment on those operating expenses on page 24 of the 28th actuarial report. They relate to the administrative cost of the CPP itself, but yes, they do level off, and there is an efficiency in that. That's different from the CPPIB costs.
On the lower-for-longer point, this is a challenge. It is a challenging investment environment globally given global central banks' activity, whether it's in Japan, Europe, the U.S., Canada, or other countries. Interest rates have been driven to low levels and are likely to stay low for a while. We have to find ways of making sure that we continue to have reasonable returns, and therefore, diversification across both geography and asset type is important, as is strategy.
We have a broadly diversified portfolio. We have 25 different investment strategies that we implement. We have investments through some private investments in 42 different countries, so we try to diversify to avoid having all our eggs in one basket or having to depend too much particularly on the low interest rates.
Sir, you've talked about the importance of transparency in keeping the public trust. I believe you've done that. Your organization has done that in many ways, but again, as with everything else, better is always possible.
Mr. Andrew Coyne, who is a nationally syndicated columnist with the National Post, or with Postmedia, and who is also on the CBC quite frequently, has had two articles, I believe, that have asked some very pointed questions about the active management strategy and its current and rising costs, and whether or not this strategy is best for pensioners.
That's an open-ended question. I have not seen any response publicly to Mr. Coyne, but again, I'd like to hear, first of all, why there hasn't been a public response, and second, what it is, because I'd like you to give it now if possible.
Thanks for the question.
To addressing climate change in particular, earlier I mentioned our ESG focus, our environmental, social, and governance responsibilities. Climate change has been one of those focuses for the last 10 years and is something that we take seriously. We think it's a risk factor that we need to understand across our portfolio and need to factor into all of our direct investments, which we do, and then understand how it might impact our portfolio overall and respond to that.
I mentioned that we publish an annual report on sustainable investing. Our head of sustainable investment is a member of the Financial Stability Board's task force on climate-related financial disclosure. This is the committee that is chaired by Michael Bloomberg, and it's one that we think is important for improving the disclosure on climate change across companies around the world, so that we can understand those risks better and factor them into what we're doing.
Specifically on renewables, we have a strategy on investing in renewable energy. We have a team that's focused on that. Again, it's in our report on sustainable investing, with a profile that team and their focus. We have a senior professional who we have hired from GE, who has lengthy experience in that area and is pursuing investments in that area. We agree, and we see great potential to invest in that area.
Ms. Jennifer O'Connell: Speaking about—
Thank you for the question.
To be clear, we have a very clear, singular mandate, which is to maximize the returns without undue risk of loss for our contributors and beneficiaries. That's the lens through which we look at everything. When we look at climate change, it's the same. We look at it through what it will do to returns and risks across our investments and across our portfolio.
When we look at climate change, we have to anticipate what regulatory developments could impact it; how demand for various sources of energy from consumers, corporates, and governments will evolve over time; how the shift in sources of energy supply will unfold over time; what the physical impact of climate change can be, and its impacts on our investments; what technological developments will happen that are related to climate change; and what the impacts will be on sectors other than energy, such as transportation, agriculture, retail manufacturing, or other areas that may be impacted by climate change. That's the lens through which we look at climate change.
Specifically, on your question about renewables and how we are looking at those investments, this is a relatively new effort. We hired the head of this team in April of this year, so the team is getting going and looking at how opportunities will emerge. I would say that within some of our infrastructure investments there have been expansions into the renewables area. Some of our North American infrastructure investments in power generation have moved more towards renewables, so that's something that's happening within our existing investments.
With regard to specific new investments in renewable energy, we are looking forward to finding those opportunities and making those investments in the coming months.
I'll start, and Mr. Cass can add to it.
On the 25 teams, we feel that it's important, again, to diversify, not just geographically, but across the types of investments and strategies that we have. We have specialists who look at different types of public market strategy. We have specialists who look at credit strategies, whether it's private credit or real estate credit. We have specialists who look at private equity, specialists who look at fund investments, and specialists who look at infrastructure, real estate, and other types of private investing around the world.
When you look at all the different strategies, it adds up. There are approximately 25 different strategies. We believe that those strategies can add value when we look at the risk-and-return profiles of those strategies over time.
On scale, when we're competing for larger investments there are fewer people competing for them, so we can find better value. Not always, but in certain strategies, we believe that you're in more rarefied territory where there's less competition. Therefore, we can demand better compensation for the risks we're taking on and better pricing. Scale helps us in quite a few strategies.
That's a terrific question.
As for what we'll say, we'll look back to the time when the act was created, bringing together 10 governments. There is a fantastic book that I recommend to everyone. It's called Fixing the Future and it describes the debates and the policy analysis taking place as to how you design this organization with a commercial purpose but with a public purpose at the same time.
We engage with interested parties all over the world, including important outlets like the Financial Times and other newspapers, and when they ask what the secret recipe is for Canada, we point to the elements in the act, such as the strong governance framework, the clarity of the mandate, and the requirement to have high disclosure, because our transparency is what ensures public trust. The more transparent we are, the more we can gain public trust.
What we would say is that it's within the hands of our stewards to decide whether there are any changes to the act. However, when people ask us what has made us successful, we point to the act. We point to this document that was created with a lot of careful balancing of different interests. It's worked really well for the organization.
If I were in the room and giving advice, I would say, “Do no harm.”