Issues and challenges facing pension funds in the current market environment

Marked geopolitical risks, intense competition for quality assets and high valuations. In the current market environment, these panellists agree that having an adequate level of liquidity is vital to being able to confront any situation and seize opportunities as they arise.

“The American elections showed us that we can’t predict the future. Nevertheless, we want to be ready to deploy capital at the right moment,” said Jean Michel. “Two conditions have to be met, however: you can’t exceed your clients’ risk budget, and you have to be internally prepared to act.”

I wanted the teams under me to be able to discuss the entire asset allocation process in one sentence. It’s a big change, and it helps a lot in terms of long-term strategy and where we see our assets evolving.

Jean-Michel pointed out that for an investor like CDPQ, which manages funds for over 40 depositors, asset allocation is becoming more complex, given the sheer variety of each one’s objectives and policies. In fact, it was precisely to gain some agility that, upon his arrival in April 2016, he put in place a new structure that would handle all aspects of asset allocation internally under one umbrella. The team he heads, Depositors and Total Portfolio, now manages this process from start to end, including everything from depositor relations and research to daily asset allocation activities. “I wanted the teams under me to be able to discuss the entire asset allocation process in one sentence. It’s a big change, and it helps a lot in terms of long-term strategy and where we see our assets evolving.”

According to Jean Michel, one of the main challenges for pension fund managers is ensuring they will be able to meet their clients’ needs over the long term. To accomplish this, they can either increase contributions or aim for higher returns, notably by taking more risks. For its part, CDPQ endeavours to reach greater returns without increasing the overall risk level of its portfolio. To this end, it focuses on the following three strategies:

• Invest more in illiquid assets (private equity, real estate and infrastructure) – which offer an attractive risk-return profile – by strengthening its internal expertise and developing international partnerships;
• Diversify its exposure to other risk factors as a means of mitigating the equity risk;
• Optimize the risk-return profile of investments as well as the management of currency exposure.

Innovation and new asset classes

The panellists believe innovation plays a key role in portfolio construction, both in terms of investment strategies and new investment products. Jean Michel gave three examples in which CDPQ is particularly distinguished in this regard.

First, in its private equity strategy, which focuses on partnerships and investment platforms as well as on value creation through its operational expertise.

We are building a leading expertise that will allow us to be involved in infrastructure projects from start to end. We’d like to export this model, which is more cost‑effective than other models.

Second, in infrastructure, with the development of the Réseau électrique métropolitain (REM), a light rail public transit project for Greater Montréal. “We are building a leading expertise that will allow us to be involved in infrastructure projects from start to end,” he explained. “We’d like to export this model, which is more cost‑effective than other models.”

Third, by evolving its fixed income strategy to place more emphasis on credit and specialty finance, the latter of which is distinct from traditional fixed income, in that a portion of the return is dependent on how businesses and financed projects perform. CDPQ sees this as an opportunity to help companies in their growth projects. “Giving capital just to give capital is not our thing,” said Jean Michel. “It’s what companies do with the dollars that counts. To us, the strategic angle of a transaction is important, it’s how you increase your chances of generating returns.”

Investment limits and the recruitment challenge

If an investment is more complex, be it on the sectoral or geographical level, you need to make sure you have a good partner.

How far can public institutions go in terms of their investments? James Davis of OPTrust feels that any investment can be put on the table, so long as you understand and accept the risk. In Louis Beaulieu’s view, investments that carry too much geopolitical risk are off limits. As for Jean‑Michel, his philosophy is: invest in what you understand. “If an investment is more complex, be it on the sectoral or geographical level, you need to make sure you have a good partner.”

To attract and grow your talent base, Louis Beaulieu and Jean Michel agree that it pays to hire young and give them the training to develop within the organization. Doing so will ensure they internalize the organization’s DNA. For his part, Jean Michel also thinks you need to know how to identify managers that think differently, as they are key to gaining a competitive advantage. Compensation is also important. In his opinion, if Canada is as good as it is at managing assets, it’s because, in addition to having an effective governance and a separation between decision-making entities, our professionals are paid at fair market value. This is what positions us to compete with the world’s biggest investment firms.