Canada’s state pension funds would have taken in tens of billions of dollars less in returns during the past 11 or 12 years had it used a passive management approach instead of an active one, according to analysis from Canada’s parliamentary budget officer (PBO).
In response to parliamentary interest, the PBO analyzed the investment performance of the Canada Pension Plan Investment Board (CPPIB) and the Public Sector Pension Investment Board (PSPIB) to determine whether their active management strategies resulted in higher returns compared to a passive strategy.
The PBO compared the actual returns of the CPPIB and the PSPIB from 2006-07 until their most recent annual reports, which was 2018-19 for the CPPIB, and 2017-18 for the PSPIB. All transaction costs and management fees associated with actively managing the funds were removed from the annual returns, while operating expenses were assumed to be the same under either approach for both the CPPIB and the PSPIB.
The passive portfolio used by the PBO was comprised of two large public equity and fixed income indices, and the baseline scenario used a weight of 70% equity and 30% fixed income. The PBO also performed the analysis using hypothetical portfolios with different allocation weightings, including one that had 85% equity and 15% fixed income, and another that had 55% equity and 45% fixed income.
In all three scenarios, the PBO found that the CPPIB’s actual net returns outperformed the returns of the hypothetical passive strategies. For the baseline scenario, total net assets under management at the end of the analysis period were C$48.4 billion ($36.4 billion) higher than they would have been under the passive strategy. This represents an average additional annual return of 1.2%.
For the higher and lower equity weighting scenarios of 85% and 55%, respectively, total net assets under management at the end of the period were C$31.5 billion and C$66.7 billion higher, which accounts for an average additional annual return of 0.6% and 1.8%, respectively.
However, the analysis found that the PSPIB’s actual net returns were roughly the same as the returns of the passive strategy, and in one case, the passive strategy outperformed the fund.
Compared to the baseline scenario of a 70/30 equity/fixed income split, total net assets under management at the end of the period were C$1.7 billion higher than they would have been under the passive strategy, which is the equivalent of an average additional annual return of 0.3%. The portfolio with a 55/45 equity/fixed income split would have returned C$9.8 billion, or 0.9%, less than the actual results. But the hypothetical passive portfolio with 85% equity and 15% fixed income would have outperformed the PSPIB’s actual results by C$6.1 billion lower, or 0.4%.