While taking an active approach to investment management is paying off for the Canada Pension Plan Investment Board, the Public Sector Pension Investment Board’s actively managed returns are similar to what they would be if it had taken a passive approach, according to a new report by the parliamentary budget officer.
The PBO prepared the report because some Members of Parliament were asking whether an active investment strategy is worth the additional cost, says Yves Giroux, the parliamentary budget officer. “It’s following these questions that we decided to undertake the report.”
To find out whether the active strategy was paying off, the PBO compared the actual returns of the CPPIB and the PSP to a customized passive portfolio from 2006-2007 up to their most recent annual reports (2018-19 for the CPPIB and 2017-18 for the PSP), netting out additional management costs related to active management.
The passive portfolio was created using the S&P Global LargeMidCap index for equities and the FTSE TMX Canadian governments nominal bonds index for fixed income, using a 70 per cent equities and 30 per cent fixed income weighting. The CPPIB uses the same indexes in its benchmark portfolio and the ratio is similar to what the PSP uses in its passively managed reference portfolio.
For the CPPIB, total net assets under management at the end of the period were $48.4 billion higher than they would have been under the passive strategy, representing an average additional annual return of 1.2 per cent.
For the PSP, total net assets under management at the end of the period were $1.7 billion higher than they would have been under the passive strategy, representing an average additional annual return of 0.3 per cent.
Giroux was surprised to see different returns from two bodies with similar mandates and long-term perspectives. He notes this may be because the PSP takes a less aggressive approach than the CPPIB.
It was also surprising to see the CPPIB beat the passive strategy by so much, he adds, noting conventional wisdom says, over the long term, active management will have a very hard time beating a broad-based index. “The fact that it’s 1.2 [per cent] above what a passive investment strategy would yield is, in and of itself, I think, surprising. And that’s net of the additional costs incurred by the active strategy.”
While the CPPIB had a similar ratio of equities to fixed income in its benchmark in 2015-16, it subsequently moved to increasing the equity weight, with a target of reaching 85 per cent equity in 2019-2020.
As such, the PBO also did a sensitivity analysis for what active versus passive would look like with a higher equity allocation (85 per cent) and a lower equity allocation (55 per cent).
In these higher and lower equity weighting scenarios, the CPPIB’s total net assets under management at the end of the period were $31.5 billion and $66.7 billion higher, respectively, than if they’d used a passive approach. This accounts for an average additional annual return of 0.6 per cent and 1.8 per cent, respectively.
And for the PSP, total net assets under management at the end of the period were $6.1 billion lower and $9.8 billion higher, respectively, accounting for a lower average annual return of 0.4 per cent and a higher average annual return of 0.9 per cent, respectively.
“One conclusion of the sensitivity analysis is the more heavily invested you are in equity, the higher your return is, which is not surprising,” says Giroux, noting for the PSP, active versus passive roughly leads to the same returns and it would need to take much more risk for passive to show a distinction.