Peer Intelligence | Fall 2024

The Strategic Asset Drought: The reason Canadian Pension Funds are forced to look abroad 

CEM Benchmarking’s analysis of 157 pension funds across three countries exposes the tension between home bias and global diversification. Read more to understand the challenges and opportunities this presents for Canadian fund managers and policymakers. 

By Chris Flynn, Head of Product Development & Research 

Canadian pension funds face increasing scrutiny.  

Critics are urging Canadian pension funds to boost domestic investments to boost Canada’s energy transition, support local businesses, and address slowing productivity through targeted capital allocation. 

Meanwhile, Canada’s Federal Government has renewed interest in pension funds. The 2024 Federal Budget calls for collaboration to boost domestic investments, potentially removing the “30 percent rule” (limiting pension funds to owning no more than 30% of voting shares in most Canadian corporations), and enhancing transparency through mandatory disclosure of investments. 

These demands raise a critical question: Should Canada Require Its Pension Funds to Invest More Domestically?  

A new report using CEM Benchmarking data answers this question head-on. Keith Ambachtsheer, Sebastien Betermier, and Chris Flynn compare domestic investments of pension funds in Canada, the UK, and the US from 2013 to 2022. They find that Canadian pension funds still favour domestic investments in certain asset classes, particularly stable income categories. However, Canadian pension funds are diversifying globally across all asset types, a trend aligning with UK and US pensions funds strategies. 

The study reveals three insights. 

1. Canada’s home bias: Canadian pension funds allocate a disproportionately high percentage of their public equity investments to Canadian equities.  In 2022, Canadian pension funds invested 18% of their portfolios in domestic stocks, while global investors allocated only 3% to Canada for diversification. 
2. Funding Canadian stability: Canadian pension funds already support the domestic economy through substantial investments in local bonds and real estate. In 2022, the average domestic share of fixed-income assets was 88%, significantly higher than equity allocations. Real estate has the highest domestic share among alternative investments, while private equity has the lowest. 
3. Global diversification trend: Canadian pension funds have significantly shifted towards international investments over the past decade. From 2013 to 2022, the domestic share in public equity dropped from 33% to 18%, while fixed-income allocations to Canadian assets decreased from 96% to 88%. Nevertheless, this trend isn’t unique to Canada; CEM Benchmarking data reveals similar patterns in UK and US funds. 

What’s driving these changes?  

One significant factor is the scarcity of strategic assets in Canada. Large-scale infrastructure projects and properties that pension funds seek are often government-owned and unavailable for purchase. Think of Toronto Pearson Airport, the Port of Vancouver, and Hydro Quebec. Meanwhile, countries like Australia, India, and the UK actively monetize such assets, attracting Canadian investment abroad. 

So, how can Canadian pension funds increase their domestic investment? 

The report advises against mandating increased domestic investment, arguing it would disrupt carefully calibrated risk-return balances and potentially harm pensioners. Instead, pension fund capital can be attracted by: 

1. Monetizing large-scale infrastructure assets through privatization or long-term leases; 
2. Achieving scale in the number of assets available; 
3. Fostering public support through transparent communication and protective regulations; 
4. Streamlining permit and regulatory processes to boost economic viability 
5. Leveraging government agencies to reduce project costs; and 
6. Issuing more Canadian fixed-income products like real return bonds or long-term fixed-rate mortgages insured by the Canada Mortgage and Housing Corporation. 

In conclusion, the key to attracting pension fund investment isn’t mandates - it’s cultivating an environment rich in strategic assets. By doing so, Canada can retain domestic capital and draw foreign investment, benefiting both the economy and pensioners. 

For a detailed analysis and comprehensive data, please refer to the full paper here.