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(P&I) CPPIB 3rd Quarter

February 18, 2014
It Will Work In Time. Just Wait.Don't worry about the gathering storm or the earthquake.Look at the rainbow.

It Will Work In Time. Just Wait.
Don’t worry about the gathering storm on the horizon – it’s far away – or the earthquake.
Look at the rainbow!

Drama. Great piles of money never survive. The Canada Pension Plan Investment Board (CPPIB) has a “great pile of money” – indeed, $200 billion or more anticipated to increase to $800 billion in the next thirty years – but the fund has just reported another accounting error as an investment return for the last three months.

That makes three “accounting errors” this year and if they stay on track and there aren’t any “accidents” – because good or bad, they’re all “accidents” when controlling for alleged “volatility risk” – they will produce on paper (possibly) +10% on $180 billion (net of net contributions or free money) in their fiscal year which ends in March – in just a month.

But where is the real money? Most of the gains appear to be unrealized capital gains marked-to-market and the investment income for the year-to-date (3rd Quarter CPPIB) is $4.4 billion on $180 billion which is a return on equity of 2.5% before transaction and management costs of $860 million.

The CPPIB has suggested that it might return a small amount to the shareholders in 2023 but it doesn’t know what that “small amount” might be and, therefore, the CPPIB doesn’t know where the “puck”  will be in 2023 but confidently predicts that we’re “good” for the next seventy-five years (CBC, January 31, 2014, Head of CPP fund investing ‘where the puck is going to be’).

Constructive Illiquidity

Constructive Illiquidity

So, what are we “good” for (The Canadian Press, January 30, 2014, Majority counting on CPP for retirement; others will rely on lottery: poll) and we ask again, where is the real money and what is this “enterprise”, the CPPIB, if it is “not for profit”?

The only meaningful test of any investment strategy is “liquidity” – how much of this fund can we take down at any time without adversely affecting the strategy.

For example, the four major North American stock markets handed out $600 billion in dividends last year and capital gains of $4.5 trillion of which $180 billion is about 1% of the total market valued at $18 trillion at the beginning of the year. Please see Exhibit 1 below.

The most recent triennial report by the Chief Actuary of Canada indicated that the CPP is sustainable over a 75-year projection period.

The most recent triennial report by the Chief Actuary of Canada indicated that the CPP is sustainable over a 75-year projection period.
Do the next 75 years include any depressions, recessions, World Wars, revolutions, or a change in the global economic balance affecting 20 billion people?

Did the people of Canada who are the  “shareholders” of this great enterprise get their “fair share”? Did they get $6 billion in dividends and $45 billion in capital gains?

If they did, the CPPIB could give back $50 billion to the people of Canada this year, and be just as good to do it again next year.

And the year after that and so on, so that the future is always now and not just something that looks like $800 billion in 30 years.

But instead of getting any money back from their investment, the people of Canada might be expected to pony-up with even more of their money in order to meet the “concerns” of the Canada Pension Plan (The Globe and Mail, October 3, 2013, Proposed changes to CPP spur momentum for pension reform).

Exhibit 1: Aggregate Market Returns and Risk Management in the Perpetual Bond™

Aggregate Market Returns - December 12 2013

Aggregate Market Returns – December 12 2013

Similarly, it is not unreasonable to compare the performance of the CPPIB with the return on equity and dividend returns of the major Canadian chartered banks and the insurance companies. Please see Exhibit 2 and 3 below and click on the charts to make them larger if required.

The Canadian Chartered Banks

Exhibit 2: The Canadian Chartered Banks – Fundamentals

The banks and insurance companies also have a lot of money ($3.6 trillion for the banks and $1.7 trillion for the insurance companies) but it is not theirs and most of it is held in trust.

The Canadian Insurance Industry

Exhibit 3: The Canadian Insurance Industry – Fundamentals

What is theirs is the shareholders equity of $199 billion for the banks and $107 billion for the insurance companies and both amounts are comparable to the net worth or “shareholders equity” of $180 billion of the Canada Pension Plan that is managed and held in trust by the CPPIB.

But the banks paid $14 billion in dividends and a return of earnings of 48% to their shareholders and earned 14.8% on the shareholders equity last year in the “debt” business; and, similarly, the insurance companies paid $5 billion in dividends and a return of earnings of 56% to their shareholders and earned 8.5% on the shareholders equity last year in the “insurance” business.

The 4 %er

Risk Manager Of The Year
Charged With “Voiding Risk” and “Capital Punishment”.

So if the CPPIB is not in the “debt” business – it doesn’t buy or sell bonds, we guess – nor in the “insurance” business – such as managing segregated funds and other investments that are required in order to earn income on capital and premiums in order to meet future liabilities, which also sounds familiar – what is the CPPIB if it is not a business?

As we understand it – and that would be true for any pension fund – it’s in the “risk business” because an investment is just and only the “purchase of risk” and “risk” is just and only about liquidity – if we buy this bond or equity or property can we expect that our cash in the investment is just as good as cash in our pocket but better than money as cash in our pocket because it might provide a hopeful return above the rate of inflation.

What other reason would there be for buying it if it can’t or doesn’t provide 100% capital safety and a hopeful return above the rate of inflation? Should we expect that the market will give it to us because we’re immunized to “volatility”?

In our view, to invest we must “buy” risk and actively embrace it. But to manage it, we need to find ways in which to arbitrage it away and not just ride with every wave like a “bobbing cork” hoping for a good outcome when we need our money. We need to:

Check Mark

Check, our alternatives provide a non-negative real return every year and we don’t need the capital right away even though we’re getting offers to buy our interest every other day.

Check MarkCheck, our bonds provide 100% capital safety and we could hold them to maturity regardless of inflation surprise.

Check MarkCheck, our equities provide 100% capital safety and a hopeful return above the rate of inflation, also known as a non-negative real return every year and they provide all the liquidity that we might need absent the fortuitous maturity of our bonds or alternatives.

S&P 500 Total Real Returns - 20 & 30 Year

S&P 500 Total Real Returns – 20 & 30 Year
If they succeed, that’s what they get.

We can see from the chart on the left that anything can happen in thirty years and even shorter periods such as ten years or seven years are just as uncertain but on a different scale of the paper (or nominal) gains and losses.

That’s why we need to bring the future forward.

What we say we’re going to be doing in the future, we need to be doing now because in the future we cannot re-visit the past. And after 50 years of CPP growth and administration, the future is surely now.

Did we get what was expected and how much of what we got came out of our own pocket?

Nickels In Front Of Bulldozers LTCM "The Financial Technology Company" 1998

Nickels In Front Of Bulldozers
LTCM “The Financial Technology Company” 1998

The chart on the left (above) is the terror of investment managers everywhere and what keeps them up at night and busy all day calculating market averages and volatility and co-volatility.

Our mandate is to invest in the best interests of Canada Pension Plan contributors and beneficiaries and to maximize investment returns without undue risk of loss.

“Our mandate is to invest in the best interests of Canada Pension Plan contributors and beneficiaries and to maximize investment returns without undue risk of loss.” – CPPIB

And if they succeed, that’s what they get – a return that looks like an accounting error – because economics and managing volatility and co-volatility have nothing to do with obtaining non-negative real returns.

For more information on “risk management” and additional references to the theory, please see our recent Post, The RiskWerk Company Glossary.

And for more on what risk averse investing has done for us this year, please see our recent Posts on The S&P TSX “Hangdog” Market or The Wall Street Put or specialty markets such as The Dow Transports & Utilities or (B)(N) The Woods Are Burning, or for the real class actionLa Dolce Vita – Let’s Do Prada! and It’s For You, Dear on the smartphone business.

And for more stocks at high prices, The World’s Most Talked About Stocks or Earnings Don’t Matter – NASDAQ 100. And for more on what’s Working in AmericaBig OilShopping in America or Banking in America, to name just a few.

Postscript

We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond
Alpha-smart with 100% Capital Safety and 100% Liquidity
Guaranteed
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to RiskWerk@gmail.com.

Disclaimer

Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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