The CPPIB Risk Return Accountability Framework
A Realistic Approach to National Pension Fund Management
Three principals of 1997 Reforms
Intergenerational fairness• Higher rates now, lower rates in the future• Fully fund future benefit improvements
Affordability• Legislated rate should not exceed 9.9% (hopefully)• Reduced future CPP benefits• Capital market returns help lower future rates
Sustainability• Mid-course plan design adjustments, if required• Self-correcting “fail-safe” adjustment if political process stalls
Charting the Path to Sustainability
0
2.5
5
7.5
10
12.5
1960 1980 2000 2020 2040 2060 2080
PAYGO Rate
Contribution RatePartially funded, legislated rate of 9.9%.
1997 reforms
Managing the Contribution Rate
Agree on the mechanism to change the contribution rate before you need it
Have independent monitoring of the contribution rate
Have independent means of changing the contribution rate
The CPP restructuring of 1997
Increase contribution rate to build up surpluses
Reduce costs by both reducing benefits and by investing surpluses in risky assets
Created default mechanism to make any necessary changes to the contribution rate
The CPPIB mission
Maximizing returns without undue risk of loss,
having regard to the factors that may affect
the funding of the CPP
Managing your objectives
1. Know your objective
2. Remove influences and constraints that may compromise meeting your objectives
3. Align your organization with your objective.
4. Make it easy for stakeholders to assess performance
Investment earnings are needed to meet future liabilities
-150,000
-100,000
-50,000
0
50,000
100,000
150,000
200,000
250,000
300,000
350,000
2000 2020 2040 2060 2080
year
Cas
h (
CA
D M
)
Net Liabilities
Investment earnings
Total
CPPIB Investment Strategy
Build a Better Beta PortfolioBuild a Better Beta Portfolio
Choose CPP Reference PortfolioChoose CPP Reference Portfolio
Estimate Net LiabilitiesEstimate Net Liabilities
Capture Attractive Sources of AlphaCapture Attractive Sources of Alpha
Take Advantage of CPPIB’s Unique SituationTake Advantage of CPPIB’s Unique Situation
Inc
rea
sin
g V
alu
e A
dd
Model dynamics make a differenceState variables (eg inflation)
tttrttttt
trtttt dZtXdttXBtXCtXrtXWtXrdW ,,,,,,
Portfolio returns = set of portfolio weights
Net contributionsMarket volatility
tttt dZtXbdttXadX ,,
Security prices
tttt dZtXbdttXadX ,,
Fund wealth
Estimating optimal financing
Formulate the stochastic dynamic control problem (Hamilton Jacobi Bellman)
Portfolio weights are the control variable
Minimize the probability of failing to fulfill the pension promise at some time in the future
The optimal portfolio strategy
• The optimal strategy minimizes the probability of restructuring the fund in the future
• The optimal portfolio is a combination of mutual funds• A risk free fund• The optimal growth portfolio• A mutual fund for each state variable
• The optimal portfolio strategy specifies security weights conditional on fund wealth, time and the value of the state variables
Fund wealth affects portfolio allocation …
0.00
2.00
4.00
6.00
8.00
10.00
12.00
14.00
16.00
18.00
20.00
0 0.2 0.4 0.6 0.8 1 1.2
Asset/Liability Ratio
Mar
ket
All
oca
tio
n
3.00%
4.00%
5.00%
… And the probability of restructuring.
-0.2
0
0.2
0.4
0.6
0.8
1
1.2
0 0.2 0.4 0.6 0.8 1 1.2
Asset/Liability Ratio
Res
tru
ctu
rin
g P
rob
abil
ity
3.00%
4.00%
5.00%
SummaryOptimal financing requires
• Alignment• a clear statement of objectives• Align governance and organization with fund
objectives• The CPPIB is developing innovative models to
inform its investment decisions.• Align financing strategies with these objectives
• Default mechanism to make any needed contribution rate changes
• Optimal financing aligned with Stewards risk and return expectations
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