Rob Carrick of the Globe published an article last week titled Critics of the overhauled CPP say it’s a bad deal – here’s why they’re wrong which contained the following puzzling statements:
Critics say the CPP pay outs offer a poor rate of return on contributions…
…
The Fraser Institute think tank critiqued this column, partly for not deploring the rate of return people will get on money contributed to the expanded CPP. The institute quotes a study saying the overall return is 2.5 per cent, which is described as “meagre.”Based on numbers only, maybe so. Guidelines for financial planners set out after-fee returns of 3.2 per cent for conservative portfolios (25 per cent stocks, 75 per cent bonds and cash), 3.9 per cent for balanced portfolios (50 per cent stocks, 50 per cent bonds/cash) and 4.7 per cent for aggressive (75 per cent stocks, 25 per cent bonds/cash.
This puzzled me because the last time I reviewed it, I figured the CPP was doing a pretty good job. The primary reason for this is that they have a captive market; therefore they have no salesmen; and therefore they don’t have to come up with interesting stories and ensure their portfolios are aligned with that story. All they have to do is choose good investments. This is an extremely important determinant of investment management results, as I have stated in this blog to the point of weariness when discussing outfits like OMERS, Teachers and HOOPP. It also helps that they can fire people without having to worry about clients’ reactions.
So I did a little checking and a little digging and, after the Fraser Institute came out with another volley in their debate, had an eMail exchange with one of the Fraser Institute honchos which included the following, taken from my side of the exchange:
Aren’t the figures quoted by Carrick (which appear to be from the FPSC Projection Assumption Guidelines, published online at [LINK] ) nominal returns, gross of 2.0% inflation, as opposed to your figures, which are net of inflation?
It makes quite a difference to the comparison!
…
As you are doubtless aware, the CPP was only 6% funded in 1996 (see [LINK] ) as the CPP was conceived as having a pay-as-you-go basis.This was changed in 1997 to a requirement for steady-state funding and full funding (see [LINK] ).
It is clear that a transition from 6% funding to 100% funding must be paid for somehow, and I see only three avenues for accomplishing this task:
– reduce benefits for the ‘early benefiticiaries’ [sic], some of whom achieved staggering rates of return on their contributions, as discussed in [LINK]
– increase contributions for ‘late beneficiaries’
– make up the difference through government general revenue, i.e., taxpayers in general irrespective of CPP status.The solution reached was to adjust the contribution and benefit rates with the effect that current contributors are over-funding their benefits. Right or wrong, that was a political decision that people seem happy with, although it leads to the gap you deprecate between the fund’s required rate of return and the rate of return realized in benefits to current contributors.
Thus, the existence of this gap is irrelevant to any discussion of CPP expansion, as the gap that existed in 1996 is slowly being erased through increased contribution rates. Any changes to the level of expected benefits must be fully funded; this implies that the gap, expressed in terms of fund- and contributor-returns will actually narrow as the plan is expanded (or, conversely, widen if the fund should become less ambitious; I note that as per the 16th Actuarial report referenced above, the contribution rate was projected to rise to 10.1% in 2016 and 14.2% in 2030.
Even after accounting for the gap in returns, contributors are expected to achieve a 2.5% real rate of return on their contributions according to your figures, a rate that can hardly be described as meagre. This is equivalent to a 4.5% nominal rate given generally accepted estimates of future inflation, handsomely exceeding the ‘conservative’ (3.2%) and ‘balanced’ (3.9%) portfolios of the FPSC Projection Assumption Guidelines quoted by Carrick. The projected contributor rate of return is exceeded only slightly by the ‘aggressive’ projection (4.7%). It is my experience in the investment management business that there are far more investors who will demand ‘conservative’ or ‘balanced’ investment portfolios – particularly among those who hold less than the median non-pension financial assets of a mere $11,600 in 2016 (see [LINK] ).
You claim that “the CPP has to earn a 4% ROR over time in order to sustainably provide a 2.5% ROR to retirees. No worker would likely make that deal voluntarily” This is absurd. There exist a huge number of Canadian equity mutual funds with MERs in excess of 1.5%, and (according to the OSC in 2013 (see [LINK] : “According to analysis from Strategic Insight on advisory fees charged by client asset size under U.S. fee-based programs (2011), 70% of U.S. investors with account sizes of $100,000 are charged advisory fees higher than 1.25% and 31% are charged over 1.50%”. Note also that, as discussed above, elimination of this gap with respect to current contributors would only move the requirement for increasing the CPP funded ratio onto other shoulders; this is in distinction to the extortionate levels of fees in the Canadian financial services industry which are paid very happily by investors.
I will also note that my analysis of annuity rates indicates that the expected rate of return on annuities offered to retail investors is 0% – the profits due to investment returns during the lives of the annuities are captured entirely by the sponsoring company – and are well in excess of 1.5% (the value of annuities lies not in their value as investments, but as insurance against unexpected longevity). Additionally, the Net Interest Margins achieved by Canadian banks are grossly in excess of the 1.5% that “no worker would likely make … voluntarily”. (see [LINK] ). It is also clear that almost every investor in Canada bonds for the past ten-plus years has voluntarily accepted a rate of return far below 2.5% real.
I remain perplexed by your statement that “please note that the CPP doesn’t offer any inheritable asset other than the death benefit. That issue isn’t included in the comparison.” Surely your analysis included all cash-flows from the CPP to beneficiaries; therefore your claim of a 2.5% expected rate of return will – under the “full funding” regime – be unaffected by whether any given outflow is labelled as a death benefit or otherwise.
Sincerely,
For the record, I don’t consider the Fraser Institute to be a think-tank at all. It’s just another murky mouthpiece for the vested interests … their funding is unusually opaque.
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| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
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| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.1935 % | 2,196.4 |
| FixedFloater | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.1935 % | 4,030.3 |
| Floater | 5.34 % | 5.59 % | 32,269 | 14.44 | 4 | 0.1935 % | 2,322.7 |
| OpRet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.0748 % | 3,257.0 |
| SplitShare | 4.90 % | 4.63 % | 57,717 | 3.92 | 8 | -0.0748 % | 3,889.5 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.0748 % | 3,034.8 |
| Perpetual-Premium | 5.82 % | -8.10 % | 89,025 | 0.08 | 4 | 0.2373 % | 2,906.1 |
| Perpetual-Discount | 5.55 % | 5.66 % | 76,831 | 14.23 | 31 | 0.2558 % | 3,000.0 |
| FixedReset Disc | 5.13 % | 5.45 % | 221,041 | 14.78 | 65 | 0.3436 % | 2,214.5 |
| Deemed-Retractible | 5.30 % | 6.21 % | 92,572 | 8.10 | 27 | 0.4378 % | 2,992.1 |
| FloatingReset | 4.35 % | 5.64 % | 53,662 | 8.42 | 6 | 0.4407 % | 2,441.9 |
| FixedReset Prem | 5.12 % | 4.16 % | 282,760 | 2.25 | 18 | 0.2243 % | 2,539.5 |
| FixedReset Bank Non | 2.00 % | 4.40 % | 170,441 | 2.81 | 3 | 0.1900 % | 2,609.6 |
| FixedReset Ins Non | 4.97 % | 6.88 % | 132,091 | 8.25 | 22 | 0.3757 % | 2,239.0 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| RY.PR.S | FixedReset Disc | -1.33 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 21.78 Evaluated at bid price : 22.20 Bid-YTW : 4.91 % |
| CM.PR.O | FixedReset Disc | -1.03 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 19.26 Evaluated at bid price : 19.26 Bid-YTW : 5.41 % |
| RY.PR.J | FixedReset Disc | -1.01 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 21.46 Evaluated at bid price : 21.46 Bid-YTW : 5.27 % |
| HSE.PR.G | FixedReset Disc | 1.01 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 19.99 Evaluated at bid price : 19.99 Bid-YTW : 6.72 % |
| SLF.PR.G | FixedReset Ins Non | 1.02 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 14.80 Bid-YTW : 9.14 % |
| MFC.PR.M | FixedReset Ins Non | 1.03 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 19.70 Bid-YTW : 7.10 % |
| ELF.PR.H | Perpetual-Discount | 1.03 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 24.19 Evaluated at bid price : 24.55 Bid-YTW : 5.66 % |
| SLF.PR.C | Deemed-Retractible | 1.07 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 20.75 Bid-YTW : 6.81 % |
| GWO.PR.R | Deemed-Retractible | 1.09 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 22.19 Bid-YTW : 6.38 % |
| GWO.PR.H | Deemed-Retractible | 1.20 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 21.90 Bid-YTW : 6.60 % |
| IAF.PR.I | FixedReset Ins Non | 1.20 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 21.05 Bid-YTW : 6.88 % |
| SLF.PR.E | Deemed-Retractible | 1.27 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 20.80 Bid-YTW : 6.84 % |
| BAM.PR.B | Floater | 1.29 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 12.56 Evaluated at bid price : 12.56 Bid-YTW : 5.59 % |
| PWF.PR.Q | FloatingReset | 1.31 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 14.69 Evaluated at bid price : 14.69 Bid-YTW : 5.64 % |
| HSE.PR.C | FixedReset Disc | 1.31 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 19.30 Evaluated at bid price : 19.30 Bid-YTW : 6.49 % |
| GWO.PR.P | Deemed-Retractible | 1.34 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 24.90 Bid-YTW : 5.59 % |
| PWF.PR.Z | Perpetual-Discount | 1.34 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 22.27 Evaluated at bid price : 22.61 Bid-YTW : 5.74 % |
| TD.PF.I | FixedReset Disc | 1.36 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 22.83 Evaluated at bid price : 23.87 Bid-YTW : 4.97 % |
| GWO.PR.N | FixedReset Ins Non | 1.36 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 14.90 Bid-YTW : 8.82 % |
| BMO.PR.E | FixedReset Disc | 1.43 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 22.47 Evaluated at bid price : 23.33 Bid-YTW : 4.89 % |
| TRP.PR.F | FloatingReset | 1.46 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 15.93 Evaluated at bid price : 15.93 Bid-YTW : 5.74 % |
| MFC.PR.L | FixedReset Ins Non | 1.59 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 18.51 Bid-YTW : 7.65 % |
| BAM.PF.A | FixedReset Disc | 1.60 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 21.35 Evaluated at bid price : 21.65 Bid-YTW : 5.63 % |
| BAM.PR.M | Perpetual-Discount | 1.65 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 21.00 Evaluated at bid price : 21.00 Bid-YTW : 5.76 % |
| BAM.PR.Z | FixedReset Disc | 1.68 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 21.15 Evaluated at bid price : 21.15 Bid-YTW : 5.72 % |
| PWF.PR.T | FixedReset Disc | 1.84 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 19.39 Evaluated at bid price : 19.39 Bid-YTW : 5.45 % |
| BAM.PF.I | FixedReset Prem | 2.02 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2022-03-31 Maturity Price : 25.00 Evaluated at bid price : 25.25 Bid-YTW : 4.73 % |
| BIP.PR.D | FixedReset Disc | 2.03 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 22.18 Evaluated at bid price : 22.61 Bid-YTW : 6.14 % |
| TD.PF.J | FixedReset Disc | 2.28 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 21.99 Evaluated at bid price : 22.45 Bid-YTW : 5.10 % |
| TRP.PR.C | FixedReset Disc | 2.54 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 13.71 Evaluated at bid price : 13.71 Bid-YTW : 5.95 % |
| HSE.PR.E | FixedReset Disc | 3.84 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 20.01 Evaluated at bid price : 20.01 Bid-YTW : 6.77 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| RY.PR.J | FixedReset Disc | 115,716 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 21.46 Evaluated at bid price : 21.46 Bid-YTW : 5.27 % |
| CU.PR.H | Perpetual-Discount | 97,820 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 23.08 Evaluated at bid price : 23.46 Bid-YTW : 5.61 % |
| RY.PR.Z | FixedReset Disc | 76,350 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 19.27 Evaluated at bid price : 19.27 Bid-YTW : 5.25 % |
| TD.PF.L | FixedReset Prem | 74,943 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 23.18 Evaluated at bid price : 25.10 Bid-YTW : 5.04 % |
| BMO.PR.S | FixedReset Disc | 69,909 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2049-02-25 Maturity Price : 19.35 Evaluated at bid price : 19.35 Bid-YTW : 5.39 % |
| GWO.PR.G | Deemed-Retractible | 63,910 | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2030-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.29 Bid-YTW : 6.21 % |
| There were 30 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| IFC.PR.G | FixedReset Ins Non | Quote: 20.77 – 21.55 Spot Rate : 0.7800 Average : 0.5139 YTW SCENARIO |
| BAM.PR.X | FixedReset Disc | Quote: 14.55 – 15.21 Spot Rate : 0.6600 Average : 0.4292 YTW SCENARIO |
| BAM.PR.N | Perpetual-Discount | Quote: 20.32 – 20.85 Spot Rate : 0.5300 Average : 0.3548 YTW SCENARIO |
| PWF.PR.P | FixedReset Disc | Quote: 14.21 – 14.65 Spot Rate : 0.4400 Average : 0.3064 YTW SCENARIO |
| POW.PR.D | Perpetual-Discount | Quote: 22.05 – 22.44 Spot Rate : 0.3900 Average : 0.2749 YTW SCENARIO |
| CU.PR.H | Perpetual-Discount | Quote: 23.46 – 23.90 Spot Rate : 0.4400 Average : 0.3359 YTW SCENARIO |