Among the many bad ideas in the Fall Economic Statement – reciprocity in procurement, a digital services tax, increased subsidies to the news industry – surely the worst was the scheme to tax people’s retirement savings to prop up the Canadian stock market.
You might not have heard it described that way. Possibly it might have been referred to, instead, as a plan to require Canadian pension funds to invest a larger part of their portfolios in Canada, rather than in other countries. Indeed, if you read the statement, it wasn’t even a requirement: more an opportunity.
After noting that “the federal government believes that continued domestic investments by Canada’s pension funds have the potential to boost Canada’s economy and create good careers for people across the country” – mark that word, “continued” – the statement goes on to announce that the government will “work collaboratively” with the industry “to create an environment that encourages and identifies more opportunities for investments in Canada by pension funds.”
Well who can argue with that? Work collaboratively, create an environment, encourage opportunities: sounds great, right? Except, why single out the pension funds? If it’s just about creating a better environment for investing in Canada, that surely applies to investors generally, not just pension funds. And why do the pension funds need the government to help them “identify” more “opportunities” to invest in Canada? Spotting investment opportunities is what they do for a living.
This government, it is well known, has some funny ideas about what mandatory and voluntary mean. Recall how it described raising taxes: “We’re asking the rich to pay their fair share.” Certainly the pension funds themselves aren’t fooled. There were already rumours in advance of the statement that the government had some sort of scheme in the works. In its wake, the industry is standing by to repel all boarders.
Because the government isn’t alone in this pursuit. It has many influential supporters. Here’s Shahir Guindi, private equity lawyer and former chairman of the Montreal Chamber of Commerce, in these pages: Canada’s largest pension funds, he writes, could play “a transforming role” in the country’s economy if only their investments, worth a total of roughly $2.2-trillion, were “more focused domestically.”
Here’s Fred Di Blasio, co-founder and chief executive of Longhouse Capital Partners: If governments were to require “a minimum of 5 per cent to 10 per cent of these pooled pension assets to be invested in Canada over a period of 10 to 20 years, equity available for infrastructure investments would be between $110-billion and $220-billion.”
And here’s Peter Letko of the Montreal-based investment management firm Letko Brosseau & Associates, one of the loudest voices lobbying for the change. “If you take big chunks of capital out of the country, you are robbing the country of a great source of capital that is an essential ingredient to economic growth.”
What will be noticed about each of these born-again economic nationalists is that they are in the business of raising and managing capital in Canada. If the pension funds were forced to repatriate hundreds of billions of dollars to Canada, that would bid up the prices of Canadian stocks, raising the value of their retail clients’ portfolios and lowering the cost of capital for companies issuing stock. Possibly this is not lost on them.
Nothing so inflames the patriotic sentiments of a Canadian businessman like the chance of an easy buck. Economic nationalism has always been the favoured cause of capitalists on the make, ever since its 1970s heyday. Then, the issue was preventing foreigners from taking over Canadian companies, and why not? Prevent foreigners from bidding on Canadian stocks, and they become all the cheaper for domestic acquisitors to snap up. Now the issue is forcing Canadians to invest at home, to make stocks dearer. But the game is the same.
Obviously Canada could use more investment. Why, after all, has Canada’s productivity performance been so awful compared with other countries? Because our workers have less plant and equipment per capita to work with – because our rate of investment has been so low. With more capital to invest, the country could build more houses, repair its infrastructure, transition to a clean economy and other good things.
But there’s a difference between creating a more hospitable investment climate – by liberalizing foreign investment rules, or cutting tax rates, or any number of other measures economists have long championed – and simply ordering Canadian pension funds to redeploy their capital within our borders. The only sustainable kind of investment policy is one that encourages people to invest in Canada because it makes economic sense, not because the government holds a gun to their heads.
If pension funds choose to invest outside Canada, it is not because they are unpatriotic or don’t know their own business: It is because they can earn a higher return, adjusted for risk, than if they invested the same dollar in Canada. One of the most basic principles of investing is diversification: other things being equal, a more diverse portfolio – across asset classes, and across countries – will earn a higher return at less risk than a less diverse one.
As it is, most pension funds, though they typically hold less than 10 per cent of their portfolio in domestic stocks, arguably still have too much invested in Canada, given that it accounts for just 3 per cent of global equity markets. But ordering them to increase their Canadian holdings further can only lead to lower risk-adjusted returns for their beneficiaries.
This isn’t mere speculation: we have been here before. Until the early years of this century, the “foreign property rule” applied, obliging pension funds and RRSP investors to pay a tax of 1 per cent a month on their foreign holdings in excess of a certain threshold: initially 10 per cent of their assets, it was later raised to 20 per cent, then 30 per cent before it was finally abolished altogether in 2005. A 1999 study by the C.D. Howe Institute found the rule reduced average retirement incomes by 6.3 per cent to 12.9 per cent a year. (It might have been worse, had it not been so easily circumvented, through the use of derivatives and complex tiered ownership structures.)
To demand that pension funds invest, not where they can get the best returns, but where politicians say they must, is to oblige them to violate their fiduciary duty to their beneficiaries. A minor objection, according to “invest in Canada” advocates: The government can simply rewrite the rules to assign them a “dual mandate” – earn the best return for their clients and “support Canadian economic development,” or what not. But a conflict does not disappear just because you ignore it. Organizations with dual mandates and multiple bottom lines – I’m talking about you, Quebec’s Caisse de dépôt et placement – generally fail to hit any of them.
Which is to say, Canadian content quotas for pension funds aren’t just bad for pensioners – they’re bad for Canada. The returns that pension funds earn on their investments abroad aren’t just returns to the pension fund or its beneficiaries – they’re returns to Canada. They factor into the balance of payments; they’re part of the GDP. They’re recycled throughout the economy, purchasing goods and services and financing other investments.
Forcing pension funds to invest in Canada, at a lower return than they could get elsewhere, doesn’t raise national income – it redistributes it, from the funds’ beneficiaries to the people hoping to profit from the resulting forced abundance of capital. When people say the money will go to “supporting Canada’s economy” or “stimulating economic growth” what they mean is it will support/stimulate certain sectors of the economy, at the expense of others. Like all protectionist policies, it doesn’t tilt the playing field in favour of Canadians over foreigners, but of some Canadians over other Canadians.
It’s far from clear this is a good trade in distributional terms, but it’s as clear as day that mollycoddling Canadian business in this way is terrible for efficiency. In an open capital market, where investment can flow to wherever it earns the highest return, at home or abroad, companies have to compete for capital, by keeping costs low and returns high. In the kind of hothouse capital market the pension nationalists are agitating for, they can just collect it.
At the same time, it would make Canadian capital markets even more cloistered and top-heavy than they already are. If you think the big eight pension funds dominate Canadian equity markets now, think of how much more dominant they would be with another couple of hundred billion dollars invested – especially since the government also proposes to eliminate the rule restricting them to holding no more than 30 per cent of the voting shares in any corporation.
It’s particularly bizarre to see the government messing around with pensions now, of all times, with Alberta debating whether to pull out of the Canada Pension Plan. I’ve had my criticisms of the CPP’s Investment Board, but at least it is relatively unpoliticized, and more-or-less focused on earning the best return for its beneficiaries, even if it wastes billions of dollars in the attempt.
That’s been a big point in favour of keeping it, versus the plan the Alberta government is promoting. People are justifiably worried it would be used as a piggy bank for whatever pet investment schemes entered the Premier’s head. But, as the columnist Rob Breakenridge has pointed out, if the CPP is no longer mandated to put pensioners first, “if that is no longer going to be the strategy, then Albertans might start to think differently about this whole issue.”
But maybe that’s not what the government is thinking. Maybe there’s a more enlightened possibility. Maybe, when it says it wants to “identify more opportunities for investments in Canada by pension funds,” it means it wants to open up whole asset classes that are now closed to them. Maybe, that is, it is planning to privatize certain public assets, allowing pension funds and other investors a chance to participate.
As the economist William Robson notes, one of the reasons pension funds find investing abroad so attractive is the chance to invest in public infrastructure, “such as airports and ports, toll roads and bridges, water utilities, and companies that generate and distribute electricity. They would like to own similar assets in Canada.” Maybe that’s all the government has in mind.
Maybe. But if you believe that, I have a bridge I’d like to sell you.
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