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People, Profits, |
Chapter 3:We're All Capitalists, NowYour comments, please! This is a draft version of Chapter 2, provided here for the purpose of getting reader feedback. This feedback will be incorporated into the final version.
As this chapter is being written, we see the the Alberta oil sands being whipped in public. Environmental groups accuse companies mining the oil sands, or tar sands, as they call them, of despoiling the boreal forest, of pumping vast amounts of CO2 into the atmosphere and causing global warming, of damaging the health and culture of native people in the area, and more. Much of the media appears to agree with that assessment, as does the public in much of the country. In fact, during, before, and after the Copenhagen summit on climate change, many Canadians publicly proclaimed their embarrassment at even being associated, by citizenship, with the exploiters of the oil sands. And, at Copenhagen, the governments of Ontario and Quebec lashed out at the federal government for failing to impose tougher emission standards on the oil sands. They argued it was unfair that citizens of their provinces had to shoulder a burden that benefited only Alberta. So, let's find out who's responsible; let's ask: Who profits from the oil sands? Well, as it turns out, they're mostly current and future retirees in Ontario and Quebec. Why? Because these two provinces have the lion's share of Canada's population, and because almost every equity pension fund in Canada wants invest in oil sands producers, it leads to the conclusion that more Ontarians and Quebecers, than Albertans, get profits from the oil sands companies. It's equally ironic that, as we'll see in this chapter, much of Alberta's public service pension money is invested in Ontario and Quebec. No doubt that includes investments in the auto sector, even though most Albertans vociferously opposed federal bailouts of the auto industry in 2008 and 2009. Like politics, pension plans make for strange bedfellows. - - - - - - - When experts talk about Canadian retirement income, they often talk about the "three legs" of our pension system:
We'll discuss the universal government plans in another chapter, but for now, let's look inside the Canada Pension Plan, as well as a typical pension fund and a typical mutual fund. Where Working Class Becomes Owning
Class When first created and enacted in the mid 1960s, the CPP operated on a pay-as-you-go basis, which meant, generally speaking, that contributions received this year provided funds for next year's payments to pensioners. But, this proved to be a problem in later decades as the ratio of working-to-retired people changed, and so the Plan increased contribution rates and invested surplus funds in fixed income investments such as government bonds. Concern grew stronger in the 1990s, with the large Baby Boomer generation soon start retiring. As they retire, fewer workers will support more pensioners, which would ultimately bankrupt the system (the American debate over Social Security reflects the same issue). In 1996, for example, the plan paid out $17-billion while bringing in only $11-billion, a deficit of $6-billion. Clearly, the plan was not sustainable. As a result of this impending crisis, the federal and provincial governments made two important decisions. First, they sharply increased CPP contribution rates, and second, created a new, independent agency, the Canada Pension Plan Investment Board (CPPIB), in 1997. The agency had a specific, objective, and non-political mandate: "To maximize long-term investment returns without undue risk, taking into account the factors that may affect the funding of the Canada Pension Plan and its ability to meet its financial obligations." (CPPIB website, January 2010). The CPPIB's legislated mandate puts it arm's length from the government, so governments are unable to use its funds, or to influence its investment decisions. The Investment Board made its first investments in the shares of large Canadian companies in 1999, using surplus Plan funds not immediately required for pension payments. At the current rate of contributions by employees and employers, the CPP is expected to take in more in contributions than it pays out in pensions until 2019. After 2019, the plan is expected to earn enough in investment income to self-sustainable on an ongoing basis. In other words, although significantly more Canadians will collect CPP, and significantly fewer Canadians will pay into the plan, benefits should remain constant (indexed to inflation) without requiring higher or additional contributions by those still working. The key to this sustainability is investment earnings, particularly dividends and capital gains from shares in big, publicly traded corporations. Here are the top 25 Canadian holdings of the plan (and their main product or service), as of March 31, 2009:
As you can see, the CPPIB's holdings reflect what was going on in the Canadian economy at that time, with heavy holdings in gold producers and other commodity companies. Surprisingly to some working Canadians, much of the CPPIB's investments have gone into companies beyond Canada's borders. Specifically, in early 2010, about 2,200 of the 2,900 companies were foreign. Why, you might ask, has this Canadian investment agency invested so much beyond our borders? Shouldn't it invest more at home? Well, investing outside the country is important for several reasons. Most importantly, it gives the fund diversification among many types of industries, to guard against having too many eggs in one basket. Should the Canadian economy be in recession, the fund would still maintain at least some earnings from investments in countries not in recession. In addition, by investing outside the country, the CPPIB can often generate higher earnings than it could by investing only in Canada. While shifting the emphasis to Canadian investments might produce a few more Canadian jobs, it would expose the plan -- and our pensions -- to greater risk. And, the CPPIB's mandate, as set by the provincial and federal governments, was simple and direct: "Maximize investment returns without undue risk of loss." Its mandate has never included, nor should it, investment primarily in Canada. We should note though, that the investments in the top 25 list represent major commitments to Canadian corporations. For example, the investment in Barrick Gold was valued at $739-million at March 31, 2009; that's almost three-quarters of a billion dollars. At the other end of the list, the investment in Tim Hortons (number 22) came to $70-million. Anatomy of a Pension Plan Now, here's the interesting fact that follows, "Last year [year not specified], about 80% of the funds LAPP paid out came from returns on these investments." In other words, four-fifths of the money paid out in pensions came from investments - not directly from existing contributors (employees). Take this information another step: Imagine that the pension fund did not invest in equities, and ask yourself a couple of questions: How much would existing contributors have to pay (in other words, how much more would have to be paid by employees and employers) in order for retirees to get the same pensions? Or, alternatively, imagine how much less retirees would receive if contributions stayed at the same levels. This helps illustrate why pension funds invest in equities (shares in corporations) as well as safer fixed income securities such as bonds and GICs. Historically, equities have earned an average 10% rate of return, about 3% higher than bonds and GICs. With their higher rate of return, equities allow funds to get back significantly more than they originally invested. Of course, returns on equities are volatile and expose a pension fund to more risk than would fixed income securities. But, it's almost universally agreed that pension funds need to own at least some equities. The question of how much is an ongoing debate, one that's being answered differently by different pension funds. In addition to holdings in public companies, LAPP had $390-million invested in private companies, which represented 2.5% of its total holdings of about $15.5-billion (all figures cited here as of December 31, 2007). Here's another interesting fact: Of the fund's equity investments in Canada, the biggest chunk went to - surprise - Ontario, with $834-million. Alberta was the second destination of investment choice, at $547-million; Quebec was third at $134-million, and BC fourth at $32-million. In keeping with prudent principles of pension fund investing, this Alberta-based fund has geographically diversified its investments. In other words, it has not invested solely in Alberta companies. If the Alberta economy slumps, perhaps as a result of lower oil and gas prices, the fund's investments won't necessarily slump, too. By diversifying into Central Canada, and in Ontario-based companies that serve all or parts of Canada, the fund is more likely to maintain an even return on its investments. Exploring the LAPP website further, we see it is managed by a Board of Directors, who include:
What are we to take from this list of Directors? It illustrates several important issues. First, like many other public service pension plans, it includes diverse representation from its many groups of stakeholders, including both management and unions. Second, it is not, as many might imagine, made up of high-flying executives with no connection to people on the front lines. Quite the opposite. As we see in the list, these directors hold other positions which routinely puts them in contact with working people. Given the strong connections between the directors and the people they represent, we would expect them to be well aware of the retirement needs and expectations of those they represent. We get no sense of an ivory tower atmosphere where decisions are made without considering the best interests of members of the plan, whether those members are retirees or still working. Is this plan representative of all Canadian pension plans? In most respects, it probably is. While there will be small differences when compared with the many other plans across the country, the essentials will be the same:
Anatomy of a Mutual Fund And selling to bank customers, a somewhat captive audience, is our first avenue of inquiry. When mutual funds first gained widespread adoption, in the 1950s, they were relatively esoteric. You could only buy them through special sales agents or through brokers, and so they went unnoticed by many working people. But, as the Baby Boom generation started to invest, banks saw an opportunity and began offering both their own and the funds of independent companies. The arrival of banks in the world of mutual funds has had a democratizing effect. To buy one, you no longer had to know a broker or a specialist sales person. Instead, you could simply walk into your bank branch, fill out some forms, and the bank would automatically deduct a contribution from your account every month. The arrival of Register Retirement Savings Plans in 1957, which allowed us to deduct pension contributions, also made mutual funds attractive investments for working and middle-class Canadians. Bank sales of mutual funds really opened the doors to investing by working people. Speaking of the American experience, which also holds for Canada, David C. Weinstein, Chief of Administration at Fidelity Investments said, "...over the past 25 years, the most powerful trend in the financial history of America and many other countries has been the growth and prosperity of mass investing by working families." Turning our attention back to the RBC Canadian Equity Fund, we see its objective is "To provide long-term capital growth by investing primarily in equity securities of major Canadian companies...." In other words, the fund was designed for investors who want to build their wealth by buying shares in (mostly) the biggest Canadian corporations. Unlike a balanced fund, which would also include bonds, GICs, and other fixed income investments, this one invests almost exclusively in stocks. As the name suggests, it focuses just on Canada and if we read the fine print we see that (as of February 11, 2009) it has invested more than 83% of its capital in Canadian stocks. It also has a slight amount of U.S. content, at 6.8%, and a smattering of international stocks at 2.2%. We note, too, that it was holding 7.3% of its portfolio in cash. In most cases, mutual funds keep a pre-determined amount in cash for a couple of reasons. First, for redemptions, which occur when people like us sell our units in the fund. And, with big funds, there's a constant flow of cash in and out, as investors buy and sell their units. Second, keeping a small portion in cash allows the fund manager to buy if there's a bargain among the stocks of corporations. When your fund holds three and quarter billion dollars, 7.3% of it means there's a significant amount available for opportunistic buying. The listed Management Expense Ratio (MER) of 1.96% points us to another key issue for investors, and especially working people who invest. The MER comes out of your fund earnings, and over time high rates will significantly erode your investment returns. Savvy investors always look at a fund's MER as well as its yields in the short and long-terms. Now, while Canadian MERs are relatively high, especially compared to those in the United States, they have allowed working Canadians to buy equities (shares in companies) easily and conveniently. Previously, only investors with several hundred thousand dollars or more could afford to invest directly in stocks and wanted a diversified portfolio. Prior to the arrival of mutual funds, working people had to make do with fixed income investments, most commonly Canada Savings Bonds, and make do with smaller returns. Finally, if you invest in the RBC Canadian Equity Fund, you can start with as little as $500, a far cry from several hundred thousand dollars. How has the fund invested the $3.3 billion dollars it controls? It has bought shares in 15 different sectors, sectors as diverse as manufacturing, utilities, and healthcare. Its top ten holdings are:
This fund's top ten holdings reflect the composition of the Canadian industrial landscape, which is dominated by financial services (banks, insurers, and investment companies) and commodities (most notably oil and gas). Of course, the fund owns shares in literally hundreds of other companies, but these are the ones in which it has the biggest stakes. So, if you hate oil companies and you hate banks, you may feel like a hypocrite if you invest in the RBC Canadian Equity Fund, or any other Canadian equity mutual fund for that matter. But you have little choice if you want to invest in Canadian equities. When a mutual fund sets out to buy into big Canadian companies, it can't avoid banks, insurance companies, and oil companies. They're the elephants of the Canadian economy and you're bound to own them if you invest in mutual funds or pension funds. Now, we've talked about mutual funds being relatively late arrivals on the investing scene. But that's not the case for the RBC Canadian Equity Fund. It launched in April 1967, just as we were excitedly celebrating Canada's Centennial, and Expo 67. That's more than 40 years of history the fund has seen go by. More importantly, though, we ask, "How much has it earned during that time?" And, the answer is an average of 8.9% per year, since its inception. That's respectable, and reasonable, for a mutual fund. That's a quick look at the two major types of investments to which you have likely contributed: pension funds and mutual funds. If you've invested through life insurance companies, your investment profile will look much the same, although the details will vary. A couple of key points to take from this chapter. First, if you invest in a pension fund, a mutual fund, or through life insurance, you have become an owner of big business. Whatever the fund, its managers will invest in stocks of big corporations on your behalf. If you only own mutual funds, you could refuse to invest in stocks, choosing a fund that holds only bonds, for example, but you'd have to settle for a much smaller retirement income. As we saw, 80% of the money the Local Authorities Pension Plan in Alberta pays to retirees comes from its investments, most of it from equities (stocks). Second, you'll be an owner of companies many Canadians love to hate: oil companies, banks, and insurance companies. And, your contributions to pension plans and mutual funds are big business. To you they may seem inconsequential in the grander scheme of Canadian business. But, collectively, the contributions of Canadian working people are huge. As you'll recall, public service workers in just one province, Alberta, own $15-billion dollars worth of investments through their pension fund. That's a lot of money by almost any reckoning. Watch for another chapter, coming soon. Next... Go to the Table of Contents Please send me your comments and questions. Send an email to wordengines@gmail.com . Thanks! Bob Abbott People, Profits, & Pensions: The Ownership Revolution, Copyright Robert F. Abbott 2010 |
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