An innovative foundation for a sustainable future

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An innovative foundationfor a sustainable future

• Valter Viola
• Vice President Research and Risk Management
• CPP Investment Board416-868-1166
• vviola_at_cppib.ca

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Introduction

• CPP Investment Board has developed an innovative
  risk management culture focused on its mission.
• Using a risk management framework anchored on
  sound investment beliefs, the CPP Investment
  Board is successfully diversifying the CPP
  reserve fund to ensure the plan's sustainability.

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Agenda

• An Innovative Foundation (1999 2004)
• A Sustainable Future (2005)

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Agenda

• An Innovative Foundation (1999 2004)
• Barriers to pension fund excellence
• 3 lack of focus or clear mission
• 1 poor processes

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Agenda

• A Sustainable Future (2005)
• Pension industry sustainability
• f(effectiveness/efficiency)
• f(right things/things right)
• f(b/a)

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I. An Innovative Foundation(1999 2004)
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CPP

• Joint federal-provincial stewardship
• Governments set contribution rates, benefits
• 16 million contributors, beneficiaries
• Benefits administered by federal government

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CPP Investment Board

• Crown corporation operating at arms-length from
  governments
• Created in December 1997
• First investment in March 1999
• 73 billion expected to grow to 190 in next
  decade

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Background Assets
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Current Asset Mix
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Forecast Growth in Assets
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Risk-based Foundation

• Enterprise-wide risks
• Investment
• Strategic
• Fiduciary
• Business environment
• Legislative and regulatory
• Operational
• Reputation

Both sides of balance sheet
Off balance sheet
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Mission

• To manage the assets entrusted to the CPP
  Investment Board in the best interests of Canada
  Pension Plan contributors and beneficiaries
• To invest in ways that over the long term will
  maximize returns without undue risk while having
  regard to factors that may affect the Canada
  Pension Plans funding and its ability to meet
  its obligations
• To help Canadians understand what we are doing
  with their money through communications and
  stakeholder relations that exceed statutory
  reporting obligations

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Our Disclosure Policy

• Canadians have a right to know why, how and
  where we invest their Canada Pension Plan money,
  who makes the investment decisions, what assets
  are owned on their behalf and how the investments
  are performing.

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Investment Framework

• Investment strategy flows from the elements of
  the Investment Framework

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Investment Beliefs

• Provide a framework for considering portfolio
  management issues and making informed decisions
  in a holistic and consistent manner
• Management of the CPP Investment Board is guided
  by the Investment Beliefs, which have been
  approved by the Board

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Investment Beliefs

• The major stakeholder risk is that the current
  CPP provisions will not be sustainable in the
  future (recognizing that investment returns are
  one of many factors which will contribute,
  positively or negatively, towards
  sustainability).
• Determining the Minimum Risk Portfolio is the
  first step towards responsible long-term
  management of the Consolidated CPP Portfolio.
• Considering the economic characteristics of the
  Unfunded Liability is important in determining
  the Minimum Risk Portfolio.
• Taking risk beyond the Minimum Risk Portfolio
  should be done only if the expected additional
  returns justify doing so.
• The additional risk to the CPP Investment Board
  Portfolio is the relevant risk to consider if
  risk beyond the Minimum Risk Portfolio is taken.
• Large positions in a single asset or Asset Class
  generally lead to lower expected returns.

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Investment Beliefs

• Markets are very efficient at pricing securities
  relative to one another, but are not perfectly
  efficient due to information and execution costs.
• Overall market direction exhibits some
  predictability in the long term, but is very
  nearly random in the short term.
• While a structural advantage (e.g. liquidity,
  size, time horizon) may be helpful, an investor
  must have skill to add value from active/tactical
  management.
• Because investors are risk averse, they expect a
  return premium for bearing risk and expect higher
  return premiums for bearing larger risks.
• Portfolio costs are more predictable than
  Portfolio Risks and these risks are more
  predictable than returns.
• Constraints never increase expected risk-adjusted
  returns.
• Certain Illiquid Assets (e.g. Private Equity and
  Real Estate) have characteristics which are
  similar to those of certain publicly traded
  assets, except that they are less easily
  converted to cash and cannot replicate Passive
  Benchmarks.

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Minimum Risk Portfolio

• The Minimum Risk Portfolio is the base from which
  the CPP Investment Board measures the Capital at
  Risk of the CPP Reserve fund
• The CPP Investment Board will use the Scotia
  Capital RRB Index as a proxy for the Minimum Risk
  Portfolio

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Minimum Return for Sustainability
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Risk Allocation vs Asset Allocation
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Capital at Risk Limit

• Management monitors Capital at Risk of the CPP
  reserve fund.
• The CPP Investment Board will use cash flows to
  keep Capital at Risk within Board approved
  limits. Management may also use its discretion
  to rebalance between cash flows, should market
  fluctuations cause Capital at Risk to exceed the
  limit.

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Active Risk Limits

• Management develops Active Risk Limits. The
  president CEO reviews and approves limits at
  least annually
• The CPP Investment Board will not exceed the
  Active Risk Limits

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Investment Risk
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Long-term Expected Return

• The VP Finance calculates the Long-Term Expected
  Return at least monthly using the following
  formula
• Return on the Minimum Risk PortfolioRisk
  Adjustment

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RANVA (Risk-Adjusted Net Value Added)

• RANVA measures
• return over the Minimum Risk Portfolio (value
  added)after accounting for actual and benchmark
  costs (net)and incremental risk (risk
  adjustment)
• RANVA measures returns relative to our most
  important benchmark (the Minimum Risk Portfolio)

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RANVA

• The VP Finance calculates RANVA using the formula
  below
• Value Added from Active ManagementValue Added
  from Passive ManagementBenchmark Costs-Risk
  Adjustment

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Risk Adjustment

• The VP Finance calculates a Risk Adjustment using
• actual Capital at Risk
• a return on Capital at Risk assumption
• Illustration1 Risk Adjustment 10 Capital at
  Risk x 10 Cost of Risk Capital

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II. A Sustainable Future(2005)
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Values

• Ethical Conduct
• Excellence
• Accountability
• Teamwork
• Alignment of interests
• Innovation
• Respect

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Teamwork

• Within the context of clear individual
  accountability and authority, we value effective
  teamwork. Optimal solutions to complex issues
  often require the blending of individuals and
  groups with different skills and capabilities who
  can work effectively across the organization as
  well as within their area of accountability and
  authority. We are focused on optimization of the
  whole as well as its constituent parts.

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Alignment of Interests

• We believe that optimal outcomes are achieved
  when interests are aligned. Specifically,
  interests are aligned when there is agreement on
  values, objectives, performance measurements and
  the basis of sharing risks and rewards. The
  result of alignment is that checks and balances
  are strengthened and the prospect of synergy and
  win-win outcomes are increased.

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Innovation

• We will not be satisfied with the status quo or
  even current best practices, but will
  continually seek to find new and innovative ways
  to strengthen our competitive position and
  improve our performance. While we will not seek
  innovation for its own sake, we do expect to be
  on the leading edge of developing and introducing
  new ways of adapting to an ever changing
  environment.

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Innovation Framework

• Areas of Exploration
• Bridge between mission, values and strategy
• Innovation return on intellectual capital?
• Human Capital
• Structural Capital
• Innovation Beliefs?
• Minimum Rate of Innovation?
• Long-term Expected Rate of Innovation?

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Summary

• We believe our innovative foundations, which
  includes our investment framework, has laid the
  groundwork for the sustainability of the CPP.

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An innovative foundationfor a sustainable future

• Valter Viola
• Vice President Research and Risk Management
• CPP Investment Board416-868-1166
• vviola_at_cppib.ca