Yahoo Finance Jack Mintz: Hands off our pensions, Trudeau Liberals!
Controversy broke out last week over a proposal from Brookfield Asset Management Ltd., the investment company, to create a $50-billion fund that would include pension and federal government money to invest in Canadian equities. Much of the uproar was focused on a conflict of interest for Brookfield senior executive, Mark Carney, who was recently appointed by Prime Minister Justin Trudeau to provide advice on economic policy.
Less attention was paid to a serious economic issue: should Canadian pension funds be directed to hold more Canadian equities? The last way to help pensioners is to create a public-private entity to manage pension funds. Pension plans want to maximize the risk-adjusted return on their portfolio. Governments pursue other objectives, like ESG, that often compromise profitability. Pension plan returns can suffer unless taxpayers make up for any losses.
So far, the proposal looks to be dead in the water. But the story is one more example of how the government has struggled over the past two years to find policies that would encourage more Canadian investment. For a while, the Trudeau government showed interest in bringing back some version of the 1994 foreign property rule limiting pension and RRSP foreign asset holdings to 20 per cent of their assets. That idea seems off the table, for now at least.
Then in its 2023 Fall Economic Statement Ottawa expressed interest in removing the 30 per cent limit on pension plan ownership of Canadian companies. That’s not a new idea: Ontario looked at it in earlier years and rejected it. Why? The change would give pension funds, which are exempt from paying income tax, a free hand in buying up taxable companies for control. Be taken over by a pension fund and, poof!, your income tax liability disappears as the operating company is loaded up with debt. This would distort corporate governance and result in at least a $1-billion loss in corporate and personal taxes. True, the government could remove the distortion, if ownership limits were scrapped, by subjecting pension funds to income taxation. But I doubt the funds would go for that trade.
After getting nowhere with these ideas, Finance Minister Chrystia Freeland appointed former Bank of Canada governor Stephen Poloz to find a suite of policies that would encourage the $2.3-trillion pension fund industry to invest more in Canadian assets.
Let’s help his thinking by asking the obvious and critical question. What market failure is it that requires federal action to be corrected? Are pension plan managers too risk-averse, putting too much money into bonds rather than equity? Do pension funds face tax or regulatory incentives to invest abroad rather than at home? Neither claim is supported by the facts.
Canadian pension funds hold plenty of equity assets — $877 billion as of the first quarter of this year, which is 38 per cent of their portfolio. And they have $487 billion in alternative assets, infrastructure and real estate, mainly, that account for another 21 per cent. Their bonds and short-term assets are $678 billion, just 40 per cent of their holdings.
Pension funds are clearly not unduly risk-averse. Quite the opposite: their tax-exempt status encourages them to hold debt rather than equity, the return to which is subject to corporate tax even though the pension fund does not pay income tax on interest, dividends or capital gains. Pension plans want to be able to cover their long-run commitments to employees. For this reason, fund managers have always valued long-term investments, such as equity, real estate and infrastructure.
As for Canadian vs. foreign holdings, pension funds did shift toward foreign assets after the 2005 removal of the foreign property rule. But almost four-fifths of total pension plan holdings are Canadian assets ($915 billion in total) of which 62 per cent is in bonds and short-term assets ($564 billion). The balance — $351 billion — is in equities and alternative assets. In its wisdom, the federal government views that as not enough.
Despite the shift away from Canadian assets since the cap on foreign holdings was removed, one can argue pension managers actually invest too much at home. Canadian equities and alternative assets are over a quarter of their total portfolio. If they were fully diversified internationally, they would only hold only 2.5 per cent of their portfolio in Canadian equities —that being Canada’s share of world stock markets.
Many investors have a “home bias” and hold domestic assets even though returns would improve if their portfolios were diversified globally. Even sophisticated investors have less information about foreign markets than domestic ones and hence are more risk-averse when investing abroad. And there are capital controls and tax barriers (e.g., withholding taxes) that discourage cross-border investment. Even Canada provides various tax preferences to domestic firms, such as the dividend tax credit, which is only available for dividends paid by Canadian-resident companies.
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Except for the 30 per cent ownership limit already discussed, I can think of no major barriers to pension plan ownership of Canadian assets. The real problem is that returns on investment in Canada are poor relative to investment in other countries, including the United States. If our economy were performing better, pension plans would invest more in Canadian equity — and they already have a bias to do so. The best advice Stephen Poloz can give the government is to get to work improving our abysmal productivity growth. That won’t happen by forcing pension funds to invest in assets with inferior returns.
The workers whose pension contributions finance the funds Ottawa wants to start manipulating should tell the government: Hands off our pensions!
