Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 14 - Evidence - Afternoon meeting
HALIFAX, Wednesday, March 18, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 3:00 p.m. to continue its study of the governance provisions contained in the Canada Pension Plan Investment Board Act (previously Bill C-2).
Senator David Tkachuk (Deputy Chairman) in the Chair.
[English]
The Deputy Chairman: Our first witness this afternoon is Mr. Richard McAloney.
Please proceed, Mr. McAloney.
Mr. Richard W. McAloney, Chief Executive Officer, Nova Scotia Association of Health Organizations Pension Plan: Mr. Chairman, ladies and gentlemen, the Canada Pension Plan is important to Atlantic Canada. As I declared when I accepted this invitation, I do not profess to have any proprietary or profound insight. I am honoured, however, to have this opportunity to share some brief, but I hope common sense, observations. I must say, what I think are common sense observations are not always followed, so maybe that is open to debate. I hope it is common sense, based upon several years experience managing multi-billion-dollar pension funds in the government sector. Very recently, I have moved to the private sector, but the bulk of my career in the pension fund area has been spent managing in the public sector, notably in the Province of Nova Scotia pension funds.
The first topic I wish to speak to is the governance model itself. We will see when we come to questions if I have interpreted the agenda too narrowly, but the majority of my comments have to do with the governance model. I should like to begin by commending the decision makers for choosing the independent governance model and rejecting the legislated governance model. I believe you have already heard many experts testify as to the crucial importance of establishing an effective governance structure. Capital markets and, indeed, the entire environment in which institutional pension funds operate is a dynamic environment. In my opinion and experience, there will always be a lag between the legislation -- and often seriously and significantly -- and the environment it should be responding to and perhaps influencing.
As you know, fiduciary obligations require pension plans to be operated solely in the best interests of its members. In my opinion, a legislated model would inhibit meeting the fiduciary obligation because the timing of updating legislation to respond to a dynamic environment would be influenced by other factors, in addition to what is in the best interests of the members of the Canada Pension Plan.
I recommend that the legislation be as open to prudent interpretation as possible. Of course, this must be complemented with a strong board of directors. Requisite qualities for board members would include: First, a sense of duty -- that is, interest, commitment and available time to serve; second, independence; and third, a combination of education and experience which, post-orientation, would enable the collective trustees to combine a general knowledge of fiduciary duty, pension legislation, the details of the CPP itself, that is knowing exactly what the pension promise is and how to manage that, actuarial principles, capital markets, and risk management. Combining all of that with a healthy degree of scepticism will enable those trustees to provide effective oversight but not management.
At the NSAHO Pension Plan, we are working with the policy governance model developed by Mr. John Carver, to ensure clarity, effectiveness and accountability in the relationship between our trustees and management. Incidentally, pages 23 and 25 of the Skinner Report on Best Practices in Pension Plan Administration refers to this model as contributing to being "at best practice in articulating board policies."
To summarize on this issue, I strongly believe that the fewer the legislated restrictions the better. In my opinion, no amount of evaluation and hearings which lead to prescriptive legislation which will meet fiduciary obligations in a dynamic world, as well as a competent, committed, independent board which understands its sole duty is to plan members, operates under legislation which permits it to be flexible, and is held accountable.
Venturing off of what I thought was the real agenda for today, I have a few other ancillary comments about the details which it seems most of your previous discussion involved, so I will share those with you if I may. The first topic is indexing versus active management. I noted that the subject of indexing received special attention at some of your recent hearings. I defer to previous witnesses who have more detailed experience, except that I do want to offer the following brief comments, but again, fully recognizing the expertise and experience behind those other comments. However, I would not like those credible comments to lead to indexing being rejected out of hand.
I believe indexing and active management can complement each other as long as there is enough active management in a marketplace to keep the market reasonably efficient. Although it is not a "no brainer," effective indexing is easier than effective active management. In partial defence of the current plans, I observe that it is usually safer to learn to walk first and run later. After all, the market investment operations of the revised Canada Pension Plan are in a start-up mode. Regarding the comments that some investors will try to act a step ahead of the indexed portion of the CPP Fund, this is true -- but this index effect already exists in Canada. Care is definitely in order, however, as another large indexer may only exacerbate the "index effect."
On the topic of internal versus external management, my previous comments assumed that the new board will lean toward internal management for those asset classes and investment strategies where it is more cost effective to "make" rather than "buy." Industry statistics support this assumption, but only in organizations that do not have artificial barriers; artificial barriers may cause sub-optimal resourcing, which could impair performance. Of course the best performance is number one. I assume you have or will hear from investment counsellors who have a different opinion on that.
Asset mix is the final subject that I would like to address, but it is the most important one in terms of the investment part of a pension plan's business. I am sure you have heard many times about how asset mix determines approximately 80 per cent to 95 per cent of the differential rate of return. Since the current asset mix is 100-per-cent Canadian-dollar fixed income, investing solely in the best interests of plan members would suggest diversification into other asset classes as quickly as the markets will effectively permit.
Any restrictions which lead to managing the "new assets" as a separate portfolio from the "existing assets" would not be supportive of the objective to invest solely in the best interests of plan members. It is one pension plan with one portfolio of assets to service one set of liabilities.
Mr. Chairman, this concludes my prepared comments. I would be pleased to clarify any of those comments or respond to any questions.
However, if I may, having heard part of Mr. Van Loon's testimony earlier and all of Mr. Cayo's testimony, I am prompted to comment further.
First of all, I would stress that while the questions you are examining are of course very important, and we should always strive to do them as well as we can, let us not miss good looking for perfect. It is better to be approximately right than exactly wrong. I first wish to commend the very significant steps taken to strengthen the Canada Pension Plan.
Most of the comments that I have heard today related to the investment side. Investment is one-half of a pension plan's business. The other half is administration of benefits and co-ordinating the two sides of the balance sheet, the assets and liabilities. I did not hear anything about that today, although I am sure that area is being considered. I actually have a different opinion than one of the earlier presenters who inferred that the rate of return on the Canada Pension Plan to date has been terrible. I assume that that opinion is based on an assumption that the problems of the Canada Pension Plan are due to investment performance to date. That is not my understanding. My understanding is that the investment performance has been quite credible, although one could argue about whether to attribute that to good luck or to good management. Was it good luck that we happened to go into 100-per-cent fixed-income investments and happened to do it, or at least build up the bulk of those assets, back in the early 1980s when interest rates were very high, and have been riding those very favourable investments since? It may well have been good luck; nonetheless, the jeopardy the Canada Pension Plan found itself in, in my opinion, was due not to neglect of the investment issues but more to neglect of long-term planning in terms of appropriate funding strategies, projecting the liabilities, and so on. I realize there were other social issues at play, that the sole objective at that time was not to create a properly funded pension plan, but I do wish to stress that investment is not the entire business of properly managing a pension plan.
I also would like to echo the comments that I think you have probably heard from many sources about the foreign property legislation. In my opinion, it serves no useful objective and does cause unnecessary implementation costs in investment strategies. As you no doubt had explained to you many times, through the use of derivatives the spirit of the rule can be easily circumvented, although it probably incurs additional implementation costs and is inconvenient. With respect to the other parties to those derivatives transactions, in their underlying positions to support their derivatives contract, at the end of the chain somewhere someone is clearly doing what would likely have been done had there been no foreign property limitation. I do not think it serves any useful purpose. A further education process needs to be targeted to those members of the Canadian public who believe that the foreign property limit somehow protects jobs here in Canada.
So there might be an education challenge but I do not feel it serves any useful purpose. I certainly concur with the proponents of first raising and eventually eliminating that limit.
Although I no longer have a biased position -- I am no longer in the public service -- I certainly would echo Mr. Van Loon's comments regarding out of hand rejecting 20 per cent -- I believe that was the number he used -- of the participants of the Canada Pension Plan from having any opportunity to participate in its governance. I do not understand the rationale for that decision.
That concludes my comments, Mr. Chairman.
The Deputy Chairman: In the organization for which you manage the pension plan, how do you operate? Who do you report to?
Mr. McAloney: I report to a board of trustees. There are 16 trustees.
The Deputy Chairman: Of the pension plan?
Mr. McAloney: Of the pension plan itself, yes. They have recently restructured it. It was not that way previously; I was just hired in January of '98. Prior to January 1998, I was, as I said, with the Province of Nova Scotia, and this is all part of their restructuring, to hire a CEO and have that CEO report directly to pension plan trustees who are legally accountable for the pension plan. Previously, I understand there was a bit of a fuzzy relationship between the pension plan trustees and the board of directors of the organization, and so on. They have restructured, and that relationship is, in my opinion, very clear now.
The Deputy Chairman: Who appoints the trustees and what kind of people are on that board of trustees?
Mr. McAloney: They are appointed by various facilities who participate in their pension plan. We are a multi-employer pension plan, serving most of the hospitals and some of the long-term care health facilities around the province of Nova Scotia. Different groupings of those hospitals have the right to appoint members.
The Deputy Chairman: They are representatives of the beneficiaries.
Mr. McAloney: Yes. That is a rather broad term. There are many interpretations of that, but generally speaking, yes.
The Deputy Chairman: The board of the organization appoints the trustees. How do the trustees report? Is there a mechanism to have them report what is happening in the pension plan to the board that is representing all the employees?
Mr. McAloney: Yes. There will be a formal annual report to the board of the overall organization, the AHO. There will be more frequent communication in that the board has the right to appoint one member to the pension plan trustees. One member of the board will sit on the pension plan trustees and the trustees as a collective body will report annually to the AHO board.
The Deputy Chairman: I do not know if you examined the legislation, but did you see that as adequate reporting to the beneficiaries? What would you describe as the formal process of the Canada Pension Plan now as to how it should report to the beneficiaries?
Mr. McAloney: The formal reporting requirements as they exist today?
The Deputy Chairman: As they would exist under the proposed legislation. I want to see if you are catching something that I am missing.
Mr. McAloney: I do not recall the details, but I think there is the principle of accountability and transparency. I recall seeing that and I certainly support those. In terms of formal reporting, was it an annual report? I believe that would be sufficient.
The Deputy Chairman: You do not think that the board of directors should be required to meet members of Parliament or meet a finance committee or talk to anybody; in other words, that they can go about and do their business without anybody knowing what they are doing? Is that the way your trustees would operate?
Mr. McAloney: I think you could capture more frequent reporting, if that were required by any stakeholders, under the principle of being transparent, whatever it takes to be transparent. Confidence in that board is paramount, so I suggest whatever it takes to establish that confidence.
Again, this is going to be an evolving situation and the less you prescribe by regulation or legislation, the more you establish with sound principles and reasonable people at the wheel and meet certain principles as you go forward, including transparency, in other words, whatever reporting is required to establish that credibility, the better.
Senator Oliver: Once this board is constituted, the chairman will probably open for discussion the mission statement or vision of this fund. Keeping in mind that this is a long-term fund, which should reach $100 billion in 10 to 12 years, what are some of the principles, in your opinion, that this first board ought to keep in mind for its vision statement?
Mr. McAloney: Clearly, if they can be given free range -- and I really hope they can -- to manage solely in the best long-term economic interests of the plan members, they first ought to do everything they can to understand the nature of the liabilities. The purpose of the plan is to pay pensions when they are due, according to my understanding, at least. Therefore, I would first of all want them to spend considerable time understanding the exact nature of the promises in the Canada Pension Plan and the forces that affect those liabilities, in terms of amount and timing, and so on.
Senator Oliver: Is it your understanding that this fund and this board as constituted in this legislation will be sufficient to fund 100 per cent all of their liabilities? Is that your understanding?
Mr. McAloney: No, that is not the target to date. But again, let us not miss good looking for perfect; it has come a long way. I forget the exact funding ratio at which it is projected to level out.
Senator Oliver: It will not fully fund it. In other words, there is a disproportion between the amounts that they will be investing and the liabilities that they will be confronting?
Mr. McAloney: Under the current set of assumptions, my recollection is that it is not projected to get to 100 per cent. However, I may be wrong about that; it has been a while since I looked at the details. Again, it is a dynamic environment. For example, were they to enjoy the wonderful rates of return -- and I am not predicting they will -- we have been enjoying over the last several years, it could easily change so that perhaps the objective should be raised from a level funding ratio -- and I forget what it is, whether it is 30 per cent, 60 per cent.
The Deputy Chairman: I believe at the last meeting it was 20/80 -- 20 per cent would be what would be the funded from the fund, the balance, 80 per cent, to come in from straight payroll tax. I believe that is the breakdown.
Mr. McAloney: I was thinking of a different ratio I believe, Mr. Chairman, in that eventually the assets of the fund will grow such that they as a percentage of the total liabilities will reach a certain per cent -- and I cannot remember if it was 30 per cent or 60 per cent, but it was not projected to go much higher than that.
The Deputy Chairman: We had heard 20.
Mr. McAloney: Anyway, in my opinion, one should never give up sight of the ultimate objective of 100-per-cent funding but, again, let us be practical and move towards it in steps.
Senator Oliver: What number should the board keep in their mind in terms of funding liabilities; 20 per cent, 30 per cent, 50 per cent, 100 per cent? What should they visualize, because you say they must keep their liabilities in mind? What liabilities at what per cent?
Mr. McAloney: The current plan is whatever the current plan is projected at. For example, if it is 20 per cent, I do not think it is practical to manage much beyond. Already there are many valid comments about the effect of that tax, like cash drag on employees and employers, and so on. Obviously raising the contribution limit is not in the cards in the foreseeable future, so they must be realistic and accept that as the target.
Getting back to the original question about the mission statement, I think they first of all must have a clear understanding of those liabilities and the projections built into the plan. That would be, I think, magnetic north on their compass for all plans going forward.
Senator Oliver: What else should be in this mission statement? If you were invited to address them at their very first meeting on what should be in this mission statement, what would your professional advice be to them?
Mr. McAloney: First of all, understand the liabilities. In understanding the liabilities, hopefully that will give them the perspective of understanding pension plan businesses, both the assets side of the balance sheet and the liabilities side of the balance sheet. A proper governance structure is crucial. If they were to consider the Carver policy governance model, they would first look to set policies in four specific areas. He refers to them as the "ends" policies; that is, the objectives, or what good for what people at what cost, in his terminology. In that case, I presume it would be to have the necessary funds available to maintain the funding ratio at X per cent, 20 per cent or whatever that plan calls for, and be able to pay pension obligations as they come due. I think that would be the primary objective.
There would be secondary objectives, but I do not think you could have more than one objective at the same level, for example, not to disrupt Canada's capital markets, and there will be other objectives like that.
The Carver model calls for them to set policy in three other areas. First, how the board will govern itself; issues such as the powers of the chair, whether they will operate by committee and, if so, the powers of the committees, and so on. The next area would be the relationship between the board and management, that is a CEO, or whatever the title would be. The next area is what they call executive limitations.
The Carver model is very much based on empowerment, not limitation, a much used new paradigm as opposed to the old paradigm we often see in many government environments -- that is, you come to us for approval of everything. I would describe that as killing a fly with a sledge hammer. If you have a concern, you do not slow everything down and make everyone come to you for approval. Carver comes out in the exact opposite way. He sets executive limitations. Should you have a concern that you do not want to delegate to the CEO and staff, something you do not want them to be empowered to do, you prescribe that in an executive limitation. They are empowered to do everything else that is a reasonable interpretation toward achieving the objectives or end statements. The first thing that I would have the board do is develop those policies. The next thing would be to hire the best CE0 they could get and go on from there.
Senator Oliver: What asset mix would you recommend?
Mr. McAloney: It would be irresponsible for me to answer that now because that is, I think, the most important of the investment questions. We require much thought and a better understanding of the nature of their liabilities than I have right now.
Getting back to my theme of it being better to be approximately right than exactly wrong, I do know that 100-per-cent fixed income is definitely wrong. As to what is the right mix, it is a matter of opinion, but clearly the majority of funds are something closer to 50-per-cent equities, 50-per-cent fixed income than they are to 100 per cent and zero.
The fund I manage now is just under $1 billion; at year end, it was about $980 million.
Senator Oliver: What kind of return are you getting?
Mr. McAloney: I have only been there three or four months, but for the year ended 1997 we were in the first quartile, measured against all Canadian pension funds. I cannot remember the exact rate of return.
Senator Oliver: Was it over about 15?
Mr. McAloney: It was around 15, yes.
My longer track record is with the Province of Nova Scotia, where we were high into the first quartile for most years now, certainly our 10-year rate of return. For large pension plans in Canada, plans of $3 billion and over, I believe we had the highest rate of return in all of Canada for the 1996 calendar year. I left in early December 1997, so I do not if I have the latest numbers from the province.
Senator Oliver: Hoe many managers are making investment in your fund?
Mr. McAloney: About eight.
Senator Oliver: Do you and your officials invest any of it yourself?
Mr. McAloney: No. In my previous capacity, up until three months ago, we invested more than 50 per cent internally. It was a much larger fund, at $5 billion, plus we had sinking funds, so we were over $8 billion in assets at the province. In my new capacity, we are under $1 billion and it is all out-sourced at the moment.
Senator Oliver: With respect to the Canadian Pension Fund Investment Board, should they do it all with outside managers, or should they manage some in-house; what is your recommendation?
Mr. McAloney: If they are allowed to operate independent of government and make rational make-versus-buy decisions, they should do that. After much study, they should set their asset mix. And for each asset class and each implementation style within an asset class, they should calculate the resources necessary to do that internally. If it is cheaper to do it internally than externally, they should do it internally; if it is cheaper to do it externally, they should do it externally.
By way of a quick example, for a fund as large as this one is expected to grow over the next several years, I propose that it would definitely be more cost-effective to do Canadian fixed income internally, certainly many types of Canadian equity internally. With respect to emerging market equities, it will be a long time before they invest enough dollars in that asset class to make it cheaper to make versus buy, therefore they would out-source that. It might well be an evolving thing. Initially, they may out-source everything; it might be more cost-effective. However, for a fund that size, there are a lot of industry statistics around that show that the cost ratio of doing it internally for large funds is much cheaper. A general rule of thumb in the industry is that it is probably about three to one times more expensive to do it externally than internally. Several years ago, when I was at the province, I measured the ratio for fixed income and it was 19 to 1. I do not propose that as a model to aspire to. My interpretation is that we were maybe a little bit thin on resources so I would never propose that, but clearly you can do it cheaper internally.
You would only consider that if you are not going to have any artificial barriers that would inhibit performance. For example, if it requires hands-on company visitation, you do not want to operate in an environment which has a silly rule that says you cannot get on an airplane and fly somewhere to interview management, if that is what it takes in that style of equity investment management. If you do, then you had better out-source it no matter how much more the cost because, of course, return is paramount.
Senator Oliver: A number of witnesses have come before this committee and said that, in terms of length of stay on the board, a three-year term is too short, for a board of this nature, where you must make long-term investments, and so on. Yesterday, someone recommended five to eight years. What is your opinion?
Mr. McAloney: I believe the legislation, as currently drafted, calls for three years but with an opportunity to be reappointed. That sounds about right to me. Clearly, longer than three years would be better, but there may be a need to make changes along the way. I think three years with the opportunity to be reappointed is a nice mix; it allows for an easier way to make changes, if changes are necessary. Of course, as you said, it is long-term decision making; it is a very complex business. Depending on the person's background before they joined the board there can be a steep learning curve, and so reappointment beyond that three-year initial term, in my opinion, would be very beneficial.
[Translation]
Senator Hervieux-Payette: Can you explain your concept of director independence? Independence from whom? Independence from the business community, personal independence by not owning shares in the businesses in which the fund invests?
Should directors divest themselves of their personal portfolios if they are not involved in the actual management, but rather in the broader orientations of the fund?
Do you agree that a certain percentage of the fund should be managed and invested in small and medium-sized businesses through private placements? Do you expect that a certain percentage could be invested in this way before the companies go public?
[English]
Mr. McAloney: The first question asks me to further explain what I mean by independence, whether I was referring to putting their own personal investments in a blind trust. A principle which says, for example, that one cannot enjoy, either directly or indirectly, any personal benefit from their involvement with the Canada Pension Plan -- I am just thinking on my feet here -- is more effective than saying "Thou shalt do this, this and this." For example, if employees of an investment counselling firm were to serve on the board of directors, at a minimum they would have to excuse themselves from any decisions in hiring managers. That does not mean that they could not provide valuable input into other decisions, such as asset mix, and so on. If certain activities were being contemplated by the board whereby a board member could personally benefit, then that board member should either declare his or her conflict or put his or her personal portfolio in a blind trust, or whatever.
I do not have enough foresight to come up with an exhaustive list of prescriptive-type solutions, but getting back to the principle, any situation in which a board member could possibly receive a personal benefit I would see as being against that principle of independence.
Senator Hervieux-Payette: In an organization such as yours, do you manage your own portfolio or is it in a blind trust? Does your board allow you to do your own investment, or not?
Mr. McAloney: Even our $1-billion plan, if we were to move it entirely in one direction, is not big enough to significantly move the market, unless we were do something extreme, so there is no opportunity for me to front run what I do in my $1-billion portfolio, or even the $8-billion portfolio in my previous employment, such that I could really enjoy any significant personal benefit, so it was never an issue.
Having said that, as a professional the only thing I have to offer in the market-place is my reputation and one always likes to err on the side of caution. I should add that as a member of the Canadian Institute of Chartered Accountants, the Institute of Internal Auditors and the Institute of Chartered Financial Analysts, I have so many bloody codes of conduct I must adhere to that I am afraid to turn right at a red light. Therefore, to err on the side of caution one always discloses any potential conflict.
The nearest I came was a transaction about a year ago where I remortgaged my home and invested on a personal level what to me was a significant amount of money, although on an institutional scale, it was not significant at all. I invested it with a firm that also managed money for us at the province but there was no conflict because, first of all, the money they managed for us at the province was fully invested, and had been for several months, before I moved my own personal money, so it was just the opposite. If anything, my personal interests would have been harmed by doing it. If I had have done it in the reverse order, there would have been a perceived problem; second, even though there was absolutely no chance of any personal benefit, I declared it to our investment advisory committee before I did it, just to be on the safe side.
Senator Hervieux-Payette: My other question is on the small business and private placement.
Mr. McAloney: Again, I do not support any prescriptive directions in legislation. Certainly I would want to enable the board to go in that direction, if and when it were deemed appropriate and in the quantities they deem appropriate. I believe they would be in a better position to make that judgment than anyone else, including legislators -- and I do not want to seem to be picking on legislators.
Senator Callbeck: With regard to investing the money, the CPP Board, I understand you to say that the only criteria is the rate of return. Is that right?
Mr. McAloney: Subject to acceptable level of risk. It is a combination of acceptable rate of return and acceptable risk.
Senator Callbeck: You say you have eight managers. What directions do you give them, besides telling them that you want a certain rate of return? Are there any areas where you ask them not to invest money in stocks or bonds?
Mr. McAloney: Yes, many areas, but again only driven by our sole objective of the best long-term economic interests of our plan members. Because we divided our portfolio among several managers, I cannot remember if it is eight or nine or ten, whatever the number is, but we are responsible for the total portfolio of assets and the performance of the total fund. Yes, we give them lots of directions in terms of what asset class they can invest in. Other than that, it is an open field. We certainly do not employ other objectives like economically targeted investments; we do not tell them to invest in Nova Scotia or not to invest in Nova Scotia, or whatever. You cannot be fish and fowl. If we told them both things, clearly there will be points in time when there is a conflict. To ensure a clear mandate, we stick to the rate of return criteria. We give them direction in terms of what percentage of our assets should be in equities, what percentage should be in bonds. As well, there is a tax imposed if one goes beyond 20-per-cent foreign property so we tell certain managers not to invest in anything that would be deemed to be foreign property under the Income Tax Act.
Yes, we give them direction to control things like that but nothing that would confuse the objective in their mandate to maximize return at acceptable risk.
Senator Callbeck: How many people would you employ? I know the funds are managed outside, but in giving them direction and analyzing and so on, how many people would there be?
Mr. McAloney: Before I answer that, I would tell you that we are in a restructuring mode so I would not suggest that our current structure is indicative of anything other than an organization in the midst of change. Right now it is just myself on the investment side. I have other duties, as well, including responsibility for the plan administration side, and so on. We have a strong relationship with an outside consulting firm.
Senator Callbeck: Would your cost of administration be pretty low?
Mr. McAloney: Yes, but that is not necessarily something we aspire to.
Senator Callbeck: You list a number of criteria for membership on the board. I do not see any reference to various regions or to women.
Mr. McAloney: Again, I do not see how that would support what I would think would be the overall mission, that is to provide pensions for members of the Canada Pension Plan. I have certainly had the honour to serve with many people who happen to be members of minority groups or of the female gender, or whatever, but they were there because of their skill set and I do not see any need to deviate from that. There are many people from all walks of life with many good skill sets that could contribute, but I would not look at that as the overriding criteria.
The Deputy Chairman: Since 50 per cent of the beneficiaries of the plan are women, for example, and since they live longer so will collect benefits longer, should they not be represented? Should there not be objectives like that?
Mr. McAloney: Again, getting back to being practical, I do not think anyone should be invited because they are of a certain gender or left-handed or whatever. I think they should be there because of competence. That is my true feeling.
My realistic answer is that if it takes that to get credibility and have confidence in the process from the beginning, so be it.
The Deputy Chairman: My view would be that there are probably more than 12 or 15 people who are capable of running the Canada Pension Plan. Maybe there are 100, maybe 200, maybe 500; I have no idea. My view is that if you do not set out your objectives, you will not meet your targets. For example, we heard today from a person who is on the advisory committee that they advertise, that people knew they could apply, but I do not believe that. I do not think that anybody knew they could apply. There were no ads; there was a press release.
How will someone who has the right skills set, say, someone from the Canadian Federation of Labour or from the Province of Alberta, know anything about it? The only people they will be looking at will be their consultant and their buddies, really.
In that sense, then, do you not think that you need objectives? That would be my view. What is your view?
Mr. McAloney: I am not here to support the recent selection process. All I am saying is that I believe the number one criteria should be the ability to meet the objectives and fulfil the mission statement, and so on. I readily accept that many more than the 12 people who will be selected are capable of doing that, and I readily accept that many of them would be female or left-handed or tall, or whatever.
The Deputy Chairman: We have had varying opinions on that subject from different witnesses. Some people have said that the beneficiaries only want investment advice from the board. Other people have said that certain groups should be representative. I have not heard or seen what criteria they are looking for, and I was not helped this morning. In other words, regarding the 12 people who will be selected from 30 million -- of which I do not know how many thousands would be qualified -- there may be lawyers, there may be accountants. Should there be two lawyers? Should there be one? Do we need farmers? We need to have not only representation from across Canada, but also expertise in managing pension funds. They do not all necessarily need to be investment gurus, right?
Mr. McAloney: Yes.
The Deputy Chairman: Now you hire those people, do you not?
Mr. McAloney: Yes.
The Deputy Chairman: Do you not think that the advisory committee would say, "This is what we want the board to be and this is the kind of representation that we think will look after the best interests of beneficiaries"? Do you not think that that would be a good place to start, or do you want to sit around a room and pick names? I do not get it.
Mr. McAloney: Had I been in charge -- and thank goodness I was not because I am sure there would have been many other flaws -- I would have referenced the criteria I listed earlier -- and I am not suggesting that everybody should be an investment guru, only that they have the capacity to learn to oversee investment gurus. That would have been the number one criterion.
The practical side of me would have said that I need to establish credibility and confidence among all plan members that this is being done well and, yes, I would have gone out of my way to ensure that there was regional representation, balance among gender, probably labour representative. I have had very good experience working with trustees who have been appointed by unions, for example.
The Deputy Chairman: Exactly, like teachers' unions.
Mr. McAloney: Yes, but I would not undermine their credibility by saying that they were selected because they are from the West Coast or female, or whatever. I would have made that part of my balancing act, in coming up with what I felt was collectively an effective and credible board, but I do not think it would be fair for me to undermine them by making it look like it was some kind of token appointment. There are too many good people who fit those categories to be undermined by that.
Senator Meighen: I am getting more confused. It sounds like we have a consensus that the people you want on the investment board are the people who can most effectively manage the managers?
Mr. McAloney: Yes.
Senator Meighen: What sort of people are these? Where do I look for them? For example, would you be a competent manager of managers?
Mr. McAloney: I cannot objectively answer that; other people seem to have thought so, given some of the responsibilities I have been handed over the last ten years.
Senator Meighen: Somebody with your experience in the field that you have worked in.
Mr. McAloney: I believe I could contribute, yes. Again, however, I would not want to come up with a list of ideal persons because I think you would want people with varied experiences and educational backgrounds, with different perspectives, male, female, mature, less mature, and so on, on the board. The last thing I would want is 12 people with similar backgrounds and similar views on life.
Senator Meighen: We are getting around to what the chairman was saying then, at least getting around to that point of view -- and I am not saying whether I agree or disagree -- that we must have a checkerboard of intelligent people of integrity representative of the country to be the manager of managers.
Mr. McAloney: Again, I would not put representative of the country at the first level of importance; I would put it somewhere down the list. The first criterion is the ability to see the big picture of running a complex business and a pension plan with very long-term decision making and to properly oversee people who are doing that in a more detailed way.
Senator Meighen: Can we just touch on one other subject, which Senator Oliver, among others, has raised, and that is the question of voting of proxies. What is your practice? Do you vote your proxies or do you give instructions to your managers? How do you proceed?
Mr. McAloney: I can only echo the comments of Mr. Van Loon, because my greater experience was at the province and virtually all of our fixed income was done internally, with my own staff, and virtually all of the equity investments were out-sourced -- we hired many different firms to do that for us. All of our equity investment decisions were made by outside managers, so I felt they were closer to those companies and in a better position to evaluate how to vote those proxies. We delegated that decision to those managers but we oversaw it, as Mr. Van Loon said this morning, by monitoring the list that is generated by Fairvest. We would manage on an exception basis only; if there was anything that alerted us, we would contact the manager to see if there was some issue that we wanted to give them direction on or not.
Senator Meighen: Did you have an established policy for the review of managers' performance, and the time frame for that; and if so, is that something that the Canada Pension Board should adopt?
Mr. McAloney: I would think the Canada Pension Board would want to make sure their CEO and his or her staff had such a policy. If I were on the board, I would ask them whether or not they have such a policy, what is it, how it is being implemented, and presumably there would be staff in whom you had confidence to do that more effectively than the board. If you did not have confidence that the staff could do that properly, then that raises bigger question, but I would not see that being raised to the level of the board, no.
Senator Meighen: Do I understand you correctly that you believe it would be the staff's responsibility to make a recommendation as to the replacement or the hiring of a manager for the board's consideration, or would the staff hire and fire managers?
Mr. McAloney: It is done both ways, I understand, in various organizations. In some organizations, hiring and firing of managers is elevated all the way to the board; in others, it is delegated to staff. Again, going back to a principle, I would try to align decision making with the skill set. If I felt the board had the greater insight in picking winning managers tomorrow and next year I would want the board to do it. If I felt the staff had the greater skill set, I would want staff to do it, and then hold the staff accountable for the results.
That would be my starting position but. However, again, to be practical, many boards do not wish to delegate that responsibility. The ideal situation is to put the decision making where the best skill set lies and hold that skill set accountable for the decisions they make.
Senator Meighen: I am not sure where we end up then with that. There would be a nice board full of nice people who make no decisions, who are people of integrity, and staff make who make all the decisions, and the board would meet every now and then and nod approval. I would assume the people of Canada would hold the board responsible, would they not?
Mr. McAloney: Yes, I would think they should. I do not think from the interpretation of my answer it would follow, as you suggested, that the board make no decisions. You asked me about that one specific decision.
Senator Meighen: I agree; I was making a little colourful my interpretation. But you did indicate that it would be a possibility, depending on the division of skill sets, to delegate to the staff the hiring and firing of the investment managers.
Mr. McAloney: I would propose that as the best place to start, yes, subject to the skill sets that lie in the different groups.
The Deputy Chairman: Do you think in the end they would hold the politicians responsible?
Mr. McAloney: I suspect they would, yes.
The Deputy Chairman: That is who they will hold responsible. That is why the problem is so difficult.
Senator Meighen: You answered me very nicely on the question of review of managers, but was there a time-frame that you set yourself for review? This is the old battle between giving somebody a chance to show how they can perform over a period of time and not letting poor performance go on too long.
Mr. McAloney: Yes. Again, I would not wish to have a prescriptive answer to that. Probably the most common scenario in pension funds in Canada is a four-year review: if you are adding value after four years, you stay on; if you are losing value after four years, you get terminated. I prefer not to operate that way, and have not. It depends on the situation. I have always told my trustees, and with their concurrence what I have tried to employ, that it was not a decision to look at past performance and reward the managers who have added value by keeping them on and giving them future business and to punish those who have not added value in the past by firing them. The past is the past; it is water under the bridge. You cannot do anything about it. We are only there to make decisions based on our confidence in their ability to add value going forward, so at any point when I became uncomfortable or lost confidence in their ability to add value going forward I would make a recommendation to terminate that manager immediately, whether it was after one year or ten years.
Again, it depends on the circumstances. I feel it would be dangerous to prescribe something very specific, such as if you are adding value after four years you stay on, if you are losing value for the fund you get terminated.
Senator Meighen: What is important then is the constant review and consideration of how the performance is going?
Mr. McAloney: Yes, we literally review performance every month, but it is not just performance. There have been many studies that prove that past performance is not a statistically significant predictor of future performance. There are many other things, like things that might happen in the environment that would affect their motivation, changes in ownership or changes in personnel, changes in investment process. At the end of the day, it is part art and part science; it is quite judgmental.
Senator James F. Kelleher (Acting Chairman) in the Chair.
The Acting Chairman: We appreciate your attendance, Mr. McAloney, and I am sure you will read our report with interest. We will see that you get a postage-paid copy of the report.
Mr. McAloney: Good luck with this very important decision.
The Acting Chairman: We were scheduled to hear Mr. Peter Marshall next, but he cannot be here so we have as our next witnesses Mr. Tom MacLaren and Mr. Robert McKim.
Perhaps before you begin to make your presentation you might tell us who SEAMARK is and your experience in this field?
Mr. Robert G. McKim, President, SEAMARK Asset Management Ltd.: SEAMARK is an Atlantic-Canadian based investment counsel firm that began in 1982. Currently we are managers of approximately $3 billion for pension and endowment accounts largely in Atlantic Canada, but our clientele stretches across the country today. We have developed a business across the country based on a very strong investment track record and high ranking by industry standards across the country, and this has been a chance for us to develop a business from this Halifax base.
Our particular expertise may fall under the heading of balanced fund management, although we have also done well with equity selections over the years.
Mr. Tom MacLaren, Vice-President, SEAMARK Asset Management Ltd.: I wish to make a short submission covering how we at SEAMARK would review the CPP. Some of this has been covered in past presentations; portions of it are relevant to what you are considering today.
Three years ago the Canadian Institute of Actuaries published a report concluding that the majority of Canadians are no longer confident that they will receive CPP benefits. The reason behind the glaring lack of confidence on behalf of pensioners has to do with mismanagement of the plan over the past 32 years. At the outset, the CPP was established to provide working Canadians with two basic assurances: the financing of the plan should be adequate to provide the promised benefits; and each generation of working Canadians should pay a reasonable cost for these benefits.
Currently the CPP is drastically under funded due to a number of reasons, including three decades of inadequate contribution levels, an investment objective providing provinces with below market rates of funding, and expansion of the plan mandate to accommodate disabled workers.
The past history and current lack of confidence in the CPP strongly suggests that change is in order. We support, therefore, the suggestion put forth previously by the Atlantic Institute for Market Studies to provide Canadians with some ownership over their pensions by privatizing the CPP.
Recognizing the public's lack of confidence in the CPP, Finance Minister Paul Martin stated in his March 1996 budget address:
The party that put pensions in place for this country must now act to preserve them.
He went on to say:
The CPP must be put on a sound financial footing.
SEAMARK believes that the sound footing that is required can be achieved with the privatization of the CPP.
Chile's privatization of pensions in 1981 stands as a shining example. The Chilean experience raised retirement savings from 3.6 per cent of GDP in 1982 to roughly 50 per cent today. The Chilean labour force has 20 separate and competing funds from which to make investment choices. We would recommend that a similar structure be put in place in Canada.
We believe that the management of CPP moneys within the plan should be overseen by the individual contributors and, like the Chilean experience, pensioners could choose among a list of competing funds chosen by the public sector. This list should be comprised of private-sector management firms who have a solid performance track record and have been in business for a minimum period of three years. Privately owned investment management firms have the independence and the depth of resources, talent and incentives necessary to provide productive investment management.
If the CPP fund continues to be managed by the public sector, Canadians will continue to lack confidence because of perceived conflicts of interest arising between social objectives and performance.
SEAMARK strongly believes that foreign investment restrictions currently placed on Canadian pension funds should be abolished. Canadian pension plans have been legislated to invest 80 per cent of their assets in Canada. This legislation has short-changed Canadians, as can be witnessed by the short- and long-term performance of the TSE 300 and the S & P 500 indices.
Actually, if we were to go back to January 1, 1988, and put $1,000 in both the TSE 300 and the S & P 500, that $1,000 would have transformed into $2,839 on the TSE 300, whereas the same $1,000 invested in the S & P 500 would have grown to twice that sum, to $5791 as of last December.
Forcing Canadians to invest 80 per cent of their pension moneys in Canada has resulted in many individual Canadian companies carrying higher valuations than comparable U.S. or non-North American companies. We believe that the large supply of pension fund moneys chasing a limited number of quality opportunities in Canada has led to this "home grown" over-valuation situation.
I have listed some examples in comparative fields for you to have an understanding that on a price-to-earnings basis the Canadian firms tend to be higher valued than that of either U.S. or non-North American companies.
The 20-per-cent foreign limitation which currently restricts pension moneys represents a fundamental violation of freedom. Within the international investment community, it colours the Canadian financial system as weak and in need of protection. We recommend that the 20-per-cent foreign restriction should be relaxed and eliminated. We believe that all Canadian investors will be best served by expanding the investment universe available to them. Further, we recognize an urgency to act now. The ongoing relaxation of foreign ownership of Canadian industry as per the terms of NAFTA, mega mergers of Canadian public companies, and promised funding of the CPP are significant factors that will shrink the universe of Canadian investment opportunities and continue to drive the scarcity value of Canadian investments.
In conclusion, we suggest that Canadians would be best served if they were given ownership over their CPP assets. This would be consistent with the direction taken by the private sector, which has elected to move toward defined contribution plans rather than defined benefit plans. CPP beneficiaries and Canadian taxpayers should expect that assets to be managed by independent and objective professional managers, seeking the highest returns in a market environment free of restrictions.
Senator David Tkachuk (Deputy Chairman) in the Chair.
Senator Kelleher: We really cannot speak to the main part of your address because the legislation itself has been passed and the only mandate that our committee has is to examine certain sections of the act, sections 51 to 57, with respect to the corporate management of the fund itself. We have no authority to look into at this point whether it can be a private plan, as you are advocating, or a public plan, as it has been now passed. At least in my case I will not be addressing that issue because it really cannot be before us.
One thing I would like to ask you about is on page 3 of your brief. You set out the reasons why you feel the former plan, the current plan I guess, is drastically under funded, and you list them, and one of them is "an investment objective providing provinces with below market rates of funding."
I do not know whether you have had a chance to see the draft regulations for the plan, but in clause 8 of the new CPP regulations, which are out in draft form, it says: This clause includes an ongoing commitment to invest in provincial debt obligations.
That is something about which I personally not very happy. I get the feeling from your statement that you were not very happy either.
Mr. MacLaren: In the past, the cost of funding has been at a rate equivalent to what the cost of money for the Government of Canada was. Arguably any province's cost of funding would exceed that of the Government of Canada, it being the most sound credit in the country. What we were saying by "below market" is that the level at which they would raise their capital is not fair; it would be higher than that.
Senator Kelleher: I agree with you totally. Be that as it may, this clause in the proposed regulations suggests that not only do they have the right to continue that practice but also that there is an ongoing commitment to invest in provincial debt obligations. I can understand the ones that are there now, but they are suggesting that it be ongoing and I was wondering if I might have your comments about the wisdom of that proposed regulation. That is something that is before us.
Mr. MacLaren: We spoke in the brief about the difference between taking care of social issues versus those of performance. Quite often perhaps that may not be what is in the best benefit of the pensioner. The golden rule of pensions is whatever you do should be in the best benefit of the pensioner. There have certainly been legal cases where trustees have been brought to task if they have done something other than provide the best benefit to the pensioner. There is some difficulty in that respect.
Is the cost at which the money will be loaned still the cost at which the Government of Canada would raise funds?
Senator Kelleher: Apparently it would be the same as they have been doing in the past, and maybe you could give us some idea of what that spread is between investing in the provincial debt obligations and what you could secure on the open market.
Mr. MacLaren: These tended to be 20- and 30-year obligations. Obviously the longer you move out the yield curve, or the maturity, the greater the risk. In some cases, in terms of the less credit-worthy provinces, such as Newfoundland -- and you would find the majority of them in the east -- it would be of definite benefit to them.
Is the amount of the loan determined by amount of CPP money received by an individual province?
The Deputy Chairman: The way it works -- and I am subject to correction by people much smarter than I -- is that we have heard that there will be $30 billion of the present money that is already owed by the provinces to the CPP fund will be revolved over the next three years. That is what this three-year period is and that is why there is no cash in the account to actually manage. There would be a limited number, I think $9 billion. I do not know when it starts. Then they will be compelled by the regulations to invest 50 per cent of their debt instruments in provincial bonds. It does not say how much each province gets, it says 50 per cent. The $30 billion is what is being revolved by from the provinces.
Mr. McKim: Is this commitment that Senator Kelleher spoke of to purchase provincial debt or to participate in provincial debt to facilitate the rollover?
The Deputy Chairman: No, that is after.
Senator Kelleher: Some of us are concerned about this because we do not see it as being true to the principle of investing in the best available type of investment, and I would like you to expand on your concerns for the benefit of the committee.
Mr. MacLaren: With regard to longer-term spreads, you would probably be giving up somewhere between 30 and 50 bases points, so a third and one-half of 1 per cent on that $30 billion each and every year. Arguably, that is that a concern to the pensioners.
The Deputy Chairman: You saw the table that was prepared as to the amount of cash that will be in the pension fund by the year 2006. Sometimes it is at $100 billion, and sometimes at $70 billion. The $30 billion is the spread of cash that is being revolved, so that is the assets of the fund, but the pension board will not manage that at all. That is stuck for the next 20 years at whatever interest rates are being organized by the bureaucrats at the present time. The other $70-some billion is what is being invested; and of that, 50 per cent of their debt instruments, according to the way I read the regulations, over and above the $30 billion, must be invested in provincial instruments.
Mr. MacLaren: That would be at market levels?
The Deputy Chairman: Yes.
Senator Kelleher: We assume that this was negotiated between the provinces and the federal government as part of the agreement which enabled the new legislation to go forward. That was the price that the provinces extracted from the federal government for their consent. That is my assumption.
Mr. McKim: If the loans to the provinces are being made at typical market spreads, you might argue that in fact you are receiving the benefit of them.
Senator Kelleher: We are advised by Finance that henceforth the bonds will be at market rates.
Mr. McKim: In that sense, you are participating in the 30 or 50-bases point spread to your advantage, notwithstanding that you are making an asset mix decision and driving a lot of money into, in this case, provincial debt. That may not be the right direction over the course of a 30-year period.
To speak to a general problem related to setting out objectives for pension fund managers, as I see it clients are trying to micro-manage their investment managers today and are putting in place many restrictions in terms of diversification, et cetera. There are many encrumbrances today on investment managers. In our view, the ability of managers to perform differently or better than other managers is curtailed if all managers are driven to do the same things.
The Deputy Chairman: I have just had the Clerk of the Committee check with the Department of Finance to make sure that I was not misquoting the numbers. It is not $30 billion but $36 billion that will be revolved. My assumption is that, over the next three years, anything in excess of that 50 per cent of what the board chooses to invest in bonds must be invested by the provinces, which is what we said except that it is for the three-year period and then after three years they have a little more discretion. I do not exactly know the right numbers but there is a little more discretion.
Mr. MacLaren: Part of the lack of confidence in the CPP that exists on behalf of Canadians is the fact that there is constant tinkering and people never know what will come down next in terms of fulfilling a social agenda that could be legislated upon them. That is a bit of a concern.
As I mentioned earlier, the golden rule of trustees is to do whatever is in the best interest of the pensioner. If in fact that happens to be in the best interest of the pension, then that is great, but it is a decision that should fall out of a thought process rather than being handed down and dictated to about how this money will be invested.
Senator Kelleher: In a sense, that discretion that you say should be there for the managers of the fund has already been removed, A, from the managers, B, from the board, and has in a sense been mandated -- I do not like to use the word "dictated" -- by the government in the regulations.
Senator Oliver: I wish to have a little explanation of the last paragraph in your brief, which says:
CPP beneficiaries and Canadian taxpayers should expect that these assets be managed by independent and objective professional investment managers -- seeking the highest returns in a market environment free of restrictions.
There are two things I would like you to comment on: "free of restrictions" and "independent and objective professional investment managers".
As you know, we are here in Halifax today because we have been asked by the Minister of Finance to review the provisions of the act that deal with the CPP Investment Board; we have also been asked to look at the regulations that have been drawn and sent out the provinces. Some of the things that the provisions of the act and the regulations deal with are the way in which the board is to conduct itself, in terms of corporate governance, and I am wondering if you could give us your professional opinion as to what kind of professional managers they should have. Should they do some of the investing internally themselves? Should they put 50 per cent, 100 per cent of the fund out for professionals to manage? What is your advice?
Second, what advice do you have for us that we can in turn pass on to the minister about what can be done to ensure that there is no political interference into this fund, which will reach $100 billion? What can we recommend be done to avoid even a hint of conflict from government or bureaucratic officials in this fund? We would like to have your advice on those two points.
Mr. McKim: In our opinion, the private sector is more independent, as opposed to having money managed by a group of people say at the CPP.
Senator Oliver: Do OMERS or the Teachers' not do some internally?
Mr. McKim: I am not saying that they do not do some internally, and I am not saying that it cannot be done internally, but in the opinion of most Canadians, the CPP's image is one of mismanagement and they will not receive any benefit from it. Maybe in the case of the CPP there is more requirement to take further steps to ensure its integrity, so to speak, or its perceived integrity. The fact is that there are lots of independent, private investment counsel organizations across Canada that already have proven records. Mr. McAloney spoke of choosing a manager to manage some money internally, but choosing outside managers for equities.
Senator Oliver: He said that he has eight managers.
Mr. MacLaren: We have noticed that companies such as Ontario Hydro, OMERS, and the Caisse dépôt in Quebec have been great schooling grounds for investment professionals. Once they have a proven track record, or are seen as successful, they quickly get hired by investment managers in the private sector who can offer them incentives through stock ownership. There is always the risk that you will continue to lose your best people because the public sector tends to have difficulty competing on a remuneration basis with the private sector.
Mr. McKim: One of the key issues of that remuneration package, in my view, in the traditional investment counsel is to have ownership in the firm that you work for, which is something that we support and have at SEAMARK, and we can boast that we have never had any investment manager turnover in our 15-year history.
Senator Oliver: How many employees do you have?
Mr. McKim: We only have a dozen.
Senator Oliver: What rate of return are you getting for the funds that you manage?
Mr. MacLaren: Over the ten years, balance fund managers rank in the first percentile across all Canadian fund managers.
Senator Oliver: Over 15 per cent?
Mr. McKim: It might be in the order of 12, but it is in the top 1 per cent of a 2,400 fund sample. In terms of relative performance, it is arguably one of the best, obviously.
Senator Oliver: What is the size of the largest fund that you are managing now?
Mr. McKim: Let us say $200 million.
Senator Oliver: Do you have any other advice that we can take back to the minister on a matter that, as you know, witnesses have raised in our cross-Canada hearings, and that is what, if anything, can be done to avoid any kind of political interference into the management and operation of this fund? What do you recommend to us?
Mr. MacLaren: The board that is selected must be completely open as to the asset mix guidelines. Also, the managers must be allowed to participate in value, when they see value. If they think bonds are over-valued and find equities that are a fair value and purchase into those knowing that the long-term liability of the pension fund is more suitable to equities than it is to fixed income, they must be allowed to pursue values as they see them, to invest in them. That would be very helpful.
Senator Oliver: Any other advice to avoid political interference?
Mr. McKim: Again, just to repeat, if you adopt the scenario that you are the manager of the managers, then you have allowed the managers to have a certain amount of independence from the typical type of political tinkering or interference because the managers have their businesses to run and they will run them the way they see fit to get the best returns. Reputations are at stake. To me, that concept is the most obvious way to indicate a true independence and objectivity.
Senator Oliver: Can you give me your view on proxy voting, and should the Canada Pension Board vote its proxies?
Mr. McKim: I would say that the managers, whoever it is that is making investment decisions, should vote the proxies.
Senator Oliver: In the case of the Canada Pension Investment Board, should the managers be foreboding the proxies, go back to the boss, the ownership or the board and get some direction, or at least explain the particular problem?
Mr. McKim: I would suggest, similar to your previous concern about how one shows independence, that if the board is going to shepherd the voting of the proxies, that looks less dependent than the investment manager who made the decision to buy company X having the ability to vote the proxy the way he sees fit.
Senator Oliver: Where do you think the buck stops? Does it stop at the door of the manager or at the door of the board of directors?
Mr. McKim: I would say at the door of the manager. As managers, when we make investment decisions, we are investing in the management of those companies. In terms of our record and our reputation, we have a lot at stake, to make sure those companies perform well. In that regard, I think it is best that the managers retain the ability, the right to vote the proxies the way they see fit.
Mr. MacLaren: A number of our clients will say to us: "If you voted against management, we want to know why." Obviously, we believe that the companies that we are investing in are sound and are managed well and, as a result, they are probably making the best decisions for the shareholders. In some instances, we have found that they have not. Arguably, some of the banks have recently tried to increase their boards and the remuneration of their directors, which we found some difficulty with on the basis that perhaps they just happened to be at the right place at the right time in the cycle, and are benefiting from that, and would like to pass that on to their board.
Senator Oliver: Did you say that some of the banks are trying to increase the size of their boards?
Mr. MacLaren: Yes.
Senator Oliver: Which banks are they?
Mr. MacLaren: I can think of two.
Senator Oliver: Could you name them? I thought that most banks were reducing the size of their boards.
Mr. MacLaren: For sure, one of them is the Royal Bank.
Senator Oliver: Are you saying it has increased the size of its board?
Mr. MacLaren: Is trying to increase the size of its board.
Mr. McKim: Paul Martin did not receive kindly the announcement of the merger in the banking industry. In this case, we are talking about the CPP, potentially a $100-billion entity, which would probably own a significant investment in the two banks in question. Do you not believe that the public might say that if the CPP Board has the ability to vote the proxies that this might not come into play, some of these political issues? Again, if you have your investment managers in charge of that you are removed at least one step from the political process, if you will.
To carry the same point forward again, if someone like SEAMARK is managing the money, as opposed to some in-house people, do you not think that it is easier for the people at SEAMARK who do not need to live in the political circles or close to the political circles to vote the way the beneficiaries would be best served as opposed to the interests of the politicians?
Senator Moore: Mr. MacLaren, when you were going through your presentation your referred to a $1,000 investment. You said that had you invested $1,000 in the TSE 300 X-number of years ago, it would be worth $2,839 today, whereas by investing the money in the S & P 500 it would have been worth $5,791. When was that $1,000 invested?
Mr. MacLaren: That was in January 1, 1988, so it was for a ten-year period. That is comparing apples to apples because it is the Canadian dollar equivalent that would have been invested in the S & P.
Senator Moore: Related to Senator Oliver's question about the makeup of the managers, their independence, their objective professional skills, and their qualities, there have been some comments made today here about the make-up of the board in terms of regional interest, gender, visible minorities. Do you have any recommendations with respect to that?
Mr. MacLaren: You must get the most qualified people, first and foremost. As Mr. McAloney indicated earlier, they can come from any sector. There are a number of banks that like to say that they have the most women serving on their boards and that they employ the most women, which is great if they happen to be the best suited for that capacity. It is very difficult to say, "We will have two of these and two of these."
First and foremost, they need to have an investment background of some sort, to be able to understand how to oversee managers and what is important in the management concept. One does not necessarily need to know a great deal about how investments work to understand that a firm that has been in business for a long time and has had very little turnover and a long-term time horizon in its investment approach is probably a suitable candidate.
Mr. McKim: Having some financial background is a benefit, yes, but you also must walk a tight line to avoid potential conflicts, including people with potential conflicts, and that is a job that I particularly would not relish.
Senator Moore: Another topic was the matter of the investment of the moneys in Canada. Do you think that that should be viewed at all in terms of where, either the region or in sectors of the economy, or should the guidelines be concerned with gaining the maximum return for pensioners.
Mr. McKim: Perhaps maximum return with an acceptable level of risk is something to consider. We are a firm that has its roots in Atlantic Canada and expectations of us might be that we would wish to put a large amount of money into Atlantic Canada. An idea from Atlantic Canada must stack up in our world as well as an idea in the United States, never mind Canada. It must stand up to whatever is the universe of investment opportunity. That is probably what you mean on your agenda going forward. You pick the best investment opportunities, regardless of domicile, and you can have some confidence that this will best serve your pension plan members or taxpayers, or whatever.
No, I do not agree with the concept of suggesting that things should be pieced out and shared.
Mr. MacLaren: That is where no tinkering should be allowed. One should not say that a certain percentage of your assets should be invested in Eastern Canada or Western Canada. The investment decision should be completely up to the investment manager, as to where he finds value. Perceived tinkering is at the root of the lack of confidence in the CPP.
Senator Callbeck: Do you invest in small businesses that are not listed on the exchange?
Mr. McKim: Our portfolios would be characterized by 70 per cent large cap companies, 20 per cent mid-cap, and 10 per cent small cap. That is a function of our investment management style. Other managers who espouse a different style could have larger commitments to small companies. At SEAMARK, we invest for the long term, we are true investors, and that means that the quality of the companies that we invest in must be very high.
Small companies just do not have the depth of resources, research and development, balance sheet, et cetera, to last in our portfolio for ten years. Other managers do that and make a business of that.
Senator Callbeck: As an asset management company, you are incorporated provincially, are you?
Mr. McKim: Federally.
Senator Callbeck: You could be incorporated provincially, could you not? Are asset management companies always incorporated federally?
Mr. McKim: They could be either. We then register with the security registration departments across the country.
Senator Meighen: The other day we were discussing with a witness the fact that the Canadian market is quite thin and that a fund of in excess of $100 billion could have quite an effect on the equity market at least, increasing the amount of product supply, asset back securities and things like that. Do you have any suggestions? Does that make any sense to you? Do you think that this can be done or do you think the market will take care of it?
Mr. McKim: We are generally of the view that the market looks after itself. Sure there will be new product proliferation, but this has been ongoing in financial markets for the last few decades.
My suggestion would be that, again, rather than approaching it from the want of new products, or whatever, finding products for your solutions, you let your talented investment people do what they do best, and if some of these products are good, fine, but most of the products that I have seen have been derivatives of basic fixed income and equity investments. I have always believed that until you can actually get that 100 per cent right, you do not need to go to the derivative products.
Senator Meighen: Of course, you may need to go to the derivative products in order to get around the 20-per-cent rule that you refer to in your brief. That would only be available to relatively large funds, would it not?
Mr. McKim: In our world it is not available to us. We will not accept derivatives as part of our culture in our firm and, in the spirit of the law, we will not use them to ratchet up the foreign exposure. This is a problem because others do. It is being done, so why cannot everyone do it legitimately?
Senator Meighen: Are you suggesting that you do not use it as a matter of principle, because of the risk element or for some other reason?
Mr. McKim: We do not participate in derivatives because of the risk. But I can go back to the period where, as you may or may not recall, we were eased into the 20 per cent. It started out at 12, it was at 10 and it moved up, and you may recall many money management firms moved in advance of the actual dates. It was our policy not to do that. We wish to play strictly by the rules.
In the case of endowment funds, which do not have these restrictions, we are 40, 50, 60 per cent invested outside the country. Purely on investment merit, yes, we are investing beyond even what the derivative root can take you in the pension fund arena because that is where we can see the better investment opportunities. We are playing by the rules and sticking to the 20 per cent limit on the foreign content.
Mr. MacLaren: At the same time, we do invest a proportion of our Canadian dollars in what we would term strong, globally competitive companies. A Seagram's to us could be just as easily from New York as it is from Montreal. Northern Telecom could easily be based in Connecticut as opposed to Ontario.
Senator Oliver: You are buying it as a Canadian company?
Mr. MacLaren: We are, but with the view that it has an extreme foreign revenue stream and is globally competitive amongst the largest companies in the world.
Senator Oliver: Seventy per cent of the Bank of Nova Scotia's income comes from outside of Canada, so is the Bank of Nova Scotia a Canadian company by your standard?
Mr. MacLaren: We try to invest without looking at borders. We would rather be looked at from a total equity concept, where we are cherry picking in what we think to be the best companies and the best industries right across the globe. We think that that is the route to take, and that is why we say we think Canadians have been penalized. For those who invest 20 per cent in foreign assets and then take the other 80 per cent and invest in what would be deemed a Canadian asset that has 20 per cent foreign in that, obviously they have that 36 per cent foreign exposure but, as Mr. McKim has indicated, we have not gone that route. The fact that it is there, and the fact that people are looking at it and nodding and saying we know it is there, should not the playing field be changed to accommodate all? It seems odd that only those who willing to take advantage of it are the beneficiaries of it.
Senator Meighen: You do not employ derivatives because you feel, as I understand you to say, that it is doing indirectly what the law prohibits you from doing directly. No quarrel with your decision. It is not shared by many others, but I am not saying that it is right or it was wrong. But on the subject of derivatives, I would like to hear a bit more on what I understood you to say, that they were inherently risky because there are managers who will make the case that derivatives are a hedge and derivatives reduce risk, properly employed.
Mr. MacLaren: The only really good hedge you can get is at a nursery.
Senator Meighen: I think I have run out on my hedge.
The Deputy Chairman: I would like to thank the witnesses for their attendance before our committee.
The committee adjourned.