Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 5 - Evidence - November 19 meeting
OTTAWA, Wednesday, November 19, 1997
The Standing Senate Committee on Banking, Trade and Commerce met this day at 6:00 p.m. to examine the state of the financial system in Canada (institutional investors).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Honourable senators, we have two sets of witnesses tonight in our continuing study on the role of institutional investors in the Canadian market. The first witnesses are from the Pension Investment Association of Canada: Gretchen Van Riesen, Russell Hiscock, and Donald Walcot. Their brief was circulated to you a few days ago. The witnesses will begin, as is usual in this committee, with a brief opening statement and then we will have questions.
I thank you for attending here tonight. Hearing from you early in our study was an important part of our scheduling of witnesses. Please proceed.
Mr. Donald T. Walcot, Executive Vice-President and Chief Investment Officer, Bimcor Inc., Montreal, Pension Investment Association of Canada: Mr. Chairman and honourable senators, thank you for the opportunity to appear before you today in this important consultative process. Bimcor is the BCE pension investment arm. In addition to being the chief investment officer of Bimcor, I am a director of the Pension Investment Association of Canada, familiarly known as PIAC, and chairman of its government relations committee. PIAC is the association which represents pension fund organizations in Canada in matters concerning pension investment and related issues. PIAC now represents 125 pension fund organizations which collectively manage almost $400 billion of pension assets on behalf of over 6.5 million beneficiaries. There are 47 public pension funds as members and 78 corporate pension funds.
In the submission and the PIAC fact book with which we have provided you, there are statistics as of December 31 last year. PIAC's membership is growing consistently and the data I have just provided is more up to date.
PIAC's constituency manages over 350 pension funds, of which almost 90 per cent are defined benefits plans which pay a pension based upon an employee's length of service and average earnings. This means that there is an onerous responsibility on those who actually manage the assets to produce investment results sufficient to pay pension cheques. To put this responsibility in context, it is estimated that 85 per cent of every pension cheque is funded by investment returns, with the remainder coming from contributions. It is for this reason that effective investment of assets is vital over the long term.
You will be hearing from other institutional investors in your consultations. There are some important distinctions to keep in mind between the pension funds we represent and, for example, the mutual funds. Pension fund assets are invested over very long-term time horizons and are managed to meet the expected liabilities -- the pension payments.
The liability profiles of pension funds vary from fund to fund based upon the mix of actively employed members and retired members in each. Those with a preponderance of employees can take a more aggressive investment posture while those with more retired members must take a more balanced approach. Mutual funds, on the other hand, invest assets in keeping with a stated investment policy and to maximize performance.
Also, pension funds tend, on average, to hold specific investments longer because of their very long time horizons. Portfolio turnover ratios are lower in pension funds than among other institutional investors and the size of individual holdings can be very large. These factors lead pension funds managers to encourage investee companies to improve shareholder value rather than simply to dispose of their shares.
Unlike the mutual fund industry, pension funds are not competitive. Their focus on performance is one of ensuring returns adequate to meet anticipated liabilities, not to attract investors. The decision about how a pension fund allocates its assets among different asset classes is reviewed less frequently than is the same decision in a mutual fund, and pension funds rarely manage to meet anticipated economic events. In other words, pension funds do not often raise cash in expectation of a market decline as do many mutual funds. They generally stick to their knitting.
What we think you should conclude from this is that when contrasting pension funds and mutual funds, pension funds make a relatively longer-term commitment to each investment and exercise greater patience in increasing shareholder value. Recognizing this growing interest in corporate governance by its larger members, PIAC formed a corporate governance committee in 1991 in a move to increase awareness amongst all its members of the importance of corporate governance issues. That committee developed and issued PIAC's corporate governance standards as a guide to all members in their voting of proxies on contentious corporate initiatives.
PIAC has also instituted an overnight proxy calendar service which identifies for members the agenda items at upcoming corporate meetings. In discussions about corporate governance activities of pension funds, PIAC recognized that there is no widespread understanding of the way in which pension plans themselves were governed. To address this and to establish a guide for all pension funds organizations, PIAC developed its own model for pension plan governance.
I should like to take a moment to discuss the elements of this model before examining PIAC's experience in the corporate governance activities of its members.
The Chairman: Senators, within this document is a flow chart which I assume Mr. Walcot will take us through. It will probably be easier to follow if you look at the chart.
Mr. Walcot: That is correct. Inside are the different components of the model.
In mid-March of this year, PIAC provided your committee and researchers with copies of this model. It was created in response to the obvious vacuum in authoritative guidelines for the governance of pension funds. Most pension funds are in fact organized along the lines suggested by the PIAC model, but without the attendant detail.
This is the only document of its kind anywhere in the world and we are impressed by the amount of interest in our work by pension professionals here and abroad. One example is the distribution by the Council of Institutional Investors in Washington D.C. of 500 copies of the model to its members.
The model is based on the belief that a corporate governance structure is centred on the pension promise and that a pension fund's primary objective is to manage assets to meet liabilities. The governing body has a fiduciary duty to the plan's beneficiaries to ensure that the pension promise is fulfilled. The selection of people for the governing body is critical. Each must be knowledgeable, be willing to accept the responsibilities of fiduciary duty, and be independent of management of the pension fund.
The model sets out the basis on which the trustees share responsibilities with those responsible for active management. It also highlights the importance of monitoring to ensure that the objectives of the funds are being efficiently met and that the structure maintains its effectiveness in allowing the plan to meet the pension promise.
I should like to discuss the experience of PIAC's members in corporate governance matters. PIAC's corporate governance standards were first published in 1993 to guide members in their consideration of contentious issues on the agenda in meetings of corporations in which they have invested. The increase in institutional investors' focus on corporate governance has resulted from the increasing size of their holdings in individual companies.
As you can see from our submission, total pension fund assets have grown by 75 per cent in the five years to 1996. Their equity investments have grown by 133 per cent in that same period compared to an increase in TSE market capitalization in the order of 67 per cent.
You can understand the dilemma facing an institutional investor holding a large position in the share capital of a company. Not many years ago it was an easy decision for such investors. Dissatisfied with corporate performance, they simply sold the shares into a liquid market. Today, it is not always as simple and many pension funds find themselves in the position of working with the company in an effort to improve long-term corporate performance.
That being said, a great many PIAC members, especially smaller members, still find that they can effectively dispose of their investments without driving prices down. For a large proportion of PIAC's membership, this is the more common response to flagging corporate performance.
However, during the period that shares of a company are held by a significant shareholder, the decisions the company takes are very important to both the company and the shareholder. One means of investor communication with the company is the proxy process. The survey of PIAC members, reported in detail in this submission, identifies those areas in which they have the greatest interest and concern.
The importance of the survey's findings is that they define the comparative importance of governance issues among a fairly large and diverse constituency of institutional investors.
We cannot stress too strongly that the attitudes expressed by PIAC's overall membership are very different to anecdotal reports you may have received of pension fund intervention in the governance of corporations. It is not correct to attribute the interests and sophistication in governance of large public pension funds to the entire pension business. That being said, PIAC believes that the motives of institutional investors, large or small, public or private, are to vote in support of good corporate governance practices which they trust will yield improved corporate performance and, hence, increased shareholder value for the beneficiaries to which they owe a fiduciary duty.
We believe that corporate governance activism is not an issue which should be regarded with concern but rather one which focuses the attention of corporate management on activities which promote improved corporate performance. That, after all, ought to be the common goal both for corporations and their shareholders.
This concludes our introductory remarks. We will be pleased to answer any questions arising from our presentation or our submission, or on any matter you believe is within our competence. Because we represent the association and the experience of its members collectively, we are not in a position to discuss special initiatives of individual members, but each of us is prepared to comment on experiences in our own organizations.
The Chairman: Thank you, Mr. Walcot. Perhaps you could just define some of the terms you used in your presentation. You talked about the importance of trustees being independent from management. Can you define "independence"? This committee, about a decade ago, when Senator Murray was chairman of the committee, developed a definition of what it meant to be an independent bank director which the government of the day ultimately accepted. There was quite a bit of debate, both within the committee and between us and the banks, as to what constituted independence. It might help if you enlarged on that a bit.
Second, you said that it is no longer necessarily a simple thing to sell a block of shares into an open market. Your exact words were "working with a troubled company." What does "working with" mean?
Third, you talked about your overnight proxy service. That could have one of two purposes. It could simply inform people of particular proxy issues, but it could also -- since we are all in the business of seeking votes as it were -- be a very effective way to get a significant bloc of votes to vote together on a proxy issue because you would be providing everyone with the same information.
My question this: Are you running an information service or are you running a bloc-generating service which is designed to, in fact, pull the various blocs together? There is no sense that there is anything wrong with that; I am just trying to understand at which of those two outcomes of the proxy service you are aiming.
Mr. Walcot: To answer the last first, the overnight proxy service is essentially a document which lists questions, usually several of them. Those questions are listed along with a comment on whether they are controversial or not. They draw your attention to them.
We use the document in our office to highlight questions that we should examine. There is no coming together. There is no communication as to how many people are voting one way or the other. There is no use of the document as a bloc document. Given that we get a great number of proxies every day, it is a way to identify questions which should be drawn to our attention.
The Chairman: So it is an information service. Most of us at this table, if faced with that, would have been inclined to start building coalitions. I am surprised you are not doing that.
Mr. Russell J. Hiscock, Manager of Investments, CN Investment Division, Montreal, Pension Investment Association of Canada: To echo Mr. Walcot's comments, not only is this an information service but also it is a one-way information service. The overwhelming majority of proxies are extremely routine. We receive information on proxies which is identified as routine or non-routine. Each individual investment organization then decides what course of action they may wish to take, once they have reviewed that proxy. However, there is no communication of any course of action back into any central facility.
Ms Gretchen Van Riesen, Assistant General Manager, Pensions and Benefits Strategy, CIBC, Toronto, Pension Investment Association of Canada: We know of no interest in doing that. I have not heard of any interest in our side of the business -- which is in the investment management side of pension funds -- to pursue, as sponsors of plans, some coalition kind of thinking. It simply does not exist as far as we know.
The Chairman: I reserve the right to come back on the following issue: Given all the material you have put out on what constitutes good corporate governance from your view and given the importance you attach to good corporate governance, there is likely a compelling argument for building a coalition to have greater leverage than any one of you might have when acting individually. We will come back to that later.
Mr. Walcot: The second question referred to selling shares or working with a troubled company. I would first reiterate that for a great many PIAC members, especially the smaller members, they still find that they can effectively dispose of their investments without driving prices down. For a large proportion of PIAC's membership, the common response is to sell rather than to work.
Regarding working with a troubled company, it is my personal experience that, occasionally, when management sets up interviews with potential investors, they will often use you as a sounding board against whether they should restructure or rethink their strategy. Often you can indicate there how we -- and we really only speak for ourselves -- would respond to certain strategies that they propose. Sometimes they say they should move more toward retail and away from financial services, that type of thing.
That is one way of working at it. I am not aware of any more detail of getting involved with a company. We are sellers of securities rather than those who work things out, generally.
The Chairman: You described a situation where a company comes to you and asks what you think of a certain idea for changing direction. Are there situations -- and would this not make sense -- where you go to the company and offer the idea? In other words, are you purely reacting to their ideas or are you, in fact, volunteering some ideas of your own?
Mr. Walcot: As a policy, I only react to ideas. I am never proactive. We do not go to management. I am speaking for Bimcor now. We do not suggest changes to them; we simply react to their ideas.
The Chairman: Can I hear from your two colleagues on this? They are talking as people who run pension plans and not for PIAC, obviously.
Mr. Hiscock: From time to time, we may ask in a meeting with a company what would happen if a certain course of action were taken. To my experience, we have never called for a meeting nor written a letter nor done anything to bring up an agenda with the objective of encouraging the company to do something specific.
Ms Van Riesen: In our organization, we rely completely on external managers to vote our proxies and to deal directly with any issues they have with companies in which they invest on our behalf. We do not have any involvement directly with corporations in which our pension fund invests.
The Chairman: Without pursuing it in detail, is there a reason for you taking the external manager route? Is the rationale that you are a pension fund? Or is it for some other philosophical reason?
Ms Van Riesen: I think it is probably a combination of those things. Our decision to use external managers may be one more of history than anything else in that we have never built an internal capability. I hesitate to say that because we did have an internal capability at one point. That has now been sold and is a business, of which we own a part as opposed to owning 100 per cent. We treat that relationship as an external provider to our fund. We have two other managers that are unrelated. We really rely on their advice.
There is a philosophical basis for wanting to manage money in-house, and our trustees have made the decision to use external advisors rather than building that capability in-house, unlike my two colleagues who have chosen to invest some of the money in-house.
The Chairman: Can you define "independence" for me?
Mr. Walcot: I cannot give you the legal definition.
The Chairman: What does it mean in practice?
Mr. Walcot: It means that the trustee is responsible to the stakeholders of the pension fund, not to the interests of the organization. Therefore, all the decisions are made in terms of rates of return and ensuring that beneficiaries receive their money. The interests of the corporation are not included in their decision-making.
The Chairman: That is what bank directors used to tell us before we got into the definition of independence from the bank. Who is excluded by that definition? Is no one excluded, provided they say that they will take the interests of the stakeholders into account?
Mr. Walcot: In our organization, it is our outside directors who are members of our pension fund.
The Chairman: Is that true in the case of CN as well?
Mr. Hiscock: Our investment committee is comprised in part of outside directors and in part of senior management of CN.
The Chairman: Are the outside directors in the majority?
Mr. Hiscock: Yes.
Ms Van Riesen: Ours is the same.
Senator Hervieux-Payette: We are familiar with the experience of government pension funds in the case of the Caisse de dépôt. I know they are in the process of removing the cap on the structure of their investments so that they will not be limited in terms of the equity portion for buying shares, et cetera.
I am wondering if no guidance in the legislation is the best way to give the proper latitude when we are talking about the pension fund which applies to most Canadians. Would you advise us to keep a cap on the equity side?
I have witnessed cases of pension funds buying, at discount, the first-issue shares over the regular Canadian citizen who would also like to buy those shares. What do you think of that practice?
We know that some countries do not have any restrictions on the percentage of investment in foreign title. My inclination would be to recommend 30 per cent to our government. However, I would be a little bit concerned about starting a new fund, with new experience for the government, without any restrictions. What is your view on this?
Mr. Walcot: I am sure we all have strong opinions on every one of those questions.
With regard to a cap on equity, I came into the business in the 1960s when we had the Canadian Insurance Act which determined what you could invest in. Over time, we moved to the prudent person rule which was based on each individual pension fund doing its best. My strong belief is that having arbitrary limits does not enhance the return of the fund; that there is a strong professional industry with strong professional rules that have been established. I do not think it is necessary to have legal rules on top of that to control what we are doing. It is a highly competitive industry. We are all watching each other. It is the market itself that seems to produce a low-risk asset mix.
Senator Hervieux-Payette: What is the usual average equity?
Mr. Walcot: One of the most interesting reports I saw was one written a number of years ago by Keith Ambachtsheer, who is a major Canadian writer. He indicated that if you invested between 40 and 60 per cent -- you would have, say, 40 per cent bonds and 60 per cent equity, and move in between that -- you capture by far the major part of your return. I have always used that as my rule of thumb and have had reasonable performance. Some people may go as high as 75 per cent, but that is extraordinary and unusual, generally with a very young, technologically oriented work force.
Ms Van Riesen: In terms of the issue of portion and asset mix generally, of which equity is a portion, you cannot ignore the underlying liabilities of the plan, the demographics of the plan, the nature of its members and their proximity to retirement. Those factors all have to come into play and relate to your asset mix decisions. To imagine that a cap would work and capture all possible situations, where it may be perfectly appropriate to go above the cap for investing in equities, would really impair the ability of that fund to meet its obligations.
Senator Hervieux-Payette: In our case, the age and the group is very well known. Therefore, it is easier to establish a standard, if we have to establish one.
Ms Van Riesen: By putting everyone below that, you inhibited the ability of folks to meet the needs, if they need to go above it. That is all I am saying.
Mr. Hiscock: I should like to stress what Mr. Walcot has said. Throughout the PIAC membership, it is true that asset mixes range between 40 per cent and 60 per cent -- which is quite conservative. The reason for that is a long-term orientation and a focus on the servicing of the liability structure because that is what the asset pool is there for in the first place.
Mr. Walcot: Your second question, senator, concerned discounts and new issues. At one time, I did the underwriting for Ontario Hydro's bond issues. It was always our objective to have retail sales, as well as institutional sales. Retail provides a liquidity to the market which the institution does not. We do not get special prices on a new issue; we get the same price as everyone else. If the underwriter is doing a proper job, there is allocation between the retail and the institutional. There should not be unfair allocation. Certainly, there should not be discretionary pricing toward the institutions. That is not right.
Senator Hervieux-Payette: It is important to know that. I have seen that happen in my case, where they are trying to bargain with you. If you are issuing your shares at $7.50, they say, "We will offer you $7.00." I feel that is discriminatory to ordinary investors. We should establish criteria for that.
Mr. Hiscock: On an IPO, institutional investors pay the same as retail investors. There can be tremendous excess demand and the price in the market goes up. However, people who did not get as much as they wanted may not be happy. In the case where there is not enough stock to go around, everyone gets cut back from what they wanted. There was an example of this situation in Australia on Monday.
The telecommunications company in Australia was floated and its shares were traded for the first time. The pricing on that was more expensive for institutions than retail investors because they wanted a certain target, proportional allocation into the retail marketplace in Australia.
Senator Hervieux-Payette: Yes, and they paid a premium. That is a different thing.
Mr. Hiscock: In that case, the institutions paid more than the retail investors.
Mr. Walcot: Your third question concerns the foreign property rule, the 20-per-cent limit.
Earlier, we were talking about independent trustees. We also talked about interests in the stakeholders and the fact that you have to service the stakeholders' interests. In looking at the foreign property rule, it is a limitation on proper risk management because you cannot diversify adequately. We know that this is costly because we have done studies which indicate that it cost the pension funds approximately $4 billion to arbitrarily include this limit in the past. From what I can see, there is no demonstrable report or objective-setting indicating whether it is doing its job on the other side.
I am strongly opposed to the foreign property rule, although we are under the 20 per cent limit. When you are investing, you can trust the investment community not to go crazy and take on too much risk. We will not do that. I think it has cost not only pension funds but also individual people. It is not a good idea.
Mr. Hiscock: I recognize that this committee has already recommended that the 20-per-cent rule be abolished. We certainly encourage you to continue with that. Those who argue that there is a reason for keeping it should be able to demonstrate that there were some negative consequences involved in moving from 10 to 20 per cent. Personally, I do not see any study or any piece of work that has been able to identify any negative consequences.
Senator Meighen: What would you do if you were a responsible legislator and could, with a wave of a hand or a pen, remove the 20-per-cent rule? Would you do it in stages, or at 2 per cent a year up to a certain amount? Or would you just simply blow the whole thing away?
Ms Van Riesen: Blow it away!
Mr. Walcot: Since it is not good policy, it should be removed immediately.
Mr. Hiscock: I do not believe that there would be any problems for Canada if it were removed immediately. However, a practical way of doing these things, in an orderly fashion, is to go again to 2 per cent a year for five years, or something of that sort. That would not be disturbing to the pension community, either.
Senator Meighen: That gets up to 30 per cent, if my math is right. Someone once suggested that 30 per cent is not a factor anymore because it is unlikely that you would have 70 per cent-plus invested outside Canada.
Mr. Hiscock: You are focusing on an important point. Responsibly managed pension assets will have a level above which it will be considered imprudent to go with a liability structure based in Canadian dollars. At some point in time, it would cease to be a binding constraint for everyone. It is not clear, in an a priori context, where that level would be.
One could look at countries that have no limitations, the U.K. for example, where they are both geographically and time zone-wise next to many different capital markets, and they are in the order of 30 per cent and no more.
Senator Meighen: They have 30 per cent?
Mr. Hiscock: Around 30 per cent and no more. There are no limits there.
As Mr. Walcot said, today some pension funds choose, for good and prudent reasons, to be less than 20 per cent. When I said that going from 20 to 30 per cent would not be a problem, it was a suggestion in recognition of some of the practical and potentially political difficulties in making a move. It is not a prescription to get to a certain level that would have any economic meaning to it.
At some point, for all pension funds -- that is, if you go to 40 or 50, or wherever -- it would cease to be a binding constraint because no funds would be imprudent to be 100 per cent foreign.
Ms Van Riesen: Another point occurred to us as we were looking at it. We heard some of the issues that have been raised concerning the 20-per-cent foreign property rule and that a way around it is that pension funds can invest in derivatives. There would be no problems with that, so why do you need to raise the limit? We looked at that.
The more sophisticated funds are certainly capable of using derivatives, and because of their complexity it is important that sophistication and understanding are brought to them. Not relying on that logic simply means that smaller funds and individual investors are excluded from the capability of being able to diversify their assets prudently and to take advantage of the same increased, enhanced returns over time that larger funds are capable of doing. We do not think that that logic holds water -- that is, if you have heard that in testimony.
Senator Angus: I wish to address some of the more fundamental governance issues. Perhaps I should address my question to you, Mr. Hiscock, since we had the pleasure of having your colleague speak to us when we were dealing with the corporate governance of the companies in which you invest.
As you know -- it was well publicized -- he said that governance of these companies is a very important matter. He has a list of 14 or 18 things, in ascending order of gravity, that he watches. You are probably familiar with it.
Mr. Hiscock: It was right between the two.
Senator Angus: I thought it was very clear. He talked about lavish lunches and all of the different kinds of loose behaviour that can and does creep into the management of a company.
I asked one of the witnesses this yesterday -- and I do not think I got an answer, so I am going to try with you, because there seems to be a lot of clear thinking that goes on at CN. Do you have a similar list that you might be able to suggest to a beneficiary of the CN pension fund regarding things that they should be looking out for with respect to the governance of the CN pension fund?
We are trying to focus not on the governance of the companies in which we invest but on the institutional investors. I understood from Mr. Walcot's words that you consider governance to be the main concern. I have some specific questions on that. To help us with a framework, could you give us a list of five or six, or maybe 10, things that would suggest poor governance?
Mr. Hiscock: CN does not have such a list; nor does PIAC.
One can go through the work that we have done here and highlight a violation of some of the key principles that we are suggesting are highly important guidelines or standards of best practice and develop such a list. I have not developed such a list, but the genesis of such a list would be contained in this model.
Senator Angus: Your model is fascinating. It jumps off the page when you look at the absolute numbers of both the private and the public pension funds that are members of your association. Judging by those numbers, there are many smaller, private funds that are not members.
Mr. Walcot: That is correct.
Senator Angus: If the standards that you are discussing for people in terms of the level of sophistication of the fiduciary could be met, there must be literally hundreds of private funds that have terrible governance. Would that be a fair comment?
Mr. Hiscock: May I make one point? You talk about many pension funds not being part of PIAC. We have organized our association so that, to be eligible to be a member of the association, the pension fund must have assets in excess of $200 million. That nominal number has been there for quite a few years. In real terms, it is coming down. The purpose of that cut-off was to ensure that the people representing the pension fund who came to the meetings and who participated in our activities were in fact people who had hands-on investment management responsibilities.
Senator Angus: It is interesting that you would have introduced that. I assumed, rightly or wrongly -- and I hope you will correct me -- that you did have standards for membership in your association and that perhaps one of those standards was governance of your members. Is that the case?
Mr. Walcot: No, it is not. It is a self-help organization. We were created back in the mid-1970s when pension funds were starting off and people were helping each other. We did not want to establish artificial standards to let people in but rather to lift the whole industry together. That is why we would develop something like this, as a way to help our whole membership improve.
Mr. Hiscock: We do represent PIAC here, but Ms Van Riesen and I are also members of an organization called ACPM. That organization will shortly be putting out a "best practices" for pension fund governance, which is close to this, but it has a much broader range. Ms Van Riesen, as a former president, can talk more to ACPM.
The Chairman: They have agreed to appear when we resume in February.
Ms Van Riesen: ACPM is the Association of Canadian Pension Management. That association actually represents 500 plan sponsors and $226 billion in assets, so there is a much wider range of small and large plan sponsors. There is probably a wide range of good and less than perfect governance practices in the organization. We did take the initiative of establishing standards and are actually seeking to survey our members in an effort to establish some parameters as to the practices that are out there and to engage, as Mr. Walcot intimates, in lifting up the industry as opposed to regulating ourselves. That is not our role. That is not what we are trying to do. We are trying to provide best practice models and lift ourselves up, if that is necessary. The first step is to find out where we are on the issue.
Anecdotally, I would say that our industry fares very well in its governance of pension funds. There are certainly some notable exceptions, but generally our sense is that the situation is not a dire one. However, we do want to be proactive.
Senator Angus: We will look forward to seeing those standards of best practices. From the literature I have read, the three private-sector organizations that each of you represent, CN and BCE and CIBC, are all recognized to have funds with good governance. We know that the CN has a mix of some outside advisors and inside managers, plus the governance. Perhaps you could describe to us the governance, as per your definition, of the CN pension fund.
In asking that question, I understand from Mr. Walcot's evidence that the board of directors of the company CN, the publicly traded company, has a fiduciary obligation to ensure that the CN pension fund is properly governed. Would that be a fair comment? Am I right?
Mr. Hiscock: Absolutely.
Senator Angus: With that fiduciary obligation in mind, the CN board has put in place a governance system. Would you tell us about it?
Mr. Hiscock: The board of directors of CN has the fiduciary responsibility to ensure that the pension fund is well managed and that the funding policies are appropriate to pay the pension benefits that are incurred by the years of service of the employees, and these are actuarially estimated. The Canadian National Railway company is the administrator of the fund. The board has established a subcommittee of the board of directors. That subcommittee also has senior executives from the company who oversee the investment division of the corporation, and the investment division on a day-to-day basis manages the assets of the pension fund.
Senator Angus: Does it report periodically to the subcommittee of the board?
Mr. Hiscock: Yes. In fact, the subcommittee meets almost every month.
Senator Angus: I understand that this is all public information. It is in the CN annual report.
Mr. Hiscock: Yes, it is.
Senator Angus: Therefore, you would not mind telling us how many members are on that subcommittee; how many are actual board members and how many are management people; and the criteria with respect to their qualifications for that job.
Mr. Hiscock: I do not have the annual report with me. Rather than give you incorrect numbers --
Senator Angus: You do not need to be precise. Is it half and half?
Mr. Hiscock: I believe it is something in the order of six and five. In terms of the criteria, those appointments are made by the board of directors, and there is no explicit criteria of which I am aware. There is no test which would indicate that one member of the board of directors might be suitable while another may not. However, the appointees to the investment committee are all knowledgeable people who have extensive business and, in most cases, financial experience.
Senator Angus: Ms Van Riesen, does the CIBC have a similar process?
Ms Van Riesen: I might say that we are speaking for our own organizations and not the scope of what those structures might be in our member companies. We are here representing PIAC, so there can be a wide range of ways in which this model may be applied in various organizations.
CIBC undertook a governance review two years ago. We brought in external advisors to look at how we did planned governance. They made recommendations both on the funding and asset management side, as well as on the administrative side, right down to how benefits are calculated.
We revamped our governance structure in accordance with the findings of that research. We created a structure which has three bodies, all directly accountable to the board of directors who, as in any plan where the employer is the sponsor, is the administrator of the plan and therefore accountable. The board delegates to these three groups certain responsibilities with respect to the management of the plan.
There are eight trustees. Seven of them are members of our board of directors. Five are external, two are internal directors, and one is a retiree. They look primarily at investment management. That group actually has an advisory committee that advises it. Our board of directors, while they are senior people in running companies, have sought additional advice on investment issues.
We have also created an expert pension investment advisory group of external advisors. We are a financial institution and, as such, have some capability in-house on the investment side, but we pooled this group who give advice to the trustees on issues of investment management.
The second group is what we call a pension funding and expensing committee that looks at the funding contributions into the plan. It reports to the board. The third is design, where we are actually looking at design changes, which again goes to our board of directors for approval. All of that comprises what we call our overall governance structure.
Senator Angus: I bet you do not have any elected people from the pensioners.
Ms Van Riesen: No. We have one retiree, but it is not an elected position.
Senator Angus: Is B.C. similar?
Mr. Walcot: We are essentially similar.
Senator Angus: It is a Wilson model.
Mr. Walcot: It is a Wilson model. It came in when he came in. We have five or six directors. They look at policy decisions. We have created a checklist at each level that clearly defines what each level is supposed to approve and not approve.
Below the board of directors, we have an investment committee made up of operational people within the organization. Unlike Ms Van Riesen, we have both the benefit and the investment side coming into this operational meeting. Part of it is spent on determining actuarial returns. The other part is spent on investments. We, as Bimcor, are hired by BCE Group to manage the investments.
One thing to note is that they are not huge boards; they are smaller boards. Generally we found that four, five, six, or seven people is an appropriate number. If it gets too big, it does not work.
We do not have any employee representation. However, because we are located in Quebec, we do have meetings with the administration where, once a year, we speak to the employees. They have three employee representatives, and we talk to them.
Senator Angus: Clearly the big public companies have elite boards of directors and top management. Yet you are advocating a self-help, from-the-bottom-up process that will ultimately lead to good governance in our pension fund governance and management. I question that. The reason is that until the problems that lead to the Day report and until the issuance of the guidelines by the Toronto Stock Exchange and the Ontario Securities Commission, nothing was happening in the area of governance. There were serious company failures, and a lot of bad practices finally came to light. However, this was a top-down process. Even though there were guidelines, they were really a form of voluntary regulation.
Today, many annual report list in column A all the points in the guidelines. "Does the XYZ company comply?" "Yes," "yes," "yes," "no," and so on, down through the list. "No, but we are working on it." Again, that is a top-down process. Many companies feel bound to comply with those guidelines, even though they are not legally bound. A lot of boards are saying, "We better get our governance committee in place."
In my opinion, it is a tremendous revolution in corporate Canada. The numbers I have seen in the literature for pension funds in Canada -- not including the big funds such as yourselves -- indicate terrible governance, I submit. Would it not be better to have a set of guidelines imposed, to get the show on the road?
Ms Van Riesen: I do not know that that is true. Maybe you have information I do not have. We would certainly be interested in seeing it. ACPM is trying to find out.
I am not sure that the governance issue is all that bad out there. I think we, as an industry, have ascribed to the prudent person principle, which states that you invest and you act as though you were responsible for someone else's money. You cannot do that halfway. You either believe it or you do not believe it. If you do not believe it, then you regulate it to death; and if you do believe it, you trust and rely on industry associations such as ours to set standards and use moral suasion or encouragement to do it. You run the risk that there may be the odd bad apple. However, one cannot infer that the whole barrel is rotten and, as such, create a bureaucratic nightmare of regulation around the industry. We prefer to pursue the approach of setting up models and encouraging that direction.
Senator Angus: I think it is excellent. Notwithstanding what was written in The Toronto Star this afternoon about what I was alleged to have said yesterday, I am a burkean conservative. I am anti-regulation. But in matters where people are dealing with the assets of others who are not in a position to defend themselves and who have made a leap of faith in the case of an investor in a public corporation or a pensioner, I just wonder if we should not impose something by way of guidelines. I was very cynical at first about the TSE guidelines, but I am now very impressed by their effect.
Ms Van Riesen: I think the regulatory body is doing positive work. We are regulated federally, and I know that OSFI has taken the approach of looking at guidelines as opposed to micro-regulation. We certainly support that direction. What we have seen has been very positive and encouraging in terms of trying to move in the direction of setting standards. Maybe in your auditing and your examination of companies, it helps you with the questions you might ask, but you stop short of saying, "You are either this, yes or no, and if you are not this, then we will come after you." There may be some perfectly valid reasons for being slightly different than what is set out as a standard. I think OSFI is moving in that direction, and maybe other regulatory bodies will do that.
We will be concerned if it becomes a regulatory nightmare and burden because we do not think that would be productive in achieving good governance.
Senator Angus: Perhaps the Senate banking committee could produce a report, as Mr. Day did, that lists a series of guidelines.
Senator Austin: I always enjoy listening to Senator Angus. My area of interest is in the same sector of governance and principles of governance. Perhaps I could use the same metaphor Senator Angus used -- a barrel of apples. Is it the industry's responsibility to identify the bad apple in the barrel, disclose it and eject it, or should OSFI, or some other regulator, determine it by audits and overview? Is it the responsibility of government to lay down guidelines that require a team of people looking at the performance of the industry?
I do not want to put an ideological title on my remarks, but I said yesterday that what I am looking for is whether, within the industry itself, there is enough difference of interest among the stakeholders to act as checks and balances on the system, or whether you essentially have all got the same interest? By having the same interest, you are really governing yourselves without any outside expertise to judge what you are doing and what is the meaning of what you are doing.
I intended to ask questions, but Senator Angus has asked most of the questions. I am avoiding ideology. I hope pragmatism is the only skill being brought to the table.
In the U.K. today, there is quite an interesting issue within their pension industry over practices that the Chancellor of the Exchequer has asked be corrected. These were practices in which the marketing side of the industry asked individual members of group plans to consider taking individual plans that were presented as returning greater pension security and pension rewards. This has not proven to be the case in experience. The story we are now reading is that the pension funds managers have been asked to put all of these people back in the status quo ante, at some considerable cost to the pension funds, and that the industry itself is dragging on performance of those directions. The chancellor is now talking about seeking legislation to deal with the issue.
Would you comment on that particular issue, if you are familiar with it? Could it happen in Canada?
Mr. Walcot: I will comment first about whether we have similarity of interests. We do all work in defined benefit plans, and we differentiated between defined benefit plans and defined contribution plans. A defined benefit plan is when everyone is under one trust. Therefore, trust law defines what the trustees have a responsibility for. They have to look at the responsibility within the terms of their trust. That is where you get a great counterweight to the problems you are describing there. In all the pension funds in which I have been involved, much time is spent by the trustees in determining their responsibility. They take their jobs seriously. In defined benefits, that can be a useful counterweight rather than government regulation of every minutia.
Regarding the U.K. pension situation, as you are aware they moved from a defined benefit concept, in a sense, to more of a defined contribution or individual people having their own pension plans. This was something that was put in under Mrs. Thatcher.
Senator Austin: At the request of the industry.
Mr. Walcot: Yes. In my opinion, defined benefit is the best way for a pension fund to be because you have a trust which assures that the pension will be paid at the end. Under a defined contribution, your assets grow, and whatever the assets are at the end tends to be your pension. If you happen to have interest rates of 14 per cent, you can get a good return for the rest of your life. If interest rates are 2 per cent, your pension will be quite low.
As well, under defined contribution plans, unsophisticated investors are investing in vehicles which are inappropriate for them. That is a concern of mine and, as such, I am leery of defined contribution plans for that reason.
I know that a number of companies will tell you that they have a good investment manager. They may even define the appropriate asset mix for the employees. However, in Britain it was taken away from the company and left with the individual.
Senator Austin: At their election. They could elect to create their own plan and, therefore, instead of taking the defined benefit, they would, by managing their assets, with an investment individuals advisor, of course, end up having a much larger benefit at the appropriate time.
Mr. Walcot: They hoped.
Senator Austin: That was the presentation that was made to them.
Mr. Walcot: Yes. Another thing to watch for is the cost of it. As you are aware, pension funds are essentially cumulative. It is not a matter of buying one hot stock to provide for your pension in the future.
If you are paying a 1- or 2-per-cent fee to manage your money, that is coming out of your return and your pension fund will be lower. Big pension funds can manage for 10 to 20 basis points as compared to 100 to 200 basis points. There is more money going to the beneficiaries. I feel rather sorry for those people in Britain because I think they were taken.
Ms Van Riesen: I am not intimately familiar with the circumstances in the U.K., but if the issue is that returns dropped as people began to do their own investing, we have plenty of experience with that in Canada. Defined contribution plans have been around for a long time. You do not have to look far to find that historically they are very conservatively invested. We see 25-year-olds investing entirely in GICs in their defined contribution accounts, which is exactly the age at which they should be investing more aggressively.
We have plenty of experience in Canada to show that the less sophisticated investor will not make the right decisions for building a retirement income comparable to that which a defined benefit plan would provide without their involvement. We have that now.
Senator Austin: If your industry and your associations thought otherwise than the two of you have said here and had come to us three or four years ago and said that the U.K. experiment will produce greater benefits and that your industry could manage those types of plans within new systems and would really like to do so, how would we judge whether they were acting on their fiduciary responsibilities or on their desire to create a bigger unit of funds to manage? As Mr. Walcot mentioned, bigger is actually better in your industry. He said that one-tenth of a lot is a very low cost per unit to the ultimate beneficiaries.
I raise the issue only to say that things do go wrong and therefore we do need a watchdog system of some kind.
Mr. Hiscock: This conversation raises two points that are important when talking about fund governance. The world is not a whole lot of pension funds that all look the same. Defined contribution pension plans and defined benefit pension plans are very different. They have very different management issues, very different investment issues, very different sets of responsibilities on the various stakeholders, some of which are well understood and some of which are not. They are very different beasts.
In addition, even within the defined benefit world, the three of us are representing defined benefit plans that are administered by a corporation that is involved in running another business. There are some very large public-sector funds in Ontario that are, solely, in their own right, enormous businesses. So the landscape is very different. It is important to mention that. We are not talking about pension funds as a homogenous set of creatures.
Senator Austin: Are there checks and balances on one another? If so, how is that done within the different categories of your industry that you have just mentioned? I ask that from the point of view of industry standards. Is there comparative governance? No. You have one uniform attitude toward governance.
Mr. Hiscock: As an association, we have come together, recognizing the various differences that the pension plan community has that I have talked about. We have developed this model of appropriate pension plan governance, and to our knowledge it was the first in the world.
We have not scored people against it, nor do we contemplate doing so, but the fact of the matter is that as a topic we have advanced it from not being documented anywhere in the world to where we are now. We are hopeful that in the years to come further progress will be made, but it is us who have taken the first step.
Senator Austin: I grant that. I think it is a very important step and of great assistance. I will tell you where I am coming from, in part. We will be dealing with the amendments to the Canada Pension Plan before too long. I am not sure exactly when, but soon. The Official Opposition in the House of Commons, the Reform Party, has put forward proposals that would create what I think is that U.K. situation. They have put forward proposals to allow self-governing plans rather than staying within the larger plan. Have you reflected on their proposals and have you any view on them, particularly in light of the discussion we just had?
Ms Van Riesen: Can you explain the concept of self-governing plans? I have not heard that term.
Senator Austin: I cannot explain beyond what I have read, which is their view that individuals should be able to opt out of the Canada Pension Plan and create a plan that would be managed for them by a professional.
The Chairman: I can simplify that. The proposal that was put forward by the Reform Party vis-à-vis the CPP was that individual Canadians who are otherwise entitled to the CPP should be allowed to opt out of the CPP and take the money that they would otherwise contribute to the CPP, matched by the employer's portion, and put it into a defined contribution plan -- which was an RRSP in the sense that the money could not be taken out until retirement age.
To pick up on Senator Austin's point, it is essentially the proposal that evolved in the U.K. In light of your comments on the U.K. experience, would you care to comment on that proposal vis-à-vis the CPP?
Ms Van Riesen: I am not sure if PIAC has taken a position on this. I will give ACPM's position on that, as well as an my individual position. For the future, it is easy to see that that could be a possibility and there are some advantages to going that route. That option does not address how one deals with the accrued benefits and how one pays for them?
That has been the fatal flaw in the proposal of moving to a defined contribution Canada Pension Plan. What do you do with the $500 billion, approximately, unfunded liability? There are no easy answers.
My conclusion would be to stick with the Canada Pension Plan and with the recommendations that have been made to improve its governance and its pre-funding and to keep the benefits and the contributions at a reasonable level and to carry on. It is a good program and it meets the needs of many Canadians.
Senator Austin: I have a question for your industry about investment grade standards. A number of your funds will buy the TSE index, for example. The TSE will take on a stock because of its volume, its market cap, and so on, and will bring it into play as an indexed item. You then, under your current standards, are either permitted or required to purchase it, depending on how you operate the plan.
We have talked about the governance of your industry; we have talked about the governance of the corporations in which you invest. Who oversees the performance of the Toronto Stock Exchange in bringing in a unit of a company without doing their own due diligence or governance, simply on a formula basis?
Do you make representations to the TSE to change their analytical standards or objective analytical standards?
Mr. Walcot: I can speak for myself. After a recent occurrence, we made representations to the TSE that we felt they should improve their standards. That was a specific representation made to them. There is a committee made up of professionals from various parts of the industry that reviews these things. We reinforced the importance of reviewing every single issue that goes in there because passive investors are caught in it.
As a result of the Bre-X event, there certainly has been a tightening of the rules and a closer review by our industry of what is being approved and what is not.
Senator Oliver: I would like to return to an issue raised in your introductory remarks -- namely, activism. You said that there is some activism on the part of some large pension funds in the market today but that it is not something that we should regard with concern. You went on to say that in cases where pension funds do become active in relation to a corporation in which it has invested, that that is normally designed to enhance shareholder value in the funds.
I want to challenge that because of the examples we heard about from our witnesses yesterday -- one example was Canadian Tire -- where large funds holding 20 to 25 per cent of a company suddenly decide as a group that they do not like the performance of three of the vice-presidents or they do not like the proposed leveraged take-outs or they do not like the new strategy. They decide to use their muscle <#0107> the ownership in the company -- to tell the company how to run its operations. In other words, the pension fund is second-guessing the management in the company.
You are telling us not to be concerned by this and it is my opinion that we should be concerned. Can you persuade me otherwise?
Mr. Walcot: When we manage the pension fund, our goal is to make adequate returns for the beneficiaries. That is our total goal. We are not interested in taking over companies. We are not interested in building empires. Our total goal, as shareholders, is to improve the return on our shares.
The activities that we were involved in with such companies as Canadian Tire related to inequitable treatment amongst shareholders. We were, as shareholders, defending the interests of our shareholders. We were not interfering in the internal affairs of the company. We acted solely in our role as shareholders taking action to defend what we saw as being within our purview. One group of shareholders was getting a great deal more money than we would have received. We thought that that was inequitable; that there should be more fair sharing between the different classes of shareholders. That is why the group came together.
That is very unusual. The Canadian Tire episode was probably the defining event for the pension industry during my lifetime. It was quite extraordinary that we all came together because of the inequity of the situation. In an organization such as mine, when we talk about activism, that is what we think of -- defending shareholders' rights to get their proper share.
Senator Oliver: I would like to hear from the others but I would also like to know whether there has been any effort on the part of any large pension funds in Canadian history to, in effect, second-guess management of corporations by using their might through their share ownership to influence the company's choice of direction.
Mr. Hiscock: To my knowledge, any activism that has taken place has been for the sole pursuit of increasing shareholder value. That is healthy for all market participants, including the small retail investor and other institutional investors. Everyone gains to the extent that shareholder value is improved.
Senator Oliver: That is provided that you are right and management is wrong.
Mr. Hiscock: No, I was getting to that. Also to my knowledge, when a company finds itself being criticized, if you wish, by an institutional investors, it is not the kind of criticism that I would characterize as a second-guessing of management. They would not suggest something like building a plant in Vancouver or closing a plant in Winnipeg. They would not suggest doing something different operationally. Rather, their criticism would be that the company has lagged behind for the last three or four years and that something must be wrong.
Senator Oliver: Could we hear from the banks?
Ms Van Riesen: I have nothing to add to my colleagues' comments. As I mentioned earlier, we do not engage in activism. I have no anecdotal experience to share. What you have heard fairly represents our association members.
Senator Austin: You were talking about building shareholder value, which is a phrase emblazoned on every door in the industry. I think one of the answers to Senator Oliver's question is in the area of takeover bids, hostile or friendly, where a company can be performing very well and, for that reason, is the result of a takeover bid. You are not at that point, I take it, interested in whether management is good or bad but only whether the price being offered meets your criteria for selling.
Mr. Walcot: When we are looking at an offer, we are trying to decide whether it is better to keep the company we have or to go along with the offer. We have a decision to make there. It is not just a matter of looking at whether we will get a better price from the offer. We have to figure out whether it would be better not to go along with the offer and to continue with the management.
Senator Austin: Better in what terms?
Mr. Walcot: Longer, higher returns to the shareholder. Our whole objective is to ensure that that stock price goes up so that our beneficiaries have higher returns in the future. That is what drives us. In our view, that is what shareholder value is.
Senator Austin: You would not take into account the performance of the fund and what you would need to book against performance to meet your own performance tests. You would look only at the long-term gains for your beneficiaries.
Mr. Hiscock: We would look at which course of action had the higher expected return. In the case of a takeover, your words were "if the company has good management". Hopefully, every company we own has good management, and some of them will be taken over.
Senator Austin: At a certain point of time, good management is not the test. It is the benefit to your stakeholders.
Mr. Hiscock: That is correct.
Senator Tkachuk: My question concerns the defined pension plan. In each of your organizations, what rate of return do you expect to get on the money that you have within the pension fund?
Mr. Walcot: In part of our pension fund governance, we suggest to everyone that they have what is called an investment policy statement. This statement defines what the pension is about and in what they can invest. However, as well, it will define the objectives of that pension fund.
For my pension fund, every year we are supposed to be above what is called the SEI index. SEI is a measurement service that measures 800 pension funds in Canada and determines the rates of return. We have to be higher than average every single year. Over four years, we have to be in the first 25 per cent. It is not an absolute rate of return; rather, it tell us that we are better than the industry, that we are competitively managed so that we are giving superior returns to the pension fund.
You will often see people comparing it to the CPI, ensuring that you do better than inflation. Occasionally, you will see, perhaps, 1 per cent, 2 per cent or 3 per cent above CPI, depending on the aggressiveness of the fund.
Senator Tkachuk: What would be your 10-year average?
Mr. Walcot: I believe we are at 15 or 18, off the top of my head.
Mr. Hiscock: A 10-year average would not be something we would consider. However, I do not think that that relates to the question you are asking.
Senator Tkachuk: No, it does not; but I am not getting an answer to my question. I am trying to find a way to get an answer.
Mr. Hiscock: Generally, pension funds do not formulate a business plan which comprises a nominal number respecting the expected return on the assets. They would look at doing well compared to all their competitors which, in effect, is tied to how well the markets are doing and what the various asset mixes are within those various markets; or a pension fund would set a target of exceeding a policy guideline mix which may, for sake of discussion, be 40 per cent of the TSE, 20 per cent of the S&P 500, 30 percent of the Scotia McLeod mid-index on bonds, and 10 per cent of cash. That would be sort of the yardstick that would reflect all the markets. A goal might be to exceed something of that sort.
Once again, the standard by which you are being compared is what the various markets are producing and what your asset mix is with regard to those markets, not a nominal number like, "We expect to return "x" per cent next year."
Ms Van Riesen: You are getting three different answers, senator, because you are dealing with an area that is unique to the pension fund and its philosophy, which is encompassed in the statement of investment policies and goals.
We happen to define two standards in our policy. One is a real rate of return expectation. At a minimum to meet our liability obligations over the long term, we have established a 3-per-cent real rate of return as necessary. That has been pretty simple to meet.
We also have another standard, a benchmark, against which we measure our managers. The benchmark is an index, a composite index; the active managers have to beat it by a certain percentage. That is not atypical of what sponsors tend to try to strive for today.
You are looking at both. One is to ensure that your liabilities can be met by a long-term real rate of return goal. The other is to ensure that you are monitoring your managers in an active way to ensure that they are getting the best in the competitive marketplace in which they are operating.
Does that answer your question?
Senator Tkachuk: No, but that is fine.
Senator Callbeck: In your opinion, should the guidelines and the rules be the same for all types of pension plans, whether they are public, private, defined benefit or defined contribution?
Mr. Walcot: Are you talking about the pension fund governance, the structure that we have here?
Senator Callbeck: Yes. Should the guidelines or the rules be the same for all types of pensions?
Mr. Walcot: I worked on putting this document together. This structure asks the following questions: What is your objective? What is your promise? Who are your trustees? Who would control it? What is the separation between the management and the trustee? Ensure you monitor it carefully and that the whole system is reviewed constantly. These measures should be applicable to every system. We have tried to make them applicable to as wide a variety of investment institutions as possible.
The Chairman: Given everything that all three of you have said about the significant differences between defined benefit and defined contribution, I have difficulty with a conclusion which says that they are as completely different as you tell us they are. You also tell us that the risk to the individual plan members is much greater. Obviously, under a defined contribution plan, what they get out is as a result of the performance. In a defined benefit plan, the real risk is not borne by the individual pension plan member but by the plan sponsor, typically the employer in the case of the three of you.
It seems to me almost an inevitable conclusion from the analysis you gave us that, clearly, the guidelines that ought to apply to a defined contribution plan should in some sense be tighter, more stringent and more in the interests of the individual plan member who, after all, is bearing the risk, as opposed to a defined benefit plan. I do not dispute that you say that these are general principles. We have already told you that we like the guideline; we like the plan. Surely, as public policy makers, we ought to be much more concerned with ensuring that you do not get the problems that exist in the U.K., for example, by ensuring that there are far more stringent rules governing defined contribution plans. My instinct is that that probably includes RRSPs invested in mutual funds. However, I would like to hear your comments on that.
If that is not right, then why would you give us this long description of the radical differences between the two if the governance process is the same? I am not trying to be argumentative. I am trying to summarize what I heard you say.
Mr. Walcot: We tried to have basic principles for all investment institutions. There is a rainbow of institutions, from less risky to more risky. I think you would adapt each of these structures as being either risky or less risky. But that does not mean that, as a basic principle, there should be a separation between trustees and management.
The Chairman: I am not disputing that at all. Do you not need to tighten these up for defined contribution plans? If that assumption is correct -- and, if it is not, I am happy to debate it with you -- tell me what it is.
Ms Van Riesen: The short answer is "yes."
Mr. Hiscock: I would agree with everything you said. It is one of those situations where part of the answer to the question is really that the devil is in the details. As soon as you get below the general notions that you need appropriate governance and what that might mean, the details will be different for each and every one of the very different examples.
To the extent that fund governance is an issue, it seems that it is a bigger issue in defined contribution plans because of the potential ultimate consequences on the pension that is paid out.
The Chairman: We need you to tell us -- and this is the big advantage of hearing you now -- what the new guidelines or the tighter guidelines or the changed process should be vis-à-vis defined contribution plans where the individual plan member is bearing the risk versus the case where the employer is bearing the risk. Frankly, we need your help on that. I hope that you can give us that, either individually or as an association.
Mr. Hiscock: Yes.
The Chairman: Finally, should those guidelines also apply to RRSPs invested in mutual funds? In this case, it is sort of a defined contribution plan, except it is individually managed. Is there any difference between RRSPs invested in mutual funds and a formal defined contribution pension plan?
Mr. Walcot: When you get to the bottom line, I do not see a real difference. It is a little hard for an individual person to separate the trustee and the management side of it, but the principles of RRSPs and the defined contribution are very close.
Mr. Hiscock: I do not know the answer to this, but I am sure you can find this out from your research people: It would be interesting to know, of the total RRSPs out there, how much of that money represents the only source of retirement income versus how much represents a supplement to another existing source of retirement income. I think that would be pertinent information for answering that question.
The Chairman: You are saying that if it is merely an incremental top-up, you would not be as concerned. Could we reduce your work from "only" to "a significant portion"?
Mr. Hiscock: I offer that as a suggestion, namely, that your committee might have someone do some research on that. For some people, RRSPs are the only pension they will have; for others, it is money that is legitimate RRSPs, but they are also getting a defined benefit plan somewhere.
The Chairman: I would think that for all self-employed professionals, such as lawyers, doctors, accountants, and so on, it would be their only source of income.
Would you agree with your two colleagues who answered "yes" to my question: Should the same rules apply to RRSPs invested in mutual funds as would apply to defined contribution plans in terms of the governance of them?
Mr. Hiscock: I would agree with the thrust of your question, but I would want to see the specific instances of what you are suggesting before I would say "yes" or "no."
In the defined contribution world, there is some reliance often on behalf of the employee for some guidance or direction that the employer might be making. In the case of a single lawyer who is fully aware that he is solely responsible for the investment return of that RRSP, that may lead to a different environment. However, I agree with the spirit of what you are getting at.
The Chairman: Since the devil is in the details and you have agreed to help us with the details, that is great.
Senator Meighen: The reason we are having this very enlightening discussion today is that some time ago this committee, during the course of its examination of amendments to the Canada Corporations Act, came across the opinion of a number of people who suggested that the influence of institutional investors was growing rapidly. It was not inferred necessarily that that was an unfortunate trend, but it was a trend, nonetheless.
The former chairman of the Ontario Securities Commission said that institutional investor activity should become more transparent. You have brought to our attention a number of things that your association is doing to try to improve good governance. We have discussed to some extent what pension funds do or do not do with respect to investee companies. Some choose to sell their shares and steal away in the night; others have perhaps too big a holding and cannot do that and exercise perhaps some beneficial influence by going to see management.
Do you think that the transparency that Mr. Waitzer is referring to is increasing? Do you think that it needs legislative encouragement to increase? Do you think that it is at the level that it should be? Do you think that the pensioners and the people who will become the pension recipients should or could have more involvement in the operation -- that is, the running and the governance of the pension fund?
There may not be a problem here, but the size of pension funds and institutional investors in general has grown steadily. There is not that much free float on the stock exchanges in Canada. For example, in Ontario, 3.6 per cent of the Toronto Stock Exchange free float is already held by the teachers' fund. Are we moving towards a situation where Senator Angus's concern about the small investor is becoming more acute?
That is a rambling question, but it is one of the reasons why we are here tonight.
Ms Van Riesen: I want to be clear on the question. Is it about the transparency of pension plan governance?
Senator Meighen: It concerns pension plan activities.
Mr. Walcot: What do you mean by "activities"? Is it buying and selling shares? I had real trouble understanding what was meant by "influence" and "transparency".
Senator Meighen: Should I, as a member of the public or as a contributor to the pension plan, know when you go to an investee company and say, "We are not happy with your management. You better smarten up or we will proceed as some institutional investors did, for example, with the Moore Corporation recently?" As a member of the public or as a member of your plan, should I know that?
Mr. Hiscock: Are you asking the question: Should you approve it? It is in the paper the day it happens.
The Chairman: Let me clarify the question precisely.
Mr. Hiscock, in your response to Senator Austin you gave the following illustrative example. You said, "You do not go and say to a company that you should open a plant in Vancouver." You do go to a company and say, "On the basis of looking at your performance and the performance of the following three companies which we regard as companies whose performance you ought to be comparable with, we are unhappy with your performance. Therefore, we think you should do something to correct it." That is what you said you did.
I believe Senator Meighen's question was: Given your knowledge base and the resources you have to track companies, should individual investors in the company whose management you have just gone to have a talk with know that you have done that? That was the issue that came up in the course of our corporate governance hearings.
One could make an argument that not knowing that puts the individual shareholder not only at a disadvantage of not having all the research resources, and so on -- which they could never match because you are in the business -- but also it puts them at a further disadvantage of not knowing management's response to your question.
Mr. Hiscock: The example I used was drawn to address the issue that the honourable senator asked as to whether institutional investors second-guess management or take the role that they are better at running a certain industry than people who have been in that industry for 20 years. To my knowledge, that kind of activism does not take place. That was the purpose of that example.
In terms of an individual investor, it seems to me that if institutional investors are acting with a view to increasing shareholder value and are successful -- and presumably they will be in a large number of the cases -- then the individual investor that happens to own those shares will be advantaged, so it is an economic, free-rider situation. It is positive for the markets.
The Chairman: That is absolutely right if your action results in an improvement in the stock performance. Let us suppose you have the lunch or the meeting and that the conclusion of it is that the management does not follow your suggestions, and therefore your decision is to sell because you are not getting the response you want. Now there is no free rider going up, but there may be a free rider coming down. At that point, it seems to me that the individual investor could conceivably be portrayed as being somewhat at a disadvantage to the position that you would be in. Is that correct?
Mr. Hiscock: To return to an earlier response, most funds prefer -- and I think the three of us would be in that camp -- that, if there were a problem, we would be sellers rather than sitting down and having the lunch, as you put it, with someone. By the time shareholder activism becomes quite pronounced in a process, I think the exit route is not there.
Shareholder activism is, once again, motivated with a view to increasing shareholder value, and everyone is a beneficiary of that.
Senator Meighen: Why would you be a seller? Given the general limit of liquidity in Canadian markets, if you sell many shares, you drive the price down and you lose money. What is wrong with having a lunch and saying, "We are not happy, and we own 3 per cent of your stock"?
Mr. Hiscock: It is the 3- or 5-per-cent blocks that might find themselves in a position where they conclude they should not be sellers. To return to a remark we made previously, it is not appropriate to generalize. The pension management industry operates the same way as a small handful of massive pools of capital. Most of them are smaller than that, and most of those people would probably be sellers in a situation like that.
Senator Meighen: Did I hear you correctly that most pensions funds would not own a significant percentage of their investee companies?
Mr. Hiscock: Most pension funds are of a size where the percentage of market capitalization of any company that they hold will not be anywhere near the kinds of numbers that you have outlined. Only the massive funds would prudently end up in a position that large.
The Chairman: Your statement is mathematically correct, but it reminds me of the individual who drowned while swimming across a river with an average depth of three feet. Average is misleading, because there is a large number of small funds. I am sure your statement about the average is correct.
What would you say about the top 25 or the top 50 members of your association for whom 2, 3, 4 or 5 per cent shareholdings are not uncommon? How would you respond to Senator Meighen's question looking only at the top group, at the big player?
Mr. Hiscock: Those funds would typically have a dialogue with management, with a view to generating initiatives to enhance shareholder value. All participants in the market would therefore benefit from that activity.
The Chairman: We are trying to pursue the point because it is a critical issue to us. We are not disputing that the objective is to increase shareholder value; and we are not disputing that if, in fact, it does increase shareholder value, the free rider rule works. That is terrific. The question is: Should other people know that that is what you did? It seems to me the individual investor should. He is more risk averse than you are. The small shareholding is insignificant from the investing company's point of view, but it could easily be very significant to the individual. Under those circumstances, the mere fact that you had that meeting could easily be a piece of information that would be influential in the investment decisions of the individual investor. Therefore, the question that Senator Meighen keeps trying to get back to is whether individual investors should know that you had those meetings.
Mr. Walcot: Perhaps I am a bit of an iconoclast here, but I am a buyer and a seller. I am not an activist, and I have never been an activist. I prefer just to sell or buy the shares. I am looking for as much information as possible, so transparency and information in the market will be advantageous to me. That is my personal view. I want to hear everything that is happening so I can make an informed judgment.
Senator Meighen: Fair enough. However, is it not also fair to say that you are in a better position to get information than I? I can only access an ordinary analyst's opinion in the press.
Mr. Walcot: I may have sophisticated people who can analyse that information more subtly than you, but I do not believe that I should get any information that you cannot get.
Senator Oliver: But you do.
Mr. Walcot: We cannot get inside information. That is against the law. We are not allowed to have inside information. We are only allowed to have public information. I believe strongly that it is our ability to analyse that information, not inside information, where we make our money.
Mr. Hiscock: Companies visit daily, with all the large pension funds, unbeknownst to one another. We do not know whether one company is visiting one of these funds and not us, and vice versa. Companies are visiting with money management people in mutual funds where the overwhelming majority of that individual retail interest is, and they are visiting on a day-to-day basis. It should not be characterized that there might be one isolated meeting and a paucity of information other than that one meeting, because that is not the way it happens.
Senator Meighen: If we do not get rid of the 20-per-cent rule, and if the Canada Pension Plan comes through as legislation as presently drafted, there will be a huge pool of money added to the private pension fund, the non-government pension fund pool, which I am afraid will make the Canadian securities market even less liquid so that there will be a greater number of these concentrations of ownership.
I am not being aggressive or critical in any way, but we heard that teachers hold an ownership in excess of 10 per cent of shares outstanding in eight companies and more than 5 per cent in over 40 companies. That is great, but that is quite a concentration, and that is motivating our interest.
Mr. Walcot: Ms Van Riesen and I were talking about the top 50. There is a small group of mega-funds, and then there is us. The differentiation between our strategies is important.I know I buy and sell, and I can do it within the market. It will be harder with the CPP and with eliminating the 20 per cent.
Senator Meighen: Significantly harder, in your view?
Senator Oliver: You can use derivatives of those.
Mr. Walcot: As a policy, we will not break the spirit of the law, which is that we should not go above 20 per cent. We have self-established 20 per cent, so we will not use the derivatives. That is something whereby we are hurting ourselves.
It is not impossible, because the money will be flowing in steadily from the CPP. It is not like $100 billion going in tomorrow. It is a cash-flow operation rather than a lump-sum operation. However, it is generally believed that our market is more expensive because of the 20-per-cent property rule.
If we had more money going in, I would have to presume that this should continue, that the prices that we have to pay are higher because there is more money competing.
I do want to stress that it is not one lump sum coming into the CPP.
Senator Tkachuk: There will be $100 billion by the year 2006; that is pretty quick.
Mr. Hiscock: I think most people would agree that the CPP is going to be a major issue for capital markets and that it has a potential hot-house effect. There is certainly some question as to how quickly that will happen and what the consequences of the hot-house effect might be, but, yes, there is additional pressure coming on the system.
I do not know the answer to this, but when you speak about the teachers' fund having large positions in many companies, the biggest funds typically have a good portion of their assets in an index fund. If they are very large, that would automatically mean a non-trivial percentage holding in every single stock which is going to be there regardless of where the stock goes because it is an index. It is indexed money. I do not know how significant that is, but I think that must be thought about in conjunction with the kinds of numbers you are talking about. Some portion will be passive, but I do not know what it would be.
Senator Meighen: Would you agree that good governance in most cases equals good performance? In other words, the better the governance of a fund, the better the performance?
Mr. Walcot: I would strongly agree, having managed three funds; yes. A clear understanding of the different relationships, what each person is supposed to do, really helps in the goals, very much so.
Senator Meighen: Keith Ambachtsheer, whom we referred to earlier tonight, has some empirical evidence coming out to that effect, and it seems to make sense.
Does your association investigate the cost of running pension funds, or publish any statistics or any comparative data on that?
Mr. Hiscock: No. As an association, we have contemplated whether we should collect such data from our members, but Keith Ambachtsheer is already in the business of doing that.
Ms Van Riesen: To subscribers.
Mr. Hiscock: There is a service available and we concluded, as an organization that does not have a great deal of paid help, shall we say, that there is no need for us to reinvent the wheel.
Senator Meighen: As a final question, do you have any information on the performance record of the funds in your association vis-à-vis other funds, at home and abroad?
Mr. Walcot: We do not publish any comparisons.
Ms Van Riesen: Are you looking for information in Canada or internationally?
Senator Meighen: Either.
Mr. Hiscock: Once again the answer would be in a similar vein. There are a number of commercial, comparative performance measurement services out there, and we have decided that we should not reinvent the wheel in that regard. In terms of comparing pension fund return performance in Canada versus the rest of the world, it would be apples and oranges if, indeed, it did exist.
Senator Meighen: Because of the 20-per-cent rule?
Mr. Hiscock: No. That is an issue for us, but every country has a different set of capital markets and a different set of return expectations. The liabilities of pension funds are denominated in a home country currency. As I said when I talked about the 20-per-cent rule, no pension fund would go totally out of a country because the liability structure is denominated in a domestic currency. To compare us to the Americans or to the British on a pure return basis would not tell you anything, so it is not done.
Senator Meighen: If I am a member, a contributor or a pensioner, what is the best way for me to determine whether my fund is doing well or poorly? Does it depend on whether it is a defined contribution fund or not?
Mr. Walcot: Certainly, there is a difference. I worked for an organization that sold defined contribution, and returns were published in relation to the market so that the holders of the defined contribution instrument would know whether they were doing well or not. This was done on a monthly basis. That was part of my job.
With defined benefit plans, you are just interested in getting your pension, so often the emphasis is more on the plan side of it, what the benefits are, rather than on the investment side.
Ms Van Riesen: I would add that employers in Canada are increasingly going the route of providing annual reports on their pension funds which do include performance data as well as liability data. Interest in that is increasing both because our plan beneficiaries are asking for it and because we think it is good disclosure.
Mr. Walcot: As I said, in Quebec we have to have meetings every year with our members to disclose that information to them.
Senator Meighen: Have the troops ever risen up in anger, to your knowledge?
Ms Van Riesen: Which troops?
Senator Meighen: The beneficiaries. Have they said, "This performance is not acceptable"? If so, how do they do it?
Ms Van Riesen: I would say that generally all pension funds get a certain number of letters, frankly more from the retiree population than from our active population; but indeed we do get letters raising concerns, some based on valid information, others just because of misinformation. That is one of the reasons we have chosen to go the route of providing an annual report. We will be sending one out this year. It is to help close that gap between mere knowledge and what is really important and meaningful.
Senator Meighen: Do you have an annual meeting the way corporations do?
Ms Van Riesen: No.
Mr. Hiscock: A practical response to your question is that in the defined benefit world, which the three of us represent, the investment risk lies with the plan sponsor, and to the extent that investment performance is inadequate, the plan sponsor must fund the difference. The pressure for performance is first most likely to come from the corporation or the plan sponsor before it is likely to come from a member of a defined benefit plan. That is the practical answer to your question.
Senator Meighen: As a matter of interest, what is the answer to my question as to whether you have an annual get-together or meeting, call it what you will?
Ms Van Riesen: We do not.
Mr. Hiscock: We do.
Ms Van Riesen: We are a retail organization. We would have to have 5,000 of them.
Mr. Hiscock: We have an annual meeting with a pension board where representatives of pensioners from across the country attend. There are approximately 50,000 pensioners; they do not all attend. However, we do have meetings and we have communications with every individual.
Mr. Walcot: I would mention that we did go through that process of having meetings with members, but it was incredibly disappointing because of the small number of people who did turn out. Rooms would be set up for 100 people and maybe five people turned out. As was said, the risk is with the sponsor.
Senator Angus: Your attendance would go up if the results were not as good.
The Chairman: We in government have certainly found that attendance at meetings increases as performance goes down.
I have one last question. If I were running a fund with the amount of money invested that you people have, I do not know why I would be passive. If meeting with individual companies in which you have substantial shareholdings can lead to the increased shareholder value that Mr. Hiscock mentioned, what is the rationale for just being what Mr. Walcot calls a buyer and a seller? Why do you not attempt to use your leverage? What is the rationale for being passive?
Mr. Walcot: I should define "passive." I am called an active investor, in that I buy and sell.
The Chairman: I used the word "passive."
Mr. Walcot: But I am not like an index fund. I go in and buy and sell. I do not presume I know how to manage a company. I have always felt strongly that I am not going to go in and try to tell management what to do. What I am doing is buying and selling shares within the market. My skill is in interpreting events about the company in light of events in the market. I am a value investor. As a value investor, I try to buy cheap. Therefore, it is not so much the company as the relationship of the company to the market that I look at. That is why I tend to look at it as purely instruments that I buy and sell. It is a traditional approach and I can still do it because I am small enough.
The Chairman: Those last four words were very interesting. If you were managing pension plan X, one of the biggest in the country, would your philosophy be different?
Mr. Walcot: I would say yes. I believe there is a liquidity level where you cannot simply buy and sell. It has not affected us. We are a $5 billion fund. We are considered one of the largest active pension funds in Canada, and I can still move around very slowly. It is difficult, but I can do it. If I were substantially bigger, I would be forced into a different strategy.
The Chairman: Obviously $50 billion is substantially more, but if you were double the size, would that be substantial in your view.
Mr. Walcot: If we were up around $10 billion in equities, I would find it tough because we are really finding it tough at $5 billion. We do have to think about what we are doing.
Ms Van Riesen: We are a $2-billion pension fund, and we have chosen to rely on the advice of our managers. We have not developed, within the pension fund governance, the capability to advise or decide when management is or is not doing the right things that we would support. We look to our investment managers for that. We rely on their expertise and their decisions, which predominantly are to sell rather than vote against management directly. That is generally how our managers tend to do it, although they have total discretion over that. We have chosen not to intercede in that. Right or wrong, that is our decision.
Senator Austin: Given your last comment, we are looking at legislation that would create a fund management entity which, within a few years, would exceed $100 billion. You would have trouble with $10 billion. I wonder if you could comment on the problems that managing $100 billion-plus would raise.
Mr. Walcot: It would be substantially different. It would be different in the way you trade, your liquidity and your ability to buy and sell. That would change your time horizon, for one thing. If you cannot buy or sell, you must say you are in the stock for 5 or 10 years rather than for 18 months. Therefore, you would have an entirely different way of looking at securities.
One thing people do is split up the management. Either you do it passively and size does not matter, or they do have a number of smaller managers. They are competing with each other in the marketplace.
Senator Austin: You diversify the management plan and break it into compartments with different management structures.
Mr. Walcot: Actually, we have a manager who has nine different portfolio managers and does above-average performance. It can work quite successfully.
Senator Austin: Who in Canada is that large, in the $100 billion range?
Mr. Walcot: No one at this time.
Ms Van Riesen: The Canada Pension Plan.
Senator Austin: We are speaking about a different investment strategy for the Canada Pension Plan.
Senator Meighen: The new one will have a huge equity.
The Chairman: On behalf of all of us, we thank you very much for being here tonight. You have been most helpful. I hope you did not find the questions too aggressive. They were meant to be argumentative; they were meant to understand the issues.
Senators our final witness tonight is Mr. Tom Hockin, the President of the Investment Funds Institute of Canada, which is the association of mutual fund dealers. You all know Mr. Hockin from previous incarnations.
Mr. Thomas Hockin, President and Chief Executive Officer, Investment Funds Institute: Honourable senators, my presentation is on corporate governance, but in a roundabout way. We are not prepared to answer all those corporate governance questions today as an institute because we are doing our own survey. However, we will be able to pull together some constituent answers to these questions. We can give you some anecdotal responses to some of them if you would like.
We were planning to focus on corporate governance policies of institutional investors by highlighting one issue that feeds dilemmas of fund corporate governance and significantly affects the investment policies of institutional investors. You have already talked about that tonight, that is, the foreign property rule.
It was noted in the committee's 1996 report on corporate governance that the foreign property rule is a part of this problem. We appreciated the wisdom of this committee when it issued its report expressing the view that over the long run the foreign property rule should be phased out. However, it also suggested that policy makers first study the implications of phasing it out and the implications on Canadian capital markets. This committee was right to ask that question, and I know the Minister of Finance is asking that question. We thought it would be prudent to do some research on that question as well. That is the major reason we are here tonight.
We have commissioned the Conference Board of Canada to investigate the impact of an increase in the foreign property rule and what that would do to capital markets. Your committee has expressed a concern about that. The Minister of Finance has expressed a concern. This is the research that we have commissioned from the Conference Board of Canada. We expect to receive this study in its entirety in about two weeks. If you would like, Mr. Chairman, we will table it here. We will not take it anywhere else because you have shown an interest in this right from the beginning
The Chairman: That would be helpful.
Mr. Hockin: The preliminary results from the Conference Board suggest that an increase in the foreign property rule from the current 20 per cent to 30 per cent would have a neutral impact on capital markets. If certain other factors that you have heard about yesterday as well as today were factored in, it might even be positive rather than neutral.
The Chairman: Perhaps you could define the words "neutral" and "positive" because they could have a degree of subjectivity or interpretation.
Mr. Hockin: Allow me to expand on the core of their reasoning, which will be enhanced when you get the report. From a theoretical point of view, there are very few grounds to expect that the simple removal of this rule would have a substantial impact on the real cost of capital in Canada beyond any very short-term transitional effects. The reason for this is that Canada does not maintain any other significant international capital controls and the portfolio funds in our economy that are subjected to the foreign property rule are a relatively small percentage of the overall liquid investments in this country. It is very illuminating to us to see the numbers, and the Conference Board will bring them forward.
Therefore, if Canadians or foreigners can obtain a higher real rate of return by investing outside of Canada, they will do so with funds that are not subject to the foreign property rule. The real rate of return on investments, and therefore the cost of capital in Canada, cannot, therefore, go much below the global rate of return on a fully risk-adjusted basis. If the foreign property rule covered a large percentage of these investable funds of Canadians, this might, in fact, affect the cost of capital and the rate of savings. However, in fact this is not the case. What they will point out is that the foreign property rule only affects 24 per cent of investable funds in our economy at present, so the cost of capital is driven by the other 76 per cent.
The Conference Board will be exploring that in its report, which will be tabled here, hopefully in two weeks, with all its details. I should be very pleased to come back then or later, at your convenience, to develop further the study and to bring the people from the Conference Board as well.
We commissioned Ernst & Young to carry out another study on the foreign property rule, to which I will turn later in my presentation. This study looked at the impact of this rule on investor returns; how we are being hurt as investors. This study demonstrates that an increase in the foreign property rule would provide investors with the opportunity to diversify their investments and earn higher returns. That report was submitted to the House of Commons committee on finance two weeks ago.
We do not intend to just pound the table and ask for something. We want to work with you and the government in carrying out the necessary research of the sticking points that have kept that rule where it is. That is why we are looking at cost of capital and at how investors have been hurt. The effect on small business will be another study which we will bring to the industry committee.
I wish to explain why IFIC believes that an increase in the foreign policy rule sooner rather than later makes good policy sense. At the heart of the hearings the committee is now holding is the impact of all of this on corporate governance. I know that that is your concern.
To put this issue into perspective, it is illuminating to consider how big the mutual fund industry has become. I was listening to the size of these pension funds a few minutes ago. The largest mutual fund company in Canada now holds $33 billion and the second largest holds $31 billion. These are large entities.
In 1982, members of IFIC managed assets of $4 billion and I think that when I was minister of state for finance it was $6 billion. It is now $279 billion. In fact, assets under management went up 50 per cent in the last 12 months alone. This is the effect of new money plus the market, which had good performance last year. Seven million Canadian households hold at least one mutual fund.
What is relevant to corporate governance is that a great deal of these funds is being invested by or on behalf of Canadians for retirement. When you consider the magnitude of these flows, and the fact that 80 per cent of them must be invested in Canada owing to the rule, you can clearly see the impact this has on corporate governance, about which you heard earlier. You can see that institutional investors often have no choice but to take larger positions in individual companies than they would otherwise. That is the link between the foreign property rule and corporate governance. The foreign property rule forces individual Canadian equity mutual funds to become bigger players in a smaller market than they would prefer.
The implication of this is that it is making institutional investors powerful. It is also reducing liquidity in the market, as Senator Meighen said earlier, because it is difficult to sell larger blocks of shares. Given the increasing rate at which investment funds are growing, I think this committee's analysis of the impact of institutional investors and corporate governance is very timely.
I submit that the removal of the rule would mitigate some of the concerns associated with institutional investors being major shareholders in Canadian companies. Lessening the influence of institutional investors on Canadian companies and improved market liquidity would be two of the benefits of increasing the foreign property rule.
A major benefit, and I think probably of more interest to senators generally, is that the foreign property increase would greatly help Canadian investors. It would give Canadians greater opportunity to achieve a financially secure environment, as you all know.
In particular, an increase in the foreign property rule would go a long way to ensure that the retirement nest eggs of Canadians are not too concentrated in one basket. It would enable investors to take advantage of growth industries in other countries, as well as industries that may not even exist in Canada. You cannot buy Disney through Canada. You cannot buy the microchip business in a major way through Canada. You cannot buy the health care business in a major way through Canada. These are all industries that exist elsewhere, but they should probably be a part of your retirement program.
Increasing diversification increases the safety of a portfolio and lowers risks. Prudent investors do not put all their money in one stock or in companies all in one city. On a world scale, however, that is what the foreign property rule amounts to.
The Canadian equities market accounts for 2.4 per cent of global stock market capitalization, yet 84 per cent of Canadians' registered investments must be registered there.
I was told the other day that the TSE index reflects 30 industrial categories, whereas the U.S. market now represents 90 different industrial categories. There are 60 industrial categories that you cannot even buy through the TSE, even if you buy the index. The recent turbulence in the stock market has shown further the importance of diversification.
All Canadians will be able to benefit from the higher return and diversification opportunities that would come from following your recommendation of increasing the foreign property rule. I want to make a point which is not widely understood in this country: Of the 5.2 million Canadians who contributed to RRSPs, which was the total in 1995, half earned less than $40,000 a year. It is not only wealthy Canadians who hold got RRSPs; it is average- and low-income Canadians. These are the people who are being hurt by this lack of diversification.
It is interesting to note that a recent Royal Trust-Environics research group survey found that a majority of those surveyed, 51 per cent, said they intend to make an RRSP contribution this year. This is up from 34 per cent last year.
Another indication of the importance of RRSPs is that, although employment income has grown by only 7 per cent between 1991 and 1996, RRSP contributions have risen by 68 per cent in the same period. There is a huge shift of money in this economy of ours.
Having a financially secure retirement is clearly on the minds of all Canadians, not just wealthy Canadians. The higher foreign property rule will help them to realize a more diversified and safer goal for their retirement.
Another good reason for increasing the rule, and you touched on this with previous witnesses, is to reduce market inefficiencies. This rule has prompted Canadians to use derivative products. Derivatives must be rolled over at considerable cost over the long term; it would be much more efficient to give investors the choice to invest in markets directly. Also derivatives are not cheap. They cost money and that decreases the returns if you go the derivative route.
Jonathan Wellum can speak to this better than I can, but most derivatives are built on indexes. An index, to some degree, denies the notion of what portfolio management should be all about. Why have a portfolio manager if you are just going to buy an index?
Most industrial countries do not have such a rule. The United States, the United Kingdom, Australia, Ireland, the Netherlands have no limit. In Japan and Switzerland, the level is 30 per cent. This is all documented in this Ernst & Young study.
Our prediction follows the British pattern as you have just heard from the previous witnesses. It would probably level out at about 30 per cent. You have foreign currency reasons not to put all your money in the pension business outside of Canada. In Britain, when they removed the rule, the investments stopped at around 32 per cent. British portfolio managers know Britain well and they invest largely in Britain. That would probably happen here. When we see the expertise in this country for Canadian equities and bonds, we would probably echo the British conclusion.
It is an important step for corporate governance and for the issues you are examining to raise this rule. We appreciate this committee's attention to this issue. We appreciate the opportunity to make a presentation tonight. We want to work with the government and the Senate through research to remove these sticking points which are preventing the rule from being raised.
Senator Kelleher: Welcome to the kindest, most gentle committee on the hill. You are preaching to the converted when you mention the 20-per-cent rule. This committee has gone on record twice to say that it should be increased.
You mentioned in your opening statement that you want to focus less on corporate governance policies of institutional investors and more on other issues.
I am not of that mind. I want to focus more on the corporate governance aspect. That really is why we have you here. When we were doing our corporate governance study over this past year, it seemed that the mutual fund industry in particular did not have the greatest record in the world. There were certain concerns about some of your practices and some of the fee structures. You know about this.
More recently, I have observed in the financial pages of many newspapers a rather public discussion between yourselves, for example, and the Ontario Securities Commission as to who should be governing you. Of course, it did not surprise me to read that you feel self-regulation is better; that you are trying to create standards. I had the impression that you were not very happy about the Ontario Securities Commission stepping in and laying down some rules and regulations.
In light of the rather public complaints we have heard over the past year and the public squabbles that are going on with the Securities Commission, could you justify to us why you feel you should be a self-regulating body rather than being under some governmental level of regulation, be it provincial or federal?
I do not want to be difficult, but we are trying to decide what to do with your industry in particular. You have just told us what a great generator of funds you are and about the moneys you have under your management and control now.
Mr. Hockin: I thank Senator Kelleher for his question. It may surprise you to know that not everything you read in the papers is accurate.
Before I answer your question, mutual funds, unlike banks and insurance, can disappear tomorrow if there is no investor confidence. There will always be banks. They may be small banks or bad banks but there will always be a need for deposit-taking institutions and cheque-writing. There will always be insurance, whether the companies are good or bad. They will always be around.
The mutual fund industry has no natural franchise. If it does not perform, if the integrity is not there, it will disappear instantly. This is a big difference.
The Chairman: I would like to force you to answer the question. I do not mind the sales pitch.
Mr. Hockin: It is a preface to answering the question.
The Chairman: I agree with what you have said. I do not know that it has any relevance to the question. We have a relatively limited amount of time. You heard the discussion earlier about defined contribution plans and you heard the previous witnesses say that the guidelines for defined contribution plans ought to apply to RRSPs and mutual funds with RRSPs. I suspect that is where Senator Kelleher was heading. I do not mind a little deviation from the question, but whether banks will continue to exist is an irrelevant response to the point and it is important that we address the real issue.
Mr. Hockin: Mr. Chairman, it is relevant. Mutual funds only exist if there is belief in the integrity and effectiveness of the product. That is why we believe, together with the IDA, that we could have a self-regulating body. We will conclude our negotiations with the IDA tomorrow at five o'clock.
The OSC was told four months ago that we were quite willing to do it with the IDA. They have known that. I do not quite know why the media thinks we do not want to be regulated. We have been regulated by the OSC. They have not done much regulating of this industry; they have spent their time on other things. There has, therefore, been a regulatory gap not because of the industry but because the regulator does not have the resources or inclination to do much regulation.
In the interim, we have produced codes for managers, codes of sales practice for distributors, codes for advertising, and so on. That experience has led us to think that we could work with the IDA to be a self-regulator. Self-regulation can be removed tomorrow by the regulator. You are given the self-regulation on sufferance only. If you are doing it well, with IDA or IFIC, you can continue. If you are not doing it well, the regulator will take it back, as the Province of Ontario or the Province of Quebec, and do it themselves.
That is our position. We would be happy to have the regulator regulate us if they want to regulate us. They do not have the resources to do it. We will, therefore, do it together with the IDA with oversight to ensure that we do it properly.
Senator Angus: On the issue of governance, I, too, read these reports. I grant you that you should not believe everything you have read in the newspapers. How are these mutual funds governed? I wrote to a couple of individuals who I know run mutual funds to see if they should like to attend here and give testimony as a witnesses. The reply I received was to the effect of, "Senator, just leave us alone. We are not interested in this thing." I do not mean to put it in that pejorative of a context. However, these were little funds that invest widely in foreign securities and do not rely for their existence on RRSP registration, et cetera.
If one were to take a typical member of your organization, how are they governed and to whom are they accountable?
Mr. Hockin: First, they are accountable under the securities legislation of this country, which is voluminous when it comes to mutual funds. There are essentially codes which could serve as an example to any country as to how to govern mutual funds. They are supplemented by some voluntary codes which we have put in place.
The Securities Commission oversees that and may or may not be very attentive at doing it. Frankly, it has not had many resources to be attentive. Therefore, in order to keep the integrity and confidence in the product we are constantly bringing forward voluntary codes for everything from sales practices, to front running, to portfolio management -- all of those things.
The big problem with corporate governance of a mutual fund is that most are trusts. This means that they are responsible to their unitholders. All the holdings of a mutual fund are sent to a custodian who holds them on behalf of the unitholders. The managers of that mutual fund are the servants of the unitholders.
When Confederation Life went down, along with all its attendant companies, Confederation mutual funds were safe and sound because the investment in those mutual funds was held for them by a custodian, by a trustee on behalf of the unitholders. They are very different. Who governs them? The unitholders, who now get annual reports, semi-annual reports and often quarterly reports, which are very transparent. They are far more transparent, frankly, than the reports you would get from the pension world or the insurance world. There is no financial product more transparent than this.
Senator Angus: These questions are not designed to be anything other than kind, gentle and touchy-feely, as Senator Kelleher suggested. You talk about being accountable to the unitholders. In the various mutual funds with which I am familiar, I have never been to a meeting convoked to elect trustees. I have never been engaged in such a process; but, perhaps, I have not read the proxy materials.
Mr. Hockin: First, you can leave by redeeming your mutual fund tomorrow. That is one thing you can do.
Senator Angus: You can sell your shares, too, in CN.
Mr. Hockin: But it is not that easy to get out of a defined benefit pension plan.
Senator Angus: That is true.
Mr. Hockin: That is the most potent discipline that exists on the managers of a mutual fund.
Senator Angus: The trustees are not elected by the unitholders. I want to ensure that you were not conveying inadvertently the wrong impression.
Mr. Hockin: That leads to a good point, which is that there has been a movement afoot to put in place independent, unaffiliated directors on to the boards of these management companies, just as we did with the banks a number of years ago. The original problem with it was that since these are trusts, they do not have a board of directors. These measures are being added in an advisory way to these trusts to ensure that there are unaffiliated directors who ask questions of the mutual fund managers that the average investor would ask. For instance, they would be asking, "Do you have to send me all this stuff in the mail? Did you have to sponsor the Maple Leaf hockey game last week, the results of which I did not like?"
These unaffiliated directors are there to ask these questions. Not every fund has them yet. Increasingly, however, that is the case with the large funds.
Mr. Wellum may wish to add to what I have said.
Mr. Jonathan Wellum, President and Portfolio Manager, AIC Group of Funds: Mr. Chairman, consistent with what Mr. Hockin has outlined, in a mutual fund there is tremendous competitive pressure to maintain a reasonable performance on a relative basis vis-à-vis our peers. As you know, on a daily basis, on a monthly basis, almost every time you turn around, all our performance numbers are published, unlike the pension fund industry. It is easy for people to determine how well they are doing vis-à-vis the peers, the averages, the indexes and so on. The biggest opportunity for an investor is to exit the fund at any point in time.
Having said that, the detail in terms of the release of what is going on in the portfolios and what is being bought and sold is available. In fact, we must make available to our unitholders, if they ask, all of the buying and selling and all of the transactions in a mutual fund. Seldom do they actually ask for that information.
The addition of independent directors which have at least some overseeing governance function is an issue that is coming. Many of the fund companies, as Mr. Hockin has said, are now putting in place independent directors who are separate from the company and separate from portfolio management. They can ensure that objectives are being maintained.
Getting back to the regulation of our industry, our prospectuses must include all of the different objectives of our portfolios. If there is any overweighting in any sectors, the risk attendant to that overweighting, et cetera, all of the different fees and summary of expenses are fairly detailed. There is a fair bit of regulation. It is becoming much more transparent to the investors.
Senator Angus: Do you welcome that?
Mr. Wellum: Yes, we have no problem with it. Perhaps Mr. Hockin could answer that question from the perspective of some of the other fund companies.
We ourselves are major investors in some of our competitors in our portfolios. We are big shareholders in some of the other publicly traded companies. We welcome that because, from our perspective, if everything is being done according to the regulations and from an investor's perspective, then there is nothing to hide.
Mr. Hockin: His fund owns 10 per cent to 20 per cent of Trimark. He owns 20 per cent of Mackenzie. He owns a whole lot of banks. He needs and wants this information. He is a big defender of the transparency of the industry.
Senator Angus: This committee has been told by senior people that they are concerned about the integrity of our financial system in Canada. Part of our mandate is to be interlocutors and to provide a forum for policy discussions on the subject. With the sustained bull market that we have had, and the mushrooming of moneys that are being invested, and the dearth heretofore of vehicles in which to invest, concerns have been expressed as high up as by the Governor of the Bank of Canada, and by regulators, about mutual funds being unaccountable and running loose and free. Obviously, when we start to do a fact-finding study on the governance of institutional investors, this is a natural for us.
I should like to have from you as strong a statement as you care to make about whether or not you agree with that concern which has been expressed by people of high credibility.
Mr. Hockin: Absolutely not. "Unaccountable," senator, it is the most accountable product there is. Its prices are in the newspaper every day.
Senator Angus: Some I own are only in on Saturdays. Usually, I am playing golf or skiing -- doing the things that senators do on weekends.
Mr. Hockin: Those are closed-ended funds for wealthy people.
Senator Angus: What about formula growth funds?
Mr. Hockin: What do you mean by running loose and free?
Senator Angus: That was, perhaps, a colloquialism that has slipped into my vocabulary.
Mr. Hockin: Frankly, it is the most regulated product in Canada, except for the nuclear industry.
Senator Angus: This is totally contrary to what we have heard, and I am glad to have it on the record. I am sure some of my colleagues will wish to pursue it.
Perhaps you are focusing more on the word "accountable" than on the word "governance," not to mention the practices of governance, at least pursuant to guidelines from the TSE, which are being brought to bear in publicly traded companies which many of your funds own. Would your answer be different in terms of governance as opposed to accountability?
Mr. Hockin: Yes. With regard to governance, it is wise for this committee to ask those questions of all the pools of capital. That is why we wish to return in two or three months with an industry response to this.
There are three or four governance problems with large funds in the U.S. One is personal trading of portfolio managers.
Senator Angus: That happens in Canada?
Mr. Hockin: Yes. After the Hirsch problem, we consulted Jim Baille to look at our code. There were areas where the code was silent, for example, concerning the access group of people who know what the portfolio manager is doing, such as the relatives, the spouse, and maybe the secretary in the office. We improved the code still further. You cannot be a member unless you follow that code. That is what we did with personal trading.
The other two or three issues are also interesting. Let us say you are AIC and you have expenses overall for running your head office. How do you allocate each of your expenses to each of your funds? In the United States, independent directors look at that and try to find that.
Another corporate governance issue is: How do you value your liquid securities? As you know, generally -- and we will be mentioning this to the industry committee on investing in small business -- mutual funds cannot invest very much in liquid securities. Approximately 1 or 2 per cent would be the most they are permitted to invest. If you buy the liquid security, how do you value it? Independent directors can ask those questions.
This insinuation of indirect investors into this vehicle called a trust, which is strange, is starting in Canada. They will be monitoring those kinds of questions.
Senator Austin: I wish to ask about the role of publicly traded management companies in the mutual fund industry. I do not know whether these are transparent vehicles that are to be desired, or whether -- because the reward is in a pricing mechanism, at times earnings on fees mechanism -- there is something inconsistent with managers rewarded that way in terms of the way in which they act on behalf of their fundholders.
Can you comment on publicly owned management companies?
Mr. Hockin: Mr. Wellum's fund is full of those types of managers. I will ask him to address that question.
Mr. Wellum: We have large positions in publicly traded companies.
The Chairman: You mean publicly traded mutual fund management companies?
Mr. Wellum: That is right.
The question you are asking does not take into effect the tremendous discipline of the capital markets. If these fund managers are not performing or are not doing a good job for their unitholders, there will be redemptions, not the asset appreciation in the individual portfolios by which the fees are generated. So there is an immediate effect on the valuation of the companies.
The best self-correcting mechanism in terms of that is the market itself. The portfolio managers and companies that are not running their business for the long-term growth of their company and, therefore, making decisions that are in the best interest of the unitholder, will be directly impacted in short order.
The market itself corrects that whole issue. Short-term decisions that are made which do not reflect longer-term opportunities for the unitholders will be reflected in the share prices. We have seen that in our own marketplace. Companies that are over-weighted in certain areas or get hit by bad investments automatically and quickly see a reduction in net sales. They often go into redemptions and the share price is affected.
Senator Austin: I was not trying to ask the question in a way which reflected a judgment on the desirability or non-desirability of these publicly funded managers. They exist in the market and are supported by the market. I am concerned, as Senator Angus was yesterday, about the smaller retail buyer -- not people like you, who have the ability to command a good deal of research and who have performance criteria, but professionals who are busy in operating rooms or courtrooms and are not watching and do not have criteria for performance. They look at the value of their portfolio but they are not able to judge whether, for example, the fund manager is being richly paid or paid according to the industry standards, or what the fee compilations are, or what they end up paying.
Could you comment on that aspect, particularly as it relates to the comments you heard earlier today about the efficiencies as to cost to the beneficiary of the pension fund industry and particularly the advantages of scale, namely, the one-tenth of 1 per cent point?
Mr. Wellum: The competitive nature of the mutual fund industry is such that if the fees are not being earned or justified -- and all the performance figures are quoted after fees -- then there will be competitive pressure to lower those fees. We are also significant investors in the U.S. market. That market is instructive as to where our Canadian market is going. As that market develops, it becomes more mature, there are more and more entrants, and there are more and more pricing pressures and more competitiveness on the management fee side.
We would look at management fees coming down over the next number of years. Up until this point in time, the mutual fund industry has been able to justify the management fees from a performance perspective.
Mr. Hockin: The management fees range enormously.
Senator Austin: I realize that. I wonder if one of the arguments for removing the cap is that the pricing pressures of the U.S. market would bring Canadian management fees more in conformity with North American practice.
Mr. Hockin: American management fees and Canadian management fees for mutual funds are as different as apples and oranges. The American definition of a management fee is very different from the Canadian one, so you cannot compare the two.
Canadian funds are smaller; thus, they have not been able to write off overhead costs over a large block of capital. Therefore, our MERs are a bit higher, even if you did a direct comparison with the Americans.
But we are just about the same on foreign funds. Canadian foreign funds and American foreign funds have somewhat similar MERs.
Mr. Wellum: Where there has been a difference in pricing between the U.S. and the Canadian marketplace, even within the U.S. domestic market, has been on fee-for-service, where you have had advice-givers and where you have not had advice-givers in the component.
So if you look at companies such as Schwab, for example, or T. Rowe Price, which is a no-load mutual fund discount company that manages over $100 billion U.S., you will see fees that are very low. But again, there is no attendant advice component to it through the investment dealers.
The Chairman: Are similar products available in Canada?
Mr. Wellum: Not at this point in time, but there has been more and more interest in coming into Canada. Relaxing the foreign content regulation will make it more interesting for U.S. manufacturers of savings vehicles such as mutual funds to come into the country because they will not be encumbered by the limitations of the Canadian marketplace.
The Chairman: To pursue that area, Senator Angus commented that that is exactly the comment that this committee used to support the entrance of Wells Fargo into the small business loan portfolio business.
I hear you saying that the only way management fees will come down is if competition increases. What you actually said was if competition increases, management fees will come down. By inference, that means that that is the way to get them down.
We are all in favour of lowering management fees. That is clearly in the interests of the individual Canadian.
You also said that if some of the American funds could come in here, they would, in fact, be no-load funds, they would be less-advice funds, and they would thereby provide the competition that we would like to see provided to lower management fees. Therefore, what precise policy regulation or law do we need to change to see that that happens tomorrow?
Senator Austin: How do we oversight a fund that is based in the U.S. and is a cross-jurisdictional entity?
Mr. Hockin: First, I would not agree that there is no competition in the Canadian mutual funds industries.
The Chairman: We are not saying that. They are your words.
Senator Austin: The management expense ratios range from 0.1 per cent to 3 per cent, and it is your choice as to which one you want to buy.
The Chairman: I think Mr. Wellum made the argument that he saw management fees coming down because of increased competition.
Mr. Wellum: Within our own marketplace.
The Chairman: What must we do to expedite the day when that competition arrives? If we could make it arrive tomorrow, we would do everything we could to make that happen. I am asking your advice as to what we have to do to create the competitive marketplace that will lower the management fees that you say will result if we create that marketplace.
Senator Meighen: We have to persuade the Americans to allow the Canadian funds to compete down there.
Senator Angus: They are already doing that.
Mr. Hockin: You must be careful that we get a level playing field and reciprocity on this. The American jurisdiction is not at all hospitable to foreign funds operating in their jurisdiction. If you want to give it away for free, you can, but frankly, only Mackenzie is down there from Canada doing anything at present.
American off-shore funds cannot be in Canada right now unless they build a clone, like Fidelity did. In other words, your fund has to be registered here, and you must have the fund operated here. When you buy Fidelity U.S. fund in Ottawa, you are buying a manufactured clone of the fund. You are not buying the thing out of Boston.
Mr. Hockin: That is the present registration requirement on both sides of the border.
The Chairman: That was not my question. I agree absolutely with what you said. My question was: What needs to be changed? I want to create the competitive marketplace that you say is coming, and I want to create it sooner rather than later. What do I have to do in order to that? You said that we need to have reciprocity, et cetera. Well, perhaps it is in the interests of Canadians. I understand why it may be in the interests of the mutual fund industry to have reciprocity, but perhaps the interests of Canadian consumers do not require reciprocity. Perhaps the Canadian consumer will say, "Don't worry about the reciprocity. Just let the American competition come in as quickly as possible to give the consumer a break." I understand why your industry may not like that. That is not my question.
My question is: What do we have to do to help the consumer? What is in the public interest? You could make the argument that the public interest would require reciprocity, so let me simply talk about the narrow consumer interest.
Mr. Hockin: I cannot believe, first of all, that an American mutual fund on Canadian equities would have a lower MER than Trimark or MacKenzie or AIC. They might have a lower management-expense ratio on an American fund that they might want to sell in Toronto. To some degree, they are not able to do that now because they must be fully registered in Canada and have an office here, and so on. You must have that provincial registration rule changed.
Senator Austin: It is a point of first impression that we raised. We will review it and see. We are trying to prepare for a new world with many new players and products in the market. We are looking at a multilateral investment agreement which is not here yet. Canada is in negotiations with respect to it and the impact of that MIA, so these are just exploratory issues. We are not taking positions. In fact, tonight we have been provocative, hopefully with a sense of humour, in order to get some responses.
Mr. Hockin: The Internet could, in fact, lead to this global phenomenon, regardless of what the Senate or the House of Commons does, in the sense that if you are willing to buy Fidelilty this or Deutsch Bank that or Japanese this on the Internet, and if you are willing to waive your rights as an investor of the protection of the Ontario Securities Commission or the Quebec Securities Commission, you can do it. People might start using the Internet and say, "I don't care about the investor protection rights that Ontario gives me; I will buy the thing on the Internet."
Whether the foreign fund will let you buy it or not is another question. Right now, they do not generally like you to do that. With the growth of the Internet, it might be coming.
Senator Tkachuk: An American could also buy Canadian funds on the Internet, sacrificing his New York jurisdiction by accepting the Ontario jurisdiction.
Senator Meighen: As the market tightens and the returns are not what they have been over the past several years, there will be more scrutiny paid to fees, and the competition to which you have referred will come.
What percentage of mutual funds, Mr. Hockin, is in IFIC?
Mr. Hockin: Presently, 99 per cent of all the managers are members of IFIC. Some small managers are not.
Senator Meighen: That is an improvement over five years ago, is it not?
Mr. Hockin: Yes. We worked hard to ensure that we can speak for the whole industry. We are also the only mutual fund association in the world -- there are 40 of them -- that represents the distributors. We represent about 75 per cent of the people who actually sell mutual funds but probably only about a third of the companies which sell. The ones that are not members of IFIC are the mom-and-pop financial planners in the small towns. They do not want to pay the dues.
Senator Meighen: There is no big distributor?
Mr. Hockin: I do not know of any big distributor who is not a member of IFIC.
Senator Meighen: In the United States, there are more closed-end funds than in Canada; indeed, the closed-end funds there trade at much less of a discount than the closed-end funds in Canada. On the other hand, it would not surprise me to see the number of closed-end funds grow in Canada in the next few years. Would IFIC have any intention of trying to gather the closed-end funds to your bosom?
Mr. Hockin: Some of the closed-end funds have been tremendous performers, and they are very similar to open-ended funds. They do not have quite the same liquidity or ease of redemption.
Senator Meighen: There is a plus to that, of course.
Mr. Hockin: There is. They have not approached us, but, if they wanted to approach us, we would be glad to take them to lunch.
Senator Meighen: My memory is hazy on this, but was there not a fair bit of criticism in the past years -- I wondered what the position of IFIC was now and what the situation is today -- about fees paid by funds to dealers or salespeople who sell their funds in a certain volume?
Senator Stewart: Holidays.
Senator Meighen: As Senator Stewart said, it took the form of holidays in exotic locations and such things. Is that still practised?
Mr. Hockin: This was all shut down with our code two years ago. The industry voluntarily came up with a tougher code than even the Stromberg report recommended. The securities commissions across Canada are putting a rule in place, I think next month, primarily based on our code. Essentially, it said that you can pay what you want to the stockbroker or the financial planner, but it must all be in the form of money. It cannot be trips to Hawaii or free golf clubs. You must quantify it, and you must disclose it in the prospectus.
Our whole industry, our distributors and the managers, got through this code, and the regulator has been able to use our code as the model for the rule.
Senator Meighen: With great respect, I do not think the answer is to open the flood gates and let every American fund come in here unless we receive reciprocity. I do not think you have really satisfied all of us in terms of the competitive element that is necessary to ensure that fees are at an equitable level.
I am not suggesting that they are necessarily in all cases exaggerated, and I am not suggesting they are not divulged. People have a choice to buy or not buy. But you know that most people do not read, they do not give a darn, and that as long as the fund is up 10, 15 per cent, who cares if the manager charges 1, 2, or 3 per cent? When times get tougher, I think they will pay more attention to it. I think it is an area that you should not overlook.
Senator Tkachuk: I wish to comment on the direction of the questions that we are taking as far as the mutual fund industry is concerned. When I look at the competition between the mutual fund industry and, say, the banking industry, and the information provided by the mutual fund industry to me as a shareholder, I much prefer the mutual fund industry. They provide greater choice for the consumer. If you are usurious or if you are a crook, I suppose government should be very concerned about the fees charged by your mutual fund.
People who own mutual funds care about only one thing, the rate of return. I do not know of anyone who has ever complained about a fee. I have only heard complaints about rate of return. All holders of funds base their judgment on the rate of return that they get with their mutual fund.
If I, for example, get an 18-per-cent return and I look at the competition and they are getting 16 and 15 and 14 and 12, I do not care what the president is getting paid or what fees are being charged.
Mr. Hockin: And those performance numbers are after the fees.
Senator Tkachuk: I get the half-yearly statements. I get the Templeton statements, I get the Trimark statements. I get much more than, or at least as much as, I would as a shareholder of a bank or an oil company.
Mr. Hockin: Do you know what the fees and the spread are for a GIC? Do you know all the fees behind your insurance contract? Do you know all the fees in your pension fund? The most transparent of all of these products is the mutual fund.
Senator Tkachuk: When we get into this business of fees and investments, we must remember that banks and other financial institutions such as trust companies have mutual funds, just like Trimark and Templeton and Dynamic and all the rest of them. We should examine the whole issue and see what bank fees are charged against deposits and savings, and what rate of return we are able to get by putting money into a mutual fund.
I am not here to support the mutual fund industry. However, I am of the view that this is a larger kettle of fish than simply the mutual fund industry because fees are charged all across the board by every financial institution, and the rate of return of the mutual fund industry is better, as far as I am concerned, than most of the other financial instruments out there.
Senator Oliver: I have one question to AIC.
We had a discussion earlier with some other witnesses about activist pension funds. Can you tell us what you do when your company takes, say, a 5-per-cent position in a Canadian company? What direct responsibility or role do you have with that company when you make such an investment? What are your day-to-day practices in relation to that investment.
Mr. Wellum: That is a good question. We are a longer-term buy-and-hold investor. We are very selective in terms of where we invest. We do a great deal of research individually on the companies. We are the antithesis of much of the pension fund business. We do detailed, analytical work, and have detailed contact with the management of the companies that we are investing in. However, we are caught, as we get into larger and larger positions as mutual fund managers, with this passive investor aspect. We must be passive at the same time as we take large positions in companies. What do we do? We talk to management, and if things are not going the way we think they should be going, we can make suggestions; but we are not activists in the sense of trying to get involved in management to enforce those issues. That is not a mandate that we have as mutual fund managers.
Senator Oliver: Give us examples of how far you have gone with some troubling investments.
Mr. Wellum: We have been fortunate in that one of the criteria that is uppermost in our investments is that we only invest in companies where we trust the management and where the management itself usually has a large stakeholding position in the business, so they are looking out for themselves as shareholders and hence for our unitholders and shareholders also.
Some of the more controversial things we would have spoken to management about would be stock options.
Senator Oliver: For management?
Mr. Wellum: For management, and the dilutive effect of them for shareholders. That is an area we feel is important. We are paid, and people are interested in buying our funds, because we have strong, long-term performance. Unless those dilutive effects on a company can be justified and the company can show exactly who will get the options, that they have specific criteria for allocating those options, that they are in the best interest of retaining good people, and so on, then we will examine that in detail.
Senator Oliver: Apart from options, can you give us a couple of other examples of areas where you have had some concerns and expressed them?
Mr. Wellum: We would get clarifications on certain individuals and management skills and what they are adding of value to the company and so on.
We must be careful because we are large investors in our own industry. We understand that industry well. So we can and do make value-added comments to help those companies realize greater growth, and sometimes they are accepted. In many industries, we must be careful. If we are investing in the health care sector or communications, which we do, those are industries where the management themselves should know best how to run those companies. We know we must be careful about getting involved. Hence we have bought companies where the management is excellent, and we do not generally get involved in those companies.
It is an issue, and I put it forward. We do own up to 20 per cent of some companies. We think that is an advantage because there are a limited number of companies in Canada that are truly great businesses in which you want to be a large shareholder for the long haul. As Warren Buffet says, quoting Mae West, too much of a good thing can be wonderful. Like every good business person, we want to own more of a company, not less, if it is a good business.
We are now the thirteenth largest mutual fund company in Canada. As we buy more companies, as we manage more and more money, the issue of being a passive investor becomes important. We are caught between those two elements, of having a fiduciary obligation under even our AMAR regulation as CFAs and so on and at the same time being mutual fund managers where you are this passive investor. We are caught. We have not become activists but we ourselves would like more direction on that.
Senator Oliver: Earlier you mentioned the case where a senior vice-president may lack certain managerial skills. If your company made that decision and you went to the company to talk, how far would you go in either having that certain vice-president retrained or removed?
Mr. Wellum: We would raise the issue, but we would not go any further than that. We might discuss a certain disappointment in a person or ask for justification for a person but we would not go beyond that because we do not feel that it is within the scope of our mandate as passive mutual fund investors.
Mr. Hockin: I know you will be looking at corporate governance. We will try to do a survey on some of these issues for you, to try to find out just how activist our industry is. I have always had the impression that our industry generally does not vote its stock, is not very activist, but we will do some research for you on that.
There is the classic example in the United States of poison pills. Mutual fund managers do not like poison pills, therefore they will object to that and get involved; but that is so clearly against the investors' interest that it is a no-brainer.
Senator Oliver: There is a whole list of things like leveraged takeovers and so on.
Senator Kelleher: We did that here with Canadian Tire.
Mr. Hockin: We will try to do some work on it and get back to you.
The Chairman: That would be helpful.
In doing that, you ought to be clear that at least some of the members of the committee do not regard activism as a bad thing. As a representative of the CN Investment Division said earlier, if it increases shareholder value, that is terrific.
Thank you very much for being here this evening. We look forward to getting the Conference Board study on the 80-20 rule. We may want to have you back to talk about that before Christmas.
In the next phase of our hearings in February and March, we look forward to hearing the results of the survey you just spoke about on the level of activism and also the governance guidelines, which you said would probably be ready in the first quarter of next year. Is that your target?
Mr. Hockin: We are trying to put together further proactive movements on that. That will take until the spring or the summer. We will get some help from some of our American friends about how they have been dealing with it. Independent directors are a new thing for us, so we want to be informed by other jurisdictions as well.
The Chairman: Thank you.
The committee adjourned.