What the “Smart Money” is telling us about how to invest our money Lynn MacNeil March 19, 2019 3783 Managing Your Money Every year when employed and self-employed Canadians file their tax returns, they contribute to their government managed pension fund, the Canada Pension Plan (CPP) or the Quebec Pension Plan (QPP). These mandatory plans collect money from working Canadians, invest and manage the money, and provide an income to retirees based on their contributions. Managing this money on behalf of the nearly 30 million contributors and beneficiaries is a huge responsibility and it can guide us in our own personal investment strategies. The Canada Pension Plan Investment Board (CPPIB) which is responsible for the investments in the CPP, recently released their 2018 Annual Report. I generally read through this report every year to gain insight on where the “smart money” is and use this information to guide the management of my client’s investment portfolios. With $356 billion of Canadian’s money in the CPP, and a 5-year annualized real rate of return of 10.4% (real return = after inflation), I think they set a good example for the rest of us. I’ve included where to find this report at the end of this article for anyone who might want to read it. The term “smart money” is a common term used in the investment community. It came from the world of gambling and referred to “the bets made by successful gamblers”. In the investment world the “smart money” is the term used for money that is being controlled by institutional investors such as pension funds, ultra-high net worth investors with financial assets of over $10 million, and other financial professionals. Following the “smart money” means looking at what areas are attracting capital, and which areas “smart money” is avoiding or moving away from. Like myself and my clients, the CPPIB’s objective is to invest the Fund assets to “maximize returns without undue risk of loss”. While we saw the Canadian stock market finish 2018 with a -11.6% drop, the CPP finished the year with a POSITIVE 11.6% gain! And that is one good reason why I think it is worth considering where the “smart money” is. Investment returns cannot be earned without accepting some form of risk – as the saying goes, there is no free lunch. The goal of CPPIB, as with most long-term investors, is to ensure that risks are taken prudently and rewarded by long-term benefits. The environment in which we all invest is dynamic and the pace of change is accelerating. The CPPIB identified some of the key risks they are facing, and in turn that we as investors are facing. It was no surprise that at the top of the list they identified political events in the U.S., geopolitical uncertainty, global trade events, and the prospect of rising interest rates as being the main drivers of additional market volatility globally. So how does the CPP Investment Board manage these and other risks? The single biggest influence on the Fund’s total portfolio risk and return is how they deploy the Investment Portfolio across a diversified set of asset classes and types, across countries and currencies, and across underlying return-risk factors. Basically, diversification – one of the most basic fundamentals of investment management. But the key is how they diversify. As with most investors, the CPPIB uses public market securities – these are investments like stocks, bonds, and ETFs that are traded on the public markets. But unlike most investors who invest solely in public markets, that’s only about half of their investment portfolio. The rest is in the private markets – private equity and private debt through privately held companies, as well as real assets (real estate and infrastructure). It’s interesting to see in the chart I’ve included from the 2018 CPPIB Annual Report, how the CPP Investment Board’s allocation to these alternative assets or private markets has evolved since 2005. Notice the last line in the chart, % of net investments. This shows that back in 2005 the CPP Investment Board had only 4.3% of the Canada Pension Plan invested in alternative assets, whereas today they have 50%! While the 2018 report is not out yet for the Caisse de dépôt et placement du Québec, which manages the investments in the QPP, RREGOP, CNESST, SAAQ, and others, the story has been quite similar. Ultra-high net worth investors and the largest endowment funds in the world have followed the same trend. Yet everyday investors are slow to catch on. I still have many people who contact me for advice or a second opinion who have no or little exposure to this segment of the market. Like any other investments, alternative assets have their own pros and cons. They tend to be harder to access, in fact many Canadian investment firms have limited access to alternatives. They can also lack liquidity which makes them more ideal for the long-term segment of your portfolio. On the plus side they tend not to be correlated to the public markets and because they are not as easy or quick to buy and sell, they remove emotion from investing decisions. For more details on alternative assets, you can check out two of my previous articles, Alternative Investing: Private Equity Simplified and What we can learn from where the wealthy are investing their money? Is real estate really the way to go?. Looking ahead in 2019 the CPP Investment Board states “Real assets continue to offer a robust and growing income stream, with an expected total return that is very attractive relative to fixed income.” Real estate and infrastructure lower the risk of the overall portfolio. This risk saving then allows the opportunity to add a wide variety of higher return-risk strategies without increasing the overall risk of the portfolio. However, another risk that was identified by the CPP Investment Board, is about the push into alternative assets by the “smart money”. As the “smart money” continues to push into this competitive environment, it has made it increasingly difficult to find attractive opportunities with adequate returns. This challenge will likely continue to increase and will become even more challenging for everyday investors. March 6th, 2019 marks the 10-year anniversary of the “bull market” (rising share prices). Bull markets don’t last forever. Might it be a good time to de-risk your portfolio with some alternative assets? The Canada Pension Plan Investment Board seems thinks so. The 2018 CPPIB Annual Report can be found at www.cppib.com/en/ar2018/ Lynn MacNeil, F.PL. Vice President, Investment Advisor, is a Financial Planner with Richardson GMP Limited in Montreal, with over 24 years of experience working with retirees and pre-retirees. For a second opinion, private financial consultation, or more information on this topic or on any other investment or financial matter, please contact Lynn MacNeil at 514.981.5795 or [email protected]. Or visit our website at www.EphtimiosMacNeil.com. Private equity and alternative assets are mainly intended for those who qualify as “accredited investors” as defined under National Instrument 45-106 Prospectus and Registrations Exemptions (“NI 45-106”). Only investors who meet these eligibility criteria may participate in this investment opportunity. Richardson GMP Limited does not endorse any investment opportunity, nor does it make any recommendation regarding the appropriateness of particular opportunities for any specific investor. Investors are encouraged to complete their own diligence before investing. Some private investment opportunities are speculative in nature and investors should be able and willing to withstand the entire loss of their investment. The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. Richardson GMP Limited, Member Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. 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