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The CPPIB Risk Return Accountability Framework

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Presentation on theme: "The CPPIB Risk Return Accountability Framework"— Presentation transcript:

1 The CPPIB Risk Return Accountability Framework
A Realistic Approach to National Pension Fund Management

2 Three principals of 1997 Reforms
Intergenerational fairness Higher rates now, lower rates in the future Fully fund future benefit improvements Affordability Legislated rate should not exceed 9.9% (hopefully) Reduced future CPP benefits Capital market returns help lower future rates Sustainability Mid-course plan design adjustments, if required Self-correcting “fail-safe” adjustment if political process stalls

3 Charting the Path to Sustainability
Partially funded, legislated rate of 9.9%. 1997 reforms

4 Managing the Contribution Rate
Agree on the mechanism to change the contribution rate before you need it Have independent monitoring of the contribution rate Have independent means of changing the contribution rate

5 The CPP restructuring of 1997
Increase contribution rate to build up surpluses Reduce costs by both reducing benefits and by investing surpluses in risky assets Created default mechanism to make any necessary changes to the contribution rate

6 The CPPIB mission Maximizing returns without undue risk of loss,
having regard to the factors that may affect the funding of the CPP

7 Managing your objectives
Know your objective Remove influences and constraints that may compromise meeting your objectives Align your organization with your objective. Make it easy for stakeholders to assess performance

8 Investment earnings are needed to meet future liabilities

9 CPPIB Investment Strategy
Take Advantage of CPPIB’s Unique Situation Capture Attractive Sources of Alpha Increasing Value Add Build a Better Beta Portfolio Choose CPP Reference Portfolio Estimate Net Liabilities

10 Model dynamics make a difference
State variables (eg inflation) Security prices Fund wealth Portfolio returns  = set of portfolio weights Net contributions Market volatility

11 Estimating optimal financing
Formulate the stochastic dynamic control problem (Hamilton Jacobi Bellman) Portfolio weights are the control variable Minimize the probability of failing to fulfill the pension promise at some time in the future

12 The optimal portfolio strategy
The optimal strategy minimizes the probability of restructuring the fund in the future The optimal portfolio is a combination of mutual funds A risk free fund The optimal growth portfolio A mutual fund for each state variable The optimal portfolio strategy specifies security weights conditional on fund wealth, time and the value of the state variables

13 Fund wealth affects portfolio allocation …

14 … And the probability of restructuring.

15 Summary Optimal financing requires Alignment
a clear statement of objectives Align governance and organization with fund objectives The CPPIB is developing innovative models to inform its investment decisions. Align financing strategies with these objectives Default mechanism to make any needed contribution rate changes Optimal financing aligned with Stewards risk and return expectations

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