Finance Committee on June 11th, 2020

[Gabriel Ste-Marie, Bloc, Joliette, QC]

Thank you, Mr. Chair.

First of all, I would like to inform you that I will be taking the first speaking turn, and my colleague Mr. Barsalou-Duval will be taking the second one. We will do the same for the next round of questions.

Hello, Mr. Machin and Mr. Leduc. Thank you for being here.

Mr. Machin, thank you for your presentation. The answers to our questions are welcome and very enlightening.

We can see that the financial markets have been very volatile since the beginning of the pandemic. This is very worrying. I would like to have your analysis of the situation with regard to the links between the pandemic and what is happening on the financial markets right now. I would also like to know your forecasts for the next few months.

I'd also like to raise something more specific. The governments of rich countries, in response to the effects of COVID-19, have brought in significant income support measures. The same is true for central banks, which has led to a significant injection of liquidity. But it seems to me that much of this liquidity, that is, new money, has not been used to support demand, either for consumer spending or for investment. Eventually, this liquidity could end up in the financial markets, which could lead to a rise in asset prices, which I would describe as artificial. On a global scale, this could even present the risk of a financial bubble.

What is your analysis of the situation, and what are you doing about it?

[Mark Machin]

Thank you for the excellent question. This is one that we will consistently wrestle with.

Briefly to your first point, I won't give a market forecast. I'll give you an economic forecast—at least based on our economics team—and certainly it's a depressing environment.

These forecasts we hope are negative and will be revised upward over time. For the moment, we see that Canada is in a very sharp recession and likely will grow negative seven-plus per cent this year, but hopefully will bounce back 8% next year. Similarly, the U.S. is over 6% negative for this year, and globally, we see 3.8% negative growth for this year.

It's a very sharp recovery. We predict at the moment that the economy won't recover to its full pre-COVID level of output around the world until the second half of 2022. That is our current prediction. We're looking at it very carefully, based on the employment forecast, based on hopefully a little more optimism around vaccine research, but that's our current prediction.

To your point on asset prices and how they may have moved given the stimulus, that's certainly something that I think, in the short term, a lot of people are taking quite a lot of relief from. There has been a huge stimulus around the world, both on the fiscal front and on the monetary front, and it has had its impacts, certainly for most of the time. Although we've had a difficult day today in markets, most of the time it's put liquidity back into markets and put confidence back into markets.

You are right that it is possible this will result in very high asset prices. Certainly we've seen a very surprising and very rapid rise in equity markets, until this morning. We've certainly seen very little fall-off in real asset prices in many markets. While that is comforting as an owner of assets, it is something we are looking at very carefully, making sure we have a portfolio that will perform no matter what happens, no matter what risks emerge and no matter what events might happen.

We consistently stress test for what would happen if there were another scenario like the global financial crisis tomorrow. What happens if there is something even worse than that tomorrow? It's certainly something we don't wish for, but it is our responsibility to make sure we understand what the consequences of that would be and to make sure the portfolio would be safe even through those types of events.

[Gabriel Ste-Marie, Bloc, Joliette, QC]

Thank you for that very good answer.

I will move on to something else. While your office's only criterion is performance, many funds incorporate ethical criteria into their investment strategy. Not only do ethical funds not underperform financially, but by limiting negative externalities, they bring benefits to society.

Your office could, like the Caisse de dépôt et placement, consider the benefits of these investments for society, for example. In this regard, would it take a legislative change to ensure that the billions you manage are also used for economic development?

We can also think about speeding up the green shift. As a first step, would you consider an environmental audit of your investments? You could for instance integrate climate change awareness into your investments, or you could assess the impact of your investments on CO₂ emissions.

[Mark Machin]

I would say two things on that front, one on the structure of our mandate and then secondly on our investments in the energy transition.

First of all, I think the country has been really well served by the simplicity of the mandate we were given back in the CPPIB Act in 1997, which is to maximize returns without undue risk of loss. Then it was left to a professional board of directors and management teams over the years to figure out how to do that.

What is the best portfolio we can find, whether in Canada or around the world, to achieve that objective? It's a very difficult objective. Managing money is not simple. It's very competitive. Having that clarity of purpose has made it at least slightly simpler for us to execute, and it has served really well, so we always have the interest of building value in the fund. That is the number one thing that drives what we do every day.

If you load in other complexities and objectives, then it becomes much more difficult, and there are obviously compromises and trade-offs. I think it's something that the country was very smart about—and people were very smart about—back in 1997 in setting up the fund this way. I think it has really proved itself over the years and is the envy of the world, frankly, as a simple, straightforward way to set up the objectives of the fund.

Having said all that, we do believe that climate change is happening, and we do believe it is a major risk, so for the last 12 years we've been focused on understanding the risk, and it's challenging. It's a very difficult risk to understand. We publish a sustainable investing report, “Investing Responsibly for CPP Contributors and Beneficiaries”, every October. It goes into some depth about how we are thinking about climate change and what we're doing with respect to it. I will give you just a couple of highlights around it, because it's a long topic.

The first is that every single major investment we make must take into account climate change risks and make sure that we understand those risks and what might happen to the company, what might happen to the asset, before we make the investment, and that we've been sufficiently compensated for it. For example, in the last year, we invested in a toll road in Indonesia. One of the major issues was, what will happen with climate change? What will happen with flooding? What will happen to the geography around that toll road as climate changes? If it changes [Technical difficulty—Editor]. Understanding the risks is really important.

The second thing is understanding overall, from a top-down perspective, what the risks are that we have in our portfolio and stress-testing the portfolio depending on whether we have faster shifts in climate or slower shifts in climate.

It's a complex area. It's one where we are determined to be at the forefront of understanding those risks and understanding where the opportunities lie around it, so that we can invest in those opportunities.

[The Chair, Liberal, Wayne Easter]

Okay. Thanks you both. We're substantially over, but I will let people go when I think there's information being provided.

We will now go to Mr. Julian, who will be followed in the second round by Mr. Poilievre.

Peter.

[Peter Julian, NDP, New Westminster—Burnaby, BC]

Thank you very much, Mr. Chair.

I also thank the witnesses for being here today. I hope that their families are healthy and safe.

My questions are going to be addressed to Mr. Machin and I'd like his answers to be brief.

It's about the salaries you pay yourselves. You got a raise this year. The Caisse de dépôt et placement du Québec carried out a consultation regarding senior executives.

[The Chair, Liberal, Wayne Easter]

Peter, the translators can't catch what you're saying. You're breaking up somehow. Maybe you can try it a little slower?

[Peter Julian, NDP, New Westminster—Burnaby, BC]

All right, Mr. Chair. I'm going to speak more slowly, even though it's difficult for me.

I was talking about the Caisse de dépôt et placement du Québec, which managed the compensation for senior executives. [Technical difficulties] in the third quarter. The same thing is happening elsewhere in the world, for other pension plans.

Do you think raising your salary this year, during a pandemic, is appropriate?

[The Chair, Liberal, Wayne Easter]

Peter, I hate to interrupt, but we're only getting you in English. The translation isn't coming through. Try your English channel and see if that works. I don't know. It's breaking up.

For some reason, the translators can't pick you up.

[Peter Julian, NDP, New Westminster—Burnaby, BC]

All right.

Can I still speak French? Currently, I'm on the English channel. Can you hear me?

I'm on the English channel right now. I tried the French channel

Now I'm on the French channel. Can people hear me? Is everything all right now?

[The Chair, Liberal, Wayne Easter]

Okay. That's good, Peter.

[Peter Julian, NDP, New Westminster—Burnaby, BC]

Here is my first question: is it appropriate to increase salaries during a pandemic?

My second question concerns nursing homes across the country, including those operated by Revera, of course, and the investments that have been made for other pension plans.

Has the Canada Pension Plan Investment Board made any investments in long-term care facilities in Canada or elsewhere?

[The Chair, Liberal, Wayne Easter]

Mr. Machin.

[Mark Machin]

Thank you. I think I got the first and the last questions. I'll take the last question. I'm just trying to understand the second question, but on long-term care.... In fact, Mr. Chair, my colleagues didn't get the second question either, so perhaps we could get that repeated.

On long-term care, the answer is effectively no. We don't have any significant investments in long-term care homes. Technically, we have some extremely small holdings, which we only have through index holdings. I would say that obviously we are really sensitive to the very difficult time that people have had in these long-term care homes, but certainly in Canada it's not something that we have had significant exposure to.

[Peter Julian, NDP, New Westminster—Burnaby, BC]

Thank you very much.

My first question was about executive compensation. Other pension funds have basically frozen compensation. Yours has increased this year. My question was whether you felt that was appropriate, but I want to move on to a key point of your presentation, which was the issue of radical uncertainty.

Climate change is the big radical uncertainty facing our country and the planet. It will cost us $5 billion this year, as you're well aware, and $50 billion a year as we go over the next three decades. I'd be interested in knowing what the sum total of carbon reserves held in companies that have been invested in by the CPPIB is. What's the sum total of carbon reserves, and of course, what is the risk, which goes with that, of stranded assets if we meet our climate change objectives?

Secondly, could you tell us the sum total of members of boards or managing directors within the CPPIB who are also holding positions on boards of directors in oil and gas companies? Isn't that a clear conflict of interest? What's the sum total of managing directors and members of the board of directors who also sit on the boards of oil and gas companies?

[Mark Machin]

On the carbon footprint, in our sustainable investing report, on page 61, we disclose—using both scope 1 and scope 2 definitions—the amount of greenhouse gas emissions from the portfolio. We also disclose it on an equity ownership basis, so the per cent of equity ownership and also the per cent of the long-term capital structure that we own. This is across all assets across the portfolio.

To give you a number—and this is challenging work; there are a lot of estimates that go into this—we use, as much as we can, specific information that is disclosed by the companies we invest in. However, it's about 25.7 million tonnes of carbon dioxide equivalent, based on long-term capital ownership. That is the amount of our total carbon emissions across the fund.

As I say, it's challenging. We have used S&P Trucost, a division of S&P, to try to get to as accurate a number for the companies, where we are using proxies and estimates, but that is.... At the moment, the based-on proxy data is about 53% of that number, 18% is coming from company-reported data and14% from Trucost models. That gives you a sense of the amount of carbon emissions from the total portfolio.

With respect to your second question, I'm not sure I have the numbers completely at hand on how many people sit on oil and gas company boards. Generally, across all of our invested companies, we have about 190 board positions for all of the boards we sit on across all the portfolio companies. Some of these are direct. Some are our employees sitting on company boards, and some of are where we will find a particular expert we think is appropriate for that position to act on our behalf. A handful of those will be on traditional energy boards.

Again, another cut would be that if you look at the overall portfolio and how much we have invested in traditional energy, it's about 2.8% of the portfolio at year-end. Our renewables portfolio right now is over 2.2% at last count, and climbing rapidly. I would imagine that in the short term our renewables portfolio percentage will exceed the amount we have in traditional energy, and that makes sense given the move along the energy transition.

[The Chair, Liberal, Wayne Easter]

Peter, you have time for a quick one. I knocked off the time where we had the trouble in the beginning.

[Peter Julian, NDP, New Westminster—Burnaby, BC]

Thank you very much, Mr. Chair.

Could you provide us with the list of managing directors and members of the board who also sit on other boards?

Secondly, coming back to the issue of executive compensation, again I'll ask, do you feel it's appropriate in a pandemic, when other pension funds have frozen compensation for their executive officers...?

[Mark Machin]

I certainly can follow up with the information on the managing directors and board directors. As far as I recall, and my colleague Michel may correct me, I'm not aware of our board of directors sitting on the boards of oil companies. I will have to double-check that.

With respect to compensation, I'll also let Michel cover that.

[The Chair, Liberal, Wayne Easter]

Michel, the floor is yours.

[Michel Leduc]

Thank you for the question.

As you can imagine, executive compensation is set by the board of directors, as is the case for most organizations. As it turns out, there was actually a comment piece that had been published in the National Post about CPPIB's compensation, which gave the opportunity for our chair of the board to respond. We'd be more than happy to provide the chair's response to the clerk for this committee, but if I have a bit of time, maybe I could summarize the contents.

First, just to be clear, the board did establish a salary freeze on the CEO's salary for the current year, as well as freezing salaries for all senior executives at CPPIB, in recognition of the economic circumstances caused by COVID-19.

In regard to incentive compensation, that's a look back. That's looking at past performance, at the past performance of 20 quarters, not only the 20th quarter that rolls out in the fifth year on which the incentive is based. That's essentially to recognize the importance of aligning investment behaviour—especially a long-term investor—with long-term decisions and not making short-term decisions that may not be in the best interests of the fund. As we have seen, significant economic problems have been caused by short-term thinking, in the financial sector specifically.

In the first 19 quarters of those 20, tremendous value was created, in the order of about $140 billion net income. In the 20th quarter, when the pandemic hit, the fund was impacted, so total fund returns were affected. Having said that, due to all of the decisions that had been made because of active management, because of the strategy put in place by the management team and because of a lot of the diversification well beyond what would be available on public markets, the fund was actually placed, because of its resiliency, in a safe harbour. Had it been invested in the passive strategy, a low-cost simple strategy of indices, the fund would have dropped by about $23.5 billion more.

I think it's a recognition in terms of both the incentive framework for the performance of total fund returns—those 19 quarters—as well as the relative return. As I've said, those details are laid out in the letter from our chair. We would absolutely share that with the committee through the clerk if that's appropriate.

[The Chair, Liberal, Wayne Easter]

Thank you, Mr. Leduc. Just send that letter to the clerk.

We'll go to the second round of five minutes.

We'll start with Mr. Poilievre and then go on to Mr. Fragiskatos.

[Pierre Poilievre, Conservative, Carleton, ON]

Thank you very much, Mr. Chair.

Thank you, Mr. Leduc and Mr. Machin, not just for your appearance but also for the openness with which you've shared information with members of Parliament and have remained transparent while you do a very difficult job in a tremendously unusual time.

I'd like to discuss the times we're in. I think all of us expected catastrophic drops in the market as soon as the governments of the world started locking down their workforces, and that did happen, albeit only briefly. In late March, markets crashed, by about a third here in Canada and roughly the same in the United States, but then they came roaring back.

That bounceback seemed to coincide with the enormous amount of money that our central banks have been printing here in Canada. It's now about $400 billion of what is effectively quantitative easing through a bond-buying program. In the United States, there's been a similarly large program of purchasing assets and an extraordinary purchase of bonds, not just government bonds but now also private bonds. In Canada, the bank is buying 10 billion dollars' worth of private sector corporate bonds.

The result is that markets are surprisingly valued. According to the CAPE or Shiller price earnings ratio, the S&P 500 this week was 28, which is extremely high. It's only been that high in the lead-up to the tech bubble bursting and in the late 1920s, in 1929, right before the great crash that led to the Great Depression.

I want to get your impressions on how our markets are valued right now and whether you think there is a bubble. If there is, how are you protecting the $409 billion over which you and your fund are the custodians?

[Mark Machin]

Those are really important questions. Before I give an answer, let me go through the skills we have as an investor.

That is, we think we have very good skill at building a diversified portfolio around the world, figuring out what the best long-term portfolio is and diversifying that. Second, we think we have developed skill at picking the right fund over the wrong fund, the right stock over the wrong stock or the right building over the wrong building in securities selection. We have great skill at diversification and securities selection. The third skill is market timing. It is one of those skills that are very elusive for investors and very hard to do. I couldn't put my hand on my heart and say that we have developed skill in telling you what the market is going to do tomorrow or even in the next quarter. We think it's a very elusive skill. We do have a macro investing team that does try to figure out shorter-term issues in markets and take advantage of those anomalies, but it's a tough skill to demonstrate.

With all of those caveats, yes, I would say that most people have been quite surprised about the rally in markets until this morning. Clearly, there's been a significant correction today in adjusting for that. Part of it has been clearly driven by the amount of stimulus that has been provided by the fiscal and monetary stimulus, including, anecdotally, in the U.S. the record number of smaller investors opening accounts and putting money into the market. We've seen extraordinary rallies in the stocks of bankrupt companies. We've seen extraordinary rallies in the stocks of well-known companies. There's some evidence that people are taking their cheques in the U.S. and putting them into brokerage accounts. I hope that doesn't end badly for a lot of people. I do hope they have been prudent in how they've invested their stimulus cheques, but it is an issue and something that we have looked at.

What can we do? We can make sure that we are really focused on our first two skills and are really focused on stress-testing the portfolio. We're really focused on making sure we have a properly diversified portfolio so that all our eggs are not in one market, one basket, one geography, one asset class or one strategy. It is properly diversified across multiple different markets, multiple different time zones and multiple different assets. If something pops in one area, then hopefully other markets are less immune to that. That's the benefit of diversification. Secondly, if we pick the right stocks over the wrong stocks, it doesn't matter if the whole market goes down; we've still made money.

Finally, as I said earlier, we run stress tests. What would happen if tomorrow the global financial crisis happened? What would happen if worse than that happened? We disclose those on page 163 or 164, I think, of the annual report. We go through those stress tests and how we shock the portfolio.

[The Chair, Liberal, Wayne Easter]

Pierre, I've been letting everybody go over time. We have a fair bit of time today. Go ahead with a quick question, if you could.