Amid all the talk about the tax leakage and problems for small investors and the government due to income trusts, we see that the Canadian Pension Plan Investment Board (CPP IB) has prposed to the federal government that it should spin-off and build a real estate investment trust (REIT).  The CPP invests on behalf of 16 million working Canadians and not only holds income trusts of all kinds.  With business trusts in its equities portfolio, the CPP has turned the public pension fund from deficit to surplus during the 10 year rise of income trusts.

This is significant, particularly because the CPP faced a deficit a decade ago that was so large that reports at that time said many Canadians felt they might not be able to depend on the public pension plan to fund their retirement. Particularly with an aging population, the federal agency faced a big and growing problem in its mandate funding the retirement of Canadians.

According to its recent report from the chief actuary for the federal government, the Canada Pension Plan is holding surplus of nearly $100 billion in 2006. The plan is not only working on a sustainable basis to cover Canadian needs for the next 75 years. The CPP funds are expected to grow the surplus to $147 billion in the next few years.

With a view to generating even better returns for Canadians, suggestion has been made to bundle together the fund’s real estate portfolio, now worth $3.3 Billion, and spin it off to the public as a REIT. Such a transaction could provide Canadians a profit through the REIT while minimizing fund management costs of about $300 million a year while avoiding certain government obligations in the current structure of the portfolio.

In terms of overall holdings, the CPP currently involves:
- $58 Billion in public equities;
- $5 Billion in private equity;
- $25 Billion in bonds;
- $10 Billion in inflation sensitive investments;
- $1 Billion in cash reserves and money market funds.

If people focus in on the public equities, they’d see that the CPP portfolio includes:
- $26 Billion in Canadian equities;
- $32 Billion in foreign equities.

For the reader who goes a bit further and looks at current holdings, they will see the long list of income trusts in the CPP fund.  While current numbers are announced in summary as part of the first quarter 2007 report, the specific list dates from the end of March 2006 [pdf]

Returns on the fund certainly rise and fall year to year.  They appear negative compared to prior years.  But significant gains were made during the last few years with the rise of income trusts and an increase in the CPP holdings of trusts.

Most notable to a leery investor listening to all the media hype about busienss trusts, the CPP holds business trusts with a stake of a million dollars or more in each. There are also oil and gas income trusts, royalty funds and approximately $5 Billion in real estate holdings.

While some had once dismissed the capability of the Board to turn around its fund management performance, many are noting that the CPP is a professionally run fund that is doing very well.  CPP investments returned an average of 8.6% per annum over the past five years. And in the future: The report says that the chief actuary expects that the overall CPP portfolio can grow 4.2% above inflation each year and over the long term.

Contributions to the fund by working Canadians is now 9.8% of their gross earnings with expectation that this will grow to more than 11% in the next 40 years.

The key change in performance results involves a switch in the group’s investment policy away from holidng only Canadian federal and provincial bonds for the sake of steady returns, as it did in the 1990’s. 

The fund has clearly moved towards a more broadly diversified portfolio including investment in foreign public equities and private overseas developments. And the CPPIB has proposed emphasizing growth in its holdings of infrastructure projects including roads and other public facilities. For example, the CPPIB is now looking to own a one quarter stake in a US$4 Billion water and sewage operation being assembled by a consortium in Great Britain.

Income trusts including real estate investment trusts, oil and gas as well as resource funds that trade on the Toronto Stock Exchange provide a significant foundation and growth potential for the Canadians through the CPP fund. 

Political action to limit the potential for these kinds of investments would be political suicide and a gigantic problem for 16 million Canadians who depend on the public pension plan to pay for their retirement.