by Adam Mayers Personal Finance Editor, Published on Mon Mar 07 2016
With interest rates below zero in real terms, big pension funds are on the hunt for things they can buy that behave like bonds. You can copy their behaviour.
The Port of Southampton is one of 21 British ports purchased by the Canada Pension Plan Investment Board in the last year. CPPIB also bought 40 student residences in the UK and more in the U.S.
Here’s a quiz: What do these things have in common?
- Student residences in Philadelphia and Phoenix, Birmingham and Glasgow.
- A nine-kilometre underground toll road in Sydney, Australia.
- A pipeline in Peru that moves 95 per cent of the country’s natural gas, which in turn generates half of Peru’s electricity.
The first is that every Canadian owns them through investments made by the Canada Pension Plan Investment Board (CPPIB) in the past 12 months. The CPPIB is the investment arm of the CPP. It generates the cash that pays your pension.
The second is that these investments — which are worth billions — are part of a decade-long trend by the board and other large pension funds to find new ways to generate higher returns. In a sign of the times, last week the Ontario Teachers Pension Plan (OTTP) and OMERS, the municipal employees plan, announced a deal that bought a small airport in downtown London, England.
The moves are a reaction to interest rates that have been near zero in North America for eight years and are below zero in Europe and Japan. Bonds that were once the staple of pension funds are losing money after inflation.
The solution is to go after things that aren’t quite bonds, but behave like them.
When you buy a bond, you lend money and in return get a stream of interest payments, plus your money back at some future date. Student dorms are a good proxy for them. Along with the buildings, the rent is yours. Residences are always full, so like a bond they are a low-risk investment with a predicable, long-term return.
Rents rise with inflation, and not many new residences are being built. Toll roads and ports are similar; they’re expensive to build, there’s not much competition, and there are plenty of repeat customers. Think of the 407 ETR, which is 40 per cent owned by the CPP.
As individuals, we can’t hope to match the deep pockets and patience of a pension fund, where “quarter” means quarter of a century, not three months. But you can get some clues from their behavior and copy them.
Their investments have a number of things in common:
- The deal with repeat customers, whether they are commuters or shippers.
- They control prices, whether those are tolls, rents or port fees.
- They are recession-resistant. College and university kids always need a place to sleep.
- They are in businesses with high barriers to entry. Highways and pipelines are expensive.
Gavin Graham, chief strategy officer for Toronto pension fund advisor Integris Pension Management Corp., says low and negative interest rates have destroyed the assumptions behind traditional pension fund design.
Integris designs individual pension plans for doctors, lawyers, small business owners and entrepreneurs.
The traditional model was that 40 per cent of a pension’s income came from plain vanilla government bonds. Back in the day of high yields, that worked. Today, though, negative interest rates are the norm in Europe. After inflation, they’re below zero here.
So now, funds are walking up the risk ladder. The big ones such as the CPP can buy roads, real estate and railways because they have deep pockets and a long horizon.
These investments makes sense for those pensions, Graham says, because “an airport, rail line or dorm is a long-term asset with an income stream. Not many are being built.”
Graham says individuals can improve their returns by imitating the giants. This includes buying the bonds of investment-grade companies, investing in infrastructure funds, or buying stocks directly.
Some of his examples that are traded on the TSX include TransCanada and Enbridge (pipelines), Fortis and Emera (electrical utilities), SNC Lavalin (engineering) and Brookfield Asset Management (global real estate and infrastructure).
Like others, Graham believes the outlook is for a prolonged period of low interest rates. We’re all going to have to adapt to get ahead. Looking at how the pros do their investing is one place to look for clues.