Government needs a set of fresh eyes to look at Investment Manager

Few Alberta municipal workers, health care workers, police officers, or provincial civil servants have ever heard of the Alberta Investment Management Corporation (AIMCo). This corporation, established by statute in 2007, and operating since 2008, now manages over $90 billion in investments, including the assets of the Heritage Fund. The corporation manages money for 26 pension, endowment, and government entities. AIMCo manages over $46 billion on behalf of roughly 336,000 active and retired members of public pension plans representing hundreds of government and agency employers. Prior to 2008, the management of these large investment funds had been undertaken by public servants employed by the Finance Ministry. The success of this organization is important for all Alberta residents, not just retirees, because some of these pensions have what are known as “unfunded liabilities.” Unfunded liabilities are equivalent to deficits which must ultimately be made up if retirees are to receive their full pension entitlement. While the pensions themselves are not formally guaranteed by the Crown, it is very unlikely that a future government would be indifferent to the plight of active members and pensioners if these deficits became too large. People might remember the Stelmach government contributing roughly $1 billion towards the deficit of the Teachers’ Retirement Pension Fund. 

Investment management is a complex undertaking and many people defer to investment advisors or “professionals” to manage their retirement funds. People that manage money usually are paid very well. And so it should be, if they achieve returns above what the average market return is over the long-run. By 2005, the Alberta government decided to examine whether the organization of this vital function should be re-structured. A report by two consultants recommended moving the investment management and administration function outside government into a provincial corporation. The authors suggested that a board, led by qualified persons operating independently from government, with an investment philosophy modelled after the Ontario Teachers’ Pension Plan, could improve returns by 2 to 3 per cent each year. In introducing the Bill to create the new corporation, Lyle Oberg suggested a more conservative improvement of between one quarter to one-half a per cent might take place. Given he large asset base of the funds being managed, the enhanced returns were in the hundreds of millions of dollars. A second motivation for hiving off the Alberta Investment Management division (AIM) was to build up a strong, local centre of expertise in investment management. It sounded like a good idea at the time- but was it?

Remarkably, there was (and is) no government plan in place to evaluate whether AIMCo has met the expectations of its creators. In a research paper published by the Institute for Public Economics, I set out to examine the question of whether AIMCo has added more value than its predecessor organization. I looked at the reported four and five year rates of return achieved by AIM above the stated “benchmark” for the Heritage Fund and the three largest public sector pension plans (Local Authorities Pension Plan, Public Service Pension Plan, and the Management Employees Pension Plan) up to 2007-08. I then compared AIMCo’s four and five year performance above the benchmarks up to 2014-15. (A benchmark is the performance of a predetermined set of securities, used for comparison purposes and are often based on published indexes (TSX) or may be customized to suit an investment strategy with a range of different investment classes (e.g. equity, fixed income, private equity).

In undertaking this study, I consulted with a number of experts who cautioned that doing such a comparison is rife with challenges. For example, AIMCo “inherited” its portfolio during the financial crisis, and so took on what might be termed legacy investments. Should the performance of AIMCO be poor in the early years of its mandate, it may be due to poor investments or investment strategies made by the predecessor organization. Since AIMCo commenced business in January 2008, the year the financial crisis came into full view, returns at AIMCo were calculated beginning in 2010. While there were some poor investments in the credit area and, possibly, in private equity, my study did not discover significant portions of the portfolio that indicated wholesale problems. Another challenge when comparing returns is which benchmark do you use? Is it appropriate and does it change over time? To account for this, the benchmarks are taken from the report of the funds themselves and therefore are chosen by the boards, not by AIMCo, and reflect the asset mix of the portfolio which changes gradually over time.

My findings were AIMCo’s performance for the Heritage Fund and Local Authorities Pension plan was poorer than AIM’s, the same for the management plan, and better for the public service plan. But overall, AIMCo’s performance was either no better, or not superior, to its predecessor organization. However when comparing AIMCo and AIM’s performance against other large investment funds such as the CPP and Ontario Teachers’ Pension Fund, AIMCo’s performance against these other funds is better than AIM’s. But such tests are highly dependent on the selection of time periods. Another factor adding to the complexity of comparisons is the use of leverage by different funds. The investment funds studied do not appear to employ leverage to boost their returns.

A second major finding was that investment expenses of the funds rose significantly since AIMCo’s inception. In the case of the Heritage Fund, expenses as a percentage of assets rose 110 per cent over seven years and for the management plan, the costs escalated by 221 per cent. To be fair, the nature of the investments changed from less costly equities to more expensive private equity. Still, higher expenses do reduce the returns to the funds’ beneficiaries unless the return on these investments is higher to more than compensate for the higher costs of managing these assets.

A third finding was that the main beneficiaries of the change in structure were the employees of AIMCo. Salaries and benefits at AIMCo more than tripled which was not a surprise as average salaries grew from about $157,000 to $209,000 over seven years and employment nearly tripled. But the top five executive officers’ salaries rose from $4.1 million in 2010 to $10.9 million in 2015. The five top executive salaries grew at more than seven times that of AIMCo’s staff and the biggest gains were in the first two years were for staff. (Average staff salary includes the salaries of the top five executives.)

The study raises a number of questions. First, was the goal of corporatization achieved? Secondly, why has the current or former government not established a review process to assess this policy experiment? Third, how did the board of AIMCo carry out its responsibilities in guiding the corporation towards meeting the performance expectations of the government? And finally, the chief beneficiaries of the re-organization appear to be the staff and notably the executives of the new agency. With a new provincial government in place, and after nearly 8 years operating as a provincial corporation, is it not time for a public review of the investment performance and governance of AIMCo? Is it also time to re-examine some of the market-based assumptions used for compensation employed by the board for managing investment performance? This is not a call to necessarily reconfigure the organization and start anew, but rather to carefully assess the strengths and weaknesses of AIMCo’s business model and reflect on the effectiveness of the status quo.

 

Bob Ascah is a Fellow with the Institute for Public Economics. The study can be found

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