Trump's global shakeup is complicating life for Canada's $2-trillion pension giants:
Ontario Teachers’ Pension Plan
Board chief executive Jo Taylor and his investing team usually rely on a
lot of real-world data when determining where to allocate billions of
dollars of investment money on behalf of retirees. But United States
President Donald Trump’s
flurry of edicts that threaten to upend global trade and geopolitical
alliances makes it hard to know what data points they should even be
looking at.
“The
predictability of what we’re investing in is lower,” Taylor said as
pension teams across the country dig into drafting and assessing
potential scenarios for a year that, given the prospect of multiple
pockets of economic and geopolitical unrest, could be very different
from those that came before it. “Looking forward and trying to predict
the future is more challenging.”
Globally invested pensions such
as Teachers’, particularly those with large exposure to North America,
are acknowledging that investment risks are rising as predictability
falls, and the uncertainty is not simply tied to a particular region,
sector or asset class like it sometimes is.
Trump exporting riskThe policies and rhetoric of the U.S. administration under Trump — including threats of escalating trade tariffs,
threats to annex Greenland, the Panama Canal and Canada, and warnings
about withdrawing traditional military support from European allies that
don’t meet North Atlantic Treaty Organization (NATO) funding targets —
are essentially exporting risk to governments and companies around the
world.
This,
combined with uncertainty of what he will say from day to day and his
ever-changing tariff policies, complicates decision-making at globally
invested pensions like the eight largest ones in Canada, which together
manage nearly $2.4 trillion to fund the retirements of millions of
Canadians.
“It’s hard to predict Mr. Trump,” is the blunt
assessment of Charles Emond, chief executive of Caisse de dépôt et
placement du Québec.
Pension managers typically assess risk and
asset allocation by using models, underpinned by data, to test their
portfolios and reveal what would happen against possible and plausible
scenarios. Sebastien Betermier, an associate professor of finance at
McGill University’s Desautels Faculty of Management, said they then
assign probabilities to each outcome.
The
problem now is that things are changing very fast — often from one day
to the next — and the movements being contemplated by the models are far
more extreme and wide-ranging than they have been in the past.
“These
scenarios capture regime shifts that are complex and hard to model
quantitatively,” Betermier said, adding that pension managers must rely
on a certain amount of “narrative building” in the absence of hard facts
and figures about how things will play out economically and
geopolitically.
What pension professionals can see is that the
U.S. equity markets that helped propel returns into the high-single and
even low-double-digit returns over the past year or more may no longer
reliably do so. Both the benchmark S&P 500 and the Nasdaq composite,
often viewed as a stand-in for the tech sector, slid into correction
territory in March.
Geopolitical risks risingThere are other less clear yet rising risks pointing to the potential for a global recession,
Steven Riddiough, an associate professor of finance at the University
of Toronto, said. The escalating trade wars already enveloping North
America, Mexico, China, the United Kingdom and Europe threaten to slow
growth across the board, he said.
But these conventional sources
of risk in economic and market systems do not even paint the full
picture for global investing entities, which are vulnerable to an
often-overlooked source that can cause major disruptions: geopolitics.
“Countries
and firms are seeing their exposure to geopolitical risk change in real
time. Many countries — especially in Europe — now feel far more
vulnerable as the U.S. creates uncertainty around its explicit and
implicit international commitments,” Riddiough said. “In effect, the
U.S. is exporting risk to foreign governments and firms through these
policy shifts, rapidly altering the risk profile of investors’
portfolios.”
In
Trump’s first term as president, he repeatedly said the U.S. might pull
out of NATO. Since he took office again in January, he has wielded a
different threat by targeting specific nations in the 32-country
alliance that don’t pay what he thinks is their fair share of the costs
to defend them.
This threat is being acutely felt in Europe, which
has relied on the U.S. as the primary guarantor for security since
shortly after the Second World War, as have many other countries. The
position taken by Trump and the White House on NATO-hopeful Ukraine,
including a public confrontation with President Volodymyr Zelenskyy that
suggested the U.S. may no longer help push back on Russia’s invasion,
sent fears through nearby NATO member countries such as Poland and
raised questions about whether an attack on one NATO member will
continue to be viewed by the U.S. as an attack on them all.
Such
challenges to nearly 80-year-old international understandings — not to
mention Canada suddenly being declared by Trump to be an enemy rather
than a partner in trade — are forcing pension managers to undertake far
more complex reviews than usual and face tough decisions across a number
of portfolios.
The situation is also challenging a key element of what has made large, globally invested pensions such as Canada’s so-called Maple 8 group
so successful: diversification. By spreading investments, from equities
to infrastructure, across public and private assets and buying in a
variety of countries, they reduce the downside risk of something going
wrong with a particular asset class or in a particular country or
region.
However,
with geopolitical upheaval spreading across jurisdictions and
threatening to penalize multiple sectors and asset classes, there could
be widespread repricing of risk, which would send investors fleeing to
safer assets in what’s known as a “risk-off” scenario.
“In
extreme risk-off scenarios, it’s like everyone rushing for the exits in
a burning theatre,” said Riddiough, whose resumé includes a consulting
stint with the Canada Pension Plan Investment Board on global tactical asset allocation.
“In
those moments, assets that normally move independently start selling
off in unison. In the most extreme case, if everything sells off in
exactly the same way, then it doesn’t really matter how many assets you
hold; it’s as if you only own one.”
Canadian
pension managers have increased investments in private assets over the
past decade or more in part to avoid getting caught in such scenarios.
Because assets such as real estate,
private equity and infrastructure don’t trade frequently or in as
volatile a manner as public markets, they can preserve value — and mask
elevated risk — even when public markets plummet.
However, new
approaches to valuing private assets are threatening to close this gap,
which can also make these less liquid assets difficult to exit in times
of crisis due to large gaps between what sellers and buyers think the
assets are worth — as happened with commercial real estate after the
COVID-19 pandemic spurred a surge in remote work and office building
vacancies skyrocketed.
“It’s
increasingly difficult to hide the elevated risk by overweighting
private markets because many firms are building tools, using
data and AI, to quantify private market risk in real time,” said Kenneth
Kroner, an economist and finance professional who spent two decades at
investment company BlackRock Inc., where he oversaw multi-asset
strategies and systemic active equities as a senior managing director
and member of the global executive committee.
“In a few years, the
true risk of private investing will be quantified and well-understood.
In the meantime, I think most sophisticated boards … aren’t fooled one
bit,” he said. “If I were a portfolio manager (at one of Canada’s big
pensions), I’d emphasize to my board (and) clients that risk is elevated
even though the data might not currently say so.”
Still, the Edmonton-born Kroner, who was a director at Alberta Investment Management Corp. (AIMCo)
for seven years until a government-led shakeup resulted in his
departure along with the rest of the board last year, said he doesn’t
think Canadian pensions should be making any sudden moves in the way
they invest in response to Trump.
Pension
managers should focus on their advantage, which is long-term investing.
Today, that’s clearer than at any time in my career
Kenneth Kroner, economist and finance professional
Instead,
he said, they should be scrutinizing everything that is happening and
modelling what the consequences are likely to be in order to focus on
what will survive in the years well beyond his presidency and invest
based on that.
“I would study and understand those risks now,” he
said. “But I wouldn’t invest for those risks until I believe that
they’ll be a reality in 10 years’ time.”
Long-term viewFor
example, pension professionals should be asking themselves what trade
policy will look like in a decade, rather than simply looking at what
Trump is proposing now, Kroner said. Another key question is where
innovation will be strongest at that point, if not the U.S. There is
also the question of how shifting alliances today are likely to alter
geopolitical order beyond the lifetimes of current country leaders.
Some
will try to profit from the “noise” around Trump, including his
shifting rhetoric on tariffs and threats to bring economic harm to
Canada to get what he wants on issues including trade and NATO funding,
but he said he would not advise pensions to try to pick short-term
winners and losers.
“The
noise level is just too high to make informed bets along these lines;
leave those bets to naive investors,” he said, adding that the
investment horizon of pension funds gives their managers the option to
set a different course. “Pension managers should focus on their
advantage, which is long-term investing. Today, that’s clearer than at
any time in my career.”
This means closely scrutinizing the impact
of the fast-shifting geopolitical order, which has the potential to
crimp growth and long-term returns.
“The (traditional) U.S. axis
has the potential to split into two further axes: those aligned with the
U.S. and those not,” he said.
The
isolationist path of the U.S. is raising questions about whether
economic growth can continue at the clip that has been helping pension
returns over the last decade or more. Even the U.S. Federal Reserve
reduced its outlook for gross domestic product (GDP) growth to 1.7 per
cent from 2.1 per cent, while inflation is forecast to grow and interest
rate cuts could be off the table this year.
After
Teachers’ turned in an annual return of 9.4 per cent for 2024, Taylor
said his team had begun to assess whether the U.S. can continue to
provide the fund with the same level of risk-adjusted returns to justify
adding to the $99 billion invested there.
“The question is, how much more do we want to build on top of that versus other parts of the world?” he said.
Kroner
said portfolio managers considering how to play the evolving situation
should move away from investing in traditional global indexes such as
MSCI World and All Country World indexes, which provide exposure to a
broad basket of large and mid-cap stocks in developed countries and
emerging markets, and instead create new indexes that reflect the shifts
and splintering of alliances and trade.
He said pensions should also focus on higher-growth segments of the market that prioritize innovation.
“To
overcome the growth deficit, one should invest heavily in markets where
innovation is best supported,” he said. “Arguably, that’s what we’ve
done for decades, but that might no longer be the U.S., like it has been
historically.”
Kroner said pension managers should be the
repricing the risk of investing in Europe, particularly countries in the
NATO alliance.
“No matter how you slice it, the risk of investing in NATO countries is elevated and will remain so for a few years,” he said.
In
one scenario, pension managers could reprice the risk of NATO countries
as a whole, taking the view that Trump’s stance will affect them all
negatively. In another, the risk for investments in counties most likely
to feel threats from Russia if U.S. support wanes, such as Poland,
could be repriced.
In
either scenario, Kroner said, assets should be reallocated to countries
outside NATO based on the changing risk-reward calculus.
“The risk is a broad geopolitical risk,” he said, adding that he favours the first scenario. “The
alternative is to go through all the NATO countries and come up with a
personal view of the Trump impact on each individual country, and that’d
be a challenging exercise to get right.”
Homegrown challengesSome
“homeshoring” — reallocating investment to a pension fund’s home market
— is an obvious strategy, he said, though this is potentially a
difficult one for large Canadian pension funds whose managers have
complained for years that large, private infrastructure investments —
from toll roads to airports — aren’t made available to them.
They
have also pushed back on pressure to invest more in Canadian companies
via stock markets due to concerns it would lead to overconcentration in
their home market and a reduction in long-term returns generated through
diversification.
After Teachers’ reported its latest annual results in March, Taylor reiterated the former.
“We’ve stated for a while that we have a strong desire to try to invest more in Canada in larger assets,” he said.
Another
alternative would be for the pension giants to shift investments away
from NATO countries to similar economies, such as Latin America and
Asia, Kroner said.
“What I would do is move some percentage away
from NATO (countries), say, five per cent,” he said. “Half of that would
come home and half would go to a LatAm index and an Asia index.”
Within Asia, China presents its own risks for pension managers, though growth is not the primary concern.
“Investments
in the China axis are extremely risky because of the very high risk
that they become stranded assets,” Kroner said. “I’d recommend that
institutional investors either avoid investing in this axis, or at least
keep their allocations to something less than cap-weight” — a less
risky way to invest in a basket of assets in an index.
The Canada
Pension Plan Investment Board has significant investments in China, but
its exposure, once representing more than 10 per cent of assets, has
been declining since 2021 and the fund has committed resources and
attention to other countries in the Asia-Pacific region.
Teachers’
and others in the Maple 8, including the Caisse and British Columbia
Investment Management Corp., paused direct investments in China in 2023
and Teachers’ plans to close its Hong Kong office this year while
targeting a doubling of investments in India over the next five years.
Concerns
about China came to the fore a couple of years ago amid government and
regulatory crackdowns on tech businesses, but the world was still more
or less perceived to be under the steady hand of the U.S.
With
that in the rearview mirror, Kroner said institutional investors should
be preparing for some pretty bad outcomes, including wars.
“But,”
he said, “nothing has changed on this front since Trump, in that
investors should always prepare for bad outcomes” through good risk
management and scenario analysis that look at what could happen to a
portfolio in very bad scenarios.
“The only difference this time is that Trump has made some of these negative scenarios pretty easy to envision,” he said.
It's a big problem and while the inclination is to shift away from the US to domestic or ex-US assets, I do agree with Kenneth Kroner, AIMCo's former Chair (featured above), it would be wise to resist making impulsive decisions based on the latest news.
The truth is nobody knows where Trump is headed with these tariffs.
All I know is Trump 2.0 is off to a terrible start and if it's one thing you need to remember about Trump is he's incredible vain and will likely fold on tariffs when the going gets tough.
In that regard, he's highly predictable.
In fact, last week, when he caught wind that Canada and the EU were coordinating a response, he showed his cards by panicking and stating the will significantly increase tariffs if that were the case.
That is telling but it shows you Trump doesn't really want to start a tariff war.
The good news is by the end of the week, we will know where his administration stands on tariffs.
The bad news is they might go through with these tariffs in the near term as a form of negotiation and that will wreak havoc on global markets and possibly send the global economy including the US into a recession.
More bad news might also come in the form of US economic data that confirms a recession has arrived.
This week we get the ISM tomorrow and then the big jobs report on Friday.
Thus far, the market is in RISK OFF mode and rates are creeping higher as investors price in stagflation.
I don't get carried away with short-term movements but it's clear growth and hyper growth stocks are bearing the brunt of this policy uncertainty.
Still, I noticed stocks came back strong today, especially growth stocks which were selling off hard at the open.
This tells me the market is sniffing out lenient tariffs but we are also closing out a bad quarter, portfolio rebalancing is helping cushion the blow and adds to volatility.
Whatever happens the rest of the year is anyone's guess.
Will stagflation prevail? Are we headed to a long tariff war which causes a global economic recession?
Again, nobody really knows, all long-term investors can do is diversify and be ready to seize opportunities as they present themselves.
Below,Scott Wren, Wells Fargo Investment Institute Senior Global Market Strategist, and Victoria Greene, G Squared Private Wealth CIO, joins 'Closing Bell Overtime' to talk the impact of tariffs on the market.
Next, Doug Rediker, founder and managing partner of International Capital Strategies, says the Trump tariff plan is fraught with uncertainty and Wednesday's announcement likely will bring only some clarity.
Third, Chris Verrone, Strategas Research Partners chief market strategist, joins 'Closing Bell' to discuss markets, making sense of the sector rotation and more.
Lastly, Joseph LaVorgna, SMBC Nikko Securities America chief economist and former Trump Economic advisor, and Mark Zandi, Moody’s Analytics chief economist, joins 'Closing Bell Overtime' to talk the impact of tariffs on the economy.
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