1 Asset-Liability Mismatching and Value Added Strategies John H. Ilkiw Portfolio Design & Risk Management CPP Pension Board Treasury Seminar CAUBO Conference, Montreal June 18, 2006

2 Overview 1.Risk-Return-Accountability at the CPPIB 2.CAUBO vs. CPPIB: Similar, but Different 3.CPPIB’s Approach to Private Equity 4.Q & A

3 1.Risk-Return-Accountability

4 CPP Rate And Benefit Changes Percent of YMPE 1966 CPP inception date 10 year benefit phase-in 3.6% contribution rate Benefit improvements No rate changes 1987 Benefit improvements Pre-set schedule of rate increases to 10.1% in Benefit reductions Rapid rate increases to 9.9% in 2003 instead of 7.35% Increased funding “Fail-safe” financing formula CPPIB established We are here with a 9.8% sustainable rate

5 Reforms Captured Three Principles  Intergenerational fairness –Higher rates now, lower rates in the future –Capital market returns help lower future rates –50 bps of additional return lowers future rate by 25 bps Affordability –Legislated rate should not exceed 9.9% (hopefully) –Reduced future CPP benefits –9.9% in 2030 instead of 14.2% pay-go rate Sustainability –Mid-course plan design adjustments, if required –Self-correcting “fail-safe” adjustment if political process stalls –Arms-length management of assets under fiduciary mandate

6 35% Debt Asset Class Weighting 65% Equity Functions as the starting point for our actual portfolio decisions Step 1: Introduced a “CPP Reference Portfolio” 25% 40% Canadian EquitiesForeign Equities 25% 10% 100% Canadian Nominal Bonds Canadian Real Return Bonds Total

7 Why 40% Foreign Equity? Why Unhedged? High long-term expected return Diversifies total portfolio volatility Mitigates risk of lower than expected wage growth, which would increase sustainable contribution rate Currency exposure magnifies risk mitigating properties of foreign equity

8 Easy to evaluate management decision-making Easy to understand by stakeholders Partially matches CPP net liabilities Embodies return requirement and risk exposure envisioned by federal-provincial stewards Low cost, low complexity but viable strategic option Advantages of CPP Reference Portfolio

9 Build a Better Beta Portfolio 1 1 CPP Reference Portfolio Net Liability Mimicking Portfolio Capture Attractive Sources of Alpha 2 2 Core Elements of CPPIB’s Approach to Adding Value Take Advantage of CPPIB’s Unique Situation 3 3 Necessary Asset-Liability Mismatch Step 2: Explained Sources of Expected Improved Performance

10 Expected Return Sustainable Rate (%) Improved returns relative to CPP Reference Portfolio Risk reduction relative to CPP Reference Portfolio 10.0 Capturing Attractive Alpha Building a Better Beta Portfolio 1 1 CPP Reference Portfolio Illustrative (Not to Scale) 5.0 Expected Risk (Legislated Rate) Step 3: A System to Measure and Report Success

11 Judging Long-Term Success Reference Portfolio Earns Returns at Level Expected by Stewards (Mission 1) CPPIB Outperforms Reference Portfolio (Mission 2) Policy CPPIB Policy CPPIB  Policy  CPPIB Policy  CPPIB  Yes No Yes No

12 2.CAUBO: Similar, but Different

13 ISSUECAUBOCPPIB FundingFull (70:30) Partial 1 (30:70) Risk Being ManagedTermination InsolvencyCash-flow Insolvency Time HorizonShort (5 years) Long (75 years) Risk-sharingFuzzyExplicit GuarantorEmployer, Members, PBGF, Taxpayers? Employers, Employees ScrutinyHighHigher SizeSmallBig CAUBO vs. CPPIB 1 In steady-state (i.e. >2030)

14 Hedge Fund and Private Equity Exposure CAUBO Endowment and Pension Funds As at December 21, 2004

15 3. CPPIB’s Approach to Private Equity

16 CONVENTIONAL WISDOMCPPIB Wide return dispersion across managersYes Managers returns exhibit persistenceYes Manager selection and access key to successYes Poor liquidityYes Good source of cash-flow (seldom asked)Yes TWR and IRR returns not comparable, but investors have no alternatives Yes/No Strategic returns above public equityNo Good risk diversifierNo Diversification of PE exposures essentialNo Target at least a 5% policy exposure to PENo CPPIB Views on Private Equity

17 Private Equity: A Security Selection, Not Asset Allocation Decision …… US Index Exposure Consumer Durables …… $400 million Consumer Durables Invest $400 million in buy-out of US consumer durable company Sell $400 million across US consumer durable sector Removes sector exposure Captures private equity Alpha decision Manage index fund to adjusted weights US Index and Active Exposures

18 Private Equity Guidance to CAUBO Members No strategic premium for LPs – the GPs almost always win Manager selection and access the keys to out-performance Successful programs require access to best funds over successive vintage years Fund-of-funds best route for most CAUBO members, but think twice  Diversification can erode above market returns  Extra layers of fees raise hurdle  Manager selection skills and funds access can be fleeting  One reputable study suggests fund-of-funds have lowest returns Hedge funds may offer better opportunities  A discussion for another day

19 4. Q & A