Build Your Own Pension-Fund Portfolio - MoneySense

Build Your Own Pension-Fund Portfolio

It’s always interesting to know what the smart money is doing. And I’m not talking about the investment managers who appear on BNN to “talk their book” — like the guy who runs the precious metals fund and suggests you by precious metals. The smart money are the managers of pension and endowment funds worth […]

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It’s always interesting to know what the smart money is doing. And I’m not talking about the investment managers who appear on BNN to “talk their book” — like the guy who runs the precious metals fund and suggests you by precious metals. The smart money are the managers of pension and endowment funds worth billions. They earn their salaries by  producing excellent investment results, not by charging high fees while delivering mediocre returns.

Steve from the Think Dividends blog recently suggested I look at creating a portfolio aligned with the asset allocation used by the Ontario Teacher’s Pension Plan, the biggest and one of the most successful pension funds in the country. However, the OTTP’s portfolio is impossible to shadow with ETFs: much of it is private equity and hedge funds. Besides, anyone who invests in the Toronto Maple Leafs can’t be taken seriously. Instead, I looked to the Pension Investment Association of Canada, which compiles data on 130 pension funds.

Before considering how you can use this information to help you design your own portfolio, remember that pension funds are not like individual investors in some important ways. First, they have an infinite investment horizon. The rest of us will eventually retire and die, hopefully in that order. Pension fund managers also have access to investment opportunities that are unavailable to individuals: private  equity, hedge funds and risk-management tools such as derivatives. While most institutional funds employ passive strategies — that is, they invest in entire asset classes rather than picking individual securities — they also use active management to try to exceed their benchmarks.

That said, the composite asset allocation of 130 pension funds represents the collected wisdom of managers who handle over $905 billion. Here’s how they invested that staggering sum, as of December 31, 2009:

Canadian equities 15.9%
US equities 6.4%
EAFE equities 6.3%
Emerging markets equities 2.3%
Global equities 13.0%
Total equity 43.8%
Canadian nominal bonds 25.6%
Real return bonds 4.7%
Mortgages 0.7%
Foreign fixed income 1.9%
Cash and equivalents 0.1%
Total fixed-income 32.9%
Real estate 9.0%
Infrastructure 3.9%
Venture capital/private equity 6.0%
Hedge funds 2.0%
Other assets 2.4%
Total other 23.3%

Turns out that only about 10% of these assets fall into exotic categories: the 6% allocated to venture capital and private equity, the 2% to hedge funds, and the 2% lumped together as “other.” The small allocations to mortgages and foreign fixed income are too small to worry about in a small portfolio, so we’ll just include them with other nominal bonds. It’s impossible to know what countries have the most weight in the “global equities” category, but we’ll divide up that 13% among the US, international developed and emerging markets. When we round off some numbers for simplicity, we can boil down our model pension-plan portfolio and simulate it with these ETFs:

Asset class

Exchange-traded fund
Canadian equities 15% iShares S&P/TSX Capped Composite (XIC)
US equities 15% Vanguard Total Stock Market (VTI)
EAFE equities 15% Vanguard Europe Pacific (VEA)
Emerging markets equities 5% Vanguard Emerging Markets (VWO)
Real estate 10% iShares S&P/TSX Capped REIT Sector (XRE)
Infrastructure 5% BMO Global Infrastructure Index ETF (ZGI)
Canadian nominal bonds 30% iShares DEX Universe Bond (XBB)
Real return bonds 5% iShares DEX Real Return Bond (XRB)

The first thing you’ll notice is that this is a very conventional portfolio — if you consider the infrastructure component just a specific type of global equity (which it is), it’s almost identical to Canadian Capitalist’s Sleepy Portfolio. Maybe CC should send his resume to some pension funds and offer his services as an investment manager.

Of course, pension funds are a lot more sophisticated than your average Couch Potato — I’m pretty sure they don’t buy ETFs through BMO InvestorLine. But overall, their strategy comes down to investing in a diversified mix of Canadian and foreign stocks, real estate and bonds. If you’re doing the same with your indexed portfolio, count yourself among the smart money.

Filed under: Asset classes

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