The World’s Best Pension Funds Are Canadian. Sorry.

Here’s why they’re producing superior returns, according to researchers from McGill University.

Illustration by Tim Peacock

Illustration by Tim Peacock

Canada’s pension funds are beating peers globally in investment performance and are stronger at hedging against liability risks, according to research from McGill University and CEM Benchmarking.

Their success is partly explained by the fact they are more likely to manage their assets in-house, McGill researchers Sebastien Betermier and Quentin Spehner, along with CEM’s Alexander Beath and Chris Flynn, wrote in a July paper. The authors’ findings are based on a study of pensions, endowments, and sovereign wealth funds globally between 2004 and 2018.

Large Canadian funds in particular outperformed in all measures of the study, which analyzed returns, asset allocation strategies, and cost structures. The authors defined large funds as those managing more than $10 billion in assets in 2018.

“Not only did they generate greater returns for each unit of volatility risk, but they also did a superior job hedging their pension liability risks,” the authors wrote. “The ability to deliver both high return performance and insurance against liability risks is notable because hedging is typically perceived as a cost.”

While the Canadian model has yet to be fully tested by the Covid-19 pandemic, the researchers said the strong performance of the country’s pension plans over the past decades kept them well-funded even as they faced the challenge of falling interest rates and rising life expectancy. U.S. corporate funds, meanwhile, are relatively expensive to run as they outsource a majority of their investments, according to the paper.


On average, Canadian pensions manage 52 percent of their assets in-house, compared with 23 percent for funds outside the country, the McGill and CEM researchers found. The gap was even wider for very large funds overseeing more than $50 billion of assets, with Canadian pensions managing 80 percent internally versus 34 percent for their global peers.

“We estimate that, by managing a high proportion of their assets in-house, Canadian funds reduce costs by approximately one third,” the researchers said. “Moving the investment team in-house requires independent corporate governance and competitive compensation schemes to attract and retain talent.”

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Another distinctive feature of large Canadian funds is the “re-deployment of resources to investment teams for each asset class,” according to the paper. While spending less on external managers, Canada’s funds outspend peers on their internally-managed portfolios, the researchers found.

“These patterns hold true within each asset class and style,” they said. “Examples of expenses include risk management units and IT infrastructure where Canadian funds spend more than their peers by a factor of 5.”

Large funds in Canada also stand out for allocating capital to assets that increase the efficiency of their portfolios and hedge against liability risks, according to the researchers. They pointed to commodity-producer stocks, real estate, and infrastructure, saying the savings reaped from in-house asset management allows the funds to invest more in real assets. Although real assets tend to be more expensive to manage than stocks and bonds, Canadian funds allocate 18 percent of their portfolios to this area — or double the allocation of their global peers, according to the paper.

In another distinction, the researchers said large Canadian pensions index their liabilities, making it easier “to hedge against their liability risks by owning a diversified mix of growth assets.”

A high proportion of their pension liabilities is indexed to inflation, driving strong asset-liability performance, according to the paper. “Indexed liabilities tend to correlate more with growth assets than nominal liabilities,” setting the funds up to invest in growth assets that strengthen both return performance and liability hedging, the authors explained.

Adopting the Canadian model could pay off in the U.S., the researchers found.

In doing so, U.S. public funds would have seen a 15 percent absolute increase in the 15-year Sharpe ratio of their asset portfolios, a 13 percent rise in the 15-year Sharpe ratio of the asset-liability portfolio, and a 20 percent increase in the correlation between assets and liabilities, according to the paper. “These estimates do not include any additional performance resulting from the Canadian funds’ decision to spend more in each asset class,” the researchers said.

Their back-testing similarly found that corporate funds in the U.S. would benefit from Canada’s approach to pension investing.

“For U.S. corporate funds, which already hedge a high proportion of their liability risks, the adoption of the Canadian model would have also led to increases in all performance metrics,” the authors wrote, “but mostly in the Sharpe ratios through the reduction of costs associated with in-house management.”