A lot of us think of risk in purely negative terms. We avoid it, as much as we can. And we believe we’re right to do so.
When it comes to managing your money however, risk is inevitable. There is an element of it in all financial decisions. Rather than seeing it as a good or bad thing, it’s useful to think about risk as a tool you can put to good use.
Take a simple mutual fund investment for example. Invest $100 in the fund, and there is a risk that you will suffer a short-term loss. It is unlikely that your loss will persist over the long term though. Stock and bond markets have shown a strong tendency to rise over long periods of time. So, you may decide to accept that risk of loss because simply leaving that $100 in a bank account will not earn you the kind of return on investment you need to prepare for retirement.
Effectively, you’re accepting risk in order to earn a return. And as we know from centuries of investment market performance, the more risk you’re prepared to accept, the greater your potential return can be.
Managing risk at CPP Investments
As the investment manager of the Canada Pension Plan (CPP) Fund, CPP Investments makes decisions based on how each investment fits into our overall risk profile. As a result, we earned a 10.8% annual rate of return on investment during the 10-year period ending Mar. 31, 2022. Our five-year return as of the same date is 10.0%. Both numbers represent what we’ve earned after all expenses are subtracted.
Certain industries or individual investment opportunities are riskier than others. The same is true of investing in certain parts of the world. For example, our portfolio includes low-risk government-issued bonds at the same time it includes higher risk private equity assets, where we’ve invested directly into a company that is not listed on a public stock market. The bonds are likely to deliver a relatively modest return. Private equity investments offer the potential for higher returns.
In fact, we run multiple investment programs covering all major asset classes. Investments are selected after rigorous, professional analysis and internal management review. The portfolio is structured to be resilient in the face of wide-ranging market and economic conditions. A set of circumstances that causes a decline in the value of one or more investments, will often have the opposite effect on other investments held in the Fund.
Because we aren’t dependent on investments in any one country, currency or region – and because we take a long-term view – we are able to manage and mitigate significant risks and achieve an effective balance of risks and returns.
You’ll sometimes hear us refer to “risk-adjusted returns.” Technically, that’s a calculation of an investment’s possible profit that also takes into consideration how much risk it represents.
Put more simply, we select investments to earn the greatest possible return, without taking on unnecessary levels of risk. Which is precisely what our mandate calls for.