Today, the 10 largest pension plans in Canada control over $2 trillion of assets on behalf of Canadian beneficiaries. At the end of 2022, these pension plans had an average of 46.2% of their assets invested in alternatives - specifically, 15.1% in real estate, 13.0% in infrastructure and 18.1% in private equity.

Following the example of their US peers, some Canadian pension plans (CPPIB, OTPP, OMERS and OP Trust) stand out from even this group with over 50.0% of their assets allocated to alternatives. Reviewing the 2022 and 2023 Annual Reports of each of these pension plans indicates that the most common motives for having higher allocations to these three sectors is the long-term risk-adjusted returns, inflation hedging and current income.

With an average of 46.2% of assets in alternatives, some may wonder what the average allocation to fixed income and listed global equities has fallen to. As Exhibit 2 demonstrates, the 10 largest pension plans in Canada have steadily reduced their allocations to both global fixed income and global listed equities to 29.5% and 20.2%, respectively.

In an interview with Institutional Investor in 2020, Bruce Flatt, the CEO of Brookfield Asset Management made the following assertion:

“A decade ago alternatives accounted for five percent of allocations at pension and sovereign funds. Today they make up almost a quarter, and Brookfield predicts that by 2030 more than half of allocations will shift into alternatives from other financial instruments held by sovereign and pension funds. By then alts could also claim double-digit-percent allocations at endowments and insurance companies. And the biggest prize of all awaits as private wealth follows suit.”

Clearly institutional investors have made Bruce Flatt appear prescient and we would argue that private wealth is beginning to make meaningful allocations to alternatives.

Asset class returns in 2022 made the case for higher allocations to alternatives for global investors. Again, looking at the 10 largest pension plans in Canada in Exhibit 3, their returns in 2022 clearly bifurcated.

In 2022 the 10 largest pension plans in Canada have greatly benefited from their allocations to alternatives. While on average they lost 1.0% for plan beneficiaries, most of this was due to their allocations to traditional asset classes which generated negative returns (-3.5% for fixed income and -6.6% for listed global equities). In contrast, alternatives delivered meaningful, positive absolute returns to the pension plans (9.6% for real estate, 13.5% for infrastructure and 12.8% for private equity). Investors know that asset allocation is responsible for a significant amount of the returns they can expect from their portfolios. For those retail investors that have been early adopters of alternatives in their portfolios, 2022 rewarded them handsomely.

Skeptics may suggest that 2022 was an aberration and not reflective of the real total returns that public equities and fixed income can provide. We reviewed the total and sectoral performance of the 10 largest pension plans in Canada for the last 5 years. Given the volatility of equity, fixed income, interest rates and currency markets over the last 5 years (zero interest rates, aggressive global monetary tightening, massive fiscal stimulus, shooting wars, attempted insurrection, etc.), we think this is a good sample of full cycle asset class returns.

With five- and 10-year CAGRs of 6.7% and 8.2% the Canadian pension plans have outperformed or matched global equities (MSCI All Country World Index, 5.8% and 8.6% respectively) and global fixed income (Bloomberg Global- Aggregate total Return Index, -1.7% and -0.4% respectively), on a local currency basis, over these time periods. When we dig into the drivers of that outperformance we can see that it is largely due to the allocations to and performance of alternative assets.

Exhibit 6 demonstrates that Canadian pension plans have been rewarded for steadily increasing their allocations to alternative assets. The period from 2019 through 2021 featured very strong returns from Public Equities however, Private Equity delivered similarly strong returns. What may surprise investors is that most companies in the US are private companies. Out of the 27 million firms in the U.S., the number of companies listed on U.S. exchanges has fallen from more than 7,000 in the year 2000 to fewer than 5,000 in the year 2020, according to statistics from the World Federation of Exchanges. Among the 5.7 million US firms with employees, less than one percent of them have shares listed on a U.S. exchange. In fact, over 87% of US companies with over $100 million of revenue are private companies so investors that limit themselves to Public Equities are missing out on exposure to the majority of the US economy.

Exhibit 6 also demonstrates the benefits of strategic diversification within a portfolio. Investors often start out with a diversified portfolio that includes exposure to alternatives. However, in a year like 2020 when Canadian pension plans lost 7.2% on their real estate holdings, many investors begin to question why they own real estate. If they succumb to short term thinking, it’s clear that they will miss out on the benefits that strategic diversification provided for Canadian pension plans in 2018 and 2022. In both years, Canadian pension plans produced materially lower and in one case, negative returns. However, in both years, alternative assets, including real estate, shone and materially added to pension plan returns. That is the point of strategic diversification within a portfolio. Investors should not expect everything in their portfolio to generate positive returns every year. Rather, in years when certain asset classes underperform or lose value, the strategic diversification and asset allocation allow other asset classes to support total portfolio returns.

Starlight Capital was founded in 2018 to provide Canadian investors with the ability to invest in institutional- quality private assets alongside some of the largest pension plans and endowment funds in the world. The Starlight Private Global Real Estate Pool and Starlight Private Global Infrastructure Pool were launched in 2020 and recently celebrated their three-year anniversaries. The Starlight Global Private Equity Pool was launched more recently in September 2022.

For Canadian investors wishing to replicate the asset allocation of Canadian pension plans, the Starlight Private Pools offer liquid access to institutional-quality private alternative assets. We partner with best-in- class global private asset managers who employ value-add strategies to generate strong, risk-adjusted returns. The real asset private pools pay tax-efficient distributions to investors on a quarterly basis and all of the private pools offer quarterly liquidity and monthly valuations and subscriptions.