CFCF Investments Process and Policy Review DG Fin Mgmt Presentation NPP BoD 1 May 06.

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1 CFCF Investments Process and Policy Review DG Fin Mgmt Presentation NPP BoD 1 May 06

2 Background CFCF size and range of investments had grown without a corresponding review to ensure structure remained consistent with investment management practices Investment Committee Tiger Team Spring 05 review recommended a reorganization of the investment management structure NPP BoD authorized hiring an external consultant to review the governance and investment structure and propose options

3 Décisions requises Prendre note du rapport sur la gouvernance et la structure d’investissement du FCFC préparé par Morneau Sobeco Approuver en principe la Politique d’investissement du FCFC Autoriser le Comité des investissements à entreprendre un processus compétitif de sélection de l’administrateur Autoriser le Comité des investissements à choisir un dépositaire indépendant et un conseiller en surveillance du rendement Autoriser le Comité des investissements à superviser la transition des avoirs du FCFC du Directeur financier de l’ASPFC vers le(s) administrateur(s) retenu(s)

4 Governance Review CFCF currently meets 12 of 19 governance best practices Need to enhance knowledge of investment committee members (may require changes to committee size) Need to implement a regular independent review of CFCF operations Need to establish formal performance objectives to evaluate fund management

5 Investment Structure Review Overall CFCF return has consistently exceeded portfolio benchmarks over last four years in both up and down markets Fixed income portfolio (currently 50%) has underperformed due to investment policy restrictions CFCF volatility lower than volatility of benchmarks – equates to lower risk

6 Investment Structure Review Equity trading commissions are higher than those normally charged to institutional portfolios Number of equity trades higher than average but not considered excessive Major weakness is the centralization of active management of all asset classes with CFO CFPSA CFO is not an investment professional subject to standards of practice External institutional fund managers and an independent custodian recommended

7 But de la politique d’investissement La politique d’investissement est le plan directeur à la réalisation des objectifs du fond Elle établit le profil risque/rendement du fond Elle énumère les différentes contraintes et préférences Elle définit les rôles et les responsabilités Elle dicte les directives pour l’administrateur de portefeuille

8 Long term asset mix policy (Benchmark Portfolio) Most critical element is the long term asset mix policy defined by the Benchmark Portfolio (“market neutral position” in the current policy) Determines the risk/return profile of the Fund by defining the long term asset mix and acceptable deviation Most of the level and variance of a portfolio’s return can be explained by the asset mix Should be determined taking into account objectives, risk tolerance, market expectation

9 Facteurs à considérer pour déterminer le portefeuille de référence Caractéristiques du FCFC –Nécessité de flux de revenus fiables et soutenables –Potentiel de dépôts et de retraits pendant l’année –Non imposable –Inclut des actifs des dépôts des Bases/Escadres, CANEX, et comptes en fiducie –Horizon de long-terme Tolérance au risque Caractéristiques des différentes catégories d’actifs –Obligations, actions, alternatives Anticipations du marché –Les prévisions à long-terme sont plus faibles que les rendements historiques –Le rendement des obligations est particulièrement bas

10 Long term asset mix policy Key Decisions Allocation among the main asset classes –Stocks and bonds Geographic distribution of stocks –Canadian, US and foreign Bond maturities –Short, medium and long term Other aspects of diversification (alternative investments, small cap stocks, etc.) These decisions are always analyzed with reference to the objectives

11 Profil Risque/Rendement Catégories d’actifs traditionnels Obligations à court terme Obligations à long-terme Actifs Canadiens Actifs étrangers Rendement Risque Risque faibleRisque élevé Rendement faible Rendement élevé

12 Risk/Return profile Traditional asset classes

13 Evolution of returns since 1970 Asset classesPeriods 1970-791980-891990-992000-20051970-2005 Money market7.0%11.9%6.6%3.4%7.6% Obligations (long term)7.7%13.7%11.6%10.5%10.7% Equity (CAN$) Canadian10.5%12.2%10.6%6.8%10.3% US7.0%17.5%20.8%-4.6%11.4% International9.3%21.8%9.5%-2.5%10.6%

14 Source: Morneau Sobeco 2006 Fund Managers Survey Anticipations Rendements historiques Catégorie d’actifs de long-terme 1981 - 2005 Comptant et équivalents3,5 %7,6 % Revenus fixes4,6 %10,9 % Actifs canadiens7,8 %9,6 % Actifs américains7,5 %12,4 % Actifs internationaux8,4 %10,6 % Retours espérés selon la référence du FCFC6,0 %10,4 % Espérances des rendements à long-terme

15 How are pension funds invested? Spread between CFCF Asset classesAverage1st and 3rd quartileBenchmark Fixed income Short terms5%2% - 6%5% Bonds35%31% - 38%50% 40%36% - 41%55% Equity Canadian38%33% - 40%31.5% US12%8% - 15%6.75% International10%0% - 18%6.75% 60%58% - 65%45% Morneau Sobeco Universe of pension fund managers as at December 31, 2005

16 How CFCF benchmark compares with pension funds? CFCF’s benchmark portfolio: –More conservative than average pension plan (more fixed income: 55% vs. 40% average) –Lower portion to foreign equities (13.5% vs. 22% average) Pension funds are increasing their allocation to foreign equities Larger pension funds ($250M +) often invest a portion (5%-10%) in alternative investments (hedge funds, real estate, private equity) The benchmark portfolio must be appropriate for the particular circumstances of the Fund

17 The long term asset mix policy - Scenarios

18 Composition cible recommandée d’actif Investissements à court terme – 2 % Obligations et hypothèques – 38 % Titres canadiens – 30 % Titres étrangers (inclus américain et internationaux) – 30 % Rendement annuel réel anticipé (après inflation) de 4 %

19 Major Policy Changes Fixed income –Mortgages added –Bond risk rating lowered to BBB from A- –20% Foreign holdings no longer limited to US –Canadian Corporate bond holdings limit raised to 40% from current 20% –Private investments authorized with approval of Investment Committee

20 Major Policy Changes Canadian Equities –Greater definition of sector limits –Real estate authorized through REITs –Private investments authorized with approval of Investment Committee –No minimum market capitalization for individual investments (max of 25% in companies under $1B)

21 Major Policy Changes Foreign Equities –US and International managed as a single group –Emerging market investments authorized with approval of investment committee Specific performance objectives established for each asset class if an active investment style is selected

22 Gestion active et gestion passive La gestion active est avantageuse si: –Il y a une forte probabilité de surpasser l’indice après honoraires et indemnités –Il y a un besoin de limiter les pertes d’un marché en baisse –Particulièrement pour les titres canadiens et internationaux La gestion passive est avantageuse si: –On ne veut pas différer trop de l’indice de marché –On ne veut pas surveiller l’administrateur de trop près –On reconnaît la difficulté de choisir un administrateur qui peut constamment excéder le marché –On recherche de bas honoraires et indemnités

23 Active vs. passive management How funds manager performed The following table show historical value added obtained from active management for the five year period ending December 31, 2005 CanadianUSInternational PercentileBondsequityequityequity 5th2.5%9.4%6.9%7.5% 25th0.5%5.7%2.3%2.7% 50th0.1%3.7%0.1%0.6% 75th-0.1%1.1%-0.7%-1.1% 95th-0.7%-1.1%-2.5%-3.6%  Extracted from Morneau Sobeco Performance Universe In the last five years, most US equity, bonds and international managers were not able to add much value when compared to the benchmark.

24 Mandat diversifié ou spécialisé FacteursDiversifiéSpécialisé Simplicité√ Capacités/talent de l’administrateur√ Surveillance√ Honoraires et indemnités√ Valeur ajoutée Répartition des actifs√ –Sélection des titres√ –Volatilité√ –Rendement total√ √ = Avantage

25 Recommendations Active management is appropriate for Canadian equities Passive management seem to be appropriate for US and international equities and fixed income Some managers have been able to constantly add value in all asset classes If diversified approach is chosen: 2 managers If specialized approach is used: up to 3 managers (one by asset class)

26 SELECTED MANAGER INVESTMENT OBJECTIVES UNIVERSE OF MANAGERS MANAGER SCREENING DETAILED REVIEW OF CANDIDATES INTERVIEWS OF SHORT-LISTED CANDIDATES FUND STRUCTURE MANAGER MANDATE SCREENING CRITERIA LONG LIST OF POTENTIAL MANAGERS SHORT LIST OF SUITABLE MANAGERS The Manager Selection Process Find the Right Fit

27 Selection criteria Organization - Well established, at least $5B assets under management, have not lost too many mandates in last 3-5 years, low employee turnover, not currently subject to lawsuits (fraud) Well articulated investment approach with focus on fundamentals, good diversification and risk control measures, team involvement in decision making

28 Critères de sélection Performance – supérieurs à la médiane et aux points de référence de rendements des cinq dernières années, faible volatilité, protection contre les marchés à la baisse Communications et divulgation Honoraires et indemnités Relations existantes à l’ASPFC

29 Manager Options Select a single manager for the entire portfolio Select two managers with separate investment mandates Select two managers with balanced mandates In all options select an independent custodian and a performance monitoring advisor

30 Comparaison de coût annuel Approche existante (424 000 $) –Commissions sur les valeurs 400 000 $ –Conseiller en revenu fixe 24 000 $ Approche proposée (450 000 $ - 525 000 $) –Honoraires et indemnités des administrateurs 350 000 $ - 400 000 $ –Responsable 75 000 $ - 100 000 $ –Surveillance du rendement 25 000 $

31 Decisions Requested/Next Steps Note the Report on the governance and investment structure of the CFCF prepared by Morneau Sobeco Approval in principle of the revised CFCF Investment Policy Authorize the Investment Committee to undertake a competitive manager selection process Authorize the Investment Committee to select an independent custodian and performance monitoring advisor Authorize the Investment Committee to oversee CFO CFPSA transition of CFCF holdings to the selected manager(s)

32 Questions