The Government of Canada should create a new debt security that will provide stable long-term cash flows for pension fund managers, according to a report by the C.D. Howe Institute.
Traditionally, a large part of a pension plan’s portfolio has been in fixed-income assets. Pension funds usually have 25% to 30% of their net assets in fixed-income and inflation-protected bonds, which highlights the importance of securities with a low-risk level.
This new security—called a “Trill”—would have its coupon tied to Canada’s gross domestic product (GDP). It’s named a Trill because its coupon payment would be one-trillionth of Canada’s GDP.
“Similar to shares issued by corporations paying a fraction of corporate earnings in dividends, the Trill would pay a fraction of the ‘earnings’ of Canada,” says the report. “Given the characteristics of GDP growth, our valuation of the Trill indicates its yield would be very attractive to the issuer, the Government of Canada—and, for the same reasons, would be a useful new source of income to investors who want exposure to income growth and protection against inflation.”
Since nominal GDP would be used to determine the coupon value of the Trill, the inflation-protection properties of it would be similar to Canada’s real return bonds (RRBs) and the United States’ Treasury Inflation-Protection Securities (TIPS).
The report says the inflation protection alone would be sufficient to generate interest in Trills, which would be comparable to the existing interest for RRBs and TIPS. And Trills would protect relative standards of living in retirement because they are a constant share of GDP whereas RRBs or TIPS purchase a declining real share of growing GDP over time.
“The recent successful effort by the Ontario Teachers’ Pension Plan (OTPP) to take over BCE Inc. is an example of pension plans’ thirst for long-duration assets,” says the report. “Matching cash inflows and outflows is at the heart of any pension fund investment strategy since pension obligations stretch out over decades.”
Apart from pension funds, Trills would be attractive to the average investor. And target date/lifecycle funds could also increase their holdings in the investment as participants approach retirement.
“Standard financial analysis suggests that Trills would provide the issuer, the Government of Canada, with a budget-stabilizing, moderate-cost debt instrument, and investors with an asset that cannot be replicated with existing assets, allowing investors new portfolio diversification strategies that preserve high returns and lower volatility,” the report concludes. “The issuer and the investors in Trills would both stand to gain from Trills, another case of win-win through financial innovation and diversification.”
To read the report on the C.D. Howe Institute’s website as a PDF, click here.
To comment on this story, email craig.sebastiano@rci.rogers.com.