The Caisse de dépôt et placement du Québec announced a 25.0% loss on depositors’ funds for the year ended Dec. 31, 2008. This is comparably worse than the 18.5% loss on the benchmark portfolio and the 18.4% loss on the median return for the universe of large Canadian pension funds.

The year’s net investment loss of $39.8 billion (of which 56% is unrealized decreases in value) has cancelled out a significant portion of the $63.2 billion of returns earned in the preceding five years. Net deposits totalled $4.6 billion and depositors’ net assets declined to $120.1 billion from $155.4 billion for the year.

“As with all other investors, the first element that explains our return this year is the global financial crisis that broke out in the fourth quarter. In October 2008, in a matter of days, the world tipped into the worst financial and economic crisis of the past 80 years. The markets became disjointed,” said Fernand Perreault, president and CEO of the Caisse. “All asset classes — with the exception of the best government securities — recorded steep and simultaneous losses. The lack of lenders and buyers caused market values to plummet. The global crisis also drove the Canadian dollar down sharply; on the year, it lost 20% against the U.S. dollar, 16% against the euro and 35% against the yen.”

Perrault added: “These unusual events affected all investors, but certain factors had a specific or more pronounced impact on our portfolio, such as our large holdings of asset-backed commercial paper and the cost of hedging the foreign exchange risk of our assets outside Canada, which increased significantly as the Canadian dollar fell.”

In response to a global financial crisis and the significant likelihood that it would intensify, as well as a Canadian dollar in freefall, the Caisse took the precaution of changing its asset allocation in October to increase its liquid assets and to reduce its stock market exposure. The Caisse’s actions included selling equities, closing out futures contracts and reducing its foreign-exchange hedging.

“At no time during this period did the Caisse run short of, or come close to running short of, liquid assets. Still, our analysis of the events prompted us to anticipate a deepening of the crisis by preserving depositors’ capital and making a high level of liquid assets an important component of our strategy for the months to come,” Perreault explained.

As a result of these changes, the weight of fixed-income increased to 44%from 30% and the weight of equities fell to 22% from 36%. As of Dec. 31, the effect of these asset allocation changes on the 2008 return was positive.

“Given the markets’ volatility since the end of 2008, these decisions significantly improved our overall positioning. The rebalancing of the portfolio toward equities will take place gradually as a function of our assessment of the various markets and in co-operation with our depositors,” Perreault explained.

Unrealized decreases in value, or paper losses, totalled $22.4 billion in 2008, or 56.3% of the net investment loss of $39.8 billion. Net investment income, including interest income, dividends and rent, amounted to $5.8 billion. Realized losses on the sale of investments during the year totaled $23.2 billion, including $6.1 billion for the realized portion of the cost of foreign exchange risk hedging alone.

“The financial crisis caused a substantial discrepancy between the market value and the economic value of investments. In normal conditions, market value is similar to economic value, and transactions take place on that level,” Perrault added. “As a result of the financial crisis, a lack of reference transactions and high rate spreads pushed market values down to an abnormally conservative level.”

For example, the real estate portfolio generated more net rental income in 2008 than it did in 2007, and a further increase is forecast for 2009. Even so, the value of the portfolio declined by 21.9% as a result of the financial crisis in the fourth quarter and the mark-to-market rule specified for investment companies by Canadian accounting standards.

“Valuing our illiquid investments as a function of the horizon on which they will be held would give quite a different portrait of the situation, but accounting standards require that they be valued as if they were available for sale on Dec. 31,” Perreault pointed out.

@page_break@After five consecutive years of first-quartile returns, the Caisse’s return for 2008 (-25.0%) is significantly below the median for large Canadian pension funds that have at least $1 billion of assets (-18.4%), with a variance of 6.6%.

Several factors distinguish the Caisse from other large Canadian pension funds. Two stood out in 2008. The first is the cost of foreign-exchange risk hedging. The second is the additional provision for ABCP.