While they were a major presence, pension funds registered considerable influence over the nature of transacting. Indicative of their tentative foothold, such influence nudged aggregate venture investment patterns of the late 1980s towards comparatively safe projects that were later stage (i.e., acquisitions, buyouts and expansions), more sizeable projects, and had little or no high technology orientation. If Canadian pension funds had stayed with the market, they may well have expanded the scope of their activity with time and greater confidence in an initially unfamiliar and underdeveloped environment. This is, at least, the historical pattern followed by pension funds elsewhere.
What caused the abrupt withdrawal of pension funds from the market? Certainly the economic recession at the end of the decade was an important trigger for them, as it was for large insurance companies and other institutional investors that similarly reduced their exposure to this asset class. Recessionary pressures were probably not sufficient, however, to sever the link entirely. CLMPC interviews with pension managers, market analysts and practitioners tried to identify supplementary factors. Responses proved divergent and occasionally conflicting.
One explanation offered by interviewees for the market pull-out of pension funds was that risk-adjusted returns were demonstrably substandard. This was immensely disappointing given the expectations created by consistently strong vintage year returns in the United States. Fault was also found in the externally managed pooling arrangements utilized by pension funds with regard to such variables as fee structures, overpricing of deals and poor communications with venture investment specialists that impaired fiduciary monitoring of on- going performance.
Other interviewees argued that pension funds were unprepared for the ebb and flow of illiquid investing. For this reason, some inflexible pension administrations may have been apt to overreact to immediate losses and neglect the longer-term realization of projected gains. Some also believe that government incentives of the 1980s - pre-eminently, the federal three-for-one tax rule whereby allowable increases in the foreign content of pension holdings were tied to assistance to SMEs - had the unintended effect of encouraging new market participation just prior to a cyclical downturn.
Regardless of these and other circumstances, the experience of the 1980s has itself become a barrier to any attempted market re-entry, considering the negative impact it had on the perspectives of many senior Canadian pension fiduciaries. A more thorough discussion of this and related current challenges is found in Pension Barriers to Financing New Economy Investment.
Following the departure of many institutional investors, the composition of venture capital supply was altered. In the early 1990s, most Canadian governments intervened to restore flows, chiefly by providing tax incentives to labour-sponsored funds, such as the Fonds de solidarité des travailleurs du Québec (FTQ). Indeed, some venture capital institutions that had previously relied on supply by pension funds turned to this new source. Finally, after several years' absence, pension participation in venture investing witnessed something of a rebound in late 1997, also as illustrated in Figure 7.
In fact, 1997 marked a peak of new dollar commitments. This translates into 16 percent of total market supply in that year (see Figure 8) or a nearly threefold increase in what had been pension involvement in the years immediately preceding.Endnote 42
Unlike the 1980s when pension participation brought together dozens of funds, the level reached almost a decade later reflects the activity of only a handful of very large funds. This includes veterans, such as the Caisse de dépôt and OMERS as well as the first-time entry of the public sector pension plans associated with British Columbia's OCIO and Ontario Teachers PPB. At the same time, other pension funds with holdings in pools originating in the 1980s have been recently liquidating these without, in the majority of cases, any subsequent follow-up with new commitments. Hence, while total pension dollar contributions may be going up, participation as measured by numbers of funds continues to decline.