Our accomplishments this year were focused on three themes: investing in a broader range of asset classes to further diversify the portfolio by risk/return attributes and by geography; enhancing the investment expertise and capability of the organization to support the management of an increasingly complex portfolio; and developing a clear longer term strategy and business plan designed to drive implementation.

Building a Record of Achievement
At the outset of fiscal 2006, we established the following five key corporate objectives for the Canada Pension Plan Investment Board:

• to further diversify the CPP fund
• to expand our investment capabilities
• to define and implement new business processes and technology
• to augment our human resources systems
• to revise our corporate strategy

I am pleased to report that we made significant progress in each of these areas during the year.

With respect to diversification, our key investment goal was to increase significantly the proportion of assets within the portfolio that have inflation related attributes in light of the CPP's inflation-indexed liabilities. Accordingly, we established a near-term target allocation of 10 per cent for real return assets such as real estate, infrastructure investments and inflation-linked bonds to complement our 60 per cent allocation for equities and our 30 per cent target for fixed income. Over the course of fiscal 2006, we were successful in increasing our real return assets to $8.5 billion or 8.7 per cent of the overall portfolio from just $1 billion or 1.2 per cent at the beginning of the year.

We are particularly pleased with our acquisition of core Canadian real estate assets in the office and retail sectors during the year. Of particular note was our 50 per cent participation in the joint venture that purchased the $2 billion portfolio of Olympia & York (O&Y) office buildings, as well as our $1 billion partnership with Oxford Developments in a collection of core office towers in major cities across Canada. We invested $660 million to acquire an 80 per cent interest in two major retail malls in the province of Quebec. Outside of Canada, we made our first investments in European real estate through the LaSalle French Fund, which owns office and industrial properties in France, and the ING Britannica Fund, which focuses on retail properties in the United Kingdom.

We also acquired substantial holdings of inflation-linked bonds during fiscal 2006 that totalled $4.0 billion at year end. Until this year, Regulation 9 of the Canada Pension Plan Investment Board Act constrained our ability to invest in these and other marketable bonds by effectively limiting our bond holdings to non-marketable federal and provincial debt. We concluded successful negotiations with the federal and provincial finance departments in June 2005 that led to the elimination of Regulation 9 and provided additional flexibility to the provinces with respect to the terms of their existing bonds that we hold. This change enabled us to acquire the inflation-linked bonds previously mentioned and, importantly, allows us to invest in other categories of fixed income in the future.

In the public equities component of our portfolio, our diversification goal for 2006 was to increase the proportion of our international holdings. We believe that international investments help reduce concentration risk, enhance returns and avoid over-dependence of the CPP on the domestic economy. Accordingly, we invested new contributions from the CPP into international equity markets this past year, while beginning to reduce the proportion of our substantial holdings in Canadian public equities, which at year end totalled $28.5 billion or 29.1 per cent of the total portfolio.

Another aspect of our diversification objective for 2006 was to expand our private equity investments. Over the course of the year, we committed an additional $5.2 billion to funds with external investment management partners, bringing our total committed and drawn investment amounts to approximately $13.3 billion and $5.5 billion respectively. Canada represents 13 per cent of this total commitment, making us one of this country's largest private equity and venture capital investors.

The ultimate goal of these multiple aspects of portfolio diversification is to allow us to generate improved risk-adjusted returns for the CPP fund. Looking back to fiscal 2006, the fund grew by $16.7 billion to end the year at $98.0 billion. Within that growth, investment returns were $13.1 billion, representing a 15.5 per cent rate of return. This compares to the median performance for Canadian pension plans of 14.9 per cent during the same period.

Our second objective for fiscal 2006 was to expand our investment capabilities. To that end, we appointed three new investment vice-presidents this year who have brought us a wealth of Canadian and international experience:

• John Ilkiw now heads our Portfolio Design and Risk Management department; John has over 30 years of pension related work experience within Canada, the United Kingdom and the United States.
• Graeme Eadie heads our new Real Estate Investments department; Graeme has more than two decades of experience as a senior officer in the real estate, retail and manufacturing sectors.
• Mark Wiseman heads our Private Investments department; Mark previously led the private equity fund and co-investment program at one of Canada's largest public sector pension funds and previously worked in the United States and France.

These three are partnered with Don Raymond, vice-president of Public Market Investments, who joined the CPP Investment Board in 2001, following a number of years spent in the financial services industry both in Canada and the United States.

In addition to expanding our internal investment resources, we also expanded our relationships with top-tier private equity, real estate, infrastructure, venture capital and public equity managers around the world. We now have relationships with 62 external managers who complement our internal capabilities and assist us in achieving our investment diversification and performance goals.

We also extended our capabilities in other important aspects of our organization last year. Our third key objective was to define and begin implementation of the business processes and technology required to support our expanding investment and operational activities. To this end, our Finance and Operations area launched a comprehensive review of all our various processes and began implementing an enterprise technology architecture that will support the growing complexity of our investment activities in the years to come.

Investment management is largely a people business and the CPP Investment Board is a rapidly growing organization. We believe that our ability to attract, develop and retain high-calibre staff in a globally competitive marketplace is crucial to our success, and hence our fourth objective for 2006 was to augment our human resources systems. During the year we implemented a new incentive compensation plan that promotes accountability for investment and other results, revised our performance management system and successfully recruited 63 new colleagues, drawing from such diverse locations as the U.K., Australia, the U.S. and South Africa, as well as, of course, here in Canada. To bring increased focus to the critical role of managing our human capital, we appointed David Wexler as our first vice-president, Human Resources. David joined us from a Canadian software company with global operations and previously held senior positions with several large Canadian financial services organizations. Human resources will remain a key focus for us in fiscal 2007.

Our final key objective for 2006 was to revise our corporate strategy. The management team and board of directors examined a wide range of options for how we could organize ourselves and conduct our investment activities to manage the assets of the rapidly growing CPP fund. As a consequence of this review we made a number of decisions that will guide our activities over the next three to five years.

One of these decisions was the formulation of the CPP Reference Portfolio as the key benchmark for measuring the investment performance of the CPP Investment Board. Another was our commitment to manage the assets of the CPP fund within a total portfolio approach. This approach places risk/return decision-making at the portfolio level rather than in each asset class; it also leads us to assess the contribution of investments to the overall portfolio by their risk and return characteristics versus their traditional asset labels. Both of these important concepts are described in greater detail in the Management's Discussion and Analysis section of this report.

These and our other strategic management choices focus increased emphasis on performance and accountability for the CPP Investment Board. Shaping and nurturing this focus will continue to be one of our primary challenges in the years ahead as we strive to help improve the long-term sustainability of the Canada Pension Plan.

David F. Denison
President and Chief Executive Officer