(Adds reaction from Quebec premier)
By David Ljunggren
OTTAWA, Feb 25 (Reuters) - Canada's biggest pension fund manager, Caisse de depot et placement du Quebec, said on Wednesday it had lost a massive C$39.8 billion ($31.6 billion) in 2008, prompting the Quebec government to announce an investigation into what happened.
The Caisse, an arm's length agency that manages investments for various public and private pension plans in the predominantly French-speaking province, blamed tumbling stock prices and a depreciating Canadian dollar for its record loss.
The fund manager posted a negative return of 25 percent for 2008 and saw its depositors' net assets decline to C$120.1 billion from C$155.4 billion.
Earlier this week, the Ontario Municipal Employees Retirement System (OMERS) reported a negative 15.3 percent total rate of return for last year, compared with a positive return of 8.7 percent in 2007.
The median return for large Canadian pension funds in 2008 was a drop of 18.4 percent.
Part of the reason for the Caisse's weak results were currency hedges that went wrong because the Canadian dollar fell faster than expected and the fund's decision to buy C$12.6 billion of asset-backed commercial paper (ABCP), the market for which froze up in August 2007.
Caisse interim Chief Executive Fernand Perreault apologized for the ABCP investment, said the fund would clamp down on the way it managed risk and announced the Caisse had changed its asset portfolio to reduce its exposure to equities.
But he put most of the blame on the global crisis, which he said had caused havoc from October onward.
"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," he told a news conference, denying the Caisse had engaged in risky speculation.
Pressed over the losses, Perreault replied: "(U.S. investor) Warren Buffett lost 30 percent last year and there are others who lost extraordinary amounts."
The size of the pension manager's loss is bigger than the GDP of some small countries, such as Kenya or Latvia, according to 2007 World Bank figures.
The Caisse is regarded with great pride by most Quebecers and the huge losses increased questions about how it is being run. Last month, the fund's new head resigned for medical reasons, after just four months on the job.
Quebec's Liberal government, which opposition politicians say has mishandled the affair, expressed disappointment at the 25 percent fall and said the province would hold legislative hearings to examine the Caisse's poor performance.
Premier Jean Charest -- saying a new, permanent chief executive for the Caisse would soon be named -- denied opposition charges that the fund manager had embraced riskier investments because the government wanted it to post a higher rate of return.
"There are some specific questions we have to ask about risk management, about ABCP, about exchange rates. We want to hear ... how they've managed those assets and we want to draw the proper lessons," he told reporters.
Charest would appear to be in little immediate political danger from the issue, since the Liberals won a majority government in last December's provincial election.
The Caisse -- which earned C$63.2 billion in the five years leading up to 2008 -- noted that 56 percent of the overall 2008 losses were on paper, reflecting the fall in value of investments that had not been sold.
Perreault said the fund had increased its liquid assets and reduced its stock market exposure, including selling equities, closing out futures contracts and reducing its foreign exchange hedging.
$1=$1.25 Canadian With additional reporting by Jennifer Kwan; editing by Rob Wilson