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Canadian pension funds shift to defensive stance

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Declines in asset values, coupled with low interest rates that serve to increase the value of pension funds’ long-term liabilities, had severe consequences on Canadian pensions’ reported funding ratios, which declined to an average of just 90 per cent in 2009 from 99 per cent in 2008.

According to Greenwich Associates, a 17 per cent year-to-year reduction in asset values from 2008-2009 reduced the value of Canadian institutional portfolios to levels below those last seen in 2006.

Among the country’s largest pension funds, funding ratios declined to 82 per cent from 94 per cent.

Corporate funds saw their reported funding levels decline from 102 per cent in 2008 to 89 per cent in 2009, while funding levels for public sector/provincial plans fell to 90 per cent from 95 per cent.

Actual funding ratios for all Canadian funds could be significantly lower, since, in keeping with normal reporting schedules, only some funds reported updated valuations in 2009.
 
Canadian pension funds adopted an increasingly conservative strategy amid the turbulent markets in 2008 and 2009. A combination of declining equity valuations and proactive shifts in portfolio asset mixes brought down institutional allocations to domestic equity to 16.7 per cent of total assets in 2009 from 18.7 per cent in 2008. At the same time, fixed income allocations increased to 36.0 per cent of assets from 30.8 per cent.

Canadian public sector funds took a slightly more aggressive approach than other institutions: they had lower allocations to fixed income than those of corporate funds and higher allocations to alternatives. Public sector/provincial funds had allocations of 5.8 per cent of total assets to private equity in 2009, compared to allocations of only 0.7 per cent among Canadian corporate funds. Public/provincial funds also had higher allocations to real estate, hedge funds and infrastructure.
 
Forty per cent of Canadian plan sponsors last year said they were planning to make substantive changes in their asset mixes in the coming 12 months, up from 31 per cent the prior year. If implemented, the changes planned by these institutions will result in additional reductions to domestic equity allocations.

Seventeen per cent of Canadian funds plan to significantly reduce allocations to active Canadian stocks; only five per cent plan to increase them. It appears much of the cash moved out of domestic equities will be invested in alternative asset classes.
 
Although decreases in equity valuations held down average allocations to international stocks from 2008–2009, the global market crisis did not stop the flow of Canadian funds broadening their commitments to international equities.
 
The proportion of Canadian institutions using a manager for EAFE/international equities increased to 76 per cent in 2009 from 68 per cent in 2008, and the share of funds using US equities increased to 72 per cent from 69 per cent.

“Although there is no strong trend toward intended significant increases in allocations among institutions that already invest in international equities, six per cent of Canadian funds as a whole say they plan to hire a manager for EAFE/international equities, the highest share reported for any traditional asset class in 2009,” says Greenwich Associates consultant Dev Clifford.
 
A growing share of Canadian institutions is also investing in alternative asset classes. In private equity, hedge funds and infrastructure, the share of funds investing is on the rise. While real estate usage was unchanged from year-to-year at 36 per cent of Canadian funds, eight per cent of funds say they plan to hire a real estate manager in the next 12 months. Those expectations are topped by the 12 per cent of Canadian funds planning to hire a manager for infrastructure. Four per cent of funds plan to hire in each of hedge funds and private equity, the latter share representing a decrease from the 6 per cent of funds that reported plans to hire a private equity manager in 2008.
 
Canadian institutions’ expectations for returns on their investment portfolios have remained remarkably consistent throughout the crisis. Average expectations for fixed income dipped to 4.7 per cent in 2009 from 4.8 per cent in 2008, while expected returns on Canadian equities inched to 7.8 per cent from 7.7 per cent.

Expectations for US equities fell to 7.6 per cent in 2009 from 7.8 per cent the prior year, while expectations for EAFE/international equities increased to 8.2 per cent from 8.1 per cent.

 Only in alternative asset classes did Canadian plan sponsors report significant movement in return expectations from year-to-year, with expectations for private equity dropping to 10.0 per cent from 10.7 per cent, real estate expectations falling to 7.1 per cent from 7.8 per cent and expected returns on hedge funds declining to an annual 7.2 per cent from 7.8 per cent.

In line with their higher allocations to fixed income and more modest exposure to equities, Canadian endowments and foundations report lower expected returns on their portfolios overall.

“As for pension funds, because the average actuarial earnings rate was unchanged from 2008 to 2009 at 6.8 per cent, Canadian pension funds face a gap of 0.4 per cent between that rate and their expected overall portfolio returns,” says Greenwich Associates consultant Andrew McCollum.

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