The solvency position of Canadian pension plans continued to improve in the second quarter of 2013 due to a sharp spike in long-term interest rates, according to the Mercer Pension Health Index.

The second quarter 2013 Mercer Pension Health Index was released on Tuesday. As of June 30th, the index stood at 94% up from 82% at the start of the year.

“The financial position of pension plans improved in June despite the recent pullback in equity markets,” said Manuel Monteiro, a partner in Mercer’s financial strategy group. “This was mainly driven by the significant increase in long-term bond yields over the last two weeks.”

Long-term Government of Canada bond yields were flirting with 3% at the end of June, up from 2.3% at the beginning of the year and 2.5% at the beginning of June. A 1% increase in long-term interest rates would reduce the liabilities of most pension plans by 10% to 15%.

“The first half of 2013 has been very good for pension plans. In the first five months, the story was primarily one of strong equity returns, particularly in foreign markets. In June, rising interest rates took over as equity markets pulled back,” said Monteiro. “While interest rates have moved up dramatically in the last few weeks, it is not clear whether this is the start of a trend or a temporary blip as the market assesses the strong economic numbers in the U.S., the slowing of China and the possible end of quantitative easing later this year or early next year.”

Canadian equities returned -4.1 % in the second quarter and -0.9 % in the first half of 2013.

Some highlights from Q2 include the following:

> The best performing S&P/TSX sectors were health care (+11.0%), consumer staples (+8.8%) and consumer discretionary (+8.6%). The worst performing sectors were materials (-22.8%), telecom services (-10.6%) and utilities (-4.5%).

> Large cap stocks (S&P/TSX 60 Index) returned -4.1%, outperforming small cap stocks (S&P/TSX SmallCap index) which returned -7.3%.

> Value stocks outperformed growth stocks as measured by the S&P Canada BMI Value and Growth indices, which returned -2.3% and -5.7% respectively in the second quarter.

Apart from revisiting their overall interest risk exposure given the opportunity to de-risk offered by the recent surge in yields, Mercer expects Canadian pension plans to continue diversifying their growth portfolio away from traditional equity markets into other sources of return such as alternative assets.