Drop in bond yields weighs on pensions in Q4: Mercer

“Long-term federal bond yields dropped about 30 basis points in the quarter for a total drop of about 110 basis points on the year,” says Scott Clausen, retirement, risk and finance professional leader for Canada. “This decrease in bond yields increased the cost of purchasing annuities and dropped the index by about 2% during the quarter. Positive investment returns bumped the index up by roughly 2%, resulting in a zero net change in the index over the quarter.”

Clausen adds that “Most pension plans also experienced significant losses in 2011 on the accounting basis used for financial reporting and that the experience of the past year again points to the importance of an organization actively monitoring and managing its pension risk.”

“Major stock indices increased in the fourth quarter led by the U.S. market which was up 9.3%. The S&P/TSX index was up 3.6%, compared to 5.3% for global developed stock markets and 2.1% for emerging markets (in Canadian dollars),” adds Rob Stapleford, leader of Mercer’s investment consulting business in central Canada.

“However, for the full year, stocks had negative returns with Canada recording losses of 8.7% compared to losses of 2.7% in global developed markets and losses of 16.1% in emerging markets. Bonds performed well as a result of the decline in interest rates which saw the yield on long term federal bond yields go below 2.5%. Some funds diversified their asset mix into alternative investments such as real estate. Preliminary indications are that Canadian real estate returns for 2011 could exceed 10% which will provide investors with some diversification benefits.”

A typical balanced portfolio would have returned 1.1% during 2011 and 3.4% in the last quarter of 2011. This return does not capture any impact from active management of any asset class.

Bonds was the best performing asset class in 2011. Canadian bond markets, as measured by the DEX Universe Bond index, returned 9.7% in 2011, led by long-term bonds which gained 18.1%, followed by mid-term bonds (10.9%) and short-term bonds (4.7%). During the year, overall bond yields (as measured by the DEX Universe Bond index yields), started at 3.11%, reaching a high of 3.39% in April and fell to a low of 2.24% in December before settling at 2.33% at the end of the year.

Canadian equities, as measured by the S&P/TSX Composite index returned -8.7% in 2011.

The best performing S&P/TSX sectors for the year were health care (+50.4%), telecom services (+24.9%) and consumer staples (+6.8%). The worst performing sectors were information technology (-52.5%), materials (-21.2%) and consumer discretionary (-15.5%).

Large cap stocks returned -9.1% (S&P/TSX 60 index), outperforming small cap stocks (S&P/TSX SmallCap index) which returned -16.4% during 2011.

Value stocks marginally outperformed growth stocks as shown by the S&P Canada BMI value and growth indices, which returned -10.3% and -10.5% respectively during 2011.

The weakening of the Canadian dollar against most major currencies except Euro during 2011 had a positive impact on the U.S. and international index returns (when measured in Canadian dollar terms):

International equities, as measured by the MSCI EAFE (CAD) index, provided a return of -9.5% in 2011. In local currency terms, the MSCI EAFE returned -11.7% over the same period.

In the US, the S&P500 (CAD) returned 4.6% in 2011. In US dollar terms, the S&P500 returned 2.1%.

Emerging markets, as measured by the MSCI Emerging Markets (CAD) index, returned -16.1% in 2011.