Canada’s pension plans saw their performance marred for a third consecutive quarter as global equity markets continued to decline.

But those pension funds that hold their assets under administration in unhedged Canadian dollars fared better than those that did not, according to a report by Toronto-based institutional advi-sor RBC Dexia Investor Services.

RBC Dexia is jointly owned by Toronto-based Royal Bank of Canada and Dexia SA, a bank based in Brussels.

The unhedged pension funds received a boost from the weakening of the C$ against a handful of other world currencies, according to the report from RBC Dexia, a global pension custodian, which based its survey on a sample of 40 defined-benefit Canadian funds.

“The Canadian dollar was soft to the U.S. dollar, and lost ground to the yen and the euro,” says Don McDougall, director of advisory services for RBC Dexia. “If you’re holding U.S. assets in Canadian dollars, the value of the assets actually went up, so you’re generating a gain because of that.

“However, if you’re hedging away the currency exposure, you have just neutralized it,” he adds, “so it makes no difference.”

According to RBC Dexia’s report, the value of the pension funds’ AUA dropped by 1.9% in the quarter ended March 31, which resulted in a 12-month average performance of minus 2.7 %.

“The MSCI World Index plunged by 11.9% in local currency terms,” says McDougall. “[Pension fund] performance almost matched the index, but Canadian pensions lost only 5.5% once exchange rates are taken into account.”

He adds that the changing exchange rate actually benefited smaller pension funds, because they are less likely to be hedged due to the complexity involved in hedging.

“I’d expect that larger portfolios are going to do a little bit worse,” McDougall says. “The smaller portfolios achieved some currency gains. The large group are going to be hedged, so they’re not going to get a benefit.”

The loonie dropped by almost 7% against a group of foreign currencies, including a 2.7% decline against the US$, 10% against the euro and 13% against the yen.

“So, where [a stronger C$] was quite helpful was for the larger portfolios over the past few years,” McDougall says. “Certainly, they have gotten a boost from it. This quarter, the hedge worked against them.”

Smaller pension fund portfolios are less likely to engage in the practice of hedging as they tend to delegate much of the asset-management responsibilities to external parties.

The really small ones, McDougall says, may use just one investment manager to run all the AUA.

PENSIONS LAG INDEX

Although the Canadian stock market saw a decline, its 2.8% drop in the most recent quarter was mitigated by hikes in commodities, with crude oil and gold reaching record highs. This resulted in a gain of 7.3% for materials and of 1.2% for energy. These were the only two sectors with positive returns in the most recent quarter.

The surge in commodities didn’t benefit Canadian pension funds; they had generally reduced their exposure to both sectors, and as a result, McDougall says, pension funds underperformed the S&P/TSX composite index by 1.6% in the quarter — and by 3.8% over the 12 months ended March 31.

Domestic bonds were strong in the quarter, earning 2.8%. However, they still lagged the DEX universe bond index by 0.2 %.

“Spreads varied considerably,” says McDougall. “Real-return bonds generated 5.9%, while longer-maturity corporate bonds lost 0.3%.”

The results reported by RBC Dexia represent the median of the 40 pension funds in the sample — drawn from a basket of data from more than 300 Canadian pension funds with a combined value of about $340 billion — that are scrutinized for the survey done by RBC Dexia.

“This universe is meant to be a barometer of pension plans across Canada,” McDougall says. “Typically, the median rate of return is a very, very stable statistic, and that’s the one we’re quoting. Once we do this work for all our clients, that media tends to be very robust and quite stable.”

RBC Dexia itself has US$2.9 trillion in client AUA and, while much of the report’s data comes from pension funds for which it is a custodian, other pension funds submit their data to RBC Dexia for analysis.

McDougall says he can’t identify the pension funds in the survey, but says it includes several large public pension funds.

@page_break@Meanwhile, Canadian DB pension funds are grappling with another challenge, according to another report, written by Robin Banerjee and William Robson of the C.D. Howe Institute.

Canadian regulations that restrict companies from contributing to DB pension plans when assets exceed liabilities by 10% are hurting single-employer DB plans, according to the report, dated April 15. In fact, that report concludes, the regulations are discouraging the sponsorship of such plans.

“By preventing contributions when surpluses reach 10%, the [Income Tax Act] either induces sponsors to inflate the size of reported liabilities so the cap does not constrain funding — a practice that perverts the cause of meaningful reporting — or stops companies from pursuing consistent contribution strategies as interest rates and asset markets fluctuate,” says the C.D. Howe report.

“First, and fundamentally,” the report continues, “limiting contributions in good times stops plan sponsors saving in fat years to cushion against lean ones.

“Having the flexibility to time investments can also help firms buy assets when they are cheaper, and enjoy longer compounding periods.”

ITA CHANGES NEEDED

The Income Tax Act restrictions are meant to discourage employers from attempting to reduce their taxable profits through the use of pension plans, as contributions to such plans are tax-deductible.

But the problem with this, the C.D. Howe report’s authors argue, is that surpluses are necessary to allow investment managers for pension plans the flexibility to map out strategies for the best long-term performance results.

“Since pension plans have long time horizons, the theory goes, they need little current liquidity and can tolerate short-term volatility in asset prices,” the report notes. “So they can earn higher returns by investing in assets that investors who either need liquidity or dislike short-term volatility shun.

“The resulting assets/liability mismatch means that even plans that are fully funded or better, on average, over time will swing [to] either side of balance,” the report continues, “as asset prices and interest rates change.”

However, the C.D. Howe report also notes that lifting these Income Tax Act restrictions will not be enough, if done without other changes, to create an incentive to encourage the growth of more DB plans in Canada, or to allow existing ones to thrive. IE