Faced with an aging population and rock bottom interest rates, Canadian defined benefit pension fund managers are increasing leverage in a bid to keep up with their benefit commitments, which also raises risks, according to a report published Tuesday from Moody’s Investors Service.
Canada’s large public pension funds — CPP Investment Board, Public Sector Plan Investment Board, Caisse de dépôt et placements du Québec, Ontario Teachers’ Pension Plan, Ontario Municipal Employees Retirement System, and Healthcare of Ontario Pension Plan — are under increasing demographic pressure as the population ages, and the ratio of workers to retirees shifts, the report notes.
“The active-to-retired ratio, a measure of the relative proportion of contributing members to retirees collecting benefits, has fallen for all six pension managers in the past 10 years as growth in retirees outpaces contributors,” says Jason Mercer, assistant vice president at Moody’s, in a statement.
This trend, in turn, places greater pressure on plans’ funding and liquidity requirements, as net contributions decrease alongside the shifting composition of plan membership.
“Weaker net cash flows make funds more dependent on market performance to maintain current funding levels, but low interest rates hinder the funds ability to make returns strong enough to offset the net cash flow pressures,” adds Mercer.
As a result, pension managers are looking to boost investment returns by increasing leverage and their exposure to illiquid assets, the report says Indeed, average leverage for the six largest funds has increased to 24% from 19% since 2009, the report notes.
“This strategy entails higher risks for pension managers since leverage magnifies not only gains, but also losses,” the report warns.