Canada’s top economists and portfolio managers are expecting interest rates to stay below the historical trend over the medium term, which creates an additional burden for the financing of traditional defined benefit (DB) pension plans.

New survey findings from global consulting firm Towers Watson suggest there will be a further delay before many Canadian DB plans become fully funded.

Overall, the survey respondents forecast modest growth, low inflation and low interest rates to continue in the short term. Expectations are for Canadian real GDP growth to hover between 2% and 2.5% this year, with inflation remaining below 2%.

While medium-term projections foresee improvement, most of the economists and strategists surveyed do not anticipate a full recovery in Canada until at least the end of 2012. Furthermore, the majority expect the central bank policy interest rate to stay below 3.5% in both Canada and the U.S. over the next few years.

Despite the generally weak economic outlook, respondents are bullish on stock market performance, with almost 40% of survey participants expecting a return of 10% or more from the TSX and S&P 500 indices in 2011. In particular, demand from emerging markets is seen as a likely driver of economic activity.

“There is a general consensus that economic growth in the emerging markets will outperform that of the advanced economies,” says Janet Rabovsky, a senior consultant in Towers Watson’s investment practice. “As a result, the vast majority of the money managers we surveyed expect emerging market equities to be one of their strongest-performing asset categories, especially over the long term.”

Equities too hot to handle?

While the potential returns provided by equities may be tempting, Towers Watson research on plan sponsors’ investment strategies indicates that smaller plans are trending away from equities into fixed income, while plans with more than $1 billion dollars in assets are shifting away from both traditional equities and fixed income into alternatives such as infrastructure, hedge funds and real estate.

“In addition to broadening the sources of risk and return, more attention is being paid by the larger players to specialized investment strategies, especially within the alternative classes,” says David Service, a senior consultant in Towers Watson’s investment practice. “The goal for many is to avoid the equity risk.”

IE