Low interest rates are hampering pension plan real returns, and will force Canadians to begin increasing contributions to their plans to achieve their desired level of retirement income, executives at Mercer said on Thursday.

At Mercer’s annual pension outlook and investment forecast event in Toronto, Paul Forestell, senior partner at Mercer and retirement risk and finance business leader for Central Canada, said pension plans had a positive year in 2010. He said most defined contribution plans produced returns of 9% to 10%.

In the three-year period from January 2008 and January 2011, however, DC plans achieved annual nominal returns averaging just 2%. And most of that return was offset by inflation.

“After allowing for inflation, the annual real rate of return on a typical DC account is around 0.5% over the three-year period,” he said. “They’re only getting back to the same level they were at three years ago.”

Real returns of DC plans are expected to show continued weakness in the next couple years, as interest rates remain low.

“Even with the same level of assets, it will produce a lower retirement income due to the lower return expectations for DC plans,” Forestell said.

He pointed out that many pension plan members likely created their financial plans a few years ago, when average levels of return were higher. In the new environment of low interest rates, Canadians will need to make adjustments to their financial plans.

“Members likely are still going to be short of their targeted retirement savings without additional contributions and continued good investment performance,” Forestell said.

Institutional managers bullish on equities

Despite low interest rates, however, institutional investment managers have high hopes for stock market returns this year. In a Mercer survey of 56 Canadian and global managers, respondents said they expect the S&P/TSX composite index to gain 8.5%, the S&P 500 to climb by 9%, and emerging market equities to outperform all other asset classes, with returns of 10%.

“There appears to be some bias towards even higher expected rates of return, with no managers predicting negative performance in the equity markets,” said Mark Fieldhouse, principal at Mercer and a senior consultant in the company’s investment consulting business.

Nearly 90% of respondents said they expect the S&P/TSX to hit 15,000 within one to three years. In the year ahead, energy and materials are forecast to be the top performing sectors, while utilities and consumer staples are expected to lag.

Managers also expect interest rates to gradually begin to climb this year, which will hurt fixed income securities.

“Managers predict that the bull bond market has come to an end, forecasting fixed income to be one of the lowest performing assets in 2011,” Fieldhouse said.

Survey respondents said they expect long-term bonds to produce returns of just 0.3%, while corporate bonds are expected to return 3%.

The price of oil is expected to average US$90 per barrel this year, and the Canadian dollar is expected to continue to trade at par with the U.S. dollar.

IE