Defined benefit (DB) pension plans in Canada saw their solvency status hold steady in the first quarter, after concerns about the risk of a trade war, among other concerns, sparked market volatility.
A typical balanced pension portfolio would have declined by 0.5% in the first quarter, as both Canadian and foreign equity markets suffered negative returns (in local currency terms), and the fixed income market was relatively flat, Mercer says.
The Canadian dollar depreciated against the U.S. dollar, the euro, and the U.K. pound during the quarter, however, boosting certain markets’ returns in Canadian dollar terms.
“We have observed a heightened level of volatility in the markets over recent periods,” says Sofia Assaf, principal and senior investment consultant at Mercer Canada, in a statement. “Investors are showing sensitivity to headwinds of tighter monetary policy, trade protectionism and geopolitical uncertainty and we anticipate volatility to ensue over 2018 as a result.”
The Mercer Pension Health Index, which measures the solvency of a hypothetical DB plan, reached its highest level since 2001 during the first quarter, before dropping back to where it started the year amid the rise in market volatility.
The index finished the first quarter at the same place (106%) it started; although the median solvency ratio ticked up to 98% from 97% for the period, Mercer says.
According to Mercer, the funding position of DB pensions was “boosted slightly” in the quarter by modest rise in long-term interest rates, whereas volatile equity markets has a mildly negative effect. Moreover, the recent volatility should serve as a reminder to sponsors of closed DB plans about the market risk that they may be exposed to after a long period of bullish markets, Mercer says.
“We believe that many of these plans are too exposed to risk, and that their sponsors should consider moving to a lower risk asset mix or entering into an annuity transaction,” says Manuel Monteiro, leader of Mercer Canada’s financial strategy group, in a statement.
Most plans that are still open likely can’t afford to significantly reduce risk, Mercer says, so these sponsors, “should consider opportunities to diversify their return sources, particularly through optimizing their equity portfolio and increased allocation to alternative assets.”