Despite a challenging investment environment that’s expected to produce losses and defaults in certain assets, Canada’s large public sector pension funds are well funded and liquid enough to ride out short-term market volatility, says Fitch Ratings.
In a new report examining the big pension funds, including Canada Pension Plan Investment Board, Alberta Investment Management Corp., British Columbia Investment Management Corp., Caisse de dépôt et placement du Québec, OMERS Administration Corp., Ontario Teachers’ Pension Plan, and Public Sector Pension Investment Board, the rating agency said the pension giants are well positioned to handle stresses such as rising losses on real estate investments.
“Canadian pension fund investment portfolios will remain pressured by a challenging market backdrop, as the increased cost of debt and anticipated slower growth weigh on private asset valuations,” it said in the report.
In particular, Fitch said it expects to see growing losses on the big pension funds’ office property investments stretching into 2025, as the effects of higher interest rates and reduced demand for office space weigh on property values.
Private credit defaults are also expected to rise in the months ahead, as borrowers grapple with “higher debt service burdens … and slowing growth,” Fitch said.
Yet, the pension funds’ finances are strong enough to withstand these challenges, it said.
“The exceptionally strong liquidity of the funds provide sufficient cushion to absorb investment volatility and gives them flexibility to work through troubled investments as they are not forced sellers of assets,” said Dafina Dunmore, senior director with Fitch, in a release.
“Pension funds that invest directly in private credit will be put to the test with respect to their workout capabilities,” she said.
According to the report, the big pension funds saw assets rise about 8% last year to $2.1 trillion, with asset allocations shifting away from private equity and toward fixed-income assets.
“Pension funds are increasingly pivoting to government bonds given the higher-for-longer interest rate environment,” the report said.
The big pension players were net sellers of private equity assets in 2023 “after becoming over-allocated to the asset class, following several years of increasing allocations and strong returns,” it noted.
Despite this recent shift however, Fitch said it expects the funds to remain long-term investors in private assets, particularly private credit.
“Pension funds expect increased opportunities to invest directly in private debt, as banks face higher capital constraints that reduce their lending capacity,” it said.
It added that the funds have also developed “strategic partnerships and syndication relationships with large alternative investment managers focused on private credit as a way of accessing the market.”