Improved performance by both global equities and real estate increased returns for Canadian defined-benefit (DB) pension plans in 2012. And although experts are reluctant to make predictions for 2013, they do note some trends that may start to make a positive dent in the solvency ratios of some DB plans.
Royal Bank of Canada (RBC) recently reported that Canadian DB pensions within the $410-billion investor and treasury services all-plan universe that RBC monitors rose by 2.5% in the fourth quarter (Q4), ended Dec. 31, 2012, vs 3.2% in the third quarter, ended Sept. 30, 2012. The median return for all of 2012 for Canadian DB plans was 9.4%.
Global equities led the way for Canadian DB plans in both Q4, at 4.5%, and for the year, at 14.7%.
Real estate also was a major contributing sector in 2012. An RBC survey of fund portfolio managers offering pooled investments to pension funds saw a median one-year return on real estate of 12.5%.
This trend toward real estate investment among major Canadian pension plans is expected to continue in 2013, says Scott MacDonald, head of pensions, insurance and sovereign wealth strategy with RBC.
“[These plan sponsors] are the ones who made a real commitment to private-equity real estate infrastructure investing,” says MacDonald. “And they’ve been trumpeting that as one of the reasons for their strong performance. They are on record as saying they are going to continue to do that and do more of it. And they have the ability to do that because of their size and resources.”
Small and medium-sized DB plans have little exposure to real estate infrastructure because of their size. Instead, MacDonald says, those smaller plans are looking to get greater exposure to asset classes that help them improve their performance without undue cost or complexity.
Interest rates, which have been held to historical lows, are expected to rise in 2013, says Fred Vettese, chief actuary with Morneau Shepell in Toronto, adding that pension plans with higher liabilities will be happy to see this because it will help to improve their solvency ratios.
“The only pitfall will be from the slow recovery that we have been seeing in the U.S.,” Vettese says. “The U.S. is the main market we have to worry about; not so much what happens in Canada. The biggest thing would be if the antagonism between the Republicans and Democrats continues and actually derails some of the actions and spooks investors – that would be about the only thing I would see as maybe being a fly in the ointment for 2013.”
Adds Vettese: “If you look back at forecasts from various experts over the past three years, we kept thinking we were going to turn the corner every year. When we finally do turn the corner, it will be so rounded and gradual, we’ll barely even know it.
“The markets had a nice little jump in the past month,” he continues. “They may go up a little bit more in 2013. At some point, they will have to revert to their long-term norms. We’re seeing long-term bond yields still at 3%; at some point, they will be going back up to 5%. When they do, it will be a good thing for pension plans because, more than stock market performance, [low interest rates] are the main reason why the funding levels of pension plans have been so poor.”
London-based Aon Hewitt released a report last month stating that the solvency of DB plans in Canada improved ever so slightly in 2012, thanks to a strong equities market and company contributions. The Aon Hewitt report says the median pension solvency funded ratio – the ratio of the market value of plan assets to liabilities – is about 1% higher this year than at the beginning of 2012. The report adds that downward pressure on yields is likely to continue this year.
Thus, MacDonald says, many DB plan sponsors aren’t counting on higher interest rates to help their solvency situation, but are adjusting their asset mix to take on a little bit more risk in exchange for more performance by investing in corporate vs government bonds. This trend is expected to continue in 2013.IE
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