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One step forward, two steps back. That phrase seems to sum up 2011 for Canada’s Top 40 money managers. On the DB side, plan sponsors enjoyed improved returns but remain shackled as historic lows in interest rates exacerbate deficits. In the DC space, the federal government threw money managers a very juicy bone in the form of the pooled registered pension plan (PRPP). But what could be a huge potential boon for managers now hangs in the balance, as Quebec buys in while Ontario raises questions and considers a different route.
With so much uncertainty, plan sponsors are turning to their managers for help—particularly in the DB space, where market volatility is getting harder and harder to handle.
Tough moves for DB plans
“DB plan sponsors and their managers have accepted the fact that market volatility is here to stay,” says Joe DiMassimo, senior vice-president, institutional investments, with Invesco (No. 37 on the Top 40 list). “We have all had to come to terms with the fact that this is the environment we will have to operate in going forward.”
Even solid returns aren’t helping. Bill Chinery, managing director with BlackRock (No. 2), points out that 2011 was actually a decent year for bond and equity market performance. “We had close to double-digit returns, and most investors were happy,” he notes. The problem is that interest rates are still at historic lows, which is hitting plans hard on a funding basis. Just look at the Ontario Teachers’ Pension Plan, for example. Despite being one of the top-performing pension plans in the world, with a return of 11.2% in 2011, Teachers’ still faces a funding shortfall of $9.6 billion.
These ups and downs have some plan sponsors crying uncle, according to Robert Cultraro, chief investment and pension officer with Hydro One. Plan sponsors desperately want to de-risk—but that’s tough to do with a deficit on the books. “If you’re in a deficit position, you need the risk,” says Cultraro. “And right now, equities are very cheap relative to fixed income.” That kind of market uncertainty is also driving more DB plans to close, according to Cultraro, who references the high-profile closure of RBC Financial Group’s DB pension plan as evidence of the trend.
Adam Bomers, vice-president, investment research and investment solutions, with Aurion Capital Management Inc. (No. 39), definitely sees more plan closures on the horizon. “For some companies, pension plan volatility is higher than the volatility in the company’s earnings—and, after three years of market volatility, it’s a lot for people to stomach,” he says. De-risking is part of the process, as plan sponsors put their plans to bed and companies take pension risk off the books.
So while most plan sponsors understand that they need to de-risk, it’s all about timing. The question is, When should we make our move?
Looking for the lead
As plan sponsors consider their de-risking options, they’re asking their managers for help. Robin Lacey, vice-chair with TD Asset Management (No. 1), says plan sponsors want advice from managers about where markets are headed and whether it makes sense to de-risk now or to wait.
“Clients are interested in hearing our views on the likely future direction of interest rates,” he says. “Any material move in rates has a powerful impact on their funding position. Plan sponsors are looking to managers for guidance on what the next couple of years might look like for them and how best to manage their investments, whatever the environment. We’re facing a low-growth environment in developed markets and slowing growth in emerging markets. All of that suggests low returns. And in the fixed income space, if yields on bonds stay where they are today, the best return you can hope for might be just a coupon payment.”
DB plan sponsors and their managers have accepted the fact that market volatility is here to stay – Joe DiMassimo, Invesco
Brendan George, investment consulting practice leader with Aon Hewitt, agrees that managers are becoming a bit more like consultants in these tricky markets—especially on the fixed income side, where they are being asked to help clients implement de-risking strategies.
“The main question for plan sponsors right now is when they should put more in bonds and when to fully match their liabilities with their fixed income,” he explains. “They are looking for more help from managers and consultants on if, and when, they should do it. Many of our clients are saying that getting more into bonds is great from a risk management perspective. But they are concerned that bond yields are at historical lows, so many will wait until yields increase before de-risking.”
DiMassimo says managers are being put on the spot, to some extent. “We do not have a crystal ball, but we are finding that sponsors and their consultants are relying on their investment managers to be more creative in helping them manage through this tough period,” he notes.
Different plans will have to incorporate different strategies to address both market volatility and low interest rates. Larger plans have greater ability to diversify their portfolios to cushion the impact of market swings. Although smaller plans have less flexibility in diversification, there are still options in the form of risk-balanced funds and low-volatility products.
According to Kevin Barber, senior vice-president, institutional sales, with Pyramis Global Advisors (No. 19), the waiting game has slowed down the de-risking trend considerably. Sponsors simply can’t afford to make the move, he explains. “They need to restructure their fixed income and make sure their assets are aligned with their liabilities. But they need returns at the same time.”
“Re-risking has been a buzzword over the last year, but the reality is, it’s harder to do right now,” adds Gary Wing, executive vice-president, institutional division, with Mackenzie Financial Corp. “I think the biggest challenge right now is working out what plan sponsors truly need from their plans and over what time period.”