Results from Mercer’s 2013 Fearless Forecast, an annual survey of Canadian and global institutional investment managers, show that those polled predict modest growth for the Canadian and global economies, lower equity and bond returns in all markets, and continued strength for the loonie against the U.S. dollar.
“2012 was a reasonably good investment year for Canadian pension plan sponsors,” said Dave Makarchuk, growth strategist for Mercer’s investment consulting business in Canada. “Overall, 2012 was a good year for most DC sponsors and members but perhaps somewhat disappointing for DB sponsors, which were hoping for some relief through a rise in bond yields. Long-term yields fell slightly, which added pressure on liabilities.”
Makarchuk noted that managers surveyed expect equities and alternatives to significantly outperform fixed income in 2013 and beyond, particularly for smaller cap and emerging market investments. But that enthusiasm is muted by expectations of lower returns than those seen in 2012.
For 2013, surveyed managers expect emerging markets to lead global equity market returns, with a median forecasted return of 8.0%. Canadian, U.S. and developed EAFE equities follow at 7.0%.
Expectations regarding bond yields were mixed. Two-thirds expect short rates to remain stable, while a small majority of managers expect longer bond yields to increase modestly throughout 2013 from current levels. The median manager anticipates universe bonds to deliver a return of 2.0% in 2013 and long-term bonds to deliver a return of 1.5%.
“While many managers expect longer bond yields to rise, none expect the increase to be significant enough to restore most DB plans to a fully funded status,” explains Manuel Monteiro, a partner in Mercer’s financial strategy group. “Consequently, plan sponsors will likely need to increase contributions in the coming years or look to alternative financing approaches such as letters of credit.”
Although the Fearless Forecast predicted a modest rise in interest rates in 2012, a combination of quantitative easing programs, anemic growth and mild inflation in developed markets all contributed little to change the yield curve. Short rates rose slightly while mid to long rates fell slightly. Corporate spreads narrowed considerably and rewarded investors who chose to bear credit risk during 2012, particularly within the high-yield market.
“If these returns are realized, a typical pension fund could be expected to earn 5% to 6% in 2013,” said Makarchuk. “Given low return expectations from bonds and uncertain expectations from equities, many sponsors and DC plan members are looking to alternative investments such as real estate, infrastructure, private equity and hedge funds to better diversify their investment portfolio.”
The participating managers forecast Canadian economic growth for 2013 at 2.0%, slightly below global growth expectations of 3.0%. Inflation was running at an annual rate of 0.8% to the end of November, but managers expect that to rise significantly in 2013, to 1.8%.
Other findings from the survey include the following:
- • Energy and financials are forecast to be the best performing sectors, while utilities and consumer staples are expected to be the poorest.
• Allocations to Canadian equities are expected to decrease in 2013 in favour of a greater focus on global opportunities.
• Return expectations for alternative assets are mixed. Private equity is generally expected to perform stronger than infrastructure, hedge funds and real estate over the next one- and four-year periods.