Money Managers Virtual Round Table

Benoît Durocher: There is no doubt that the U.S. casts a wide shadow over its northern neighbour. However, economic policies in both countries have drifted apart in the past few years. For instance, Canada has rid itself—for now, anyway—of deficits that still plague the U.S. government. And the recent rescue package will do nothing to improve this situation, with potential consequences on U.S. dollar-denominated assets.

Canada has also benefited from the clarity of its monetary policy, owing to inflation targeting. As for the U.S., achieving the Federal Reserve’s monetary policy goals of maximizing employment, stable prices and moderate long-term interest rates may tilt policy toward reaching one goal at the expense of the others.

One can not ignore the economic ties that link both countries especially in tradable goods, but services make up an increasing share of economic activity domestically and domestic economic policies will define the environment for services. So there is some argument to be made that Canada can perform differently than the United States in some areas. In addition to services, most investors think of Canada as a producer of natural resources and as the recent run-up in commodities prices showed, our equity market will be reflecting conditions for natural resources.

Peter Lindley: The U.S. is Canada’s No. 1 trading partner, so if there is a U.S. recession, Canada will be affected. But we have to recognize that the strength of the global economy is what largely benefited the Canadian dollar and the massive terms of trade boost we have enjoyed over the last five years.

So, if the rest of the world could decouple from the U.S. slowdown, Canada would be less affected than other countries. Unfortunately, it is becoming clear that problems exist in the U.S. economy and that a global slowdown in economic growth has emerged.

On the positive side, Canada has the world’s soundest banking system, according to a survey by the Geneva-based World Economic Forum. Our corporations are generally cash-rich, and our citizens are not overly burdened with credit-related debt. Although Canada cannot escape the fallout from the current economic storm, we are well positioned to withstand the downturn. BC

All of these factors mean that although Canada can not escape the fallout from the current economic storm, we are well-positioned withstand the downturn than any other developed country.

What has been the take-up of alternative investments among Canadian plan sponsors?

Benoît Durocher: Alternative investments have been part of the portfolios of large pension plans for some time already. During the last few years, it expanded to smaller plans as we could observe a growing interest for “de-risking” through investing in long term bonds and re-allocating risk to other asset classes such as global equities, commodities, infrastructure and real estate investment trusts.

How well those strategies come out of the market turmoil over the next twelve months might impact the decisions of many plan sponsors that are considering the addition of such alternative investments to their pension portfolio as a source of additional return with little extra risk.

What is the strongest investment trend you’re seeing now?

Benoît Durocher: Pension plans have been hit from both sides. The decline in interest rates has revealed the plans’ vulnerability to downward movements in interest rates while the recent financial crisis has highlighted the volatility of returns. In this context, sponsors are looking for ways to be protected against the impact of interest rates while seeking more stable and greater returns. It is the age old question for investors to minimize risk while maximizing returns.

Part of the answer to this dilemma rests with LDI strategies. While not a guarantee, LDI structures at least address the issue of the impact of interest rates on the plan’s financial equilibrium while allowing for some flexibility in returns. However, there is no such thing as a free lunch and expected returns will only result from taking on greater risk.

Peter Lindley: Two strong investment trends which we see emerging relate to the integration of alternative investments amongst Canadian plan sponsors. The first trend is a migration towards the integration of absolute return and hedge fund strategies into broader portable alpha frameworks. As more plans are adopting some form of an LDI framework and are looking to increase their asset liability matching with the inclusion of long-duration fixed income assets, the reality is that very few plans can afford to forgo the higher expected returns associated with equities. In this context, plans no longer view absolute return strategies as a distinct asset class but more as a way of increasing the returns of an otherwise generic fixed income allocation.

The second trend that we are seeing is the integration of investment techniques previously associated with the alternative space in traditional investment mandates. While we currently see evidence of this trend in the growing acceptance of 130/30 equity strategies, we also expect this trend to gain further traction in the fixed income space.

The current environment has emphasized the limitations of traditional duration and yield strategies, and as we see plans increasing their fixed income allocations, we see a strong potential for Canadian core bond mandates that permit managers to diversify their alpha sources beyond traditional duration and yield strategies by removing the constraints on shorting and further diversity potential rate and curve views through the inclusion of global bond strategies.

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© Copyright 2008 Rogers Publishing Ltd. A shorter version of this article first appeared in the November 2008 edition of BENEFITS CANADA magazine.