It’s been a bumpy year on global stock markets and at least some plan sponsors appear to be fastening their seatbelts in anticipation of more volatility, according to a Benefits Canada pulse survey conducted in February.
At that time, investors had once again witnessed extreme downside volatility with the MSCI Global Index falling eight per cent during the first week of January and the S&P TSX 60 Index plunging nine per cent in the first few weeks of the year. That followed a rough summer that saw world markets drop precipitously in reaction to China’s own stock market crisis on Aug. 24, 2015.
Surveys of pension solvency have reflected the market turmoil, with Aon Hewitt reporting median solvency ratios at 83.1 per cent for the first quarter of 2016. The report, which covers 449 Canadian pension plans administered by Aon Hewitt, showed the median solvency ratio was down from 87.6 per cent at the end of the previous quarter.
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In the wake of the market drama, Benefits Canada surveyed some of Canada’s leading pension investors to get their views on market volatility and how they’re faring. The survey involved a series of questions on market volatility posed to 52 of the top pension plans in Canada through the Canadian Institutional Investment Network. The average plan size is almost $3.5 billion.
Overview of the results
The majority (75 per cent) of respondents said the recent volatility and global sell-off hasn’t changed their investment strategies or asset positions. More than half said they’re planning to stay the course with regard to their equity exposure. In fact, 60 per cent said they’re not considering reducing equity exposure or de-risking based on the volatility.
However, a large number of plan sponsors (65 per cent) worry the market volatility could spill over to the broader economy and lead to a recession. The low value of the Canadian dollar was less of a concern, with respondents evenly split on whether or not they were worried about the impact of the struggling currency on their pension plans.
Shifting strategies
Given the volatility, are any of the plan sponsors looking to implement specific risk-hedging strategies? Plan sponsors were again split down the middle, with 52 per cent answering yes and 48 per cent answering no. However, many are considering a range of alternative strategies to dampen volatility with top options including real estate (58 per cent), infrastructure (53 per cent), private equity (40 per cent) and hedge funds (34 per cent).
A key question for plan sponsors is whether or not ongoing market volatility would make them more likely to broaden or restrict investment parameters or guidelines for their asset managers. The majority (74 per cent) would give their managers more leeway to allow them to navigate choppy markets. However, few plan sponsors would change contribution rates in response to market volatility. At the same time, 79 per cent of respondents said they weren’t planning to shift to liability-driven investing.
Plan sponsors react
None of the research results surprise Blair Richards, chief executive officer of the Halifax Port ILA/HEA pension plan, but the focus on short-term volatility worries him. “You don’t allow week-to-week movements to drive allocation,” he says.
Realistically, however, pension returns have to come from somewhere. “It’s all well and good to say you don’t want to be whipsawed by the markets, but at the end of the day, you need returns,” Richards adds.
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Anybody switching from equities and taking the de-risking route probably has a plan with a solid funded status. But that’s the exception rather than the rule, as equities remain a big part of pension portfolios even with the volatility, he says.
So while plan sponsors express concerns over market risks, they aren’t really in a position to deal with them. “They’re not changing their longer-term strategy but they are concerned about the implications of volatility for the broader economy,” says James Davis, chief investment officer at OPTrust in Toronto.
For Davis, the survey results reveal deeper concerns among plan sponsors about the impact of volatility on the broader economy. However, the long-term strategies aren’t reflecting the worries about the link between them.
“The inconsistency surprises me,” he says.
But that could be a reflection of overall uncertainty. Ken Choi, director of investment consulting at Willis Towers Watson in Toronto, says everyone is struggling to predict the economic trends, a fact that might explain the mixed nature of the responses in the survey.
“We’ve had differences of opinion for some time now,” he says. “Not that anyone is certain there will be global recession, but the uncertainty itself can create market gyrations as we’ve seen.”
As a result, investors must be mindful not only of a possible downturn but also the volatility that comes with the mere threat of one.
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Davis is very concerned about the macroeconomic implications of what’s happening in the financial markets. “The question is: How are markets perceiving policy-makers’ decisions? I don’t think you can look at today’s markets in the same way as you did five years ago where a sell-off is a great buying opportunity, especially for mature plans. This feels to me like it’s all about hope. I need returns and I am going to hope that they come out.”
John Poos, vice-president for pensions and investments at George Weston Ltd., also believes the survey results reveal some short-term thinking as plan sponsors make decisions based on day-to-day volatility.
“There are some plans looking at asset classes they might not have considered in the past as a result of volatile markets,” he says. “To me, that seems reactionary and not good pension practice. You get into real estate based on what is the long-term interest of the plan, not as a reaction to public markets as they are today.”
Malcolm Hamilton, a former pension consultant and now a senior fellow at the C.D. Howe Institute, believes the research shows a worrying link between short-term market movements and decision-making among Canadian pension plans.
“I was shocked that people were attaching so much importance to this,” he says.
“If that kind of volatility is going to cause you to question your risk exposure and asset mix, then you are taking too much risk. The respondents are really saying that they are not comfortable with the amount of risk they are taking. January’s volatility just reminded them of something they should have known earlier. This trend-chasing approach to managing money has proven over and over again to be the road to disappointment.”
‘Good reason to pause’
The survey results, however, weren’t a surprise at all for Janet Greenwood, senior vice-president for investment solutions with Aurion Capital Management Ltd. in Toronto. “When you experience short-term market volatility, there is good reason to pause,” she says. “You might think tactically about risks and exposures you would be prepared or not prepared to take, but generally, your longer-term investment strategies would not be affected by short-term market volatility.”
Greenwood does see a gradual strategic reshaping of pension assets, however, as a result of tolerances for volatility. “It might not be reducing exposure but, rather, a reshaping of exposures cognizant of your asset-class equity betas,” she says. “Your overall risk budget might be the same, but you may want to spend it differently.”
In fact, the results of the survey show a trend of shifting exposures towards categories with a different risk profile. “It suggests a new financial assessment framework to manage volatility,” says Greenwood.
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Richards believes the move to consider new strategies is a natural one given his view that the traditional 60-40 split between equities and fixed income is largely dead. But what should investors replace it with? “I’m not sure what the new norm is,” says Richards.
“People don’t want the volatility of traditional equities, but if your bogey is six-per-cent [return], then what do you switch to?”
THREE PLANS’ APPROACHES TO VOLATILITY
George Weston Ltd.: Reducing obligations
Volatility isn’t an issue for the George Weston pension plans, says John Poos. “We’ve built our portfolio to absorb these kinds of market shocks. So our plan has not suffered materially as a result, which is why we’ve set it up that way. We won’t see huge upside when the market goes up, either.”
Poos says George Weston has a long-term strategy to get the plan fully funded. “We did a bunch of annuities last year,” he says. “We are reducing obligations as we can. As we get close to fully funded and as the opportunities present themselves, we are annuitizing.”
Halifax Port ILA/HEA: To hedge or not to hedge
While Blair Richards says his pension fund is more strategic and long term in its vision, the volatile Canadian dollar is an issue. “The only thing we are now looking at is a currency hedge,” he says.
It’s the first time the plan has ever looked at it, but Richards believes that at some point, the currency situation will change. “We think we are at an inflection point right now,” he says. “We think there is money to be made in the Canadian dollar strengthening if you can get everything right.”
Optrust: De-risking
With a lower appetite for volatility than in the past, OPTrust has made a decision to de-risk and undertake what the plan is calling a member-driven investing strategy focused on balancing assets and liabilities.
“Given the market and the demographic challenges in the plan, we need to be confident we are getting paid adequately for the risks we take and only take the amount of risk we absolutely need to take to meet our pension obligations,” says James Davis. “As such, we embarked on a strategy to reduce our exposure to market drawdowns and are de-risking.”
Caroline Cakebread is a Toronto-based freelance writer.
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