For the last 10 years, taking risk did not pay off for DB plans, said Leo de Bever, CEO and chief investment officer of Alberta Investment Management Corp. (AIMCo), speaking today at The Conference Board of Canada’s 2011 Summit on the Future of Pensions: Rebuilding Pensions, Rethinking Retirement in Toronto.
DB is an efficient system, de Bever said, but the lack of funding risk sharing is problematic. For typical pension plans in Canada in the ’90s, funding ratios increased. “But the way we calculate ratios is inconsistent with making a ‘pension promise’ secure,” he said.
For example, in the 1950s, people worked for 40 years and retired for 10, with a 13% contribution; in 1998, people worked for 30 years and retired for 30, with a contribution of 12.2%, he explained. “You can’t improve risk-adjusted pension funding by taking more risk.”
With a typical Canadian pension plan funded at 80%, extra contributions could make up the deficiency in 10 to 15 years, but there’s a 50% chance of not being 100% funded in 10 years, he said. “The market returns aren’t going to be spectacular. We’re not going to repeat what we had in the ’90s.”
Contrast this with the Netherlands, he explained, which tends to fund conservatively and invest aggressively. It forces typical 60/40 pension plans to have a 125% target funding ratio. Liabilities are discounted at the expected bond rate, and there’s only a 25% chance of not being 100% funded in 10 years. “And, there’s an adjustment in the pension deal if the ‘target pension’ is underfunded,” he stressed.
AIMCo’s approach
Right now, de Bever says investing in long bonds is not so good, as the yields are at a general low. And, he adds, the 10-year equity outlook looks average at best (the return is high in the long run because it is unpredictable in the short run).
At AIMCo, economies of scale (which help to reduce operating costs), cost containment and governance models are important. And the company manages return on risk instead of return on assets.
To increase active returns, de Bever offered a few suggestions:
Security selection – AIMCo looks at private equity and listed equity (what AIMCo calls relationship investing), taking a significant position to affect outcomes.
Infrastructure – Going forward, as governments need to finance these projects, de Bever says they’ll need private capital. Pension plans, then, can take advantage of this and make some good investments.
de Bever left the audience with some key take-aways:
• Underfunding, rising contribution rates and mediocre market returns have put pension financing under pressure.
• Pension plans can’t be long-term investors and insist on consistently high returns in the short run.
• A disciplined search for return in unusual places can add 1% per year or more in the long run.
• Active return alone will not cure long-term design issues with pension plan funding and the volatility of return/risk.