Canadian pension plans continue to see improved fiscal health, with funding levels bouncing back strongly after this most recent recession. But with many equity markets at record highs, and the lessons of 2008 still fresh, there is renewed discussion about de-risking in order to protect against future funding shocks.
However, recent research undertaken by Sun Life Investment Management and Rogers Publishing shows that much of the talk of de-risking hasn’t yet turned into action. Many plans still have a significant amount of risk, with a disproportional amount of their assets exposed to equity markets. We surveyed 100 defined benefit plan sponsors about a range of issues faced by pension plans today.
From our survey results, it’s clear that memories of 2008 and the funding crisis that arose in its aftermath have not been soon forgotten. Nearly three-quarters of the surveyed plans (73%) state that the most immediate investment goal for their plan is either de-risking or increasing yields while not increasing their risk levels.
But here’s the issue: few plans are taking action. Despite a stated desire to de-risk, as highlighted in surveys over the past two years, asset allocations haven’t budged—nearly 50% of plan assets are still invested in equity markets. In fact, the allocation to many alternative investments, such as real estate, infrastructure, and private equity and fixed income, actually stayed the same or decreased over the past year.
These alternative investments offer greater diversification and enhanced returns over public market benchmarks, hence lowering a plan’s overall investment risk. In short, they represent an excellent opportunity for plans to implement de-risking.
Holding back
So why isn’t this happening in a bigger way? There’s a short, simple answer for many plans: liquidity concerns.
The trade-off for gaining the benefit of alternative asset classes is that these are generally less liquid investments. When we asked plan sponsors the reasons why they would exclude certain alternative investments from their portfolio, liquidity was one of the top concerns for private fixed income (53%), real estate (42%) and commercial mortgages (27%).
But the truth is that most plans have more liquidity than they need. For a typical pension plan with a mix of pensioners and active participants, the annual cash requirement as a percentage of their fund is no more than 6%.
Although it is important to have enough cash on hand to pay current liabilities, manage unexpected outflows and re-balance a portfolio, excess liquidity costs money. In this low yielding and low return environment, recalibrating liquidity needs is the next best trade for a pension plan. Consider this carefully.
It means that liquidity is an asset that pension plans may be overlooking as a source of opportunity. It’s clearly a “Goldilocks” attribute—you don’t want to have too little, but there is a cost to having too much.
Plans with excess liquidity could earn additional yield, improve returns while reducing risk, and potentially reduce contributions by adding alternative investments to their asset mix.
Carl S. Bang is President, Sun Life Investment Management Inc.