Are pensions searching for yield or solvency?

The asset mix in Canadian pension plans has shifted in recent years, and new research argues that these efforts aim to reduce solvency risk rather than to boost returns.

In a research note, analysts at the Bank of Canada looked at the evolution of pension portfolios between 1998 and 2018 using data on the assets and liabilities of 128 federally regulated defined-benefit plans.

The researchers found that, over that time, as interest rates declined, almost two-thirds of pensions (64%) abandoned a traditional asset mix (60% stocks and 40% bonds).

For about one-third of the plans, this move was significant, with more than 30% of total assets turned over, the researchers noted.

“In its place, they opted for portfolios with more alternative assets, such as private equity, real estate and infrastructure,” the paper reported, “but a majority allocation in bonds.”

While a shift to alternative assets is often seen as a move to enhance returns, the researchers argued that managers were actually seeking to reduce their solvency risk in the face of low interest rates by opting for larger bond holdings.

“The larger allocation to bonds — with safer and lower returns — is hard to square with reaching for yield,” the researchers said. “Instead, we argue that managing solvency risk can explain this broad shift.”

For plans that overhauled their portfolios, most reached 100% funded status and saw their solvency ratio volatility decline by 30%, the research found.

In contrast, most plans that kept a traditional 60/40 asset mix ran a solvency deficit in 2018, they reported.

Additionally, the plans that altered their portfolios recorded slightly lower returns — about 25 basis points lower — than the plans with traditional asset mixes.

“It is true that, in isolation, investing in alternative assets and corporate bonds or using financial leverage means taking specific risks in exchange for higher returns. But we show that these investments are part of a broader strategy that aims to reduce overall solvency risk,” the researchers concluded.

James Langton

James is a senior reporter for Advisor.ca and its sister publication, Investment Executive. He has been reporting on regulation, securities law, industry news and more since 1994.