Canadian pension funds to take action in 2009

Last year was the worst year on record for Canadian pension plans, but fund managers have several options to help them draw valuable lessons from the economic crisis and to prepare for a return to better times, according to Morneau Sobeco.

With a median return of -16.5% in 2008, Canadian pension funds suffered the most significant losses since Morneau Sobeco began compiling their performance results, explained Joseph Connolly, an investment consultant with the firm, at a recent breakfast seminar in Toronto.

Outlining the origins of the global economic crisis, Connolly noted that no sector was spared from the carnage. Fourteen of the 50 strongest performers on the TSX showed negative returns, with some securities posting losses down to -80%. As many pension funds have significant investments in securities, this was bad news for their returns.

“The impact on pension funds as a whole has been difficult,” said Connolly. “The end of 2008 saw an increase in solvency liability as a result of a deterioration of financial position by 25%, a drop in government bond yields and new CIA standards.”

Citing factors such as the U.S. housing bubble, mark-to-market accounting standards and the spending habits of U.S. consumers, Connolly explained that the onset of the recession has brought about what John Maynard Keynes referred to as the “paradox of thrift,” in which individual acts of frugality by millions of consumers result in the fall of aggregate demand, deepening the recession and leading to lower total savings.

“When things are going well, people don’t save for a rainy day,” he said. “However, when things become a little bit fearful, they save very quickly. That’s a problem.”

One way to avoid the paradox of thrift is to restore consumer confidence, suggested Connolly. “Once that happens, things tend to turn around.”

He pointed out that despite the recent volatility and alarm in the markets, Canadian pension plans did not panic. According to Morneau Sobeco’s research, 68% of defined benefit plan respondents did not take any significant action during the initial crisis, while almost half of defined contribution plans sent out special communications to members.

Looking ahead to 2009, Connolly expects to see a significant rebalancing of portfolios, taking market liquidity and the use of derivative products or buy/sell securities into account. Investment policy reviews are also likely to occur, he said, to make sure that target portfolios are still appropriate.

Connolly also expects pension funds to examine their manager mandates now that there is a track record to look back on since the onset of the crisis in August 2008.

“Now’s the time to ask yourself: Do I understand why a manager performed a certain way?” he said. Noting that some managers claim to protect their clients in bad markets, he added that it’s worth taking the time to examine a few basic issues, such as whether your manager provided protection on the downside and, if not, what should be done about it.

“Take a look at the fiduciary boundaries, the constraints,” he said. “Did they test the boundaries of what they’re allowed to do? What types of bonds did they have in their portfolio? Were they correct? Sometimes they’re given a little bit of flexibility — but how much did they take?”

(02/20/09)