Strong dollar hurting pension plans

Despite the promise of cheap shopping south of the border, a soaring loonie isn’t necessarily good news — especially for pension plans.

A survey released by RBC Dexia Investor Services on Friday said the rising Canadian dollar had a negative impact on foreign equity returns last quarter. While the MSCI World Index rose 6% in the quarter that ended June 30, in local currency, that resulted into a loss of 1.8%.

“Currency fluctuations have assumed crucial significance for pension plan sponsors,” says Don McDougall, director, advisory services, for RBC Dexia, adding that about half of pension plan investments are in foreign stocks.

He also says most plans don’t hedge for foreign currency exposure. Stephen Bonnar, principal at Towers Perrin, agrees. “Most plans haven’t really thought of the currency issue,” he says. “And as a result they’re unhedged completely.”

Over the second quarter, the Canadian dollar appreciated about 8.3% against the U.S. greenback, 6.8% against the euro and 13.2% against the yen.

Bonnar says it’s the exposure to the American dollar that’s hurt pension plans the most. “Appreciation of the Canadian dollar has certainly hurt returns that were not hedged, but the impact is much more with respect to the U.S. dollar than anywhere else.”

What can a plan do to mitigate the effects of a rising dollar? For starters, managers should reconsider currency hedging. As more plans buy foreign equities, Bonnar says, they must make separate decisions on whether or not to hedge currency. “Managers are not thinking about it from a strategic standpoint,” he says. “Generally, they only hedge when they’re extremely bearish on a particular currency.”

For plans that do hedge, most go only halfway. That’s because plans don’t want to wipe out all the upsides to currency exposure, but they don’t want to get hit too hard on the downside either. “You can think of it as the ‘sleep at night solution,'” says Bonnar. “You win half your bets; you lose half your bets.”

He says equity performance improved when the Canadian dollar moved from 91 cents to 60 cents in the late 1980s but started to lag as the dollar rose. Hedging it at 50%, though, helps cushion the pain. “It’s the minimum regret scenario,” he says.

Making matters worse was a domestic bond sell-off, in anticipation of the interest rate hike. Domestic bond holdings fell 1.8%, while long duration bonds, with a maturity of 10 years or more, had their worst showing in 13 years. Canadian real return bonds were affected the most, dropping 3.5% in value.

The one small upside to the quarter was that domestic stocks had a 6.3% return because of firm commodity prices and M&A speculation. “Year-to-date, Canadian pension plans have beaten the S&P/TSX Composite benchmark index by almost a full percentage point. That’s a 10% gain on the strength of superior security selection in the materials sector,” says McDougall.

That helped Canadian pension plans earn 0.9% last quarter, bringing the year-to-date totals to 2.9%. “A lackluster return, although still ahead of inflation,” says an RBC Dexia release.

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com