The Canadian Source Of Employee Pension Fund Investment And Benefits Plan Management

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We’ve Come A Long Way Baby!

By: Kathy Taylor

How times have changed! Itʼs hard to believe that just 25 years ago the majority of Canadian pension assets were managed by large insurance companies in balanced portfolios that held primarily Canadian equities and bonds. Only a limited number of larger pension plans held real estate and virtually none ventured into private equity. Most plans populated their 10 per cent foreign content ʻbasketʼ with U.S. equities and international investing in developed markets was in its infancy as was currency management.

Gradually, enterprising portfolio managers left the security of their insurance company employers to set up ʻboutiqueʼ investment management firms. Some radicals began promoting ʻModern Portfolio Theoryʼ concepts such as portfolio optimization and risk budgeting.

In the mid-1980s, providers of sophisticated risk analytics such as BARRA adapted their U.S. software for the Canadian market. Managers developed quantitative investment strategies that used these tools to select securities and structure portfolios with defined levels of risk, ʻoptimallyʼ positioned along the ʻefficient frontier. ʼ But managers offering these quantitative strategies struggled to explain the nuances of their ʻblack boxʼ approaches to an understandably skeptical audience.

Alpha Or Beta

Few industry participants could define terms such as alpha or beta and anyone suggesting separating the two would have been laughed out of the room. Long/short investing was virtually unheard of. As for hedge funds, you want me to invest in a nursery?

Today, itʼs hard to imagine a portfolio manager not using computer analytics in some aspect of the investment process. Enhanced indexing strategies (as those early quantitative strategies have become known) are widely used since their risk controlled returns provide a reliable core portfolio holding. Likewise, optimization and risk budgeting have become mainstream techniques for managers, plan sponsors, and consultants alike.

Plans of all sizes invest in real estate, either in directly managed investments or in REITs.

With the removal of the foreign content limit, plans have significantly increased their non-Canadian exposure by investing in both developed and emerging markets. Currency management is used to control the risk profile in the non-Canadian portfolio or as a standalone strategy to generate alpha.

Market neutral and hedge fund investing has become so popular that there are concerns of a speculative bubble.

Customize Their Portfolio

Plan sponsors have the securities and investment tools available to customize their portfolio any way they choose – futures, swaps, exchange-traded funds, credit default swaps. You may like the alpha your small cap manager is generating, but are overweight in that sector and underweight large cap. No problem, short the futures contract or exchange traded fund that most closely matches your managerʼs benchmark and go long the equivalent large cap security. Voila, the small cap managerʼs alpha is now linked to the large cap beta you want.

Many sponsors, worried about the onset of mark-to-market accounting for their pension funds, are evaluating liability relative investments; that is, creating a primarily fixed income portfolio with duration and other characteristics that are closely linked to the characteristics of the planʼs liability.

It is said that the only certainty in life is change. Given what has transpired in the past 25 years, what might the investment landscape look like in 2030?

Kathy TaylorKathy Taylor is managing director with Barclays Global Investors.

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