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

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The Need For Return

By: Clive Morgan

During the past 50 years, plan sponsors completed asset/liability studies to determine the optimal asset allocation policy. This analysis focused on both the level and volatility of the contribution and expense policy. The result, in most cases, was to continue with the traditional policy mix of 60 per cent equities and 40 per cent bonds. The fundʼs performance was then measured against that of its peers.

This strategy was acceptable as corporations had a long time horizon; the equity markets had, and were forecast to have, positive returns; and bond markets were relatively stable.

However, market forces since 2000 resulted in negative equity returns and lower interest rates, and pushed corporations to reconsider their policy mix. The focus was now on the impact of the mismatch between the expected returns on the assets and the liabilities.

Significant Deficits

This focus is no different from that used in studies done in the ʼ80s and ʼ90s. However, corporations have significant deficits today, which affect their cash flows and financial statements due to the pension expense calculation.

The need to match assets and liabilities has led to new investment terminology such as liability-driven investing (immunization) and risk budgeting (asset/liability studies that use long bonds as the minimum risk portfolio). In addition, new investment tools have evolved using active trading strategies to either reduce portfolio volatility and/or to add return above a passive index.

While alternative investments – such as hedge funds, private equity, commodities, and infrastructure – have been used by endowments and family offices for many years, they have generally not been part of a pension fundʼs toolbox.

Since 2000, Canadian plan sponsors have worked to better understand the role of these products in their portfolios and their associated risks. In the past two years, plan sponsors have shifted to implementation, with a clear focus on reducing the asset/liability mismatch and improving returns.

Return On Assets

In my opinion, the need to match assets with liabilities will have a significant impact on the investment management business as managers are forced to develop strategies that protect capital to meet plan sponsorsʼ needs. In future, performance relative to an index will be far less important than the return on the assets relative to the return on the liabilities.

The alternative ʻgenieʼ is out of the bottle and the traditional investment world will be forever changed.

Clive Morgan Clive Morgan is president of York Investment Strategies Inc.

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