Median Canadian Pension Plan Loses 3.7% in Q3

For the quarter ending September 30, the median Canadian pension plan returned negative 3.7%, according to data from the Northern Trust Corp.’s Canada Universe. Stronger returns in previous quarters provided some cushion, resulting in a 1.6% increase in return year-to-date for the median Canadian plan.

The Canada Universe tracks the performance of Canadian institutional defined benefit plans that subscribe to Northern Trust performance measurement services.

Threats of a U.S. government shutdown, strikes by the United Auto Workers and the downgrade of the U.S. sovereign rating and 10 regional U.S. banks all impacted international markets and economies, particularly Canada, in the third quarter. According to Northern Trust, investors were alarmed by mixed economic readings, such as record oil prices that factored into inflation readings, combined with positive economic data, making investors fear that those metrics meant inflation could stay at elevated levels for an extended period of time.

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Because of these economic uncertainties, yields trended higher, resulting in a sell-off in bonds and a decline in the equity markets, resulting in negative results for both asset classes during the quarter.

According to Northern Trust, Canadian inflation rates (3.8% at the end of September, up from 2.8% at the end of June) are lower than at this time last year, although still higher than many central banks’ target levels. The Bank of Canada raised interest rates to 5% during the quarter, up 25 basis points from Q2.

“The combination of uncertainty and high interest rates resulted in a decline for both equity and bond markets during the period” and resulted in a decline for the median Canadian pension plan, Northern Trust’s summary stated.

“This past quarter demonstrated how rapidly volatility can resurface, creating unfavorable market conditions and increasing pressure on investment portfolios,” said Katie Pries, president and CEO of Northern Trust Canada, in a statement. “As monetary policymakers adhere to their mandates and exercise discipline amid these pockets of uncertainty, pension plan sponsors also maintained discipline in challenging environments, affording them the ability to deliver on their long-term pension promise.”

Northern Trust found that Canadian equities, as measured by the S&P/TSX Index, returned a 2.2% loss in the quarter, with information technology the best-performing sector. Consumer staples, materials and real estate were the weakest-performing. U.S. equities returned negative 1.2%, as measured in Canadian dollars, with only three out of 11 sectors positive. International developed markets, as measured by the MSCI EAFE Index, returned negative 2%.

The Northern Trust Canada Universe tracked positive returns for the first and second quarters of 2023, with Canadian pensions returning a median of 4.2% and 1%, respectively. Negative returns were tracked in the first and second quarters of 2022, when Canadian plans returned –6.4% and –8.8%, respectively. In Q3 2022, Canadian plans returned 0.76%, and in Q4 2022, Canadian plans returned a median of 2.8%, resulting in a return of negative 12.8% for the full year.

Given that Canadian pension funds, and the markets overall, had a rocky quarter, the Canadian economy fared somewhat better: Solid job growth was reported in August and September, with 100,000 jobs added, although the unemployment rate rose 0.1% to 5.5% during the quarter.

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In response to a U.K. government call for evidence as to whether defined benefit pensions should increase their investments in productive finance, including infrastructure, experts at the EDHEC Infrastructure and Private Assets Research Institute warned that such a move is too risky.

The institute’s report, submitted to the U.K.’s Department of Works and Pensions, stated that defined benefit pension plans in the U.K. “should abstain from investing in infrastructure, unless they are able to do so with enough information about risk and the true market value of these investments.”

However, the EDHEC Institute researchers wrote they do not believe there is currently enough accurate information available about infrastructure investments for pension plans to know the true value of the investments.

“The main stumbling block preventing the widespread development of infrastructure investment amongst DB plans in the UK is [that] the type and quality of data available to investors in such assets has been remarkably poor and unreliable,” the EDHEC Institute report stated.

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The report also warned that if a pension plan makes an investment using bad data, it faces the risk of breaching its fiduciary duties. Annuity guarantees or lump sum calculations based on incorrect data can lead to an unfair valuation of pension rights and “distort the benefits received by the pensioners,” according to the report, which added that “investors face significant hurdles to invest in infrastructure in a manner that is in line with their prudential and fiduciary responsibilities.”

Despite its caution for pension funds investing in the asset class, the EDHEC report stated that infrastructure can offer “very attractive investment characteristics” for defined benefit plans. Its research found that unlisted infrastructure equity and debt can “play very useful roles in the portfolio of a defined DB plan.” Those classes’ fixed-term and high distribution profile provide bond-like quality, while retaining equity-like features.

EDHEC analysts also wrote that infrastructure investments have “the potential to improve both sides of the balance sheet: by diversifying the portfolio and improving the risk-adjusted returns of a plan’s performance-seeking portfolio, while contributing to its liability hedging objectives.” The institute attributed this quality to the interest rate sensitivity of infrastructure equity and the yield pickup of infrastructure debt, compared with corporate bonds of the same credit quality and duration.

However, according to the report, the tendency in private markets to rely on contributed appraisal data rather than information that accurately represents the risks of the asset class “masks the true characteristics of these investments and precludes any rational decision-making process when it comes to investing in infrastructure.”

The report also pointed out that there have been multiple cases of infrastructure companies going bankrupt or facing significant write-downs.

“Robust data enables an investor to be aware of these risks and, more importantly, manage them in a timely manner,” the report stated. “As long as fair value and risk are not properly measured, U.K. DB plans will continue to either not invest in infrastructure or fail to invest wisely and face the consequences of not managing the risks.”

The report called for the adoption of “serious infrastructure valuation practices” that use the right comparables to estimate the risk premium and “therefore the right discount rates to use in infrastructure valuation.” It also suggested that the U.K.’s workplace pension watchdog, the Pensions Regulator, set up best practice rules and require pension funds to show that they have “a serious investment process for this asset class, which should not remain marginal in institutional investors’ allocations due to its macro and microeconomic benefits.”

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Tags: Defined benefit (db) pension plans, EDHEC Infrastructure and Private Assets Research Institute, Infrastructure, Pension, Pension Funds, pension schemes