Funded Levels of Canadian DB Plans Climb to 20-Year High

Surging bond prices helped boost defined benefit plans’ funded ratios to 124%.


Thanks to surging bond prices, Canadian defined benefit (DB) pension plans ended the first quarter of this year at their highest funded levels in more than 20 years, according to Mercer. However, the asset manager and consulting firm warns that the lofty funded positions might not last, depending on the trajectory of interest rates, inflation expectations, and equity market performance.

Mercer’s Pension Health Index, which tracks the solvency ratio of a hypothetical DB pension plan, increased to 124% at the end of March from 114% at the end of 2020. That is the index’s highest level since it was launched in 1999. Meanwhile, the median solvency ratio of the pension plans of Mercer clients was 104% as of the end of March, up from 96% at the end of December.

Long bond yields jumped 77 basis points (bps) during the quarter to lower the plans’ liabilities and more than offset the negative returns reported by many pension funds during the period.

“The first quarter of 2021 has been very good for DB plans,” Ben Ukonga, a principal in Mercer’s financial strategy group, said in a statement. “In March 2020, as markets were experiencing a gut-wrenching freefall, nobody would believe that pension plans would be breaking funded position records only a year later.”

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Mercer said there is reason to be optimistic about the pension plans’ continued funding improvement, due to COVID-19 vaccines rolling out and the re-opening of the global economy combined with government stimulus spending.

However, the firm also said there are also risks, such as new variants of the coronavirus, sharp increases in government debt levels, inflation, interest rate worries, and geopolitical tensions. Mercer cautioned that increases in inflation expectations and interest rates could negatively impact economic recovery, corporate earnings, and equity market returns.

“Despite the good news, plan sponsors should not be complacent,” Ukonga said. “We all saw how quickly DB plans’ funded positions deteriorated at the outset of the pandemic. The improved positions we now see could be short lived.”

Mercer said well-funded closed and frozen plans should consider reducing their risk by increasing allocations to defensive assets, annuity transactions, or even merging into jointly sponsored pension plans, among other suggestions.

Open plans, and those with long time horizons, however, face a more difficult challenge, Mercer said. Despite the rise in bond prices during the first quarter, fixed-income yields are still low, which means open plans must remain highly invested in growth assets to remain affordable. However, Mercer also said that large allocations to growth assets could make those plans more sensitive to market volatility.

“The challenge will be to strike the right balance that best meets the objectives of the plan sponsor and plan members,” said Mercer. “Realistic contribution rates, risk-sharing design features, broad diversification across asset classes and geographies, and selecting the right investment managers will become even more important going forward.”

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Electric Vehicle Stocks Will Short Out, Arnott Predicts

A lot of the EV makers will go bust, paralleling many once-hot smartphone and airline outfits, says his Research Affiliates.


Electric vehicle (EV) shares are an accident waiting to happen, according to Rob Arnott, with a lot of stock-market darlings headed for a crack-up. The EV craze is a sign of a “big market delusion” that has bedeviled investors for a long time, wrote the chairman of quant pioneer Research Affiliates.

Namely, that enthusiasm for the new thing will fall prey to economic creative destruction. The eight companies that specialize in EVs—this excludes the big automakers such as General Motors (GM) and Volkswagen, which are getting into the space—saw their stock prices surge 600% over a year through this past January, he stated in a report.

In fact, this octet climbed to a collective market value of $1 trillion during the period, Arnott indicated in the paper, done with Lillian Wu, a researcher at his firm, and Bradford Cornell, a finance professor at the University of California, Los Angeles.

True, some of the froth has come off EV stocks lately. The group’s leader, Tesla, is down 14% since February, as are other EV specialists such as Lordstown and Nio. Nikola, which focuses on hydrogen power, has been hurting since last summer, due to a damning analysis from Hindenburg Research. It’s off 85% since last June.

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Meanwhile, amid a sales jump from housebound consumers yearning for the open road, the big car makers like GM have enjoyed continued stock appreciation.

To Arnott, the fate of the current crop of EV tyros likely will follow the evolution of the smartphone. His report noted that the now-ubiquitous appliance owes its origins to the once-hot and now defunct PalmPilot, which begat the rival that bested it, the BlackBerry. And then came Steve Jobs and Apple to flush them all into obsolescence with the iPhone.

And an even more apt comparison, the Arnott report observed, is with the airline industry, which like autos is labor-intensive and strewn with carcasses—TWA, Pan Am, Braniff, People Express, etc.

“All of these companies are priced as if they are going to be huge winners, but they are competitors!” Arnott’s paper declared, referring to the EV makers. “They cannot all assume dominant market share in the years ahead!”

Right now, the EV stocks are way more expensive than those of legacy car manufacturers. And let’s face it, their sales amount to about 2% of the big dogs’ over the past three years, Arnott said.  

The valuation gap between the eight EV makers and traditional companies is enormous, the report said. Tesla, whose sales reached a new high in the first quarter, finally turned a full-year profit in 2020, which allowed it to join the S&P 500 in December. It alone is in black ink. But look at Tesla’s astronomical trailing price/earnings ratio (P/E): 1,068. That’s versus 14 for GM.

“In a competitive industry, market disruption benefits society at large, not necessarily the disruptors, and disruptors are often disrupted themselves in due course,” Arnott and his collaborators wrote. “We suspect that as EV competition heats up, many companies will fail, as was the case in previous industry booms.”

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