© Copyright 2000 Rogers Media. The following article first appeared in the April 2001 edition of BENEFITS CANADA magazine.

The Top 100 Pension Funds of 2001

Adhering to the old Boy Scout motto, Canada's largest pension funds were prepared for volatility last year. Still, growth slowed considerably among the Top 100.

By Kathryn Dorrell

Early on in 2000, Teachers' cut its overall equities exposure to 60% from 65%, and later made a further reduction to 55%. The fund put these resources into inflation-sensitive investments (real return bonds, real estate and commodities), which earned an impressive 19.9% last year, says Claude Lamoureux, chief executive officer of Teachers' in Toronto.

The fund also used futures contracts on the Standard & Poor's (S&P) 500 composite index and the Nasdaq 100 index to address concerns over technology stocks, says Leo de Bever, senior vice-president with Teachers', and it concentrated a greater portion of its equity holdings in actively managed value stocks.

About one-third of Teachers' windfall came from its decision to substantially reign in tech holdings. "We felt at the beginning of last year that the technology sector was overvalued and we even went below [the weighting] we had agreed upon with the board," says Lamoureux. At year-end, Teachers' asset mix stood at 55% equities, 18% fixed income (with 14% in Canadian and U.S. bonds) and the remainder in inflation sensitive investments.

Pension fund executives offer contrasting views on just how apparent a downturn was to the industry last year. Lamoureux maintains that plan sponsors saw the writing on the wall before the slide began in earnest and it took action. "Pension plans were prepared. Daily, you could see the volatility with changes of 3% to 4%."

Donald Walcot, chief investment officer at BIMCOR, a wholly-owned pension fund management subsidiary of BCE Inc. in Montreal, doesn't see it that way. "I think people, generally, in the pension industry were surprised by the level of volatility," he says. "I think it really was a surprise to have so much happen so quickly."

One thing is certain: Teachers' wasn't the only pension fund that stayed true to the Boy Scout motto: 'be prepared.' The Hospitals of Ontario Pension Plan (HOOPP) in Toronto used a derivative strategy--zero cost collar--to control the added risk in its portfolio brought about by a substantial exposure to Nortel Networks, says John Crocker, HOOPP's senior vice-president of investment management and chief investment officer.

Ontario Municipal Employees Retirement System (OMERS) increas-ed its overall international exposure by 5%, diminished its Canadian exposure (again, on account of the Nortel factor) and boosted the policy weights of two inflation hedging asset classes--real estate and real return bonds--also by about 5%. "Now we look at it [the fund] almost daily--we are on top of it, in terms of risk analysis and rebalancing," says Dale Richmond, chief executive officer at OMERS in Toronto.

DOWN TO DETAILS

The Top 100 Pension Funds report assets of $511.1 billion as of Dec. 31, 2000. That translates into growth of 6.5% or $31 billion. Growth was smaller last year--which wasn't surprising given the poor showing in the S&P 500 composite index and the Nasdaq--compared to 10.1% in 1999 and 8.8% in 1998.

Just over half of the Top 100 provided their rate of return for 2000. These figures range from a high of 15% to a low of 6%. The average rate of return was 8.1%. This compares to 13.2% for 1999 and 9% for 1998--making 8.1% the lowest rate of return on record for the Top 100 since 1994. There's evidence that the industry did a good job of calling the slow-down, with the average anticipated rate of return on investment for 2000 stated by the Top 100 as 8% in 1999.

For the eighth year in a row, Teachers' holds the No. 1 spot on the Top 100 list. The fund held $72 billion in assets on Dec. 31, 2000 and beat the average growth rate with an increase of 7.5% or $5 billion over 1999.

While Teachers' calculated bets saved it billions, it wasn't completely immune to market volatility. The fund's $5 billion year-over-year increase represents a drop of almost 50% in growth over 1999, when it posted a healthy increase of 15.5% or $9 billion over 1998.

For the second year in a row, the top five pension funds remain unchanged, as Teachers', Quebec Government and Public Employees, OMERS, HOOPP and British Columbia Municipal Superannuation Fund hold onto their spots. These funds have $192.6 billion or 37.7% of the total assets of the Top 100. This is up $7.4 billion as of Dec. 31, 2000, compared to a year-over-year increase of $17.1 billion in 1999. Of the elite group, OMERS asset growth of $1.1 billion in 2000 is particularly impressive considering the fund has been on a contribution holiday for two and a half years.

The remaining five funds that comprise the top 10 are also the same players as last year: Quebec Teachers' Superannuation Plan, BCE Master Trust Fund, Ontario Electricity Financial Corporation Pension Plan, Canadian National Railways and the B.C. Public Service Superannuation Fund. The top 10 hold $255.5 billion in assets or 50% of total pension assets among the Top 100. The increase of $10.1 billion is modest when compared to the $21.4 billion jump posted in 1999. The average rate of return for the top 10 in 2000 is 7.1%.

There are 13 names in the $10 billion club this year, with OPSEU squeaking into the pack for the first time at $10 billion. Only six funds remain below the $1 billion mark, that's a noticeable jump from 15 as of Dec. 31, 1999.

EQUITIES OUTLOOK

The Top 100 had $120.2 billion invested in domestic equities as of Dec. 31, 2000. That's down 5.6% from $127.3 billion held in 1999. The class, on average, represented 29.4% of all assets, down from 33% in 1999.

While U.S. equities were primed for a fall, they bounced back in terms of popularity among pension funds, posting much stronger growth than in 1999 among the Top 100.

The Top 100 had $46.6 billion invested in the U.S. equity market last year, up 16.8% or $6.7 billion from $39.9 billion in 1999. U.S. equities also gained ground in terms of average per cent of asset mix, representing 10.6% compared to 9.3% in 1999.

BIMCOR's Walcot is certainly a fan of this asset class, pointing out there are now good buying opportunities in the U.S. and Canadian equity markets. "U.S. equities were really very good in 2000. You just can't beat the breadth and liquidity of the market, and the innovativeness of the country," he says. "It's just so much easier to manage money in the U.S. because of that diversity."

In contrast, equity holdings in Europe, Australia and the Far East (EAFE) show a notable decline among the Top 100. They dropped close to the 1998 level ($37.1 billion) to $36.9 billion in 2000 from $43.1 billion in 1999. As a percentage of average asset mix, however, EAFE equities exceeded 1999 levels. They stood at 9% as of Dec. 31, 2000, up from 8.7% in 1999. The $1.8 billion invested in emerging markets also represents a significant decline, with a return to 1998 and even 1997 investment levels, from $3.1 billion in 1999.

The big winner is clearly the global equities market, (excluding EAFE as well as North American and emerging markets), which was up by $8.8 billion to $20.3 billion in 2000. This represents a 77.3% increase from $11.5 billion in 1999. "There has been quite a move by pension funds into the overseas area," says Walcot. "We are getting more managers in to see us, offering their services in these markets." This trend is also seen in the use of derivatives. Deriviatives gained ground last year despite expectations in some quarters that raising the Foreign Property Rule to 25% in 2000 and 30% this year would result in use leveling off or even declining.

Looking at the big equity picture, the Toronto Stock Exchange 300 composite index was up 6.2% in 2000--only the second time in the past 25 years that the Canadian market was one of world's best performers. The S&P 500 composite index was down 10.1% in 2000, marking its worst performance since 1977. The Nasdaq composite index dropped by 39.3% in 2000--its worst showing ever. In fact as of Dec. 31, 2000 both the S&P 500 and the Nasdaq had returned to March 1999 levels.

On the fixed income side of the equation, Canadian bonds fared well at $121 billion or 31.7% of the average asset mix, up from $104.9 billion in 1999. For the first time this year, the Top 100 Pension Funds report tracked high yield and real return bonds. High yield bonds totaled $516.3 million as of Dec. 31, 2000, with real return bonds considerably more popular at $14.3 billion. "We have several billion dollars invested in our bond portfolio (government of Canada, provincial and corporate bonds) and [2000] was a very good year for us," says Crocker of HOOPP.

Meanwhile, real estate dropped $2.4 billion to $23.1 billion in 2000 among the Top 100. HOOPP certainly wasn't disappointed with this market, though. Crocker says the fund has a $1.25 billion real estate portfolio and it earned a double-digit rate of return last year.

The rest of the asset mix breaks down as follows: guaranteed investment certificates were at $225.4 million (down $162.8 million) as of Dec. 31, 2000; private placements were also down, dropping $600 million to $4.9 billion; cash rose by $1.8 billion to $12.9 billion; while assets held in venture capital were cut in half from $1.1 billion in 1999 to $537.8 million last year.

Pension fund investors are watching the markets and their asset mixes closely to ensure they'll be prepared for a steeper downturn, if one materializes. "One thing we have learned is that you cannot look at the future as always being the same," says Lamoureux.

Indeed, HOOPP is one pension fund preparing for a rough ride. "We seem to be unwinding a mania--a high tech, Internet, e-commerce mania--that peaked in March 2000, and most people don't have a lot of experience [in managing] this," says Crocker. "This is not a normal kind of slowdown. We were at valuation levels that in some cases haven't been seen before in history and the unwinding of that may be more time consuming and unpleasant than we may have expected."

de Bever, senior vice-president of Teachers', admits the funds' investors--including himself--are still nervous about equity markets. Why then does Teachers' still have the majority (55%) of its assets invested in equities? "It would be very arrogant to assume that we could predict all things going forward," he says. de Bever is willing to make one prediction. On average over the next 10 years, he says equities will not outperform bonds.

Pension funds do have the luxury of broad horizons. For this reason, Walcot isn't losing any sleep over the prospects of further volatility. "Our outlook is 40 years, and a market downturn is really an opportunity to buy, not to panic sell."

Derivatives breakdown

Despite the increase in the Foreign Property Rule, derivatives continue to gain ground. This is how plan sponsors are using derivatives.

SOURCE: BENEFITS CANADA's 2001 survey of the Top 100 Pension Funds

Asset allocation

Canadian equities dropped by $7.1 billion in 2000.

SOURCE: BENEFITS CANADA's 2001 survey of the Top 100 Pension Funds

The fine points

• The Top 100 Pension Funds report assets of $511.1 billion as of Dec. 31, 2000--a 6.5% year-over-year gain.
• Total market value of the Top 100 Canadian equity holdings as of Dec. 31, 2000 is $120.2 billion, down 5.6%from 1999.
• U.S. equities were up 16.8% to $46.6billion, while holdings in EAFE showed a decline from $43.1 billion in 1999 to $38 billion in 2000. The equities class showing the strongest growth was the global market (excluding EAFE, emerging and North American markets), up $8.4 billion to $20.3billion.
• Canadian bonds are up by $16.1 billion to $121 billion.
• Among the Top 100, 90 reported their DB/DC breakdown--71 are DB, 3 are DC and 16are a mix of the two.
• Of the Top 100, 47 are public sector pension funds.
• New pension fund contributions in 2000 totaled $4.6 billion.

Returns

• Average return for the Top 100 was 8.1%, compared to 13.2% in 1999, 9% in 1998 and 14.8% in 1997. The average return for the top 10 for 2000 is 7.1%.

Asset mix

• Average asset mix: Canadian equity (29.4%); U.S. equity (10.6%); EAFE (9.1%); emerging markets (0.5%); global equity (3.8%); Canadian bonds (31.6%); real estate (2.9%); GICs (0.1%); private placements (0.3%); venture capital (0.1%); and cash (2.6%).
• Respondents were asked to report who determines their funds' asset mixes. Total findings: internal staff (64); balanced manager (21); consultant (19); specialist (2); committee trustees (3).

Style

• In-house managers were responsible for $199.2 billion (44.3%) of the Top 100 Pension Funds. Specialist managers rang in at $138.3 billion (30.8%) and balanced managers at $111.9 billion (24.9%).
• Of Canadian equity investments, 28% was indexed. The Top 100 report $86.2 billion actively invested and $34 billion passively.
• 50% of U.S. equity investments were indexed with the Top 100 reporting $23.4 billion passively invested and $23.2 billion actively.
• Of the $121 billion invested in Canadian bonds, $101.5 was managed actively in 2000, $18.9 billion was managed passively and $552.5 million was immunized.

Fees

• The average total cost of running a pension fund was 25 basis points.
• The average fee paid for active management of Canadian bonds was 16.7 basis points; for Canadian equity, 27 basis points; for U.S. equity, 41.8 basis points and for non-North American equity, 48.7 basis points.
• Average fee paid to active balanced managers was 15.7 basis points.
• Average fee paid for passive management of Canadian bonds was 4.9 basis points; for Canadian equity, 5.2 basis points and for non-North American equity, 8.2 basis points.

The big picture

• Looking beyond the Top 100, there was approximately $703.2 billion in Canadian pension assets as of Dec. 31, 2000. This figure is based on the amount of pension assets managed internally by the country's 100 largest pension funds ($199.2 billion) and the total Canadian pension assets managed externally as of Dec. 31, 2000 ($504 billion).

Active vs. passive

The majority of Canadian assets are still managed actively.

SOURCE: BENEFITS CANADA's 2001 survey of the Top 100 Pension Funds

Foreign content

Global equities rose $8.8 billion in 2000.

SOURCE: BENEFITS CANADA's 2001 survey of the Top 100 Pension Funds

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