Nearly two years after the declaration of the global coronavirus pandemic and its subsequent impact on the worldwide economy, institutional investors are looking to the future with cautious optimism.
Amid a recovering economy and rising inflation, pension plan sponsors are taking a long-term investment view and staying the course in the year ahead, while incorporating the lessons learned from an unprecedented global event.
While Fidelity Investments Canada saw a panic within its pension plan sponsor clients in the early days of the pandemic, a little information and context went a long way toward calming those fears, says Rajan Burney, the organization’s vice-president of institutional client management.
Roughly 23 months later, those concerns have largely subsided as returns and earnings have rebounded and plan sponsors maintain their current investment strategies in 2022. “When we spoke to clients in the heat of the pandemic in the first few months [of 2020], it was a case of providing a little bit more information to plan sponsors to provide them with more comfort that things were going to turn and to take a long-term approach. We’ve seen a huge rebound in the market and our clients are a lot more reassured a year and a half out.
“From a solvency and going-concern perspective, things are going much better as well. A lot of plan sponsors are de-risking and they’re continuing with that. The asset mix changes weren’t dramatic — clients that were moving towards alternatives and increasing these allocations are continuing to do that.”
And while James Davis, chief investment officer at the OPSEU Pension Trust, says he’s bracing for the possibility of further waves of the pandemic in the year ahead, he feels policy-makers have demonstrated that they’ve effectively dealt with its financial impacts. The OPTrust ended 2020 with an 8.9 per cent net investment return and maintained its fully-funded status.
“There may be some reverberations as a result of monetary policy and the fiscal stimulus, especially in the U.S., that we’ve had since the pandemic began, [but] I think that has mitigated some of the impact on financial markets. We have to get used to the fact that [the coronavirus] will be with us for a long time, but it’s impact on the economy and markets is diminishing.”
The Alberta Investment Management Corp. also continues to rebound from a difficult 2020 — marked by a $2.1 billion loss through a volatility trading strategy — but it continues to focus on alternatives such as infrastructure, private equity and real estate, says Dale MacMaster, its chief investment officer. As of June 30, 2021, the AIMCo earned a year-to-date total fund return of 7.3 per cent, surpassing its benchmark by 3.5 per cent and almost tripling its 2020 return of 2.5 per cent.
Although there’s been a “strong and rapid” rebound following the “quick and deep” recession of 2020, David Nowakowski, senior strategist for the multi-asset and macro team at Aviva Investors, says the recovery has been marked by inflationary pressures in the goods sector, caused by the global supply chain crisis at a time of increased consumer demand enhanced by government stimulus.
In October 2021, the Canadian inflation rate increased year over year by a record 4.7 per cent, the largest increase since February 2003, according to Statistics Canada. Despite rising inflation making headlines, Davis says he’s more concerned about the potential for a policy mistake in 2023 or beyond than the inflation rate itself.
“If we have inflation rising at its current pace with no signs of it letting up, the central bankers — and, in particular, the [U.S.] Federal Reserve — will be concerned whether that changes inflation expectations. Inflation expectations are anchored at this time, but if that begins to change, the Fed will act and, when they do, I’m mindful that there’s a lot of leverage in the system.
“Financial conditions are incredibly easy and you could easily see a reaction. Given how well financial markets have performed since the global financial crisis, coupled with extremely low interest rates, [there could be] an unwinding and that could easily precipitate a potentially severe equity market decline. . . . We could see volatility beginning to pick up and, in my mind, it may not be as easy to generate returns as it has been since the 2008/09 global financial crisis.”
With interest rates expected to remain low, fixed income is facing challenges in 2022, says Nowakowski.
However, his outlook on the asset class remains fairly bullish, citing the potential for rates to rise amid a continuing economic recovery. “You’re not getting compensated much from taking duration risk with longer bonds. We’re only at the beginning of some form of tapering cycle in countries where quantitative easing has been done, as well the beginning of rate-hiking cycles in a handful of developed markets like New Zealand and Norway — mostly smaller and open markets that didn’t have deflation problems. We’re also in the early to middle innings of hiking cycles in emerging market fixed income.”
However, Eugene Lundrigan, president of Sun Life Capital Management Inc.’s Canadian arm, says among his plan sponsor clients that are de-risking, alternative forms of fixed income — such as private debt or commercial mortgages — provide a liability hedge. “One area we’re seeing a lot more interest in now is multi-asset credit strategies, where a manager can invest in several fixed income markets and make decisions based on where they see the best risk-return tradeoffs.
“I think the benefit of that strategy is there’s a lot of levers for managers to pull, such as investment grade versus below investment grade or fixed rates versus floating rates and private market versus public. I think having that many levers gives managers the opportunity to play offence and defence, depending on what the market environment is.”
While the OPTrust reduced its bond holdings in 2020 — due to the negative impact of low interest rates on the liability-hedging properties of bonds — that portion of the portfolio will be increased as interest rates rise, says Davis.
“It doesn’t take too much of a move higher in interest rates for that efficacy in liability hedging to begin to return and for diversification potential to begin to show up. . . . Our overall investment outlook is focused on the funded status, [so] this goes to thinking about bonds not just as an investment vehicle, but an insurance vehicle.”
Compared to fixed income’s continued challenges, Nowakowski says equities are a much different story. “Even though valuations are fairly expensive, they’ve been supported by earnings and growth and strong inflows. That’s something that still has potential for a pretty decent year. Policy support is still there in level terms, but it’s going to be decreased. . . . Overall, if earnings continue to deliver and we avoid some potential risk scenarios, the outlook for equities is pretty good — if central banks can achieve a soft landing, rein in inflation and not pull the handbrake.”
And although there may have been an exodus of pension dollars from the Canadian stock market pre-pandemic, that trend may be reversing amid rising inflation, says John Carnegie, director of Baillie Gifford Overseas Ltd. “If you think about the Canadian domestic stock market, it’s got all the stuff you want in an inflationary environment, such as banks, commodities and raw materials. You might be tempted to not take money out of that market at the moment.”
With $10 billion assets under management in its foreign real estate portfolio, the AIMCo will continue to invest in the asset class, expanding from Europe and the U.S. into Asia, says MacMaster.
Similarly, the investment manager is growing its infrastructure holdings in the Asia-Pacific region, he adds, citing recent investments such as an electrical transmission company in Australia and a renewable energy project in India.
The AIMCo is also exploring alternative risk premium — largely through hedge funds — as a stand-alone product in the asset mix. “That meshes well with a desire to avoid equity market beta to earn a steady return,” says MacMaster. “Even if it’s going to be low, earning maybe two per cent to four per cent, it reduces volatility in the portfolio. You trade off a little bit of return to bring more stability.”
Lundrigan says his pension plan sponsor clients are taking a similar approach, noting a general shift away from Canadian real estate. “We see our clients looking at global exposures rather than Canadian exposures and we see some of them looking for exposure in areas like logistics or industrial, which we think are likely to outperform as we come out of the pandemic.”
While environmental, social and governance factors aren’t new considerations for institutional investors, an increasing number of extreme weather events and the 2021 United Nations Climate Change Conference have sharpened investors’ focus on sustainability.
Sustainable investing is important to both the OPTrust and its members, says Davis, noting roughly a third of the pension plan’s infrastructure portfolio is currently invested in renewable energy. In addition, the plan has introduced a sustainable investing team to explore investments in sustainability technology and innovations.
“Climate change is a huge challenge to humanity and technology and creative solutions will help in mitigating that challenge. [The sustainable investing team] is focused on helping not just all of our investment teams integrate ESG into their investment decision-making process, but also focused on identifying opportunities at the intersection of innovation and sustainability.”
While the AIMCo continues to expand its holdings in renewable energy, it’s choosing engagement over divestment when it comes to fossil fuel investments, says MacMaster. “We also work with ESG laggards — companies using coal-fired utilities, for example — and provide them with capital and take boards positions to influence and accelerate their move towards a greener future. If they’re still not ESG-compliant, it’ll be reflected in their valuation, so by nudging them towards a green future, we’re going to capture an outside gain and be aligned with our ESG policy. . . . We can approach climate change without divesting.”
Carnegie says the pandemic has also drawn investors’ attention to health care, both as an investment opportunity and a source of potential liabilities such as the longevity risk posed by longer lifespans. “We’ll continue to see more interest in those stocks. It took Illumina just two days to sequence the genome of the coronavirus in January 2020 and it took Moderna two days to develop the vaccine.”
And with 2021 marked by retail investment trends like DogeCoin and non-fungible tokens — the acronym of the latter becoming Collins Dictionary’s word of the year — pension investors are being increasingly drawn toward the digital investment space. Davis says the OPTrust is just beginning to explore opportunities in blockchain investments.
“People think of digital assets as Bitcoin or Ether, but it’s much broader and we’re looking at it through a very wide lens. We think blockchain has the potential to disrupt traditional businesses significantly. You don’t necessarily have to pick the winners in this space — you just need to avoid the businesses and industries that will be disrupted the most.”
Blake Wolfe is an associate editor at Benefits Canada.