This is Part 4 in our series on pension and benefits plan management for mid-size and smaller plan sponsors.
Read Part 2: Risks and solutions
Read Part 3: Benefits without breaking the bank
According to numbers from the Pension Investment Association of Canada (PIAC), an average Canadian pension fund in 2000 was invested almost entirely in domestic equities and nominal bonds, with 27.9% allocated to the former and 29.5% to the latter (with an additional 2.6% in real return bonds). Just 7.5% of assets were allocated to alternatives, in the form of real estate (5.2%), venture capital and private equity (1.5%) and other assets (0.8%).
Not surprisingly, given the market-moving events of the past decade, that allocation mix has since shifted significantly. PIAC data from 2010 show that the average Canadian pension held 26.2% in Canadian nominal bonds and 4.6% in real return bonds. The focus on Canadian equities had dropped to 16%. Alternatives, on the other hand, were picking up the slack, with an 8.9% allocation to real estate, 7.2% to private equity and venture capital, and 4.2% to infrastructure.
David Rogers, partner and founder of Caledon Capital Management, says pension plans of all sizes are looking for ways to reduce the risk from continued volatility in the public markets. For those looking to diversify and replace the returns they were once able to count on from equities, alternatives make sense.
“I think the small and mid-size pension plans in Canada realize that, as long-term investors that need to generate 7% to 8% all-in returns, they need to diversify away from their traditional dependence on just public equity and fixed income,” he says. “I think they have to look at these alternatives, or they’ll be underfunded for a long time. Their challenge is how to do it in a prudent way.”
Roadblocks and opportunities
For small and mid-size pension plans, being prudent means working with limitations in time, knowledge and available investment dollars.
“There’s definitely more appetite [for alternative investment options]. But it also comes down to education of not only the committee but [also] the advisors who work with them,” notes Mark Dowdell, vice-president, retirement and investment services, with Pal Benefits.
Dowdell says the education component is already challenging for smaller pension plans whose governance committees may not include individuals with strong investment knowledge. This is further complicated by a shift in focus from just looking at asset performance relative to benchmarks, to how the assets are moving in relation to a plan’s liabilities. “For us, educating pension committees is the first consideration.”
Janet Rabovsky, director of investment consulting with Towers Watson, agrees that diversification of asset classes is essential for continued plan health. But, in addition to the governance problem, the smaller plans she deals with are also handcuffed financially.
“Some of these [assets], in addition to being complicated, have minimums. If you’re a $100-million plan, it’s unlikely you’re going to put more than 10% into something that is less liquid. That means, you’re probably looking at one allocation, as opposed to a plan that’s, say, $750 million and can get meaningful dollar value such that you can get manager diversification.”
While many of the pension plans that Pal Benefits works with maintain a 40/60 or 50/50 allocation mix of equities and fixed income, due to the constraints they face, they are looking for a path away from traditional balanced portfolios. Dowdell says that for most of those plans, Pal considers de-risking strategies while also positioning the plans to consider a broader asset mix down the road.
“We’ve been exploring more of a ‘plain vanilla’ approach using traditional universe bonds and long-term bonds, while simultaneously undertaking a dynamic de-risking approach. We work with the plan actuary to figure out [the plan’s] funded position and then determine an asset mix to transition to as the funded position improves. That concept is well received by committees.”