The funded positions of Canadian defined benefit pension plans continued to recover in the third quarter of 2020, but major risks lie ahead, according to both Mercer Canada’s latest pension health index and Aon’s latest median solvency ratio survey.
Mercer’s index, which represents the solvency ratio of a hypothetical DB pension plan, increased from 101 per cent at the end of June to 107 per cent at the end of September, but is still down from 112 per cent at the beginning of the year. Meanwhile, Aon’s survey found Canadian DB plans’ solvency positions rose from 95.4 per cent at the end of June to 99 per cent at Sept. 30.
However, both consultancies also warned that major risks lie ahead, including a second wave of the coronavirus and the possibility of a disputed election in the U.S. Indeed, despite positive signs, many large risks lurk around the corner.
“The level of uncertainty we face today is unprecedented,” said Manuel Monteiro, partner and leader of Mercer Canada’s financial strategy group, in a press release. “Plan sponsors should evaluate the impact of alternative scenarios and adjust their risk profile accordingly.”
In a separate release, Erwan Pirou, chief investment officer at Aon Canada, called the last few months the “calm before the storm, with several risks on the horizon, such as the potential for further increases in COVID-19 cases during winter and a reduction of government assistance programs. Long bond yields are at record lows on the back of central banks’ intervention and clients may want to review how much duration they have.”
Mercer’s index also showed a typical balanced pension portfolio would have posted a return of three per cent during the third quarter of 2020, as equity markets trended upwards and bond yields remained roughly unchanged from the second quarter of the year.
With all equity markets positive over the quarter, emerging markets equities led the way, returning 8.8 per cent in local currency terms (7.6 per cent Canadian) as investors sought future growth prospects. Small cap and growth-oriented stocks continued to outperform their large cap, value-oriented counterparts; a trend that has continued to persist for several quarters. And the S&P/TSX composite index returned 4.7 per cent, with nine out of the 11 sectors posting positive returns.
The pandemic has also affected private assets, noted Mercer’s index. The rapid move to virtual workplaces caused many organizations to re-evaluate their requirements for office space, adversely affecting the value of some commercial real estate investments. Conversely, the acceleration of e-commerce has propped up the value of warehouse space.
And long-term bond returns were close to zero compared to their double-digit returns in the second quarter, as bond yields were relatively unchanged. Universe bonds were modestly positive (0.4 per cent), while real return bonds significantly outperformed (4.4 per cent).
“The rally in risk assets continued throughout the first half of the third quarter over supportive monetary policies and signs of a global economic recovery,” said Todd Nelson, partner at Mercer Canada, in the release. “However, the recent spike in global COVID-19 cases and the uncertainty around the upcoming U.S. election has unnerved investors, leading to losses in global equity markets in September.
“Concerns have also resurfaced regarding the possibility of an increase in medium to long-term inflation following the unprecedented monetary and fiscal policy actions in response to the crisis.”