© Copyright 2006 Rogers Publishing Ltd. The following article first appeared in the May 2006 edition of BENEFITS CANADA magazine.
A matter of size: Top 40 Special Report
This year’s top alternative managers are getting a lot of attention from plan sponsors. But they say some small- and mid-sized plans are having trouble getting into the game.
By Caroline Cakebread

Alternative investments aren’t so alternative anymore. These days, many plan sponsors in Canada are moving from merely kicking the tires to actually integrating alternative strategies such as hedge funds and private equity into their pension portfolios. This year’s list of Top 20 alternative investment managers(see list on page 34)reflect the growth that has hit the industry over the last few years. While the industry is growing fast, Canadian plan sponsors—in particular small to midsized plans—still face some key barriers when it comes to fitting alternative strategies into their pension portfolios.

In 2005, the collective assets under management for the Top 20 alternative managers topped $57 billion. How did they get there? Volatility in public equity markets is a big factor. David Mather is executive vice president with Integrated Asset Management Corp.(ranking: 6th). He’s seen the industry grow substantially since 2001, following the two-year downturn in public equity markets that resulted in back-to-back doubledigit losses for many investors. “That was a sobering experience for a lot of pension funds. Not only in terms of the size of the hits that they took, but because, prior to that, markets were doing so well. As a result, people were improving benefits, putting in inflation indexing, taking contribution holidays…everybody thought it’d go on forever,” he notes.

But it didn’t and, says Mather, plan sponsors have been “getting reacquainted with a variety of risks” ever since. For many, getting to know risk again means looking at alternatives like hedge funds, private equity, commodities and infrastructure. Why? Because such investments offer an opportunity for diversification as returns from public equity markets become increasingly volatile and historically low interest rates present even more challenges on the liability front.

According to Stephen Foote, vice president at Northwater Capital Management Inc.(ranking: 8th), it’s all about dealing with volatility. “The interest created by alternatives stems from the opportunity for diversification,” he explains. “If you have a smaller risk premium opportunity, then you try and get what’s available to bring down the volatility of your overall portfolio by diversifying and spreading the risk out.”

John Sinclair, president, chief executive officer and chief investment officer with crown corporation, New Brunswick Investment Management Corporation(ranking: 11th), says alternatives are a good source of diversification for the three provincial pension plans he’s responsible for. “We’re trying to reduce public equity exposure to some degree because of the volatility and the correlation of returns across various markets,” he points out. “We’ve looked at introducing private equity and a long-short market neutral strategy to give us public equity-like returns that aren’t correlated to public equity.” In addition, Sinclair says that they have created a group of inflationlinked alternatives such as commodities, infrastructure and real estate, all of which offer additional opportunities for diversification at the fund.

While many plan sponsors are opting to use alternative investments to add diversification, small- and mid-sized plans are having a hard time getting into the game. Mather says he’s seen a major gap develop between the big players like the Ontario Teachers’ Pension Plan and the Ontario Municipal Employees Retirement Plan, and the small- to mid-sized plans who are trying to get into alternatives with limited resources. “Many smaller plans are severely resource constrained,” says Mather. “It’s not uncommon for smaller plans to have a full-time staff of a couple of people, who not only have to deal with the asset side, but with the liability side as well, and all other areas of the pension fund,” he notes. While big plans like Teachers’ have the capacity to do the necessary research, evaluation and execution in-house, a smaller plan is at a disadvantage when it comes to assessing and implementing alternative investments. Says Sinclair, “A smaller plan with only one or two people faces a lot of challenges when it comes to adopting these strategies.”

That leaves some small plan managers out in the cold because they don’t often have the time and resources to make a foray into alternatives. “They are conflicted because they have a highly developed sense of their fiduciary obligation,” notes Mather. “They don’t want to be seen as taking an inappropriate risk. At the same time, they know that they need to have alternatives in their programs because the math of pension finance is killing them.”

Leo de Bever, executive vice president, Global Investment Management at MFC Global Investment Management(ranking: 1st)agrees that small plans face barriers based on their size and limited resources. “If you can’t do it yourself because you’re too small, then cooperate,” de Bever says. But the idea is a hard sell for many plan sponsors. “There’s a pride of ownership issue,” he explains. “In addition, the governance process usually requires the board to sign-off on decisions.”

In spite of the barriers, however, many plan sponsors still have their sights set on alternatives and, looking ahead, the challenge will be finding effective approaches such as hedge funds of funds that can accommodate all sizes. Moving forward, the challenge for Canadian plan sponsors will continue to be managing risk and dealing with volatility. What’s certain is that those issues will continue to face both small and large plans in the future.

Caroline Cakebread is the editor of Canadian Investment Review. caroline.cakebread@rogers.com