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.
SMALLER PLAN CHALLENGES
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.”
STRENGTH IN NUMBERS?
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. firstname.lastname@example.org