When pension plans have access to a lot of forecasting information, it’s easy to be tempted into straying from an initial plan.
Yet sticking to strategy is key, said Duncan Burrill, managing director and chief executive officer of the Canadian Broadcasting Corp. pension fund, speaking at a Canadian Pension and Benefits Institute event in Toronto on Thursday.
The CBC pension fund is a traditional, medium-sized defined benefit plan that’s very mature. It pays out almost $3 worth of benefits for every dollar it gets in. “We basically have negative cash flow,” said Burrill.
In 2005, the CBC plan adopted a liability-driven investing approach, implementing it over two years. It includes both a return-seeking and hedging component, using a bond overlay for the hedging. “We’re about an $8-billion plan and we have a $3-billion hedge and that hedge has helped insulate us from the movement in interest rates.”
The CBC plan was in good shape before 2008, but it suffered when the financial crisis hit, said Burrill. “And we basically spent the last decade trying to dig ourselves out of a hole created by the financial crisis.”
It’s important to highlight that the CBC plan has basically no forecasting capability, he said, noting it adopted LDI as a long-term approach rather than basing it on short-term forecasts.
But the plan made some tactical calls that turned out to be wrong since it’s difficult to predict the accurate movement of interest rates, said Burrill. In 2013, for example, the plan thought interest rates had hit their bottom and the market would revert. And at the time, after two rounds of quantitative easing, Ben Bernanke, former chairman of the Federal Reserve, noted he would taper QE. The plan bought into the belief that rates were moving higher, but with the taper tantrum, rates moved higher and then reversed.
Yet the plan took its hedge ratio from around 80 per cent to 65 per cent, which turned out to be a bad call, he said. “Luckily, we only took it from 80 to 65.”
But it learned lessons in the process, such as the importance of sticking to a strategy and avoiding the temptation of forecasts, noted Burrill. And, if a plan is going to respond to a forecast, it should do so on a relatively small basis. “I think forecasts can be hyper seductive.”
The CBC pension plan’s success with LDI was partially driven by making calls at the fringe instead of making total reversals, he added. “But we would have been way better off if we had just stuck to our strategy.”
It’s also important to check biases by seeking out as much non-confirming forecasting as possible, he said, noting plans that use a forecast should consider what could happen if that forecast is wrong.
And pension plans must be comfortable telling their boards they don’t know which direction rates will go, ensure they’re prepared for either situation and have built a robust strategy.
“You have to make sure that you have faith in your strategy if you’re going to stick with it,” he added, noting plans should invest time re-assessing and enhancing the strategy, not trying to predict the direction of interest rates.
Since the financial crisis, the CBC plan has made great headway. “This year, with any luck — we haven’t completed our final numbers yet — we’ll be above 100 again and that will bring our three-year average above 100 because we’re a federally regulated pension fund.”