Changes to Quebec’s pension legislation, including a move away from solvency funding requirements and the introduction of a cost-sharing model, against the backdrop of a low interest rate environment has had a major influence on the City of Montreal’s pension investment strategy.
The City manages six plans under one pooled portfolio. The assets from all six pension plans are invested by an investment committee, La Commission de la Caisse Commune Régimes de Retraite des Employés de la Ville de Montréal.
While each plan is responsible for its own investment policy, they’ve been essentially the same since inception. In 2019, all of the plans adopted updated policies that target a two per cent allocation to cash, 29 per cent to bonds, 10 per cent to Canadian equity, 34 per cent to foreign equity and 25 per cent to alternatives.
“We are not there at this moment,” says Jacques Marleau, director and deputy treasurer of the City’s finance department and president of La Commission de la Caisse Commune. “We have lower exposure to alternatives and higher exposure to Canadian equity, but we are working to go down that route to achieve this new asset mix that was adopted during 2019.”
The latest change is part of a broader, gradual increase in alternatives — in 2000, the portfolio’s allocation to the asset class stood at three per cent, then grew to eight per cent in 2001 and 16 per cent in 2008.
Over the years, the plans’ investments have been influenced by changes to the legislative landscape and the current investment context. In 2006, Quebec’s municipal sector retirement plans became exempt from solvency obligations. In 2014, legislative changes forced the plans to move to a cost-sharing model, requiring a 50-50 sharing of current service costs and future deficit costs. However, the model had to be negotiated with various unions and it took a few years to reach an agreement. When the agreement was finalized, the City started the process of reviewing its investment policy.
As a result of the solvency changes, the plans are focused more on portfolio optimization than the mark-to-market position of their liabilities, says Marleau. That said, the cost-sharing model raised concerns about risk and a desire to lower the portfolio’s volatility.
The City was also sensitive about moving too fast to lower risk assets because it would require reducing the expected rate of return for the plans’ actuarial valuations, he notes. In addition, lower expected rates of return on the valuations would lead to higher current service costs in order to meet benefits payment obligations.
“You are in a dilemma where you don’t want to have too much risk in the future, but you don’t want to make changes that will create a big impact on the expected rate of return.”
In the context of a low interest rate environment, the plan moved to alternatives because they complement a traditional fixed income portfolio, achieve good cash flow and earn a better expected rate of return, says Marleau. “If you make a big allocation to the bond sector, you will end up with a lower expected rate of return for sure, and then it will [result in an increase of current service] costs and there’s a lot of sensitivity on that side.”
He notes the City’s plans are looking specifically for alternatives that offer a stable cash flow. And the plans are moving to their new alternative allocation target through a phased approach, says Marleau. “There’s not that much product in the market that meets our objectives.”
If interest rates stay low, when the plans reach their target, they may try to achieve an even higher level over time, he adds.
Yaelle Gang is editor of the Canadian Investment Review.