Canadian pension funds contribute to financial stability by helping maintain the diversity of market behaviour, according to the deputy governor of the Bank of Canada.
“They are the Warren Buffetts of the financial system,” Lawrence Schembri said in a speech to the Pension Investment Association of Canada in Quebec City on Thursday. “In other words, pension funds can more easily bear market and liquidity risk and earn the associated risk premiums because they can diversify these risks over time.”
He noted that pension funds’ long-term investment horizons are different from those of most other market participants, giving them the capacity to smooth and absorb short-term volatility as well as act as a net provider of liquidity and collateral to the system, especially in times of stress.
“Pension fund rules for asset allocation, position limits and rebalancing work in the direction of smoothing asset prices,” Schembri explained. “Rebalancing encourages pension funds to sell assets that have gained in relative value and vice versa. Consequently, via rebalancing, pension funds can help to mitigate excessive asset price movements.”
He added that pension funds don’t rely primarily on borrowing to fund their investments and aren’t vulnerable to excessive leverage or significant liquidity and maturity mismatches, which caused many banks to fail during the financial crisis. Therefore, Schembri said they’re not a source of systemic risk to the financial system.
And because contributions to most pension funds are locked in, they are not subject to massive withdrawals or runs of the kind witnessed during the crisis.
“Given these important differences from other market participants, pension funds have had, in general, a positive impact on financial stability,” he said. “Although not definitive, there is some anecdotal evidence that pension funds contributed to financial stability during the crisis by acting in a counter-cyclical fashion, buying assets when their prices fell.”
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