No Limits

As plan sponsors grapple with the task of finding good global fund offerings for their DC members, those same members could soon be faced with more choices and more complexity than ever before when it comes to the limitless world of investment without borders. And while the investment landscape is becoming bigger and more complex, could easy-to-use options such as asset allocation funds help narrow the decision-making field?

A consistent gainer on our Top 50 has been Queen’s University in Kingston, Ont. One of a handful of employers (mainly in the university sector)that offers its DC plan in tandem with a defined benefit minimum pension to all employees, Queen’s has seen its assets rise again this year: its DC plan grew 5.8% to $1.1 billion in 2004. Bill Forbes, director, pensions and insurance at Queen’s University, attributes part of the plan’s success to a disciplined and effective approach to choosing and monitoring managers. He says being a university also has its advantages—it has leading finance and economics experts from its faculty available to serve on its committee.

Queen’s also made a shrewd currency decision a few years ago. Just before the Canadian dollar began its steady climb, Forbes says the university decided to start hedging currency in its pension plan, even through the Canadian

dollar had been declining steadily for many years. “When the Canadian dollar was at about 63 cents we decided to do some hedging,” says Forbes. With the help of a global equity manager and its trustee, the plan was able to develop a hedging strategy that has helped it weather the fallout from the steeply rising loonie in its global investments.

GOING GLOBAL

While Queen’s started hedging currency early, the elimination of the FPR has added some new concerns for sponsors of other CAPs where the choice is left up to members. Today, many plan sponsors are looking for ways to provide their members with clear information and helpful tools to navigate a virtual global village of investment choices—including possible risks.

Terri Troy, director, pension investments at Royal Bank of Canada in Toronto, says the elimination of the 30% cap is a welcome change but it does present a few new issues from a communications perspective. Until recently, RBC offered members of its DC plan a U.S. equity synthetic index option. When foreign content was limited, synthetic funds made sense. This is because they mirror the performance of various indices, like the U.S. S&P 500 Index, but are treated as Canadian content because they invest primarily in Canadian T-bills and buy futures to achieve exposure to equity indices. Now that the limit has been removed, those funds can be replaced by ones invested directly in the indices. RBC recently replaced its U.S. synthetic equity index fund with a physical U.S. equity index fund in order to provide its members with a lower cost investment option which does a better job at tracking the index.

It’s a big plus. However, communicating these changes—and their benefits—to members is a challenge. Troy, along with other DC plan sponsors, is looking for ways to help RBC’s DC members understand and deal with significant currency risk bred by unlimited access to foreign investment options. “Some Canadian plan members might be aware of the currency risk if they had invested in a U.S. equity product in the last two years,” she points out. “Even though the U.S. markets did well overall, when those returns were converted back to Canadian dollars, the performance was relatively poor.” But making the majority of plan members aware of the complexities of currency risk—and the importance of hedging—can be a challenge.

Even if plan members are aware of the risks, says Troy, there aren’t a lot of hedged products out there for plan sponsors to add to the line-up of offerings in a typical DC plan. On her wish-list? “I would love to offer a U.S. equity fund that is hedged,” she says.

RBC’s search for hedged global fund options has been a tough one. Many managers just don’t have the products and without greater demand from other plan sponsors, Troy says they are less likely to develop them. It’s all about helping plan members manage risk in their DC plans, she says. “If I don’t offer [a] hedged product and yet a member can put all their money into foreign funds, then I’m assuming they’re all willing to take on that currency risk,” says Troy. “But some of them might not be. They might want the opportunity set but not the currency risk.”

Beyond the dearth of products out there, the challenge is communicating the benefits and risks of global investment to DC members. “Many members are at a pretty basic level,” says Ripsman. “They don’t understand the difference between fixed income and equities anyway. Explaining foreign versus domestic is even more difficult.” Plus, he says, many weren’t even close to the old 30% limit anyway.

Indeed, plan sponsor Ashok Kapoor, advisor, pension investments with Syncrude Canada Ltd., in Fort McMurray, Alta., agrees that most of his members are far from being globally inclined: “We’re nowhere near to the 30% limit in foreign contents so the change might not result in a big change in our case. Most employees’ money is in the money market fund or segregated funds,” he points out.

SIMPLIFYING THE PROCESS?

But while many plan sponsors grapple with the new challenges of communicating the complicated world of global opportunities and risks to members, Ripsman sees another big story developing in the DC world: the move to products that take the asset allocation challenge out of the hands of members altogether. “We’ve seen a steady increase in the use of static asset allocation funds over the last five years or so,” he points out. “This addresses the issue of how plan sponsors can help members by giving them the right tools to make effective investment decisions.”

So, in a foreign content limit-free environment, are asset allocation funds the answer? Says Ripsman, “Ideally you’d like to have every member think about what their choice should be and build an asset mix that makes sense for them. In a perfect world, that would happen.” But, he points out, in the not-so-perfect world of ever-expanding choices, such funds are providing more and more plan sponsors and their members with a potential solution.

“The defaults and asset allocation or lifecycle funds provide a short-cut response to concerns that plan members aren’t being proactive or taking the reins in making decisions,” he says. “In this way, asset allocation funds can work well.” Members go through a questionnaire and come up with an asset mix that’s not just based on age, but also on key factors such as risk-tolerance. “[Plan sponsors] can really build something that’s tailored to the members’ needs.” On the other hand, Ripsman cautions, the whole notion of asset allocation funds might just be too simple to solve all of the problems. “The answer might just be too easy,” he admits.

Whatever route DC sponsors decide to take, it’s certain that navigating an environment of even more choice is going to be challenging. While plan sponsors call for more selection when it comes to global offerings and hedged products, they’re also going to be working to help their plan members cope with the increasing global opportunity set they’re currently faced with in terms of their individual investment choices. Now that the world’s our oyster, here’s hoping the search for opportunities leads to more pearls than perils.

Caroline Cakebread is a freelance writer living in Toronto. caroline.cakebread@rogers.com

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