Whether plan sponsors expect a bear or a bull market in 2018, if they’re in a position to de-risk their pension plan, they should do it now, according to two investment consultants who spoke at an event in Toronto on Thursday.
“From our perspective, if you look at the world over the last six years, we have seen returns that nobody would have expected,” said Hrvoje Lakota, a senior investment consultant at Mercer, speaking at the organization’s annual retirement outlook event.
“The funded status of defined benefit pension plans is better than it has been in a very long time, and from our perspective, the time is now to lock in at least some of those gains. If you can afford to de-risk your plans, then do it now and soon.”
Lakota also acknowledged many plan sponsors wouldn’t be in a position to take risk off the table immediately, noting they’ll still need healthy real returns to deliver on their pension promises and meet their objectives. “But even for those investors, this is not the time to be complacent.”
At the event, Lakota took a bearish outlook on 2018’s investment prospects, suggesting 2017 was a great run but the end is near. “The simple reason is valuations,” he said, referring to a 30-year decline in bond yields. “For DB sponsors in the room, it has also meant that your DB liabilities have gone up significantly over the years. And the value of all the risky asset classes has also been pushed up as a result. As bond yields start to rise, it’s going to be interesting to see how much risk is actually being hidden by the recent market euphoria.”
On the other hand, Dave Makarchuk, a senior investment consultant at Mercer, took a bullish outlook during the event. But he also agreed many plan sponsors should be looking at their de-risking options right now.
“While I’m really excited about markets going forward, there are a group of investors that should get out while the getting is good. If you don’t need real returns, you probably should get out. If you can’t afford to lose money, none at all, I’d fold. And if you’ve reached your end game . . . then consider your windup options sooner rather than later.
“We’d all like windup to be cheaper, we’d all like annuities to be less expensive, but there’s no guarantee they’re going to get any cheaper. Capitalizing on the gains that you already have and reducing your risk makes sense for some investors in the market today. If your time horizon is long enough, at least five years or more, and I think that’s almost every other plan in Canada, I think it’s time to pursue new sources of return.”
Makarchuk added that it’s important to think about every investment decision in the context of four factors — return, risk, cost and time — whether plan sponsors are buying stocks, choosing managers or changing their portfolio risk. “It’s a complicated world out there, so if we can find a way to clarify and articulate our objectives with regards to each of these factors, I think it’s a lot more likely that . . . we can help people innovate, move things forward and ultimately deliver better outcomes.”
Also speaking during the event, Teresa Palandra, Mercer’s central wealth business leader, put the suggestions into the context of Ontario’s new pension solvency funding rules. One of the most significant changes is that defined benefit pension plans will have to fund themselves on a solvency basis only if their funded status falls below 85 per cent. For plan sponsors committed to their plan for the long haul, the change allows them to shift their focus from the short term, said Palandra.
“And this now allows sponsors to change the conversation and perhaps the strategic direction they’re taking with such things as their asset allocation, because the emphasis on the short term isn’t as strong as it was before,” said Palandra.
But are the solvency funding reforms too little too late? Jean-Philippe Provost, leader of Mercer’s wealth business, referred to a number of trends affecting the industry during the event on Thursday. They include the growth of a gig economy, which means a decrease in workplace retirement savings; people living and working longer; multiple generations in the same workplaces; and the continued misalignment between people’s savings expectations and their actions.
“We’ve talked about the funding changes in Ontario. Also, Quebec, B.C. and Alberta have made changes. But is it too little too late to salvage the situation? Time will tell.”