Having a huge amount of assets doesn’t make you impervious to external threats. A case in point: Canadian pension funds are looking at various economic and industry trends that could hinder their ability to satisfy their stakeholders’ needs, according to a new report from the World Bank.
The first concern involved lower expected returns and interest rates, which have led to a variety of responses. “Many Canadian plans have shifted assets substantially into less liquid, and in some cases riskier, asset classes such as infrastructure, real estate, and private equity,” the report said. A few have reportedly lowered discount rates to reflect downward-revised assumptions, while others such as CDPQ and OPTrust are increasingly looking at emerging markets.
The second challenge came from the aging baby-boomer generation. As proportions of contributing members decrease across plans, different tactics are being used to mitigate funding risks. These include raising contribution rates, reducing early retirement provisions, making indexation contingent, and merging with plans that have more favourable demographics.
Another concern was the growing gap between public-sector and private-sector workers as more private firms shift from defined-benefit to defined-contribution plans. To address this, Canadian policymakers and regulators have been working to create plans for uncovered workers, enhance existing plans’ benefits, and taking steps to preserve defined-benefit plans in the private sector, to name a few.
The high growth of some pension funds also reportedly present challenges. “Although greater scale can unlock access to some kinds of deals and investment strategies, other strategies are not scalable,” the report said. “Moving into new asset classes, sectors, and geographies in search for these investments can add layers of complexity for pension organizations with in-house, direct-investment models that may require changes in governance, processes, and capability.”
The prospect of stakeholders demanding to be shown value for money was another issue. Canadian pension funds are able to deliver cost-effective active management because of their scale, in-house teams, and patient capital. However, the rise of passive investment, increasing expectations of transparency from major institutions, fiscal challenges faced by provincial and federal governments, and the growing prominence and success of Canadian pension institutions will likely drive tighter value-for-money scrutiny.
Regulation was another consideration. To deal with the fragmented regulation governing Canadian pension funds, there’s been a push from different sides to harmonize rules, update regulators, and create a new regulator. At a broader market level, lingering concerns from the global financial crisis has prompted the creation of new regulatory bodies, the drafting of new rules, and efforts to scrutinize pension funds in terms of financial stability and macroprudential regulation.
Finally, Canadian pension funds said they were preparing for the next major market downturn mainly by constructing and testing portfolios to make them more resilient. They are also reportedly using communication to manage expectations and avoid knee-jerk reactions from key stakeholders.
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