‘The ability to deliver both high return performance and insurance against liability risks is notable’
Between 2004 and 2018, Canadian pension funds outperformed their international peers both in terms of asset performance and liability hedging, according to a study.
“Not only did they generate greater returns for each unit of volatility risk, but they also did a superior job hedging their pension liability risks. The ability to deliver both high return performance and insurance against liability risks is notable because hedging is typically perceived as a cost,” say the authors of The Canadian Pension Fund Model: A Quantitative Portrait.
What’s driving this success? A central factor is the implementation of a three-pillar business model – for funds whose pension liabilities are indexed to inflation -- that consists of:
- managing assets in-house to reduce costs
- redeploying resources to investment teams for each asset class
- channeling capital toward growth assets that increase portfolio efficiency and hedge liability risks.
A complementary factor driving the Canadian funds’ success is the indexation of their pension plan liabilities, say the researchers.
“This feature has made it easier for large Canadian pension funds to hedge against their liability risks by owning a diversified mix of growth assets. Additionally, we find a large number of smaller Canadian funds have adopted a ‘light’ version of this business model that is more feasible for their size,” say Sebastien Betermier and Quentin Spehner of McGill University and Alexander Beath and Chris Flynn of CEM Benchmarking.
To conduct this analysis, the researchers used data from CEM Benchmarking and analyzed performance metrics, asset allocation strategies, and cost structures for 250 pension, endowment, and sovereign wealth funds across 11 countries.
Pandemic impact raises questions
Looking ahead, the Canadian model will be put to the test, says the study.
“The severe impact of COVID-19 on commercial real estate, equities and corporate bonds will undeniably hurt the funds’ assets in the short-run. How resilient is the Canadian model to a global pandemic? Will two-pronged strategies that increase asset performance and hedge against liability risks change in the postpandemic world? We leave these questions for future research.”
Looking to provide employees with secure and valuable DB pension benefits, Torstar, SHARE and the United Way of Greater Toronto decided to try out a new type of plan.
Employers take note: Eighty per cent of Canadians say they would rather have a pension plan instead of a higher salary.