Five reasons pension funds deserve top rating

Canadian pension funds are in good shape to benefit from a recovery in the markets, according to rating agency DBRS, provided they don't try to overcompensate for a brutal year by taking excessive risks under improving conditions.

"The downturn has reduced the financial flexibility of these [funds]and it will likely take several years to make up for the poor performance of 2008," managing director of public finance Eric Beauchemin and senior financial analyst Ryan Domsy wrote in a report. "However, these [funds]do remain underpinned by several factors that provide considerable resilience and keep them solidly at the AAA level."

Here's a quick reminder of how some of the funds fared in their last fiscal year - Caisse de dépôt et placement du Québec was down 25 per cent, Canada Pension Plan Investment Board was down 18.6 per cent, Ontario Teachers' Pension Plan Board was down 18 per cent, OMERS Administration Corp. was down 15.3 per cent and the Public Sector Pension Investment Board was down 22.7 per cent.

"The poor investment performance had the effect of significantly shrinking their asset base and eroding their funding position, suggesting that the risk level in certain portfolios may have been higher than originally measured," they wrote.

They say there are five reasons the funds deserve their top ratings and are likely to prosper in the coming years.

Hugeness: The funds "continue to benefit from very large asset bases," ranging from $33.8-billion to $120.1-billion. Meanwhile, "recourse debt remains very low... as such, these credits enjoy, at all times, access to unencumbered assets several times in excess of recourse debt, providing considerable flexibility in the face of adverse financial developments."

Mandatory members: Most funds are funded by employees and their employers, which means any shortfalls are likely to be backfilled by the government in the case of public funds. These workers also tend to keep their jobs, which keeps the coffers full as they keep contributing through economic downturns.

Liquidity: Most of the funds have large pools of liquid assets, which can be flipped if needed to cover losses. "Under DBRS's liquidity policy, public pension funds and asset managers issuing commercial paper are required to maintain high-quality liquid assets (defined by DBRS as cash, debt securities of AAA-rated sovereigns, provincial governments and government-guaranteed entities, as well as R-1 (high) short-term Canadian bank notes) in an amount equivalent to at least 1.5 times the limit of the commercial paper program."

Long run: Cash flows are predictable because the funds carry liabilities that are long-term. This provides " considerable time for sponsors and plans to initiate corrective measures in response to any potential funding challenges."

Legislation: Public pension funds must increase member contributions or reduce benefits to address funding shortfalls. "In contrast to pension plans, asset managers have no direct responsibility for the liabilities of their plan depositors, or for the ensuing funding shortfalls."