A soaring number of Canadian pension plans are shifting their investment strategies this year to embrace real estate and other alternative assets as they struggle to cope with the challenges of a world with entrenched low interest rates.
A survey of pension plans by RBC Investor Services Ltd. suggests a majority of plans have given up waiting for higher interest rates – which would boost returns and reduce their long-term funding liabilities – and are making structural changes to their investment approach.
The poll of 56 pension plans, titled Navigating Low Growth, found 71 per cent believe the low interest rate environment is "the biggest challenge" facing them over the next year. In last year's poll, just 27 per cent cited interest rates as their biggest challenge.
The survey found 48 per cent of pension plans expect to increase their holdings in the next year of so-called "alternative" assets, which refers to assets other than stocks and bonds. Alternatives include real estate and infrastructure holdings such as utility companies, mass transit or road infrastructure.
In the same survey a year ago, 21 per cent of pension plans said they were planning to boost their alternative asset holdings.
Scott MacDonald, head of pensions at RBC Investor Services, says there are "no obvious signs of rescue coming any time soon" in the form of higher interest rates, so many funds have finally concluded it is time to change their investing approach. "When you see zero, and it's not moving off of zero, there just isn't an external force that's going to change your fortunes materially without intervention on your part."
Of those funds looking at boosting alternative asset holdings, 45 per cent said they planned to increase their real estate holdings, 34 per cent are looking at infrastructure, 14 per cent are planning private equity investments and 7 per cent are planning more hedge fund investments.
Mr. MacDonald said large public sector pension plans have had better performance in recent years due to their investments in alternative assets, and smaller plans increasingly want to emulate that success.
The Canada Pension Plan Investment Board – one of the country's largest pension fund managers – has increasingly shifted into alternative asset investments, reducing its holdings of public company stocks from 45.7 per cent of its portfolio in June, 2009, to 34 per cent as of June this year. It has boosted its weightings of private equity investments, real estate and infrastructure assets over the same period.
CPPIB chief executive officer Mark Wiseman said alternative investments fit the fund's long-term investment nature and have the right risk-versus-reward profile. "We believe that private equity assets can produce risk-weighted returns that will outperform public equities in the long run," he said Wednesday.
He added, however, that it takes "significant capabilities" to invest in these asset classes, and many smaller pension funds "don't have the scale to develop these capabilities in-house."
Many smaller pension funds have been slower to make the shift because it is harder to invest in alternative assets. The RBC survey found smaller funds cited their lack of expertise and insufficient scale as their main hurdles in shifting to alternative assets. Despite the barriers, just 17 per cent of funds said they had no plans to expand into the sector.
Mr. MacDonald said there are ways for smaller funds to get into alternative assets through investment pools, but noted costs rise when plans have to invest indirectly through other intermediaries.
The survey also found pension plans saw further worsening of their funded status in 2012. On a solvency basis, 70 per cent of pension funds said their funding level is below 90 per cent, which means their assets are equal to less than 90 per cent of their long-term liability for funding pensions. In the 2011 survey, 51 per cent had a funding level under 90 per cent.
The good news for pension plan members is that 61 per cent of survey respondents say they are committed to maintaining their traditional defined-benefit plans, which RBC says means "the pension promise lives on."
The survey also found 27 per cent of respondents have closed traditional defined-benefit plans to new hires, who must instead join defined-contribution plans that do not pay a guaranteed level of income in retirement. A further 12 per cent said they intend to close their plans to new hires in the next two to five years.