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A study sponsored by the Canadian Public Pension Leadership Council says governments considering converting their traditional defined benefit (DB) pension plans would face higher administration costs because defined contribution (DC) plans cannot be run as efficiently.Roy Henderson/Getty Images/iStockphoto

Canadian pension plans are facing another weak year in 2015 with interest rates forecast to remain low and Canadian economic growth expected to trail global gross domestic product expansion.

A survey of investment managers by consulting firm Mercer shows most are expecting modest increases in interest rates this year and low investment returns, combining to create slow growth in pension plan funding in 2015.

The weakness in 2015 comes after months of disintegrating financial strength for Canadian pension plans, which saw their funding levels fall in 2014 after posting strong gains in 2013.

Mercer said its Pension Health Index, which tracks the solvency position of a hypothetical pension plan with typical asset allocations, fell from a surplus position of 106 per cent at the end of 2013 to a shortfall position of 95 per cent by the end of 2014.

Mercer partner Mathieu Tanguay said most pension plans saw their funded status drop in 2014 because long-term interest rates fell, undermining investment returns for the year. Pension plans determine the size of their long-term funding liability using long-term interest rate levels, so falling interest rates mean a greater cost to fund pensions for plan members.

"Last year wasn't too bad from an asset-return perspective only," Mr. Tanguay said. "If you look at financial markets, a typical investor would have earned in the area of 10 to 12 per cent. So it's not bad. But what hurt pension plans was the fact that interest rates dropped. Assets went up, but liabilities went up higher."

The weakening was especially acute in the final quarter of 2014 as long-term interest rates fell toward 60-year lows. Long-term government of Canada bonds closed the year at 2.3 per cent, a drop from 3.2 per cent at the start of 2014.

Investment managers surveyed for Mercer's annual Fearless Forecast said they expect a modest increase in interest rates of just 0.4 percentage points  in 2015. The survey shows Canadian long-term bonds are forecast to earn just 0.9 per cent this year and the FTSE TMX Canada Universe bond index is anticipated to return just 1.5 per cent in 2015.

Mr. Tanguay said the survey suggested it is unlikely pension funds will see a significant improvement in their funded status in 2015 as long as interest rates remain so low.

"It could be a slight improvement. To have something significant, you'd need another 2013, where rates go up a lot and at the same time equity returns are very, very good. But that's not what managers are forecasting at this point."

Fund managers forecast Canadian and U.S. stock markets would both post gains of 7.5 per cent in 2015, the survey showed. The Canadian dollar is expected to end the year at 87 cents (U.S.), slightly up from 86 cents at the end of 2014, and gold prices are anticipated to close 2015 at $1,200 (U.S.) an ounce from $1,184 at the start of the year.

With fixed-income investments expected to be so weak, 65 per cent of investment managers surveyed said they will increase their investments in emerging markets, 62 per cent said they will boost infrastructure investments and 62 per cent said they will buy more global equities.

Only 8 per cent said they plan to buy more large-capitalization Canadian stocks as domestic growth is expected to remain low in 2015. The fund managers forecast Canadian GDP would grow by 2.3 per cent in 2015, trailing an anticipated 3.2 per cent global GDP growth.

Mr. Tanguay said Canadian pension funds have been reducing their exposure to equities in general as they turn toward less volatile alternatives such as real estate. And they have also been reducing their geographic exposure to Canada to diversify their holdings globally. Both trends are contributing to a lack of interest in Canadian stock market investments.

Combined with the volatility in natural resource prices, Mr. Tanguay said Canadian large-cap stocks are less appealing to most pension plans.

The survey was conducted in early December as oil prices slid from $69 to $56 a barrel over the first two weeks of the month. At that time, investment managers surveyed predicted oil would recover to around $80 a barrel by the end of 2015.

While investment managers were not keen on adding more Canadian stocks in general, Mr. Tanguay said many fund managers said they saw opportunities in oil stocks because the price of crude had dropped below its expected long-term equilibrium price.

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