Canadian Pensions Offer Lessons for U.S. Plan Sponsors

Many Canadian funds manage assets in-house, redeploy resources to investment teams and focus on liability hedging.

“The Canadian Pension Fund Model: A Quantitative Portrait,” a paper written by two executives from CEM Benchmarking and two professors from McGill University, outlines the reasons Canadian pensions outperform their international peers.

The paper says there are three things that help the funds outperform. First, they manage assets in-house, which lowers costs. They also redeploy resources to investment teams for each asset class, and they focus capital growth on increasing the efficiency of the portfolio and on hedging liability risks. The researchers say this model works best for funds with pension liabilities that are indexed to inflation.

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Canadian pensions have been found to have superior performance for decades, with earlier research pointing to their independent governance, in-house management, scale and extensive geographic and asset-class diversification, according to the paper.

The research is based on CEM Benchmarking data on 250 pensions, endowments and sovereign wealth funds from 11 countries. The researchers split the sample into large funds with more than $10 billion in assets in 2018 and those smaller than that, and they then analyzed the features of the Canadian funds.

The large Canadian pension funds outperformed their peers between 2004 and 2018 on all fronts. “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 paper says. “The ability to deliver both high return performance and insurance against liability risks is notable because hedging is typically perceived as a cost.”

On average, the researchers found, Canadian pension funds manage 52% of their assets in-house. Non-Canadian funds manage only 23% of their assets internally.

Among the very largest funds—those that manage more than $50 billion—80% of the Canadian funds’ assets are managed internally. For non-Canadian funds, the figure is 34%. The researchers estimate that managing funds in-house is one-third less expensive.

“The second distinctive feature of large Canadian funds is the redeployment of resources to investment teams for each asset class,” the paper says.

“The third distinctive feature of Canadian funds is the allocation of capital toward assets that increase portfolio efficiency and hedge against liability risks,” the paper says. “These assets not only include commodity producer stocks but also real estate and infrastructure.”

On average, the researchers say, Canadian funds spend 57 basis points (bps) of their assets under management (AUM) to run their fund, compared with 62 bps for non-Canadian funds.

Another factor helping Canadian funds’ performance, the researchers say, is the fact that a high proportion of their pension liabilities is indexed to inflation.

The researchers back-tested how this approach would have benefited U.S. public pension funds and found that it “would have led to a 15% absolute increase in the 15-year Sharpe ratio of the asset portfolio, a 13% increase in the 15-year Sharpe ratio of the asset-liability portfolio and a 20% increase in the correlation between assets and liabilities.”

When the researchers looked into how small Canadian pensions fared, they found that they only adopt a “light” version of the three-pillar model. Thus, they perform less consistently well compared with the larger funds.

In conclusion, the researchers posed the question of whether the Canadian model could be broadly adopted in other countries around the world. They caution that moving the investment team in-house requires independent corporate governance and competitive compensation. “It also requires a regulation system that provides some flexibility regarding the ability to manage balance sheet shortfalls,” the paper says.

Even so, the researchers conclude, other pensions could at least adopt some elements of the Canadian model, as well as indexing pension liabilities to inflation.

“The years ahead will put the Canadian model to the test, as the severe impact of COVID-19 on commercial real estate, equities and corporate bonds will undeniably hurt funds’ assets in the short-run,” the researchers write. “How resilient is the Canadian model to a global pandemic? … We leave these questions for future research.”

Workers Continue to Take Withdrawals From Retirement Accounts

An American Consumer Credit Counseling (ACCC) report found 23% of employees are also increasingly unconfident in the economy.

Almost a quarter of U.S. workers (22%) have borrowed money from their retirement accounts.

That’s what American Consumer Credit Counseling (ACCC) found in its new financial health index, which measured financial confidence among workers. The survey also reported the percentage of employees who are increasingly doubtful of the U.S. economy rose as well, from 16% in March to 23% in June. Since March, the ACCC has assisted more than 1,400 clients with financial issues related to COVID-19.

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The U.S. opened up retirement plans for participant withdrawals under the Coronavirus Aid, Relief and Economic Security (CARES) Act, to act as a temporary solution for those without emergency savings. Those who take a coronavirus-related distribution (CRD), which can be up to $100,000, are not subject to the 10% excise tax that otherwise applies to distributions made before an individual reaches 59.5, and can pay back the loan within three years. The option proved to be a useful solution among some workers, and in June, the IRS expanded the categories of individuals eligible to borrow.

Many believe the provisions under the CARES Act offered a soluble option for those affected by the coronavirus and in need of financial assistance. Neil Lloyd, a partner and head of US Defined Contribution & Financial Wellness Research at Mercer, said he believed the CARES Act is a positive thing for some workers. “There was a shortage in people’s financial need that needed to be addressed. Retirement is something we still need to deal with, but it’s not today’s problem,” he said in an interview with PLANSPONSOR.

Yet others are worried about participants’ retirement readiness, noting that retirement savings should be used as a last resort for meeting emergency expenses. In an April opinion piece for PLANSPONSOR, Neal Ringquist, executive vice president and chief sales officer at Retirement Clearinghouse, argued that short-term needs shouldn’t take charge over long-term planning.

“Most plan participants still have the benefits of time and continuous paychecks—both of which disappear in retirement,” Ringquist writes. “That’s why retirement savings should be used as a last resort for meeting emergency expenses after all other alternatives, such as government assistance and borrowing, have been exhausted.”

As the pandemic continues throughout 2020 and even into 2021, more reports are expressing concerns over its effect on the retirement industry. A working paper issued by the Pension Research Council of the Wharton School at the University of Pennsylvania says the coronavirus pandemic has weakened the retirement system. The paper drew attention to a World Economic Forum estimate, which projects the retirement savings gap will grow by 5% each year and ultimately reach $400 trillion by 2050.

Even as participants borrow from their retirement accounts, the ACCC report noticed an increase in confidence concerning employment stability. In March, 27% of respondents said they believed their employment to be “very stable,” while in June, that rose to 34%. Additionally, there was a 6.7% increase in consumers being very confident about continued employment—however, there was also a 3% increase in consumers who are not confident at all.

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