Canadian Pension Funds: End of restrictions on foreign investments spells new opportunities for alternative investing

Canadian Pension Funds: End of restrictions on foreign investments spells new opportunities for alternative investing

Mon, 31/10/2005 - 06:11

Canadian plan sponsors intend to increase allocations to non-domestic alternative investments by 50 per cent, according to new research.


Although strong asset growth over the past year has helped raise the average funding ratio of Canada's pension plans, under-funding remains the most pressing problem, according to the study by Greenwich Associates.


"If Canadian pension plan sponsors in years past have been slow to address some of the challenges facing their funds, their inability to improve funding ratios has probably now brought them to the point of action," says Greenwich Associates consultant Lea Hansen. "With that motivation, and the recent elimination of the limitations on foreign holdings, Canadian plan sponsors in 2005 can be seen as having something of a blank slate."


These comments are based on Greenwich Associates' 2005 Canadian Investment Management study. In addition to analysing trends in assets under management and funding levels, the report also presents the following key findings:


• In the wake of the elimination of the Foreign Property Rule, Canadian plan sponsors intend to increase foreign equity allocations by 13 per cent, non-domestic alternatives by 50 per cent, and foreign fixed-income allocations by almost 70 per cent. US and global asset managers stand to benefit from the expected pick-up in Canadian institutions' investment in foreign securities.


• Canadian funds reduced domestic equity allocations from 2003 to 2004, while increasing allocations to domestic fixed income and alternative asset classes.


• Unlike their counterparts in the United Kingdom, only 20 per cent of Canadian plan sponsors have closed their defined benefit plans to new employees, and just 3per cent say they intend to do so over the next two to three years.


Canadian pensions: beyond under-funding


Total assets of the largest Canadian institutions -- including corporate, public and provincial pensions, endowments and foundations -- increased by 20per cent from 2003 to 2004 due to significant asset growth among some of Canada's largest funds buoyed by strong market returns. Thanks in large part to this asset growth, the funding positions of Canadian pension funds improved to a point at which the typical Canadian pension fund is now close to being fully funded. The average funding ratio of Canadian plans increased from 95 per cent in 2003 to 97 per cent in 2004.


"It is important to note, however, that several of Canada's largest pension funds are still seriously under-funded, so as an industry, Canadian funds are not yet out from under this burden," says Greenwich Associates consultant Rodger Smith. "Indeed, when asked to name the most pressing issue facing their funds, almost 40% of plan sponsors in 2005 cite the under-funding situation."


Farewell, foreign property rule


Alongside these strategic considerations, the elimination of the Foreign Property Rule stands front and centre in the minds of Canadian fund officials in 2005. A special study conducted by Greenwich Associates revealed that a quarter of Canadian plan sponsors plan to increase their allocations to foreign investments and another 30 per cent are considering such a move.


The Canadian institutions that participated in Greenwich Associates' special study have an average of 30 per cent of their assets in foreign equities; 3 per cent in foreign fixed income and 2 per cent in non-domestic alternative investments. After the rule removal, this group of plan sponsors -- which represented a smaller research base than the universe of Greenwich's annual research programs -- intends to increase foreign equity allocations by 13 per cent, non-domestic alternatives by 50 per cent, and foreign fixed-income allocations by almost 70 per cent.


"The most significant change to Canadian institutional asset mixes in coming months will almost certainly be a shift out of domestic equities and into foreign investments," says Hansen.


Domestic equities, which represented 30 per cent of institutional assets as recently as 2000, fell from 27 per cent of assets in 2003 to 24 per cent in 2004. More than 35 per cent of Canadian plan sponsors say they will decrease their allocations to active domestic equities by 2007, while less than 15 per cent expect to increase them. For passive domestic equities, 13 per cent expect a decrease and only 4 per cent an increase.


Dedication to defined benefit


Defined contribution structures play a smaller role in the strategic formulations of Canadian plan sponsors than they do in the strategies of funds in other markets. The continued devotion of Canadian plan sponsors to their defined benefit structures can be attributed in part to funding levels that are stronger relative to those of funds in the United States, and to the fact that Canadian regulators have not embraced mark-to-market accounting to the same extent as their counterparts in the United Kingdom.


About 20 per cent of Canadian plan sponsors have closed their defined benefit plans to new employees, and just 3 per cent say they intend to do so over the next two to three years. By way of comparison, almost half of UK defined benefit plans are now closed to new employees. "Canadian plan sponsors do not appear to be following in the footsteps of their counterparts in the United Kingdom, where plan sponsors on a wide scale are closing their defined benefit plans to new employees and shifting to defined contribution structures," says Smith. "Instead, Canadian funds seem to be rolling up their sleeves and saying, 'bridging the funding gap is a challenging task, but we are committed to our defined benefit plans and we are ready to do the work necessary to preserve them."


 


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