Fitch Ratings issues high grades for two of Canada’s largest pension plans.
By Ed McCarthy
Dafina Dunmore
The coronavirus has disrupted investment markets, and central bank moves to reduce interest rates have increased the value of pension plans’ obligations. It’s a challenging environment, but Fitch Ratings’ recently published “Canadian Pension Plan Peer Comparison Special Report” offers a positive review and outlook for the country’s largest investment managers and pension plans.
Plan Scorecards
The report includes detailed analyses of Caisse de dépôt et placement du Québec (CDPQ) and OMERS Administration Corporation (OMERS), the second- and seventh-largest pension organizations, respectively, as of Dec. 31, 2019.
Both received a AAA rating and Stable outlook from Fitch Ratings. The remaining nine of the largest 11 funds and managers were analyzed over the same period using published data, although Fitch did not rate them.
Dafina Dunmore, director, Financial Institutions with Fitch Ratings, says the report considered these key credit factors:
- Creditors having a priority claim on plan assets over pensioners, which leads to significant asset overcollateralization on the debt.
- Total collateral coverage, as measured by unencumbered assets to corporate debt, being strong even under a variety of stress scenarios.
- Leverage, defined as commercial paper, unsecured term notes and guaranteed facilities divided by net assets, being low on an absolute and relative basis for the largest plans, although there have been slight increases recently given increased term debt and commercial paper issuance and declines in net assets.
- Pension funds not depending on marketing and fundraising. They have captive flows, which are relatively predictable over time as most pensioners are required to contribute a certain amount to the funds.
Portfolio Compositions and the Role of Alternatives
Asset mixes varied considerably with the allocations driven largely by each plan’s maturity, i.e., the ratio of active to retired participants.
However, alternative investments such as private equity, private credit, infrastructure and real estate enhanced diversification and had a significant impact on fund returns in recent years, Dunmore noted. Among plans disclosing the data on their use of alternatives, the average exposure increased to roughly 46% of assets.
These asset classes allowed plans to capitalize on the illiquidity premium they afford and can provide an inflation hedge and increased income stability, particularly for real estate and infrastructure investments, according to Dunmore.
For example, CDPQ generated an annualized return of 8.1% for the last five years (2015-2019). Over that period its private equity investments returned 12.5%, infrastructure 9.2% and real estate 7.3%.
OMERS had an annualized five-year return of 8.5%, with its private equity, infrastructure and real estate allocations generating respective returns of 10.3%, 12.0% and 11.2%.
Outlook and Trends to Watch
In the short term, pandemic-driven market disruption will challenge fund returns, given potentially more volatile equity markets, lower rates and a weaker economy, each of which will also impact alternative investments’’ performance and valuation, Dunmore said.
Nonetheless, Fitch Ratings believes Canadian pension plans have the ability to withstand market downturns given their financial strength, long-term focus, ability to adjust contribution rates and the captive nature of inflows. The market disruption may also provide some attractive investment opportunities.
Looking ahead, Dunmore cites increased globalization of plan investments and increased expansion into alternative investments, both of which enhance diversification, as positive trends.
Possible negative trends include increased leverage and an aging population, which reduces the active participant-to-retiree ratio and makes plans more vulnerable to economic downturns.
Ed McCarthy is a longtime financial writer and author of three books, including “Foundations of Computational Finance with MATLAB.”
