Underfunded pensions inch closer to surplus

Canada's many underfunded pension plans saw their funding deficits shrink in the first quarter of this year, powered byhealthy stock market gains, two new reports say.

The consulting firm Mercer said a typical balanced pension fund portfolio grew by 4.1 per cent in the first quarter. That growthhelped to boostMercer's pension health index to a reading of 87 per centas of March 31up from 82 per cent at the end of 2012. It hasn't stood at 100 per cent since 2007, before the financial crisis.

U.S. markets, as measured by the S&P 500 index, gained almost 13 per centin Canadian dollar termsin thefirst quarter, while international equities returned7.4 per cent. Bothperformedfar better than the resource-heavy Canadian market's 3.3 per cent gain. So Canadian pension funds that invested outside Canadaas most do reaped the benefits.

"All the key drivers of pension plan health moved in the right direction in the first quarter of 2013," said Manuel Monteiro, a partner in Mercer's financial strategy group."Equity markets performed very well, long-term interest rates edged up, and plan sponsors have been making contributions to fund the deficits," he said.

Aon Hewitt Canada also reported Tuesday that despite the first quarter's solid stock market gains, the vast majority of Canadian pension plans in its sample survey 97 per cent still had a solvency deficiency at the end of March.

Aon said themedian solvency ratio among a large sample of defined benefit pension plans was 74 per cent at the end of the first quarter. The funding ratio had been an even more dismal 69 per cent three months earlier.

Time to 'de-risk'

Partners at both Aon and Mercer said now is the time for pension funds to take measures to reduce risk. For instance, figures from Aon show that if the typical plan two years ago had boosted its investment in bonds from 40 per cent to 60 per cent and invested in long bonds instead of universe bonds, the "de-risked" plannow would have had a solvency ratio of 82 per cent instead of the actual median plan's 74 per cent.

"There are many ways to de-risk a portfolio and it is especially important to have a strategy when there is uncertainty around market direction," said Aon Hewitt Canada partner Ian Struthers.

The Mercer study also noted thatit's seeing "growing interest" among Canadian pension plans for investments in alternative asset classes, such as real estate and infrastructure, where it said returns are less volatile than stocks.

The latest annual report from the giant Ontario Teachers' Pension Plan (OTPP)showed just how rewarding it can be to round out the more typical equity and fixed income investments with alternative investments.The $129.5 billion fund reported a 13 per cent overall rate of return for 2012. But real assets, which include real estate, infrastructure and timberlands, returned 14.7 per cent.

The OTPP, whichis the largest single-profession pension fund in Canada,was 97 per cent funded at the start of this year.