Canadian pension plans take the risk-shedding route

Now Canadian plans are looking for ways to take risk off the table to keep that funded status from slipping and keep their plans open. In many cases, that means an LDI approach. In its most basic sense, LDI involves using derivatives or bonds with longer duration to extend the duration of a plan’s assets so they more closely match the plan’s liabilities.

Many Canadian plan sponsors are still waiting for interest rates to rise, so that they can move to the LDI approach after rising rates lower their liabilities.

But Canada’s requirement for companies to start using international financial reporting standards this year will likely push plans into LDI strategies faster, predicted BlackRock managing director and LDI strategist, Paul Purcell. As early as 2013, new IFRS pension accounting standards may require companies to reflect pension gains and losses on the income statement. Under the current IFRS standards, companies are permitted to smooth actuarial gains and losses, meaning that accumulated gains and losses are not on the balance sheet until they are realised as part of the pension expense on the income statement. Recognition on the income statement only becomes necessary if the accumulated gain or loss is above a threshold amount, and then only a portion is recognised annually. This means gains and losses can be deferred for a very long period, if not indefinitely. 

 “That will drive a faster change (to LDI) here,” Purcell said. “I think the changes to IFRS will be a big tailwind.” He added that many Canadian plan sponsors are already working with their boards to implement a schedule to gradually move to heavier LDI investments on an incremental basis as a fixed amount of time passes or as interest rates hit certain levels.

Unique challenges
Other Canadian plans who jumped on to LDI sooner are addressing some of its challenges. Towers Watson’s Rabovsky said one of the challenges unique to Canada is that the country does not have the deep derivatives market of the US or UK, making it difficult to synthetically extend the duration of assets. Managers admit this is a challenge. “Most of the (Canadian) LDI solutions are in a cash market.

They don’t use derivatives,” said Emmanuel Matte, a vice president at Standard Life Investments who handles marketing for many of the firm’s LDI offerings and other products.

Meanwhile, Canadian plans that have adopted the LDI approach and manage assets internally are working on ways to reward investment staff for a more conservative LDI approach. The $36bn Healthcare of Ontario Pension Plan (HOOPP) started moving assets more heavily into fixed income as part of an LDI approach back in late 2007. Within the last two months, the board has started discussing how they can better compensate investment staff for matching assets to liabilities, as opposed to beating a benchmark.