Smaller plans need more investment solutions to vary the asset mix

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For years, Canadians have faced calls to invest overseas given the narrowness of the Canadian equity market and the relatively small proportion of global gross domestic product Canada represents. Publicly listed Canadian companies have ranged between three and five per cent of global GDP, and yet Canadian investors’ allocations to Canadian equities have historically been much higher. The Canadian equity market is heavy on material, energy and financial services companies and lacks exposure to health-care and information technology companies.

In its recent market trends report, Greenwich Associates noted Canadian institutional investors’ allocations to Canadian equities decreased to 11 per cent on a dollar-weighted basis in 2016. However, allocations differed vastly by size. Institutional investors with fewer than $250 million in assets maintained a 27 per cent allocation to Canadian equities. Those with assets ranging between $250-$500 million also had a relatively high allocation of 20 per cent. However, those investors with assets greater than $1 billion had a 10 per cent allocation to Canadian equities. On average, the allocation by sponsoring entity doesn’t vary much with allocations ranging between nine per cent for public plans and 13 per cent for Canadian subsidiaries of U.S. corporations. Thus, size of assets is the dominant determinant of Canadian equity allocations.

That makes sense when viewed alongside alternative asset allocations, which are much lower for smaller pension plans due to the governance requirements. Alternative asset classes tracked by Greenwich Associates include real estate, private equity, hedge funds, infrastructure and commodities. Many smaller plans don’t have the investment expertise, decision-making and monitoring structures and size of assets that alternative asset classes require to be successful.

According to the report, the average institutional investor’s allocation to alternatives in 2016 was 21.6 per cent on a dollar-weighted basis, mainly due to high amounts (26.7 per cent) allocated by large public pension plans. As with Canadian equities, the allocation varied depending on the size of the asset pool. Investors with fewer than $250 million in assets had a 9.5 per cent allocation, whereas those with assets ranging between $250-$500 million and $500 million to $1 billion had five per cent and 7.1 per cent, respectively. The results in the small- and mid-size range seem counterintuitive, as smaller plans have a higher allocation. The numbers reflect the relatively large allocation by endowments (13.9 per cent), whose investment committees and boards tend to include investment industry professionals.

Real estate remains the largest and most common alternative allocation regardless of size or sponsoring entity. That’s not surprising since most fiduciaries are comfortable with real estate and mortgages. The average allocation in 2016 on a dollar-weighted basis was 9.3 per cent, led by the large public pension plans at 10.9 per cent. Small- and mid-size plans had allocations of 2.9 per cent and 4.2 per cent, respectively. Corporate pension plans tended to have a higher amounts (8.5 per cent), whereas endowments tended to have smaller allocations (3.7 per cent). Endowments also tended to have allocations across most of the alternative asset classes, except commodities.

Anecdotally, we know that until recently, real estate allocations have been mainly in Canadian products and assets, but since Canadian core real estate is so expensive, we’re seeing many fiduciaries considering U.S. and, to a lesser degree, European real estate. As well, stable, income-oriented strategies such as multi-unit residential investments are becoming more popular in the search for yield.

In recent years, the allocation to infrastructure equity has increased. According to the Greenwich Associates report, the average institutional allocation in 2016 was 5.3 per cent on a dollar-weighted basis. Public and corporate pension plans, as well as endowments, tended to have allocations around the average, whereas small- and mid-size pension plans were in the range of one to two per cent. The relative lack of core, open-ended investment vehicles has been a deterrent for many small- to mid-size fiduciaries.

According to the report, investors highlighted risk management as being more important in 2016, with nearly one-third citing that as a focus, an increase from 25 per cent in 2015. They cited low interest rates and volatility in the equity markets as key concerns across public and corporate pension plans.

The increasing shift to alternative asset classes is an attempt by some institutional investors to lessen their reliance on the equity risk premium. Many are increasing allocations to private debt to reduce the impact of what will ultimately be a rising interest rate environment. While the Greenwich Associates report doesn’t track allocations to private debt, we know anecdotally that that’s the case, with mortgages and direct lending being the most predominant segments at the moment. As with infrastructure, there’s a need for more open-ended funds for small- to mid-size plans.

While most of the report’s results aren’t surprising, they’re a reminder that the larger Canadian public pension plans tend to be a bellwether for the broader institutional industry. As well, a wider range of product solutions are necessary for small- and mid-size asset pools. Finally, while objectives may be different among various institutional investors, their concerns are common.

Janet Rabovsky is a partner at Ellement. She has more than 25 years of experience in the industry. These are the views of the author and not necessarily those of Benefits Canada.

Transcontinental Media G.P.