Lackluster returns the norm in eventful year
But interesting happenings in the macro environment failed to translate into strong investment returns of pension funds in six of the world's major markets.
The average pension fund in each of Australia, Canada, Japan, the Netherlands, the U.K. and the U.S. all produced investment returns lower than in 2014. Canada and Australia were the standout markets for the year, helped along by falling currencies.
The average Canadian pension fund returned 6% before taking inflation into consideration, said Bruce B. Curwood, director, investment strategy at Russell Investments Canada, Toronto. Last year was a “poor year for Canada,” he said. In 2014, Canadian pension funds returned on average 10.1% before inflation was taken into account.
Mr. Curwood highlighted slowing growth in China and “the ineffectiveness of the OPEC oil cartel” leading to falling material and energy prices across the globe. These issues led to subdued domestic growth in Canada and low inflation, which Mr. Curwood said was hovering around 1.5%.
As well as macro issues, Canada's major stock index, the S&P/TSX, was one of the worst performing stock markets in the developed world last year, returning -8.32%, he said. Interest rates also fell in Canada, increasing pension liabilities. He said five-year government bonds fell by 58 basis points, while 10-year yields dropped by 38 basis points and 30-year government bonds slipped 18 basis points in 2015.
“Based on these three events, one would have expected extremely weak Canadian pension fund outcomes. However ... the silver lining for many domestic pension funds was the falling Canadian dollar and the extent of their global diversification strategy,” Mr. Curwood said. The Canadian dollar fell 16% vs. the U.S. dollar in 2015. “In short, any unhedged international investments resulted in a rebound to performance.”
Diversification pays
Canadian pension funds' diversification strategies saw them move further away from the typical 60/40 portfolio, he added, investing more in alternatives, and in particular global infrastructure and global real estate. “In addition, many funds concentrated on better matching their investments (to their liabilities), while others utilized downside protection strategies, such as defensive equity,” said Mr. Curwood.
Australian pension funds also benefited from currency depreciation. With the Australian dollar falling 10.9% vs. the U.S. dollar in the calendar year, investment returns were boosted to an average 5.6% before inflation, said researcher SuperRatings Pty. Ltd. That compared with returns of 8.1% in 2014.
The key driver of Australian retirement fund returns in 2015 was international shares, with the median international shares investment option increasing 8.8%. In comparison, the ASX200 Accumulation index grew 2.6%.
“We have noted in recent years many funds moving greater portions of their assets into international shares” and away from the domestic stock market, said Adam Gee, Sydney-based CEO at SuperRatings. The firm also has seen many not-for-profit pension funds gaining greater exposure to unlisted assets, such as infrastructure, private equity and hedge funds, he said.
It was not just pension funds that failed to impress in 2015. The Russell 3000 index gained 0.48% over the year, vs. 12.53% in 2014; while the MSCI All-Country World index lost 1.79% in 2015, vs. a 5.62% gain the year previous. Bond markets also fared poorly, with the Barclays Capital U.S. Aggregate Bond index gaining 0.55% vs. 5.97% in 2014.
These elements hit U.S. pension funds hard. Preliminary analysis of the 219 portfolios in Bank of New York Mellon (BK) Corp. (BK)'s universe shows an average investment return of -0.08%. John Houser, senior consultant for BNY Mellon's global risk solutions group, in Boston, said the last time the universe posted negative results to close the year was 2008, “when the universe median finished down with a -25.23% return.”
The U.S. equity segment of its analysis produced a median result of 0.14% — that “significantly underperformed its historic average,” said Mr. Houser, with third-quarter median losses of 7.44% proving to be too much. The U.S. fixed-income segment median was -0.03%.
“The real estate segment continues to be the asset class of choice as its median one-year return closed at 12.68%,” he said.
For the average U.K. pension fund, which returned between 0% and 2% in 2015, “many will look back on 2015 as, I think, a bit of a damp squib,” said Phil Edwards, Bristol, England-based principal at MercerLtd. The year in the U.K. looks particularly weak compared with 2014's average investment return of 11% before inflation.
These pension funds have continued to derisk, he said, with asset allocation analysis likely to reveal a reduced reliance on equities. “And also schemes are looking to add dynamism to portfolios,” using multiasset credit strategies that allow managers to shift across asset classes as the environment and opportunities change.
Japan's pension funds also produced single-digit returns, with Russell Investments' universe of corporate pension funds in Japan returning on average less than 2%.
“In the public pension area, the topic in 2015 which had the biggest impact was the allocation change of public pensions,” said Konosuke Kita, director of consulting at Russell Investments in Tokyo. He highlighted the $1.2 trillion Government Pension Investment Fund, Tokyo, which increased its equity allocation to 50% from 24%, and others that have followed this move.
Corporate governance, he said, was another hot topic, following the publication of the Corporate Governance Code in 2015. “It will create pressure for investment managers to be conscious of corporate governance more than ever,” he said.
Fallen angel
The biggest year-over-year fall in returns came from pension funds in the Netherlands, which produced an average investment return of 1.1% before inflation. That compared with a 15.8% return in 2014.
Edward Krijgsman, Amstelveen-based principal and investment consultant at Mercer, said one reason for this “modest” return was an increase in interest rates. The 30-year swap rate in the eurozone increased to 1.61%, from 1.46%. The average Dutch pension fund has hedged about 40% of the interest rate risk of nominal liabilities.
Mr. Krijgsman added that Dutch pension funds benefited from falling allocations to hedge funds and commodities. “The ambition of Dutch pension funds to invest more in hedge funds has reduced the last three years, driven by increased transparency (demands) from De Nederlandsche Bank, plus poor performance. It is the same for commodities, although transparency requirements are a bit less for them.”
The HFRI Fund Weighted Composite index returned -1.02% in 2015; and the Bloomberg Commodity index returned -24.66%.
Dutch pension funds also benefited from another year of euro depreciation vs. the dollar, with a 10.22% drop in 2015. Mr. Krijgsman said Dutch pension funds on average hedge 50% of their currency risk.
Alongside lower investment returns were lower funded ratios, falling to 104% from 108% in 2014.
However, Dennis van Ek, principal and investment consultant also at Mercer in Amstelveen, said the average funded ratio actually would be 110% were it not for a change in Dutch pension fund rules last year under the Financial Assessment Framework, known as the FTK.
De Nederlandsche Bank, the Dutch financial regulator, dropped the ultimate forward rate — the discount rate used to calculate liabilities — to 3.3% from 4.2%, in 2015. “Because of that, and other changes, the funded ratio fell to 104%,” Mr. Van Ek said, with the change leading to an increase in liabilities. The change means many pension funds in the Netherlands are dealing with having to recalculate their recovery plans.
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