Academic study points to in-house management, concentration on real assets, and indexed liabilities as keys to strength
A mix of prudent practices has allowed Canadian pension funds to do well on various measures of investment performance, according to research from McGill University.
The research, conducted in partnership with CEM Benchmarking and published in July, drew from a study of how pensions, endowments, and sovereign wealth funds around the world performed between 2004 and 2018.
As reported in Institutional Investor, large Canadian funds – defined as those managing more than $10 billion in 2018 – were notable outperformers across all measures including their returns, asset-allocation strategies, and cost structures.
“Not only did they generate greater returns for each unit of volatility risk, but they also did a superior job hedging their pension liability risks,” the authors of the research said.
One key element to the Canadian model’s success, the researchers found, was in-house investment management: Canadian pensions managed 52% of their assets in-house on average, as opposed to 23% for funds in other countries. For very large funds representing more than $50 billion, the gap was even more pronounced, with an in-house management ratio of 80% among fund managers in Canada compared to 34% for those outside the country.
“We estimate that, by managing a high proportion of their assets in-house, Canadian funds reduce costs by approximately one third,” they said, noting the need for independent corporate governance and competitive compensation to lure and retain investment talent.
The researchers also pointed to the “re-deployment of resources to investment teams for each asset class” among large Canadian funds. Specifically, they found that Canada’s fund plowed five times more money than peers into cost centres such as risk-management units and IT infrastructure.
Funds in Canada also stood apart because of their propensity to allocate toward assets that hedge against liability risks – a strategy that will doubtless be tested by the pandemic crisis – and make their portfolios more efficient. While real assets tend to cost more to manage than stocks and bonds, Canadian funds put 18% of their portfolios in that area, which is twice what their global peers allocate.
Additionally, Canadian fund managers index a high proportion of their pension liabilities to inflation, which the researchers said powers strong asset-liability performance. “Indexed liabilities tend to correlate more with growth assets than nominal liabilities,” they said, which allows funds to invest in growth assets that bolster both return performance and the ability to hedge against liability risks.
