How is inflation impacting some of Canada’s largest investors – pension plans – and how are they invested?
At a recent Pensions & Investments webinar focused on the range of considerations facing plan specialists, including diversification, preferred asset classes, climate and, of course, inflation, representatives from Fidelity Investments, Manulife Investment Management, Sun Life, Aon, Finisterre and Amundi US shared a number of insights for the benefit of those gathered for the virtual presentation.
Manulife’s senior portfolio manager and global head with the firm’s multi-asset solutions team, Eric Menzer says the firm had a view at the beginning of the year that inflation would run higher initially but that things would unwind and get back to normal moving into 2022.
“Obviously nobody could have forecast a Russia-Ukraine war and the geopolitical risks that have been permeating through the world right now. That certainly changed the game.”
Today, he says the firm sees inflation abating somewhat by year’s end, coming down to settle around three or four per cent at the end of 2022.
The experts gathered looked at both indexed pension plans and looked at the sensitivities non-indexed plans have to inflation, as well. (Indexed plans, they say, are often more likely to include retirees than other less mature plans with longer durations associated with them.) They say both plan types will be challenged by inflation in different ways.
“The reason why we haven’t had those conversations as much is because we’ve been in a persistently, low, moderate rate and inflation environment for 40 years.” Menzer says. “We really have to sit back and reflect on what those impacts are.”
In both cases he says even small movements and inflation expectations can have significant long-term impacts that could ultimately impact a plan’s funded status levels.
“In the extreme cases, the fully index plans where benefits are fully indexed, obviously that magnifies because you’re not only growing salaries over time, you’re adjusting those benefits in retirement as well,” says Menzer.
Ultimately, it was said that plans will be dependent on investment strategies and performance to close the gap caused by inflation.
To help, Menzer suggests companies take a close look at their investment policy statements and build in the flexibility needed to adjust to conditions along the way.
“The investment policy statement really is something that plans should be looking at typically on an annual basis anyway,” he adds, calling it a good fiduciary and governance practice.
“The key thing is to give yourself enough room that if you do want to think about making a pivot in your investment strategy, particularly as it relates to some of these other asset classes, that you have some flexibility built in there to do that.”
Emerging market debt, real assets and annuities were all discussed as opportunities available to the country’s pension plans.
“It’s virtually impossible to predict from one year to the next what will be the best performing asset class,” says Fidelity’s multi-asset class strategist, Francois Pellerin.
He also recommends active portfolio management, “not only for alpha purposes, but also risk management purposes. It’s important to do active management, we think especially in the fixed income arena.”
Emerging market debt
Emerging market debt, an income asset class says Finisterre Capital senior portfolio manager, Christopher Watson, was first discussed as one possibility for webinar attendees to consider. “We think a total return approach is the best way to approach the asset class,” he says.
In looking at the emerging market debt issuer universe, he adds that it has a significant amount of exposure, positive exposure, to commodities.
The emerging market inflation cycle is also much further advanced than it is closer to home as central banks around the world have been tightening their monetary policy response now, quite aggressively for some time in some emerging markets.
More, he says if investors look at the performance of emerging market assets, they will find that somewhat paradoxically, “certainly counterintuitively, emerging market assets have actually performed very well at the beginning of tightening cycles.”
On the real asset front, the experts gathered say plan sponsors need to think about how they’re currently positioned and how they might want to be positioned in the future.
“Should inflation be persistent and last longer than expected, we start to look at things like infrastructure, real estate, timber and farmland. We look at these assets in terms of how they behave in various inflationary environments,” Menzer says. “We went back and looked at a good 20-year history under various inflation regimes, and we could see the benefits, really the asymmetric benefits of these assets. In particular, in environments where inflation is going up, you see some good performance coming out of those real assets, these direct private assets that we talk about, relative to the public markets, public equities and public fixed income.”
He also says the assets will hold the line when inflation is falling, as well. “Lower correlations relative to public market assets are a real benefit in terms of helping to protect against inflation movements.”
If a defined benefit pension plan seeks buy-in or buy out options, meanwhile, Alexandre Larouche, managing director of client relationships, defined benefit solutions at Sun Life says annuities are currently priced attractively with yields that are very much in line with the yield provided by a corporate bond portfolio. Competition among companies developing such solutions have also improved the landscape in terms of capacity and risk appetite. This, he says “is enabling transactions of many sizes and profiles to be executed.”
For those interested in pursuing such a deal, Larouche adds that companies should have clean and complete data and come to market well prepared with good governance and clear triggers set for decision makers.
Finally, Annie Chor Joyce, managing director and head of environmental, social, and governance in the United States for Amundi US says climate change, meanwhile, is a macro trend that is here to stay. The frequency and intensity of extreme weather patterns and global regulators are going to have market impacts; preparing for future climate risk is something plan sponsors and their managers need to be thinking about now.
“Climate change is a mega trend driving long term secular themes,” she says. “Climate change could wipe $23-trillion in global GDP by 2050 if global temperatures continue on the current trajectory,” Joyce adds, saying it is necessary to break down what investments are needed to reach net neutral emissions by 2050.
“Understand what you own and be aware as to what’s needed within that portfolio from a transition perspective towards a low carbon economy.”