Pension Plans

A recent study by the Pension Investment Association of Canada (PIAC), which represents 130 Canadian pension funds, found that the average asset mix of pension funds at the end of 2012 was 40% in Canadian and foreign equities, 10% in real estate, 5% in infrastructure, 35% in bonds, and the remaining 10% in various other assets. While a portfolio like this is understandable, it is one that offers little growth. It remains questionable whether or not this type of portfolio will meet demand over the long run.

In today’s low interest rate environment, 35% in bonds is a guaranteed loss. When interest rates start to climb, sometime next year after the midterm elections, the whole bond market will drop causing substantial losses in the process. This is a given because bond prices trade opposite to the rate of interest.

The term to maturity of the bond is proportional to the fall in bond prices that will take place. The chart above depicts this relationship. Who really wants to own a piece of paper that pays you 3% when you know your return will be 4% a few quarters down the road? Our other major concern with bonds is the level of risk they actually bear and what little return one receives from that risk. It will not take much for an investor to wipe clean the interest earned and a large chunk of their capital.

This would not be a concern if the majority of the bonds have terms of less than a year because they would be trading at par. However, this is most likely wishful thinking. Anything today with a term of less than one year should maintain a price of around par ($1,000).

Outside of the odd U.S. stock, we still believe investors need to avoid foreign securities for the following reasons;

We are bullish on the Loonie and expect a devaluation of other currencies against ours that will lower the rate of return on foreign investments.

Buying foreign securities tend to have high transaction fees.

Canadian companies offer investors the Canadian Dividend Tax Credit which adds an additional 1% to one’s return, if she/he qualifies. Plus, one can earn additional returns by enrolling in a Dividend Reinvestment Plan.

There is too much political and economic risk present across the globe. If you have trouble following what takes place in your own backyard, how can you keep on top of what happens an ocean away?

Very few countries offer the economic potential that Canada does. Why look elsewhere?

Hoping foreign securities will bail out a pension plan could easily end up making it poorer. Just management fees, currency exchanges, and brokerage commissions are a sure bet that zero money will be made, especially over the short term.

What I find interesting is that real estate comprises such a small part of the pie. I do not find it surprising because it is smart to do so, but it is contrary to what the media continues to shove down our throats about how it is one of the greatest long-term investments. If this was the case, real-estate would be a much bigger holding. It would be interesting to see how much this weighting has declined over the past few years. I am willing to bet it has been a sizeable shift, given the vast number of empty store fronts and condo towers pension fund managers drive past on their way to the office, no matter the city.

Real estate trades like bonds. When interest rates rise, the purchase price will shrink accordingly. The one difference is that real-estate tends to be heavily leveraged equating to much higher losses. In this type of environment, the asset is hard to unload and lease rates are hard to increase. Therefore, this asset will prove to make many investors miserable for the foreseeable future.

Our readers can earn a minimum 5% on Canadian equities today. Yet, few pension and mutual funds have much money invested in these shares. If the funds were invested in these shares, the dividend yield would be much lower based on their volume buying ability alone. They would have bid up the share prices causing the yield to decline.

Instead, most pension funds are speculating they will be lucky and make huge capital gains. Unfortunately, most have not been successful for the past 6 years, nor will they be for the rest of this decade.

It is plain to see the majority of pension funds will not come close to meeting their future obligations. For example, it is public knowledge that both the Air Canada and the Canada Post pension plans are insolvent. The two combined have a shortfall of roughly $4b. In the U.S. most State government pension plans are also in the same boat. How many more are out there? Seeing that we are at the crest of the greatest demographic shift in history, time will certainly tell.

One of the world’s best funded pension plans is our Canada Pension Plan (CPP). Unless the world slides into another Dirty 30’s type depression, which is unlikely, the CPP is viable until around 2030. Furthermore, recent changes to eligibility will probably add another 5 to 10 years to the solvency of the fund.

Where is all this money going to come from to cover the pension shortfalls? Governments are the only possible source. Yet, led by Washington, the majority of world governments are bankrupt. In order to fix this ongoing mess, Federal governments will be forced to make a major devaluation of their currency in order to increase inflation and to enact tax increases.

What all this means is no one should count on getting the pension they are anticipating. Instead, everyone should build up their own pension plan. Whatever one gets from a company plan in the future shold be considered as a bonus.

We strongly recommend keeping all investment monies working in Western Canada. If these four provinces cannot be successful we doubt any other region in the world can be because this part of the country helps fuel the bigger engines of global GDP. Western Canada has all the resources to be successful. There is no other region in the world that has such a diverse selection and a vast quantity.

Pension plans will be big news for the rest of this decade. Avoid the mess that is coming and set up a proper plan for oneself. Make sure it is simple and built around the Sacola Strategy.