Chief Investment Officers discuss strategic shifts, including a move away from alternatives towards fixed income
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Pension funds are Canada’s pinnacle of ‘smart money.’ Asset managers, institutional or retail, will look to our pension funds to validate or inspire a novel strategy. You don’t need to look much further than the rise of alternative investments in the past decade, once the sole purview of the ‘maple eight’ pension funds, allocations to real estate, private equity, and private debt have become a mainstay in modern portfolios. In a moment where higher rates have shifted some of the returns profiles investors now see from different asset classes, two pension fund CIOs weighted in on how they’re allocating assets.
Aaron Bennett, CIO at the recently-formed University Pension Plan, and Blair Richards, CIO at Halifax Port, explained some of their outlooks and recent decisions at a panel discussion at the Canadian Pensions and Benefits Institute 2024 Forum in Ottawa. They highlighted some of the strategies that brought them to this present moment, and how current market conditions are forcing them to reconsider certain outlooks.
“When I think about the big things that have changed recently, a couple items stand out,” said Bennett, “One is that cash actually makes money now, raising the question of what your allocation not cash is and how you manage leverage because leverage actually costs something now. This also drives you into the idea of fixed income. We’ve increased out allocation to fixed income, meaning government bonds, to put us in a better position in terms of our liability, but also because you’re seeing a return out of fixed income now. Then there’s real estate and infrastructure.”
Bennett explained that despite some more negative headlines around real estate and infrastructure allocations, his pension fund is looking for some specific opportunities. While areas like office may be somewhat under pressure, he says that multifamily residential offers some interesting prspects, provided the details of specific assets work out.
For his part, Richards highlighted what brought his pension funds to funded status over the past decade. Namely, an allocation to alternatives entered in the early 2000s. In the past five years, however, the Port of Halifax has exited more of their alternatives strategies due to complicating factors in real estate and other alts. They’re adding fixed income assets again to counterbalance.
While both Bennett and Richards have a great deal of management success under their belts, they both stressed the value of bringing in external managers and subject matter experts to consult on key strategic decisions. Bennett added that there may be a growing avenue for active management as the traditional index allocations flag somewhat or struggle with a rebalance away from highly concentrated performance drivers.
Underneath their outlooks and strategic allocations, both CIOs agreed that it’s likely inflation will rest at a higher elevated point in the next 5-10 years than it did for the decade preceding the COVID-19 pandemic. That is in part due to the ‘four Ds’ of demographics, deglobalization, decarbonization, and digitization. However, they noted that higher and more volatile inflation is still going to be single digit inflation, with the central bank two per cent target functioning more as a floor than a ceiling.
Bennet said that to manage this risk, he would love to be able to buy real return bonds from the government of Canada. However, the federal government no longer issues those products. So he looks for alternatives in the US-market with inflation-linked bonds. He also sees real estate and infrastructure as useful inflation hedges. While those assets can appear interest-rate sensitive, that sensitivity is truly dictated by the specific assets and the nature of their ability to pass through inflation. Bennet also says that commodities can be a helpful inflation hedge, despite challenges in scale related to accessing commodities.
Richards added that his pension plans have remained aware of longer-term inflation numbers resting above that two per cent target. He harkened to his own experience in the 1990s of high inflation and sky-high interest rates to inform his view. He says that by factoring in those outlooks and that experience, he has been able to capture positive opportunity.
“In 2022, our funded status improved,” Richards says. “2022 was a relatively terrific but absolutely terrible year. But because we’re conservative, we guard against big losses. We give up on the upside on other years, but in those loss years we outperform. You have to have a plan to survive.”