U.K., Canada fare best in nightmare year

Date: Monday, January 26, 2009
Author: Drew Carter, PIonline.com

In a year when equity markets plunged worldwide, producing double-digit average investment losses across the six largest pension markets, pension funds in the U.K. and Canada outperformed their peers in 2008 —largely because of currency devaluation.

Pound and Canadian dollar declines eased the pain for unhedged U.K. and Canadian pension funds' foreign portfolios: Estimated investment returns for 2008 were -13.2% and -14.7%, respectively.

Currency devaluation didn't work so well elsewhere, however. Despite an approximately 20% decline in the Aussie dollar, pension plans Down Under fell 22%.

Hardest hit were plans in the United States, where falling equity markets and a rising dollar resulted in a median return of -25.2%.

The two remaining markets of the six Pensions & Investments looked at — the Netherlands and Japan — dropped an estimated 16.6% and 20.1%, respectively.

“Equities have been terrible,” said Greg Stewart, regional product manager for the Americas in New York for BNY Mellon Asset Servicing. “Given that many institutional investors will have long-term horizons and higher allocations to equities, that will affect returns.”

Equity losses for the year ended Dec. 31 reached as high as 50% in some markets, and pension funds found little shelter in alternative investments, such as hedge funds and real estate.The estimate for U.S. plans is based on returns through Nov. 30 in BNY Mellon's Master Trust Universe plus a December returns estimate; the universe comprises 583 funds, including corporate and public pension funds.

The 1,793 U.S. plans in the Wilshire Cooperative Universe returned an average -23% for the year ended Dec. 31, according to Wilshire Associates Inc., Santa Monica, Calif.

“Unless you had a portfolio in high-grade (bonds) or Treasuries, diversification did not work” in 2008, said Maggie Ralbovsky, managing director at Wilshire. “There was no place to hide.”

She said the massive sell-off across markets was caused by deleveraging, “The entire system is bleeding out money,” Ms. Ralbovsky said.

Following five years of positive returns, many in the double digits, investment returns in all six pension fund markets surveyed were well below those seen in 2007.

“Clearly it was a horrid year (globally) for funds,” said Graham Wood, senior consultant at WM Performance Services in Edinburgh, which provided the U.K. estimate. “But in a way, U.K. pension funds were protected to an extent because of fairly large shifts that have taken place in the past four to five years to more bonds.”

Pension funds in the U.K. also benefited from currency changes — to the tune of about 25 percentage points on equity returns in an unhedged U.S. equity portfolio, Mr. Wood said. Pension funds “tend to be ... unhedged on the equity side. On the bond side it is mixed.” U.K. funds not hedging their overseas bond portfolios saw an eye-popping 40.1% average return on these bond portfolios in 2008.

But U.K. hedge fund and property investments did not provide the steady, uncorrelated returns they were supposed to, declining 13.2% and 20.7%, respectively, last year. The real return for U.K. plans was -16.2%, down from 5.8% in 2007.

Australian woes

In Australia, the bottom dropped out, driven primarily by the worst-performing year for Australian stocks and an average asset allocation to stocks of 58%, according to data provided by the Melbourne office of Mercer LLC.

“The bull run in the Australian market, which resulted in five consecutive double-digit calendar year returns, came to a spectacular halt in 2008,” according to Mercer's 2008 Sector Survey, an annual report. The S&P/ASX 300 set a record at -38.9% in 2008, blowing past the previous -34% record that stood since 1930.

“With the equity markets going down (and other markets declining, too), there weren't too many places to hide over the year's time,” said David Carruthers, principal at Mercer in Melbourne.

Add a 5% inflation rate and the real return for Australian superannuation funds was -27%. Real return in 2007 was 4.1%.

And that was in spite of a decline in the Australian dollar of 20% against a basket of currencies. Australian retirement plans on average held 25% of assets in international stocks and 33% in Australian stocks, and about half of international assets were unhedged.

Bonds made up just 18% of total assets in 2008, although unlisted alternatives funds (such as private real estate, private equity and hedge funds) provided some solidly positive returns, Mr. Carruthers said.

For example, the S&P/ASX 300 Property index, which tracks public real estate like real estate investment trusts, fell 55.3% in 2008. The Mercer Unlisted Property fund, which makes direct real estate investments, making a difference between the two of more than 60 percentage points.

“You can expect there'll be differences between listed and unlisted markets, but that's a pretty big difference in a year,” Mr. Carruthers said, adding that he expects returns of private and public assets to converge in 2009.

The median Canadian pension fund's assets declined 14.7% in 2008, dragged down by equity market losses, especially in the energy and materials and financial sectors, according to Russell Investments' Toronto office. Bonds rose 6.4%.

Canadian plans' real return was -16.2% vs. 0.3% in 2007.

Japanese pension funds posted negative returns for the second year in a row, declining 20.1% in 2008 despite an average equity allocation of just 35%, according to the Tokyo office of Russell Investments. That follows a -0.8% return in 2007. A move to hedge funds from fixed-income investments added to hefty stock declines to drag down returns in 2008.

“Most pension funds hired hedge funds of funds as alternatives to Japanese fixed income,” said Konosuke Kita, senior consultant in Russell's Tokyo office. “Japanese fixed-income rates are very low, so pension funds had to earn some extra alpha above the rate of fixed income, so they have moved to low-risk hedge funds” in the past five years.

But in 2008, Mr. Kita said, hedge funds of funds returned between -15% and -25%. At 2.73%, Japanese bond returns were up slightly from 2007, when they posted 2.53%.

The real return for Japanese plans was -21.1% vs. -1.2% in 2007.

Although consultants used different methods to calculate returns, actual returns through Sept. 30 generally were combined with fourth-quarter estimates that were based on average asset allocations and index returns. That could introduce a wider margin of error into this year's estimated returns, said Neil Pinkowski, senior consultant in Toronto for Russell Investments. Because of enormous volatility in the fourth quarter, active managers likely strayed further from benchmarks. If active managers underperformed, losses would be even greater.

However, in the Netherlands, actual losses might be reduced, as WM's estimate does not account for the liability-driven investment strategies many pension funds implemented in 2008 or before.

“The Dutch Pension Fund index returns do not include the full effect of certain derivatives such as interest rate swaps because they cannot be modeled,” Michelle van der Ham, WM customer manager, wrote in an e-mail.

'Diversification benefit'

Although Russell's Mr. Pinkowski could not provide data for alternatives in Canada, he said returns were strong enough to reinforce a trend toward growing allocations to private equity, hedge funds and infrastructure. “It looks like there's been some diversification benefit there,” he said.

Most consultants said they are recommending clients keep their asset allocations and rebalance back into equities to grab an eventual upswing. Wilshire's Ms. Ralbovsky, however, is taking a different tact.

Believing deleveraging will continue in 2009, Ms. Ralbovsky is recommending clients rebalance, but create a new credit allocation to take advantage of dislocations.

Contact Drew Carter at dcarter@pionline.com