Inflation Fears Dampen Pension Plan Gains?

Barbara Shecter of the Financial Post reports, Inflation fears dampen pension plan gains:

Inflation jitters and a stronger loonie dampened pension plan gains in the first quarter on the back of healthy stock market returns, according to a survey released Wednesday by RBC Dexia Investor Services.

Within the $340-billion RBC Dexia universe, pension assets earned 2.3% in the quarter that ended March 31, bringing 12-month results to 10.8%.

“Equities continued to do well despite the geopolitical tensions in the Middle East and the tragic events in Japan, but have been exceedingly volatile,” said Don McDougall, director of advisory services for RBC Dexia.

Canadian stocks were the top performing asset class for a third successive quarter as the S&P TSX Composite index gained 5.6%.

The two largest sectors, financials, which were up 9.1%, and energy, which gained 8.7%, accounted for the bulk of the increase. However, pensions were “generally under-exposed to both and subsequently lagged the index by 0.3%,” said Mr. McDougall.

“Over the year, pensions are up a solid 19.0% but trail the S&P TSX benchmark by 1.4%,” he said.

Canadian pension plans saw their bond holdings lose 0.2% for the first three months of 2011, as price declines outpaced coupon payments for a second successive quarter.

Digital Journal added some more details on the RBC Dexia survey:

Healthy stock market returns helped pension plans maintain momentum in the March quarter but inflation jitters and a stronger loonie dampened their gains, according to a survey just released by RBC Dexia Investor Services, which maintains the industry's most comprehensive universe of Canadian pension plans and money managers.

Within the $340 billion RBC Dexia universe, pension assets earned 2.3 per cent in the quarter ending March, bringing 12-month results to 10.8 per cent. "Equities continued to do well despite the geopolitical tensions in the Middle East and the tragic events in Japan, but have been exceedingly volatile," said Don McDougall, Director of Advisory Services for RBC Dexia.

Canadian stocks were the top performing asset class for a third successive quarter as the S&P TSX Composite index gained 5.6 per cent. "The two largest sectors, financials (up 9.1 per cent) and energy (up 8.7 per cent) accounted for the bulk of the increase, but pensions were generally under-exposed to both and subsequently lagged the index by 0.3 per cent," noted McDougall. "Over the year, pensions are up a solid 19.0 per cent but trail the S&P TSX benchmark by 1.4 per cent."

Foreign equities also contributed but currency losses on US and Japanese assets muted their gains. In the quarter, the MSCI World index appreciated 3.6 per cent in local currency terms but pensions only rose 2.6 per cent once converted to Canadian dollars. Year-over-year, currencies had less impact on performance as the loonie's strength in relation to the US dollar was more than offset by it's weakness against the other major currencies.

Canadian pension plans saw their bond holdings lose 0.2 per cent for the first three months of 2011, as price declines outpaced coupon payments for a second successive quarter. McDougall added, "With mounting speculation over higher inflation, weakness came from the longer end of the curve as long-term bonds declined by 1.4 per cent versus 0.3 per cent for the DEX Universe."

You can read the full RBC Dexia release by clicking here. Late this evening I spoke to a senior fund manager from an insurance company and he told me 2010 was one of their best years whereas Q1 2011 isn't as strong because their bond portfolio isn't doing as well.

The big question is inflation already a problem in Canada, forcing the Bank of Canada to resume increasing interest rates? According to Stéfane Marion and Yanick Desnoyers of the National Bank of Canada, the brisk rebound in March CPI will put pressure on the Bank of Canada to raise rates in July:

After the February low core inflation rate, a brisk rebound occurred in March with almost all of the components showing strong acceleration. As a result, the twelve- month core CPI experienced a substantial change from February to March (0.8 percentage points). In our opinion, the underlying trend of inflation in Canada is closer to 1.5% rather than the February number of approximately 1%. Core goods CPI registered its biggest March increase in more than 20 years. Despite the high flying Canadian dollar, core goods CPI is now back in positive territory on a y/y basis. Thus, the cyclical low for core CPI is now behind us. In its last monetary report, the BoC described Canada as an economy with "material excess supply". In light of this morning’s inflation data this wording appears to be too strong. The process of normalizing interest rates must resume in Canada. We think that a July rate hike is the most likely scenario.

Will the Bank of Canada resume increasing rates? Given the rise in core inflation, it's highly likely but remember, the Bank of Canada can't veer too far off from the Fed, so any rise in rates will be modest and gradual. Also, the Bank of Canada is concerned with the rise in personal debt. And then there is the bigger problem of the Canada bubble fueled by Canada's mortgage monster.

In other words, while inflation pressures are building, I wouldn't be reducing my exposure or actively shorting Canadian bonds, because when the Canada bubble bursts -- and mark my words, it will eventually burst -- those Canadian bonds will outperform all other asset classes.