The ‘Inexorable' Global Shift to DC Pensions?
Defined contribution pension plans still account for a tiny minority of all pension assets in Canada even though they have emerged as the dominant pension vehicle in the United States.Funds Europe also reports, Global pension fund assets reach new highs:
A global study of pension assets by consulting firm Towers Watson shows 96 per cent of registered pension assets in Canada are held in defined benefit (DB) pension plans, while only 4 per cent are held in defined contribution (DC) plans.
In the U.S., by comparison, just 42 per cent of pension assets were in DB plans in 2014, while 58 per cent were held in DC accounts, the study says.
DB plans are traditional pension plans that provide a guaranteed level of payment in retirement, while DC plans operate like savings accounts with the final value of payouts dependent on investment choices and market performance.
Many companies have been moving their workers into DC plans so they do not have to fund shortfalls and do not face funding volatility as investments rise and fall. But the trend has advanced far more quickly in some countries than others.
While many Canadian companies have shifted workers into new DC accounts – typically by closing their DB plans to new hires – the proportion of pension assets held by workers in their DC accounts remains a tiny minority of all pension assets in the country.
The huge Canada Pension Plan, with assets of $234-billion, remains Canada’s largest DB pension fund, while most other government workers have large scale DB plans, and major DB plans continue to exist in the private sector.
Canada’s division of assets between DB and DC plans has remained virtually unchanged over the past decade, with DC assets shifting from 3 per cent to 4 per cent of all pension holdings between 2004 and 2014. By contrast, DC plans in the U.S. have grown from 52 per cent of pension assets in 2004 to 58 per cent by 2014.
On a global basis, the Towers Watson study says DC plans now account for 47 per cent of pension assets, up from 38 per cent in 2004.
“The inexorable shift to DC, which we believe will soon constitute the majority of pension fund assets, means it is becoming the dominant global pension model,” said Towers Watson global investment director Roger Urwin.
Mr. Urwin said in a statement Tuesday that the DC shift “brings with it a transfer of risk,” with the onus for ensuring adequate retirement incomes shifting from employers to employees.
“These billions of new pension members have high and immediate expectations in a world of low returns,” he warned.
Among the seven countries with the largest pension holdings, only Japan has a lower proportion of DC pension assets than Canada. In Japan, 97 per cent of assets are in DB plans and only 3 per cent are DC holdings. A decade ago, all pension assets in Japan were in DB accounts.
In contrast, 85 per cent of all pension assets in Australia are now held in DC accounts, due to the country’s large superannuation savings plans, which cover all workers in the country in DC-style accounts.
British companies have aggressively moved workers into DC plans, which now account for 29 per cent of all registered pension assets, but the country still has large legacy DB plans under management.
The Towers Watson study also shows pension assets in the world’s 16 major markets grew by 6 per cent in 2014 to a total of $36-trillion (U.S.) after posting a 10-per-cent growth rate in 2013.
Over the past 10 years, global pension assets have increased by an average of 6 per cent per year. DB plan assets have climbed by 4.3 per cent per year, while DC assets increased by 7 per cent annually.
The report shows pension plans are increasingly investing in global equities outside of their home country. Since 1998, the weight of domestic equities in pension portfolios has fallen from 65 per cent to 43 per cent by 2014. U.S. pension plans continue to have the greatest propensity to invest in domestic equities, while Canada and Switzerland are the least likely to invest in domestic stocks.
In Canada, 33 per cent of pension assets are in domestic equities, but 98 per cent of fixed income investments such as bonds remain Canadian-based, the study says.
Global institutional pension fund assets reached a new record of $36 trillion in 2014, according to research from professional services company, Towers Watson.Indeed, Damian Fantano of the FT reports, Urwin: shift to DC pensions ‘inexorable’:
Pension assets now amount to around 84% of global GDP, a 30% increase since 2008.
Assets grew by over 6% during 2014, a slight decrease on the 10% growth in 2013, but still continuing an upward trend that started in 2009, according to the Towers Watson's Global Pension Assets Study.
The research also shows that defined contribution (DC) assets grew rapidly in the ten-year period to 2014, with a compound annual growth rate of 7%, against a rate of just over 4% for defined benefit (DB) assets.
As a result DC pension assets have grown from 38% of all pensions assets in 2004 to 47% in 2014 and are expected to overtake DB assets in the next few years.
Roger Urwin, global investment director at Towers Watson, says: "The inexorable shift to DC, which we believe will soon constitute the majority of global pension fund assets, means it is becoming the dominant global pensions model."
When looking at asset allocation, the study found that weight of domestic equities in pension portfolios fell, on average, from 65% in 1998 to 43% in 2014.
During the past ten years US pension plans have maintained the highest bias towards domestic equities, while Canadian and Swiss funds remain the markets with the lowest allocation to the asset class. UK exposure to domestic equities has more than halved since 1998.
In terms of fixed income, Canadian and US funds have retained a very strong home bias since the research began, while Australian and Swiss funds have reduced exposure to domestic bonds significantly since 1998. In the UK, pension funds have increased allocations to bonds from 24% to 37% since 2004.
Allocations to alternative assets - especially real estate - in the larger markets have grown from 5% to 25% since 1995. In the past decade most countries have increased their exposure to alternative assets, with Australia increasing them the most.
Urwin adds that this shift away from domestic equities is one indication of an increased focus on risk management, an idea supported by the increasing diversification of assets in portfolios.
Defined contribution assets are expected to overtake those of defined benefit schemes in the next few years, Roger Urwin of Towers Watson has said.Finally, Richard Stolz of Employee Benefits News reports, DC plan assets continue march toward dominance globally:
The global investment director was speaking after the consultancy firm released its yearly Global Pension Assets Study on Monday.
The 39-page report showed DC assets grew with a compound yearly growth rate of 7 per cent for the 10-year period to 2014 against a rate of more than 4 per cent for DB assets.
As a result DC pension assets have grown from 38 per cent of all pensions assets in 2004 to 47 per cent in 2014.
Mr Urwin said: “The inexorable shift to DC, which we believe will soon constitute the majority of global pension fund assets, means it is becoming the dominant global pensions model.
“This brings with it the transfer of risk and a new tension in the balance of ownership and control, which will test governments and pension industries around the world.
“The use of passive approaches and smart betas in DC will lead to fee compression. So far that fee compression has been small, but over time it is likely to be a large disruptive force.”
The report also showed global institutional pension fund assets in the 16 major markets grew by more than 6 per cent during 2014 to reach a new high of US$36trn (£23.6trn).
Global pension fund assets have now grown at 6 per cent a year on average since 2004. The UK, however, achieved 37 per cent, while the US had 32 per cent growth.
The only major market to grow its pension assets more than the UK as a proportion of GDP over 10 years was the Netherlands, where they went up by 51 per cent.
This came as research by Citigroup and the Pension Protection Fund found that deficits were rising among UK pension schemes. According to Citigroup, DB schemes could see a deficit of £380bn, while the PPF suggested that its 6,000 schemes have a total liability of £1,503bn.
John Bramwell, an adviser with Yorkshire-based PenLife Associates, said: “Over the past few years there has been a drive to put the onus on the individual rather than the employer.
“I worry that individuals won’t understand what they are doing but there are opportunities there, because if they have proper advice they could do very well.”
The rest of the world is following the U.S. lead in embracing the defined contribution model of retirement savings plans, with America’s employer-sponsored plans taking a huge share of global assets. And with those huge assets come huge risks, according to analysts.You can download the Towers Watson 2014 Global Pension Assets Study by clicking here. Let me briefly make some important observations:
Nearly half (47%) of retirement plan assets within the 16 largest international pension markets (known as the P16) is held in DC plans. DC assets “are expected to overtake DB assets in the next few years,” according to the latest Towers Watson Global Pension Assets Study.
A significant component of that growth, however, is attributable to a rapid increase in DC assets held in the U.S. The American share of the $17 trillion in P16 DC total is $13 trillion, or 76% of the total. Total U.S. retirement plan dollars grew by 9% last year, versus 6% for the P16 total.
Total retirement plan assets within the 16 top pension markets (which account for an estimated 85% of the global total) stand at about $36 trillion, according to the study.
DC plan assets in the U.S. now stand at 58% of the combined DB/DC total, up from 47% a decade ago.
DC shift has consequences
The global momentum in favor of the DC model will have consequences. In a statement released along with the survey results, Steve Carlson, Towers Watson’s Americas investment practice, warned that this shift “brings a transfer of risk and new tension to the balance between ownership and control, which will test governments and pension industries around the world.”
The overall growth rate for retirement plan assets in the P16 cooled off a bit in 2014, to 6% from 10% in 2013. (All growth rates in the study encompass both net contributions and investment returns.)
A higher growth rate would be required within the DB sector to strengthen those plans. “While there has been a significant improvement in various pension balance sheets around the world since the financial crisis, many DB pension funds are still in very weak funded positions,” Carlson said. “However,” he added, “the U.S. pension plans are in a better position, given the contribution flexibility.”
U.S. pension plans also typically have significant flexibility when it comes to where to invest. Yet the “domestic bias” for equity investments – the proportion of total equity investments in domestic corporations – is highest in the U.S.
According to the study, 67% of pension dollars invested in equities were invested in U.S.-based companies, a percentage that has risen over the past three years. During the same time, the P16 equity bias has declined, to 43% last year, down from 65% in 2008.
This may be explained in part by the fact that the aggregate capitalization of U.S. publicly held companies is significantly larger than that within other P16 countries, implying that non-U.S. pensions seeking a significant allocation to substantial corporations have had little choice but to load up on U.S.-based companies.
Another investment trend noted in the study is the increased allocation to “alternative” assets – generally real estate, hedge funds, private equity and commodities. That allocation rose from 5% in 1995 to 25% last year. U.S. pensions have the greatest appetite for alternatives, with a 29% allocation last year.
The P16 countries are, in addition to the U.S., Australia, Brazil, Canada, France, Germany, Hong Kong, Ireland, Japan, Malaysia, Mexico, the Netherlands, South Africa, South Korea, Switzerland, and the United Kingdom.
- First, the 'inexorable' shift to DC pensions is all part of a bigger war on pensions. As the world follows the United States of pension poverty, shifting out of defined-benefit (DB) into defined-contribution (DC) plans, it will exacerbate wealth inequality and reinforce global deflation.
- Second, the brutal truth on defined-contribution plans is they can't compete with large, well-governed defined benefit plans. I emphasize well-governed because if they're not well-governed, defined-benefit plans are subject to too much political interference and deliver poor results (which is the case of many U.S. state pensions).
- Third, the study gives the false impression that DC plans are outperforming DB plans, citing the former's asset growth over the last ten years (7% vs 4%) but it's worth noting DC plans are heavily weighted in public equities and to a much lesser degree bonds, both of which have done particularly well since the 2008 crisis with all the aggressive quantitative easing going on across the world (especially U.S. equities which garner the bulk of the assets). In other words, part of this asset growth discrepancy is simply due to "beta" which is when stock and bond markets are roaring but not so fine when a prolonged bear market strikes. This skews the data to make DC plans look far better than they actually are.
- However, there is no doubt there is an important shift going on. Kevin Uebelein, AIMCo's new CEO, shared this with me: "the asset growth disparity is driven by differences in net flows as much as by differences in asset performance (perhaps even more). The net flows difference would derive from i) differences in maturity between DB and DC plans, generally, and ii) the tectonic shift in many countries out of DB and into DC, about which the Towers Watson report writes." Bernard Dussault, Canada's former Chief Actuary shared similar views stating: "the higher DC asset growth is mainly due to the DB/DC shift/conversion, i.e. decrease in DB coverage, increase in DC coverage."
- Still, the report doesn't discuss performance, thus leaving the impression that this 'inexorable' shift to DC pensions is in our best interest. It most certainly isn't. Over long periods, well-governed DB plans do perform better because they are properly diversified in public and private markets and are not subject to the downside risks of DC plans which are much more correlated to public markets. I can assure you Canada's top ten are outperforming their DC counterparts over the last ten and twenty years. In fact, Jim Keohane, CEO of HOOPP, told me that "Towers Watson has done other studies that show that DB plans have significantly outperformed DC plans over virtually any time period you want to look." It's a shame Towers Watson doesn't discuss these results in their annual report on global pension assets.
- Another senior pension fund manager shared this with me: "Returns mean nothing if you don't compare volatility as well. My personal DC plan had a much lower bond weight than most DB plans. It's very hard to compare returns because of vastly different investment policies. Also, the last 5 years have been smooth sailing, you need a full cycle to analyze the performance (again, it's a shame Towers Watson doesn't discuss this in their annual report on assets).
- Fourth, the report discusses the explosive growth in global pension assets but makes no mention of the explosive growth in global pension liabilities. I wrote a recent comment on how deflation will decimate pensions and we're doing a great disservice to informed readers to discuss assets with no proper discussion on liabilities. Importantly, who cares about global pension assets in a world of ZIRP and QE when global pension liabilities are soaring?
- Fifth, the report mentions the shift in alternatives stating global pensions are focusing primarily on real estate, private equity and then hedge funds. All true but their approach and performance to these alternatives is what worries me. Canadian pension funds snapping up real estate are going direct, saving huge on fees and they're increasingly doing direct and co-investment deals in private equity, which is another big savings on fees. As far as hedge funds, Ontario Teachers is in a league of its own as their CEO, Ron Mock, has sustained a few harsh lessons in hedge funds. Most pensions are better off heeding the wise advice of George Soros and get out of hedge funds while they still can. Interestingly, Soros is taking his own advice, firing his outside managers amid poor returns, which goes to show you even the king of hedge funds has difficulty picking winners in this environment.
- Sixth, the report discusses the growth of 'smart beta' strategies in DC plans. Smart beta is the new craze but let's be clear, it's still beta. But if you're looking for someone to help you in this area, let me plug my friend Nicolas Papageorgiou who teaches finance at HEC and also works at HR Strategies here in Montreal where he and his team implement and manage cutting edge smart beta strategies for global funds (you can read more about Nicolas and his team in an older blog comment of mine on chasing smart beta).
- Lastly, the report discusses how Australia's pension assets are now primarily in DC plans (85%). Sure, Australia has done some great things to force people to save but if I had a choice of taking lessons from Down Under or going Dutch on pensions, there is no question I'd opt for the latter. Policymakers around the world should take a closer look at the benefits of DB plans in Canada, the Netherlands and in other Nordic countries. Importantly, as the demographic shift continues and people are living longer, bolstering DB plans will be a way of increasing government revenues and mitigating the ravages of deflation. It's mind-boggling that our policymakers are not bolstering DB plans and quite worrisome given that global deflation is knocking on our doorstep.
Take the time to read that comment very carefully because even though I emphasize the need to scrutinize executive pay of senior pension fund managers a lot more closely, there's no doubt that Canada's large DB plans are delivering outstanding long-term results and saving stakeholders a bundle in fees. I don't want the Bill Tufts of this world to use that comment as ammunition against DB plans. Quite the contrary, it should be used to bolster the case for DB plans around the world.
Below, as we discuss the 'inexorable' shift to DC plans, PBS travels to one country -- The Netherlands -- that seems to have its pension problem solved. Ninety percent of Dutch workers get pensions, and retirees can expect roughly 70% of their working income paid to them for the rest of their lives. I think we can all learn a lot from the Dutch on bolstering our retirement systems.