Canadian pension plans are diversifying into international assets, private equity and real estate, but aren’t as keen on hedging strategies, according to new research from Greenwich Associates.

Following the lifting of foreign property constraints, along with a desire for diversification and higher returns, Canadian pension plans, endowments and foundations are adding international assets to their portfolios at a rapid rate, Greenwich reports. But growing holdings of non-Canadian dollar assets are also bringing a new set of currency risks, it points out.

According to the newly released results of Greenwich Associates’ research, international equity represented slightly less than half of institutional equity portfolios in Canada in 2003, that share rose to 51% in 2004, to 56% in 2006 and surged to 58% in 2007. “Since Canada represents roughly 3% of the MSCI World Index, we would contend that foreign exposure is still under-represented in Canadian equity portfolios and we expect those percentages to continue to rise,” says Greenwich Associates consultant Rodger Smith.

All told, foreign securities represent about 30% of institutional assets in Canada, with non-domestic equities making up more than 29% and international bonds accounting for slightly more than 0.5%, it says. Those average foreign allocations are skewed upward by the 42.3% of total assets invested in foreign securities by the Canadian subsidiaries of U.S. companies. Among Canadian corporate funds, foreign investments represent 32.8% of total assets, while Canadian provincial government funds have invested slightly less than 28% of assets in foreign securities. Canadian endowments and foundations have just more than 37% of their assets in foreign investments.

As Canadian institutions expand their foreign holdings they are also taking on currency risk — an exposure to which many funds have only limited experience, and one that dealt a painful blow to many pension funds over the past 12 months as the Canadian dollar soared, the firm notes.

Nevertheless, when Greenwich Associates asks Canadian funds how they hedge their non-domestic investments, 35% say they do not. “Many funds opt not to hedge their foreign exposure on the belief that, over a long-term investment horizon, currency fluctuations will even out to the extent that hedging is not worth the cost,” says Smith. “But as Canadian funds shift a growing share of their assets to non-domestic instruments, we would encourage them to consult with their managers, consultants and currency overlay specialists in order to make an informed decision weighing hedging costs against mounting currency risks.”

Canadian managers aren’t big hedging fans generally, it also found. Indeed, Greenwich said that, unlike their counterparts in the U.S., Canadian institutions are not making a big move into hedge funds. Rather, when seeking out alternative investments, Canadian institutions are drawn to real estate and private equity. Allocations to real estate jumped to 8.4% of Canadian institutional assets in 2007 from 5.5% in 2006 and 5.3% in 2004. Meanwhile, allocations to private equity surged to 5.0% of assets from 2.6% last year and 2.2% in 2004. Allocations to hedge funds have been moving in the opposite direction, shrinking to 1.2% of Canadian institutional assets in 2007 from 1.5% in 2006 and 1.6% in 2004.

Additionally, Greenwich found that Canadian institutions are in the early stages of a strategic shift that could ultimately transform the way pension assets are managed. An increasing number of Canadian plan sponsors are adopting techniques and strategies designed to more closely align the structure of their investment portfolios with pension liabilities, it says. About one quarter of Canadian institutions say they have adopted some form of asset-liability matching strategy in their portfolios and another 19% say they have plans to do so. Slightly more than 10% have taken the next step and implemented liability-driven investing strategies — more complicated approaches that use derivatives to more accurately match assets to liabilities. Another 18% of funds say they expect to incorporate LDI strategies into their portfolios.

Greenwich also found that Canadian plan sponsors are under less pressure to close their defined benefit plans to new employees. While the proportion of plans closed to new employees in the U.S. jumped to 26% in 2007 from 22% in 2006, the share of closed Canadian funds has been stable at about 20% for the past three years. At the same time, the share of Canadian plan sponsors operating DC plans has been steady at about 50%.

@page_break@Canadian plans are remaining open in part because the plans themselves are better funded, Greenwich notes. The average funding ratio for Canadian pension plans now stands at 99%, up from 97% last year. Canadian corporate plans are funded at 101% on average, provincial government plans are funded at 98%, and Canadian subsidiaries of U.S. corporations are funded at 97%.