Good stock market returns and a slight rebound in long-term federal bond yields in the fourth quarter allowed Canadian pension plans to make up for most of the losses incurred in the second quarter.

Consulting firm Mercer said Friday that its Pension Health Index stood at 73% on December 31, up 5% over the quarter but down 1% on the year.

“Stocks delivered another strong performance in the fourth quarter and in 2010 overall, both domestically and abroad, with the biggest gains observed in Canadian stocks, signaling continued increase in consumer and investor confidence,” said Yvan Breton, leader of Mercer’s investment consulting business in Canada and Latin America. “The typical pension plan experienced a return on assets of almost 4% in the fourth quarter, improving the Mercer Pension Health Index by about 2%.”

“After dropping 70 basis points in the second and third quarters of the year, long-term federal bond yields rebounded by roughly 20 basis points in the fourth quarter, which, together with a slight drop in the cost of purchasing annuities, bumped the index up about 3%,” said Scott Clausen, retirement, risk and finance professional leader for Canada. “Over the year, strong asset performance was offset by the overall drop in long-term federal bond yields. Any increase in the actual funded status of pension plans in 2010 is likely due to employers pouring cash into their plans,” Clausen added.

Mercer expects that the funded ratio of most pension plans as shown in year-end 2010 corporate disclosures will drop compared to last year, even after employer contributions are accounted for, since corporate bond yields used to value obligations for that purpose have dropped around 1% since the start of the year, due in part to a continued decline in credit spreads.

A typical balanced portfolio would have returned 9.2% during 2010 and 3.6% in the last quarter of 2010. This return does not capture any impact from active management of any asset class.

Canadian equities was the best performing asset class in 2010 with a return of 17.6%. The S&P/TSX returned 9.4% in the last quarter.

The best performing sectors for the year ending 2010 were Health Care (+57.0%), Materials (+36.5%) and Consumer Discretionary (+25.3%) according to the S&P/TSX sector indices. The worst performing sectors were Information Technology (-11.6%), Consumer Staples (+10.3%) and Financials (+10.5%).

Small cap stocks returned 35.1% (S&P/TSX SmallCap Index), significantly outperforming large cap stocks (S&P/TSX 60 index) which returned 13.8%.

Value stocks outperformed growth stocks as shown by the S&P Canada BMI value and growth indices, which returned 20.6% and 16.5% respectively.

Canadian bond performance, as measured by the DEX Universe Bond index, returned 6.7% in 2010, led by long-term bonds which gained 12.5%, followed by mid-term bonds (7.8%) and short bonds (3.6%). During 2010, overall bond yields (measured by the DEX Universe Bond index yields), started the year at 3.32%, reaching a high of 3.62% in April and fell to a low of 2.72% in October before settling at 3.11% for the year.

The strengthening of Canadian dollar versus most other major currencies had an overall negative impact on foreign equities during 2010.

International equities, as measured by the MSCI EAFE (CAD) index, provided a return of 2.6% in 2010. In local currency terms the MSCI EAFE returned 5.3%.

In the United States, the S&P500 (CAD) returned 9.1% in 2010. In U.S. dollar terms, the S&P500 returned 15.1%.

Emerging markets, as measured by the MSCI Emerging Markets (CAD) index, returned 13.0% in 2010.

IE