Drivers of Successful Pension Investing:
Lessons from the Canadian Model
The classic model of pension investing faces bleak solvency and funding realities that foreshadow a precarious future and will likely result in defined-benefit (DB) plan obsolescence. Over the past forty years, two factors have seriously attenuated the sustainability of DB plans which provide retirees with a fully-insured pension accrued from wage contributions during their active years of employment. The first factor causing the decline of DB plans is the appreciable and protracted drop in interest rates. The continually low rates have led to diminished returns for DB investments, making it difficult for DB plans to remain fully funded and thereby provide adequate long-term provisions for the promised pensions. The second factor causing the decline of DB plans is the increase in life expectancy. This has compounded the problem of underfunded plans by substantially increasing the total pension liability. The combined impact of these two factors has resulted in DB plan discontinuation and the rise in popularity of defined-contribution (DC) plans which transfer pension investment risk from the employer to the employee.
The decline of the DB model is widely viewed as a welfare loss to society. When the DB model works, it leads to social and economic prosperity. For example, Canadian reforms resulting in the CPP/QPP DB system have proven to be highly successful in reducing poverty among seniors by establishing a healthy retirement system. Under the DC model, employees no longer benefit from either the pooled mortality insurance or the expertise and economies of scale of large pension funds intrinsic to the DB model. This surfaces a critical problem in the DC model: educating employees to become competent investors of their own retirement funds. In what can be considered a highly specialized skill-set, it remains to be seen whether individuals (diverse in education, socio-economic background etc.) can acquire the knowledge, discipline, and the technical skills necessary to accumulate adequate savings that allow them to retire with confidence in their financial security.
Given the precarious future that overshadows pensions and those who depend on them, it is now more critical than ever to find both the means and the methods to improve the current condition of pension funds. This is the goal and purpose of our research project outlined in this proposal. We will conduct an empirical analysis investigating the factors that lead to successful pension investing under the attenuating pressures of low interest rates and high life expectancy. The Canadian pension industry will serve as the performance model because it is one of the unique examples, when compared to international counterparts, of successful and sustainable DB-plan management. We will access and analyse datasets of public Canadian pension funds that provide both a broad and an in-depth look at performance, asset allocation and fund characteristics. We will then evaluate the effects of liability profiles, risk-sharing mechanisms, corporate governance, organizational, and compensation structures, and regulations on pension asset allocation decisions, and identify the key drivers of pension fund performance.
The proposed study will have multiple beneficial outcomes for the Canadian pension fund industry. It will provide a structured and comprehensive understanding of where differences in asset mix across Canadian pension funds come from. It will empirically identify which factors have the greatest impact on strong and sustainable fund performance. It will determine the extent to which the Canadian model is applied across the spectrum of Canadian funds. It will evaluate the conditions under which the Canadian model becomes more difficult to implement in a cost efficient way, and then propose solutions to improve cost efficiency. It will analyze how changing economic conditions are leading Canadian model innovators to shift to new strategies. Finally, from the aggregated results and insight, we would like to develop a general framework for long-term and sustainable pension investing.
Sebastien Betermier, the lead researcher, is a tenured Associate Professor at McGill University and an established scholar in the field of asset management. He brings considerable research experience to this project. He has conducted extensive analysis on household portfolio decisions using extraordinarily comprehensive and sensitive datasets on the portfolio holdings and socio-economic characteristics of large population samples from Scandinavia. His work on the determinants of value and growth investing was published as lead article in the Journal of Finance (Betermier, Calvet, Sodini 2017), which is widely regarded as the premier academic journal in finance. His work on relating portfolio decisions to labour income risk was published in the Journal of Financial Economics, another of the top three academic journals in finance (Betermier et. al, 2012). In 2017, he was named one of the World's Best 40 under 40 Business School Professors by Poets and Quants.