Pension fund performance up on strong markets

Another strong year for equity markets, coupled with the year's comeback in bonds, propelled the investment returns for pension funds in seven major markets in 2014.

The Netherlands was the standout market, helped by Dutch pension funds' interest rate hedges, with a 15.1% real return for 2014, up from 3.1% the previous year, according to data from Mercer Ltd. Meanwhile, major currency movements put a dent in returns for pension funds in Switzerland, Australia and Canada.

Pensions & Investments analyzed data drawn from a number of money management and consultant sources for pension funds in the Netherlands, U.S., U.K., Switzerland, Canada, Japan and Australia, for the year ended Dec. 31.

While equity markets continued to rise in 2014, their returns were significantly lower than the year before. The Russell 3000 returned 12.53% for the year ended Dec. 31, compared with 2013's 33.6%. The MSCI All-Country World index gained 5.62% vs. 27.4% a year prior. However, fixed income in 2014 rebounded from negative territory — the Barclays Capital U.S. Aggregate Bond index gained 5.97%, compared with -2.02% in 2013. The Barclays U.K. Gilt 15+ Year index gained 26.02% in U.K. pound terms in 2014, compared with -5.97% in 2013. The variations in returns were not limited to indexes. While the Dutch pension funds were at the top of the list, Australian funds — with a 5.2% real return — were at the bottom.

The U.S. was in fifth place for real returns with 6.6% according to preliminary data from Bank of New York Mellon Corp., down from fourth place in 2013 with a real return of 11.5%. The 2014 return came despite the impressive returns from the Russell 3000 index.

“Median U.S. plan performance was lower in 2014 mainly due to the significant drop we saw in equity returns, coupled with slightly lower allocations to equities as an asset class,” said John Houser, senior consultant for BNY Mellon's global risk solutions group, in Boston.

The Netherlands, on the other hand, reversed course to become the leader among pension markets in 2014. The biggest contributor to this performance was the average Dutch pension fund's interest rate hedges, using duration from longer-dated bonds, said Dennis van Ek, principal and investment consultant at Mercer in Amstelveen, Netherlands.

“The overall 2014 headline investment return will be higher in the Netherlands than in most other countries — the reason is that Dutch funds have implemented interest rate hedges more than pension funds in other countries,” said Mr. van Ek. The reason, he said, is related to the longer-term liabilities in the Netherlands, compared with other markets.

But that alone, said Edward Krijgsman, Amstelveen-based principal and investment consultant at Mercer, is not enough to give such a strong return. He said euro-based investors benefited from a depreciation in the euro. The euro depreciated 11.97% vs. the dollar in 2014. “Typically, Dutch pension funds tend to hedge about half of their foreign currency risk,” he said.

Liabilities also increased, with pension funds reporting an average 17% increase in liabilities. “However, using the market value of liabilities, which excludes the ultimate forward rate and excludes averaging, liabilities increased by 26.3%,” said Mr. van Ek. That means funding ratios would have dropped.

U.K. pension funds delivered the second-best return of the seven markets, at 11%, and a 10.45% real return, according to preliminary figures from State Street Corp.'s investment analytics business, up from 9% in 2013.

The U.K. FTSE All-Share index also was up, although only with gains of 1.45% in U.K. pound terms, down from 23.6% in 2013, and U.K. pension funds had an average allocation to equities of just under 40%, said Phil Edwards, Bristol, England-based principal at Mercer. Mr. Edwards put the average U.K. fund returns between 10% and 15% overall.

“The big difference will come from the extent to which schemes were invested in gilts and (which) had hedged their liabilities quite highly. Long-dated gilts — fixed and index-linked — were two strong performers. Schemes that had hedged their liabilities with long-dated gilts would have seen stronger returns than those that hadn't,” he said.

This year, U.K. pension funds might be putting more focus on their alternatives portfolios to deliver growth. “We think the environment for alpha-focused strategies is probably improving; we think with diverging monetary policies (between the U.S. and U.K., and Japan and Europe), there will be more volatility and dispersion, which should be good for hedge fund strategies in particular,” said Mr. Edwards.

In Japan, all eyes were on the Government Pension Investment Fund, Tokyo, and the ¥127.3 trillion ($1.1 trillion) pension fund's October decision to increase its equity allocation to 50% from 24%.

“Even though Abenomics looks to be successful, corporate pensions are still moving in the direction of derisking,” said Konosuke Kita, director of consulting at Russell Investments in Tokyo, referring to the economic program instituted by Japanese Prime Minister Shinzo Abe. “But the pace of decreasing equity (allocation) has been slowing. On the other hand, GPIF has been increasing its equity allocation ... other public pension funds may follow this example and raise equity allocations,” he said.

The Nikkei 225 returned 8.91% in yen terms, down from 59.39% in 2013. In 2014, Russell's universe of corporate pension funds in Japan returned an average of approximately 8%, giving a real return of about 5.6%, taking inflation into consideration, compared with 13.4% in 2013.

In the three remaining markets, currency played a big part in returns.

In Australia, the average pension fund real return was 5.2%, using figures for total returns provided by SuperRatings Pty Ltd., compared with 14.8% in 2013. Jeff Bresnahan, Sydney-based founder and chairman of SuperRatings, said 2014 “was a year dominated by currency and international influences rather than local markets.”

Superannuation funds benefited from a falling Australian dollar, which saw a 7.9% drop vs. the U.S. dollar in the year ended Dec. 31. The ASX index returned 5.61% in Australian dollar terms, but in U.S. dollars terms, it lost 3.38%.

Clare Armstrong, Melbourne-based principal at Mercer, said Australian pension funds have become more dynamic in currency hedging management, particularly as the Australian dollar has fallen.

Currency moves also affected Canadian pension funds. Real returns for the average pension fund, with an assumed 60/40 allocation to equities and bonds, was 8%, said Bruce Curwood, Toronto-based director of investment strategy at Russell Investments.

“There were three major surprises for Canadian pension funds in 2014: long-term interest rates in Canada, after rising significantly in 2013, fell by about the same amount in 2014,” he said. “Oil prices ... fell dramatically in the fourth quarter ... (and) the U.S. dollar appreciated noticeably against most currencies in 2014.”

The Canadian dollar, he said, fell to C$1: $0.86 at the end of 2014, from C$1: $0.94 at the end of 2013. The S&P/TSX gained 10.53% in Canadian dollar terms, and 1.14% in U.S. dollar terms.

Mr. Curwood said despite growth on the asset side of the balance sheet, “liabilities grew almost as fast as the assets, due to declining discount rates” used to calculate those liabilities.

In Switzerland, a positive equity market and deflationary environment led to an estimated 9.58% investment return, according to Daniel Blatter, Zurich-based retirement solutions consultant at Towers Watson & Co., and an estimated a real return of 9.91%. Of the 230 billion Swiss franc ($264.3 billion) universe analyzed by Towers Watson, the allocation to Swiss equities was between 7% and 17%, for 90% of the funds. Allocation to overseas equities for this 90% of funds ranged from 12% to 45%. “Even increased volatility in equities was not enough to detract from a positive 2014,” said Mr. Blatter.

Consultants said currency will continue to matter through 2015, with the first few weeks of January testament to this forecast.

The Swiss National Bank announced Jan. 15, that it was scrapping a currency peg with the euro, which it implemented in late 2011.

“It was really surprising that the SNB decided to remove the currency cap on the Swiss franc vs. the euro,” said Mr. Blatter. “We estimated that of our 750 billion CHF universe, with a 25% unhedged foreign currency asset allocation, Swiss pension funds lost 30 billion CHF” on Jan. 15, he said in a latere-mail.

Swiss equities lost about 9% that day, and a further 4% to 5% the following day. The average plan would have seen a 4% reduction in assets over the course of Jan. 15, said Mr. Blatter. “Most pension funds did not hedge the euro due to the cap” implemented by the SNB. n