Report: Pension Plan Debt Issuance in Canada · Total Net Assets under Management (AUM) for Top 10...

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Report: Pension Plan Debt Issuance in Canada

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Overview

$317

B

$271

B

$176

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$136

B

$136

B

$96B

$85B

$70B

$24B $19B0

50

100

150

200

250

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350

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CPPIB CDPQ OTPP PSP bcIMC AIMCo OMERS HOOPP OPB OPTrust

Net

AU

M (

C$B

)

Total Net Assets under Management (AUM) for Top 10 Pension Plans in Canada

The top 10 pension funds in Canada managed over $1.3 trillion dollars as of December 31, 2016(1). This represents 35% of all Canadian retirement assets and 80% of public pension plan assets.

(1) Year-end dates for CPPIB, PSP and bcIMC are on March 31, 2017.

Historically, Canadian pension plans have issued very limited debt, which has been restricted to short-term borrowing such as commercial papers and lines of credit. A new trend of long-term debt issuance has been emerging, with the Canadian Pension Plan Investment Board (CPPIB) and Alberta Investment Management Corporation (AIMCo) issuing their inaugural bonds in 2015 and 2017, respectively. This report aims to uncover why Canadian pension plans have begun issuing long-term debt and how it impacts institutional investors. Key factors examined are:

i. Burden of Defined Benefit plans on employers

ii. Decreasing ratio of active contributors to retirees

iii. Demand from investors for high quality fixed income securities

iv. Low interest rate environment

v. Increased pressure to generate additional investment returns

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There are two main employer-administered pension funds in Canada: Defined Benefit (DB)

plans, where retirees receive a set monthly income for life, and Defined Contribution (DC)

plans where retirees receive a variable monthly income dependent on how much they contributed

to the pension plan and how this money was invested. Investment risk for a DB plan is placed

on the employer whereas for DC plans the onus is on the employees.

Types of Pension Plans in Canada

Chart 1: Registered Pension Plan Membership as a % of Total Employment

Due to drastic cost-cutting measures, employer-administered DB plans have fallen steadily since the 1980s, while DC plan membership has nearly tripled.

Source: Statistics Canada

0%

1%

2%

3%

4%

5%

6%

7%

20%

25%

30%

35%

40%

45%

1976 1981 1986 1991 1996 2001 2006 2011 2016

All Plans (left axis) DB Plan (left axis) DC Plan (right axis)

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6.2%

34.6%

23.3%

While some employers have eliminated pension plans altogether, many have

restructured their plans from DB to DC in order to cut costs and minimize

future liabilities. Research in Chart 1shows total Canadian registered

pension plan membership, plotted as a percentage of employment:


Chart 2: Defined Benefit Plan Membership as a % of Employment by Sector

62%

81%

43%

27%

20%

40%

60%

80%

100%

1982 1987 1992 1997 2002 2007 2012

Public Sector Private Sector


Indeed, Chart 3 shows that 44% aged 35-44 with over 15 years experience at a firm has a DB plan and

similarly 52% aged 45-54 with over 15 years tenure at a firm is covered under a DB plan. The

corresponding numbers for those with less than five years of tenure were 19% and 18% respectively.

These differences in coverage rates by DB plans

across tenure do not merely reflect an age effect. In fact, the likelihood of belonging to a DB plan rises with

time spent with the employer regardless of age.

Chart 3: DB Plan Coverage by Tenure and Age in 2012


Looking solely at DB plans (Chart 2), another interesting trend can be observed. Although the overall

DB plan membership rate is decreasing, when looking at just the public sector group, DB plan membership rate is

actually increasing. Thus, most of the decline in DB plan membership can be attributed to the private sector. One

possible explanation is that public sector employers still needs to keep up with the tradition of DB pension plan

benefits in order to attract new talent to the firm.

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Defined Benefit Plans

19%

32%

41%44%

18%

27%

36%

52%

0%

20%

40%

60%

<5 yrs

5-10 yrs

11-15 yrs

15+ yrs

<5 yrs

5-10 yrs

11-15 yrs

15+ yrs

Age 35 to 44 Age 45 to 54

For the largest Canadian public pension funds - whose primary donors are public sector employees - this

indicates there has been an increase in new DB plan memberships. Research has shown that DB plans tend

to reduce employment turnover in order to maximize their future pension wealth.


Changing Demographics

Compounding to the trend of more boomers becoming pensioners is the fact that not enough new members

are joining the public sector to match the amount leaving, and therefore not contributing enough new

money into the fund to maintain healthy ratios. As a majority of the pension plan’s income is from working

members’ salaries, this creates a significant decline in the ratio of working members to retired members.

Chart 4 shows the current active member to retired member ratio of various pension funds.

0

2

4

6

8

10

1976 1986 1996 2006 2016

Numbero

fActiveMem

berperPensio

ner

OTPP OMERS HOOPP OPTrust

Source: Annual Reports

Chart 4: Ratio of Working Members to Retired Members for Various Pension Funds

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When combined with the general trend of increasing life expectancy,

this suggests pension plans will have an increased future liability, and as a

result, pension fund managers have increased pressure to generate

additional returns. With this increased pressure, adding leverage becomes a

more attractive option for fund managers.


Changing Demographics

Year Avg.StartingPension Working: RetiredRatio ExpectedYearsonPension Avg.RetirementAge

1954 $1,600 11.0:1 18 62

1976 $7,800 6.6:1 22 61

1984 $19,100 4.5:1 23 60

2001 $34,800 1.9:1 29 55

2008 $41,200 1.6:1 30 58

2012 $43,400 1.5:1 31 58

2016 $45,000 1.3:1 31 59Source: OTPP Annual Reports

Chart 5: Statistics on Retired Teachers in Ontario

Taking a closer look at demographic trends experienced by OTPP (Chart 5), we see

pensioners on average are living longer, receiving higher salaries, and retiring earlier

while there are fewer new pensioners supporting them.

In order to make up for this gap, pension plans

must somehow generate additional cash flows to both support the monthly payouts as well as

invest in more assets in order to generate higher returns for the future. Combined with

other factors, this all leads to an increased need to issue debt.

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Success of the Canadian Model

Despite the fact that DB plans are bec omingever so unpopular among employers,

Canadian pension plans have managed to doquite well in terms of returns when compared

to peers in other countries. Chart 6 showsthe 5-year annualized returns for top 10

pension plans in the country versus the S&PTSX Total Returns Index.

Nearly all of t he funds have managed to

generate close to 10% returns annually,which is quite impressive consideri ng the

minimal amount of risk taken to ac hieve t hat.This has led to pension fund managers from

around the world looking int o t he c auses forsuch s uccess and even coined the term

“Canadian Model ” when referring to optimalpension plan investment strategies.

Chart 6: 5-Year Annualized Net Investment Returns versus Market

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11.8

%

10.6

%

10.5

%

10.2

%

10.1

%

9.5%

9.1%

8.5%

8.5%

8.4%

2.7%

0%

2%

4%

6%

8%

10%

12%

5-Ye

ar A

nnua

lized

Ret

urn



Success of the Canadian Model

One major contributor for such success of the “Canadian Model” can be attributed to the early adoption of

investments in alternative asset classes, namely, private equity. OTPP led the change on that in the late 1990’s and

the results today can speak for itself. Chart 7 shows the amount of PE assets each fund currently holds as a

percentage of total net assets. In order to fund more PE acquisitions and maintain the high returns, pension plans

are more inclined to issue long-term debt securities.

(1) PE Assets includes investments in Real Estate, Infrastructure and Natural Resources; both directly and through externally managed funds

Chart 7: Private Equity Assets(1) Held as a % of Total Assets

46%

38%

35%

34%

29%

28%

27%

24%

23%

5%0%

10%

20%

30%

40%

50%

Perc

enta

ge o

f PE

Asse

ts H

eld


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Some other factors that led to the success of the “Canadian Model” can be attributed to:

• Becoming more of an active investor rather than passive investing; by improving the operations of

a company via board seats rather just focusing on returns

• Gaining in-house investment management expertise to save on external management fees

and attracting better talent to build competent deal teams

• Consolidation of smaller pension funds/plans for better bargaining power internationally and

ability to fund larger direct investment opportunities


Dec 4, 2002OMERS Realty CorpC$500M 5.48% 2012

Debt Issuances

Timeline of First Issuances(1) by the Top 10 Pension Funds

2001 2002 2003 2004 2005 2006

Oct 6, 2003CDP Capital IncC$750M 4.20% 2008

Jul 4, 2012OPB Finance TrustC$350M 3.89% 2042C$150M 3.87% 2062

Oct 31, 2001Ontrea IncC$600M 5.70% 2011

Dec 15, 2004bcIMC Realty CorpC$200M 3.94% 2009C$100M FLT 2006

Dec 2, 2008PSP Capital IncC$600M 4.57% 2013

2007 2008 2009

2010 2011 2012 2013 2014 2015 2016 2017

Jun 4, 2015CPPIB Capital IncC$1,000M 1.40% 2020

Jun 26, 2017AIMCo Realty Investors LPC$400M 2.27% 2024

With all of the aforementioned reasons, it is no wonder pension plans have started to issue long-

term debt. One major factor contributing to this is the low interest rate environment in the post dot

com boom and post mortgage crisis. Looking at the timeline below, we can see that’s exactly where

these funds made their initial debt offerings, with OTPP take the lead in late 2001.

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(1) First issuances of long-term bonds, not including commercial papers or other short term financing instruments


Debt Issuances

Chart 8: Current Amount of Debt Outstanding

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2,000

4,000

6,000

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Amou

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utst

andi

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Fast forw ard t o today, t he Chart 8 s howsthe t otal amount of debt from pension

funds that is outstanding today. This is notrepresentative of all debt that has been

issued t o date as some may have beenalready redeemed by t he issuing entity or

matured.

Generally, t he amount issued correlates t othe asset size of each fund. There are still

two funds on our list that have yet t oissue: HOOPP and OPTrust. Perhaps wit h

the beginning of a rising rat e environmentor a large LBO opportunity, t hey might joi n

the other funds in the near future byissuing debt for the first time.

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Fintech Tools to Monitor Future Activity

Capital markets fintech platform Overbond offers issuers a suite of Corporate Bond Intelligence (COBI) tools. One of them is an automated, machine learning pricing tool that can help treasury managers evaluate funding costs and determine the

optimal time to issue. Combined with other analysis and visualization tools debt maturities, credit curves and more, this can give issuers an edge over their peers when it comes down to a new bond issuance or reopening.

Another feature is COBI Opportunities, which leverages

big data technology and machine learning to provide

automatic investment ideas by predicting potential new issues

which are curated for a particular investor. Users will be

able to input their investment preferences in pension plan

debt and follow these issuers’ activities on the platform.

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Raw Data Set

Investor DataInvestment preferences

Portfolio preferencesInvestor holdings

Issuer DataSecondary bond market data Company and sector analysis

Propensity to issue

Market SignalsMarket sentiment analysis

General market trendsSector specific trends

SupervisedLearning and

Algorithm

SupervisedLearning and

Algorithm

Prediction Model

COBIOpportunities


Conclusions

Key reason for why pension plans are starting to issue more debt have been discussed in the report.Below is a summary of our findings and conclusions:

1. Defined Benefits (DB) pension plans in Canada have become increasingly burdensome for employers to fund. In order to cut cost, many DB plans in the private sector have been eliminated, however within the public sector DB plans are still the norm

2. Pension fund managers therefore must find ways to overcome a steep decline in the ratio of active members to retired by increasing investment returns via leverage

3. On the demand side for pension plan debt, investors are also extremely receptive of any new issues due to the consistent high annual returns generated by these plans and a high investment grade rating

4. The low interest rate environment in both the early and late 2000s and has also encouraged fund managers to issue as they can now secure even better rates than traditional mortgage loans

5. 8 of the 10 biggest public pension funds in Canada has begun issuing long-term debt since 2001. Cumulatively they current have over C$31.9B debt outstanding or 2.5% of combined net assets

6. For investors that would like to take advantage of this trend, they can use Overbond to monitor pension plan issuance activity, receive curated investment ideas and pricing prediction on potential new issuances

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Overbond brings all bond market participants together. It is a platform that makes primary bond issuance digital, transparent and secure. Overbond connects corporate and government issuers with dealers and investors directly.

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Report: Pension Plan Debt Issuance in Canada · Total Net Assets under Management (AUM) for Top 10...

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