Canadian pension plans took a severe hit from volatile stock markets during the third quarter, hammered by the turmoil in Europe and disappointing growth in the United States, according to a new report by RBC Dexia Investor Services.
The Canadian pension plans that RBC Dexia tracks were down 5.5 per cent in the three-month period ended Sept. 30 and down 3.2 per cent for the year so far, the company said.
RBC Dexia said markets were weighed down by persistent uncertainty about the sovereign debt crisis in Europe, the downgrade of U.S. government debt from a AAA rating by Standard & Poor's, and concerns that the situation could get worse.
But poor returns on the stock markets may not be the biggest worry for pension plans as long-term interest rates — which affect the liabilities for plans — wallow near record lows.
The U.S. Federal Reserve helped push long-term interest rates lower with its so-called Operation Twist in hopes that if people and businesses can borrow money more cheaply, they will spend more and boost the economy.
However low interest rates can have serious consequences for pension plans.
Long-term interest rates are important for pension plans because they are used the calculate the liability for defined benefit pension plans. The lower the rate, the more funds the pensions will need to pay benefits to retirees.
The hardest hit asset type within Canadian pension portfolios were Canadian equities, according the RBC Dexia report.
The main index at the Toronto Stock Exchange was down 12 per cent in the quarter, the worst quarterly result since the 2008 financial crisis, the firm said.
"The pull back actually started in April followed by six consecutive months of negative returns on Canadian stocks," said Don McDougall, the director of advisory services at RBC Dexia.
Global equities were down as well, with the MSCI World index off nearly 10 per cent for the quarter.
"Exchange rates were a key factor this quarter as a weaker Canadian dollar against most major currencies, particularly the U.S. dollar, helped reduce the loss to Canadian investors," noted Mr. McDougall.
The weakness gave bond markets a boost, however, as that market rose 5.1 per cent in the quarter as investors moved into less risky bets.
The RBC Dexia report follows an analysis by pension consultant Mercer which saw its pension health index fell to 60 per cent at the end of September, down from 71 per cent in June.
The index indicates a model fund's holdings were worth only 60 per cent of its long-term obligations to retirees at the end of the quarter.
Though the drop does not immediately affect the payouts made to retirees by pension plans, it could require companies to put more money into the plans or see benefits cut if plans are wound up.
RBC Dexia is equally owned by Royal Bank of Canada and Dexia, a Belgian bank that's in financial trouble. RBC has said it's in talks to acquire full ownership of the joint venture.