Where’s the Money? Asset Allocation a Pension Challenge for 2012

Towers Watson Survey of Economic Expectations predicts more trouble for pension plan funding as economic uncertainty and low interest rates continue

TORONTO, January 10, 2012 – Canada’s top economists, strategists, and portfolio managers forecast modest growth for 2012, along with continuing low interest rates, moderate inflation and lackluster capital market returns in Towers Watson’s 31st Annual Canadian Survey of Economic Expectations. These conditions will likely lead to further trouble for the financing of traditional defined benefit (DB) pension plans in Canada.

The majority of the respondents surveyed expect the Bank of Canada overnight interest rate to remain at historic lows for 2012, hovering between one-half and one percent, with interest rates staying below half a percent in the United States. Interest rates in Canada are forecast to rise to 2.5% between 2013 and 2016 and to 3.5% after 2017. In the U.S., the policy rate is expected to increase to 1% over the mid-term and to 3% over the long-term.

“With the Canadian dollar being near parity to the U.S. dollar, pension funds have been able to shop the globe for assets; however, record-low long bond yields are hampering solutions to the pension funding crisis” said Janet Rabovsky, a Senior Consultant in Towers Watson’s Investment practice. “Given the poor market performance of the past few years, many plan sponsors are finding themselves obliged to make funding contributions to cover deficits – and they are concerned about how to best allocate those dollars to generate the returns they need.”

2012 Outlook: Modest Growth in Both Canada and the U.S

Canadian growth is expected to hover around 2% in 2012, while U.S. GDP is forecast at 1.8%. Over the mid-term, Canadian and U.S. GDP are expected to increase to 2.5% and 2.4% respectively, showing improvement but below long-term trends, especially in the U.S. Inflation in Canada is expected to remain benign at 2%, rising in the long-term to 2.5%.

A key question for 2012 is whether equity markets will rebound after a less-than-stellar 2011. Continuing concerns over the state of the Euro, U.S. and European deficits, and slowing growth in Asia, are all casting a pall over investor outlook. The majority of respondents polled expect that U.S. and Canadian markets will deliver returns of around 8%, although some believe this could be lower. Survey participants remain concerned about Europe, and anticipate that international equity markets will only deliver about 5%. Emerging markets appear to be the one bright spot, with most respondents expecting returns greater than 10%.

For pension plan sponsors, the outlook presents a challenge. “In a world of fluctuating markets, pension funds are more than ever seeking stable sources of return – whether it be through ‘absolute return’ strategies, alternative investments including real estate and infrastructure, or selecting managers who are more likely to out-perform” said David Service, a Senior Consultant in Towers Watson’s Investment practice. In the current environment, plan sponsors are also actively considering de-risking, As Service notes, “de-risking can include plan design changes, which are being considered by some sponsors, though liabilities will remain a concern for many years to come.”

Whether or not the bulls or bears prevail in 2012, DB plan sponsors are unlikely to see their fortunes improved by market forces alone. With pension reform in the air, funding relief in 2012 may be easier sought in the legislatures than in financial returns.

About the Survey

Towers Watson’s 31st Annual Canadian Survey of Economic Expectations provides forecasts from leading business economists, analysts and portfolio managers from more than 45 organizations. The results have been compiled to give a consensus opinion on Canada’s economic prospects over the short (2012), medium (2013 � 2016) and long terms (2017 � 2026).

About Towers Watson

Towers Watson (NYSE, NASDAQ: TW) is a leading global professional services company that helps organizations improve performance through effective people, risk and financial management. The company offers solutions in the areas of employee benefits, talent management, rewards, and risk and capital management. Towers Watson has 14,000 associates around the world and is located on the web at www.towerswatson.com.