Canada’s Pension Funds Lever Up

Canadian pension plans are among the most admired institutional investors for their prowess as money managers. Now pension plans in Canada are upping the ante, increasingly issuing long-term bonds and using the borrowed money, or leverage, to try and generate even better returns, a new report shows.

Much of the money raised will back private equity investments, a big source of outperformance for the top-ten Canadian pension plans, according to a research report on pension plan debt issuance that will be released this week by capital markets technology firm Overbond. The company is an electronic platform for primary bond issuance, directly connecting issuers with investors.

“On the back of their huge private equity businesses, Canadian pension plans have become debt issuers themselves,” says Vuk Magdelinic, CEO of Overbond.

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According to the report, Canadian pension plans are taking advantage of their strong long-term track records and high credit ratings to issue debt at low rates. The report is based on interviews with institutional investors and data from the Overbond platform. The platform allows issuers to identify potential bond buyers, as well as benchmark and price issues.

“The plans want to lever up, but not at all costs,” says Magdelinic. One such recent deal: AIMCo Realty Investors, a division of Alberta Investment Management Co., issued C$400 million ($327 million) in seven-year senior unsecured notes on June 26th.

Plans are using borrowed money to try and counter the pressure from the falling number of active workers that are supporting their retirees. Institutional investors, particularly corporate pensions, have been eager to buy bonds issued by the Canadians.

“The market is hungry for new bonds, and this is a quality type of issuer,” says Magdelinic. “Financing private equity through the bond market is an efficient form of financing.”

Issuing bonds is not the only way institutional investors can leverage their portfolios. They can also directly invest in hedge funds and other vehicles that use complex derivatives.

All but one of the top-ten Canadian pension plans have more than 20 percent of their portfolios in private equity, an allocation that has contributed to excess returns over the past ten years, according to the Overbond report. Ontario Teachers’ Pension Plan, for one, has a whopping 46 percent of its portfolio in private equity.

“In order to fund more PE acquisitions and maintain high returns, pension plans are more inclined to issue long-term debt securities,” write the report’s authors. Eight of the top-ten Canadian pension plans have issued debt, with $32 billion currently outstanding, or 2 percent of their combined assets.

Five-year annualized returns for the top-ten Canadian funds hover around 10 percent, compared with the 2 percent generated by the S&P TSX Total Returns index. Still, many Canadian pension funds need more. They have to support a growing number of retiring baby boomers through longer life spans than previous generations.

At the same time, fewer workers, who pay into the pension system with each paycheck, are joining the public sector than are retiring, putting more pressure on other income sources. According to the report, OMERS, the Ontario pension for municipal workers, had nine active employees for every retiree in 1976, four in 1986, and less than two active workers per retiree in 2016.

Canadian public pensions are issuing debt to increase returns, even as corporate pensions are selling bonds to fill funding holes. In July, Kroger, the U.S. supermarket chain, issued debt to help the underfunding of its pension plan, while FedEx did the same in January.