74
HALIFAX 29 JANUARY 2015 2015 PENSION OUTLOOK AND FEARLESS FORECAST ARE WE ENTERING A NEW ERA FOR PENSIONS?
HALIFAX29 JANUARY 2015
2015 PENSION OUTLOOK ANDFEARLESS FORECASTARE WE ENTERING A NEW ERA FOR PENSIONS?
MERCER
TODAY’S SPEAKERS
JONATHAN CROFTInvestments
1
DOUG BRAKERetirement
BENOIT HUDONRetirement
TODD SAULNIERInvestments
MERCER
1 FEARLESS FORECAST
2
MERCER
2014 Fearless ForecastA Few Surprises
3
Interest rates droppedeven lower
Despite manyheadwinds, equity
markets performed well
Canadian dollarweakened significantly
Typicalpension
plan return10-15%
MERCER
2014 Fearless ForecastThe Economy
2014Forecast 2014 Actual
Real Canadian GDP Growth Rate 2.0% 2.3% (est.)
Real Global GDP Growth Rate 3.5% 3.3% (est.)
WTI Crude Oil Price (US$) $95 $53
US/CAD Exchange Rate 0.93 0.86
Spot Price of Gold (US$) $1,200 $1,184
Source: Bloomberg, IMF
4
xx
MERCER
2014 Fearless ForecastLong-term Yields
2014 Forecast 2014 Actual
FTSE TMX Canada Universe Bond 1.5% 8.8%
FTSE TMX Canada Long Bond 0.5% 17.5%
Source: Datastream
84% Long termyieldsdropped by 0.90%
xx
Expected rates tostay unchanged or
to increase
5
MERCER
1-year Canadian Dollar Returns
2014 Fearless ForecastEquity Markets ($CDN)
8.0% 8.0%9.1% 9.0% 9.0%
15.0% 15.0% 15.0%
13.0%
19.5%
4.4%
-0.4%1.3% 1.5%
-2.0%-5.0%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
2014 Returns
S&P/TSX S&P 500 MSCIEAFE
MSCIACWI
MSCI EM
10.6%
23.9%
4.1%
14.1%
7.0%
6
MERCER
Fearless Forecast
• Survey of Canadian and globalinstitutional investment managers
• Includes predictions and views of theeconomy and capital markets
• 46 managers surveyed
• Surveyed in December 2014
2015 “There are two kinds of forecasters:
those who don't know, and thosewho don't know they don't know.”
John Kenneth Galbraith
7
MERCER
Looking Ahead to 2015
A few tailwinds including:
• Low interest rate environment• US and UK moving in the
right direction• Trans-Pacific Partnership
within reach• Efficient responses to Ebola
and ISIS
But also many challengesincluding:• Our high household debt and
overvalued residential market inCanada
• Potentially higher interest ratesin the US and the UK
• Potential recession in Eurozoneand Japan
• Slower growth in China• Political uncertainty in countries
such as Russia and Greece
8
MERCER
2015 Fearless ForecastThe Economy
2014Actuals
2015Forecast
Real Canadian GDP Growth 2.3% (est.) 2.3%
Real Global GDP Growth 3.3% (est.) 3.2%
WTI Crude Oil Price ($US) $53 $80
US/CAD Exchange Rate 0.86 0.87
Spot Price of Gold ($US) $1,184 $1,200
CDN Inflation Rate (CPI) 2.2%* 1.9%
Source: Bloomberg, IMF, Bank of Canada*YTD to November 2014
9
MERCER
2015 Fearless ForecastInvestment Benchmark Returns
LONG-TERM (10+ YEARS)
Expectations of managers: Interest rates increasing or decreasing over 2015
4%
13%
37% 36%
11%
Rates declineby 0.75% or
more
Rates declineby 0.25% to
0.75%
Rates remain atcurrent levels +/-
0.25%
Rates increaseby 0.25% to
0.75%
Rates increaseby 0.75% or
more
47% of managers expect longterm rates to increase by 0.25%
or more(vs 51% last year)
10
MERCER
2015 Fearless ForecastInvestment Benchmark Returns
11
UNIVERSEBONDS
HIGH YIELDBONDS
LONGBONDS
REALRETURNBONDS
-3.3% 3.0%
-8.3% 6.0%
-6.1% 3.7%
-5.1% 3.7%
1.5%
3.8%
0.9%
0.6%
I. FIXED INCOME Forecasted at December 31, 2015
MERCER
2015 Fearless ForecastInvestment Benchmark Returns
12
S&P/TSXCOMPOSITE
S&P 500 (C$)
MSCI EM(C$)
MSCIWORLD (C$)
-6.5% 10.6%
2.4% 11.1%
0.0% 13%
-0.3% 11%
7.5%
7.5%
8.0%
8.0%
II. EQUITIES Forecasted at December 31, 2015
MERCER
2015 Fearless ForecastInvestment Benchmark Returns
13
CDN DIRECTREAL ESTATE
PRIVATEEQUITY
HEDGEFUNDS
INFRA
-2.4% 7.2%
3.3% 9.7%
1.9% 8.3%
2.4% 8.3%
5.0%
7.4%
5.0%
5.8%
III. ALTERNATIVES Forecasted at December 31, 2015
MERCER 14
Top and bottom performing sectors of the S&P/TSX Composite Index in 2015
PERCENTAGE OFMANAGERS WHOFORECASTSECTORS TOOUTPERFORM
PERCENTAGEOF MANAGERSWHO FORECASTSECTORS TOUNDERPERFORM
Industrials IT MaterialsConsumerDiscretionary
ConsumerStaples Energy Financials Health
CareTele-
communicationsUtilities
21% 12% 9% 15% 21% 24% 58%12% 3% 24%
15% 12% 55% 21% 24% 15% 6%12% 6%33%
2015 Fearless ForecastCapital Markets
MERCER
2015 Fearless ForecastEnvironmental, Social and Governance (ESG)
“In what time frame, if any, do you believe the integration of environmental,social and corporate governance (ESG) performance indicators will become acommon component of mainstream investment decision-making?”
15%
46%
31%
8%Over thenext 1-2
years
Over thenext 3-5
yearsOver thenext 5-10
years Never
92% of managersanticipate an
increase in use ofESG factors
15
MERCER
2015 Fearless ForecastConclusion
Find ways to capitalizeon a low interest rate
environment
Improve diversification
Revisit currency hedgingstrategy
16
MERCER
2 THE FUTURE OF THECANADIAN RETIREMENTSYSTEM
17
MERCER
MERCER
A Look At 2014
19
PRPPs introduced with no impact
CPP expansion - debated
No clear answer for individuals
MERCER
The ORPP – A Move Forward?
Earnings covered Up to $90,000Contributions 1.9% for employees and employersBenefit 15% of earnings for a 40 year careerService Prospective from 1.1.2017
20
Design is expected to be fully funded by contributions with no intergenerationaltransfers
MERCER
The ORPP – Details To Sort Out
21
• Definition of ComparableWorkplace Pension Arrangement
Issue 1
• The Right Minimum EarningsThreshold
Issue 2
MERCER
The ORPP – The Details
Coverage - Ontario employees who are not covered by a “comparable”workplace pension plan
22
DB Plans and TB Multi-employer plans are most comparable to the CPP and ORPP
Key Features of theORPP
CanadaPension
Plan(CPP)
DefinedBenefitPension
Plan(DB Plan)
TargetBenefit Multi-
EmployerPension Plan(TB MEPP)
DefinedContribution
PensionPlan
(DC Plan)
PooledRegistered
PensionPlan
(PRPP)
GroupRegisteredRetirement
SavingsPlan
(RRSP)
DeferredProfit
SharingPlan
(DPSP)
1. Benefit Providedfor Life (LongevityPooling)
2. Indexed to Inflation Varies by Plan Varies by Plan
3. MandatoryEmployerContributions
4. Pooled InvestmentRisk
5. Locked-in Funds
MERCER 23
DC plans should be considered comparable
GRRSPs, TFSAs and PRPPs likely not comparableIf you have a GRRSP, TFSA or PRPP what to do?• Switch to a DC Plan?• Reduce contributions?• Get rid of your plan?
What do national employers do?
The ORPP - Coverage
MERCER
The ORPP - Earnings Threshold
24
EARNINGS THRESHOLD NEEDS TO BE HIGHER
• Mirror CPP– Year’s Basic Exemption - $3,500
• ORPP benefits subject to OAS and GIA clawback at lower income levels
MERCER
Defined Benefit Plans
25
Momentumbehindelimination orreducingemphasis onsolvencyfunding
SolvencyReserveAccounts inAlberta
MERCER
3 RISK MANAGEMENT
26
MERCER
Where Are Interest Rates Going? Are We At The Bottom Yet?
27
MERCER
The Financial Position Of Pension Plans Has Generally Deteriorated In 2014Despite Favourable Investment Returns…
28
10%
MERCER
The only function of economic forecasting is to make astrology lookrespectable
29
-- John Kenneth Galbraith
MERCER
Where Are Interest Rates Going? Is The Current Level Unusual?
30
4.0%annual GDP
growth
1.9%annual GDP
growth
3.2%annual GDP
growth
MERCER
Will Long-term Interest Rates Go Anywhere From Here?
...with many looking for morede-risking opportunities
31
MERCER
Record Volume Of Pension Risk Transfer Transactions In 2014Despite Prevailing (And Declining) Interest Rate Environment
32
$2.5 billiongroup
annuitiespurchased
Largestpension risk
transfertransactions
ever
Motorola US settled $3 billion ofpension obligations (30,000 retirees)
MERCER
Zooming In On The Canadian Annuity MarketThe Annuity Market In Canada Is Growing At A Rapid Pace
33
RecordYear
Volume (number and size) of transactions is increasing
MERCER
Why Is Activity Increasing?
34
Fiduciaryduties
Appetitefor risk
Economicoutlook
Financialuncertainty
Plan windupor closure
Size andnature ofliabilities
MERCER
Pension De-risking Transactions2014 Forecast And Current Expectations
35
Likely to be seen inthe coming years…2014
All of the aboveremains true, plus…*New*
First jumbo annuity transaction
Significant increase in capacity- reinsurers and new entrants
Competitive pricing in the shortterm, but likely less so in the future
- more conservative view on longevity- increase in demand
Increased market efficiency(e.g., with online auctions)
Significant increase in activity levelFirst longevity swap
MERCER
Global TrendsThe Growing Variety Of Solutions To Manage Cost And Risk
36
AssetsLDI
Dynamic de-riskingCash-flow driven
Complex StructuresCaptives
Combinations
FundingSolvency reserve
Special contributionsContingency funds
LiabilitiesCash-outs
Liability managementRisk transfer
MERCER
Cost of Annuities vs. LDI Bond Mandates
37
$70
$80
$90
$100
$110
Non-indexedAnnuities
Blend of BondIndices
LDI:Lower Yields
LDI:Higher Yields
Residual risks remain:longevity, credit, reinvestment, etc.
Non-indexed annuities can be attractivelypriced relative to a matched bond portfolio
MERCER
Making LDI More Competitive
LDI (matching) Bond Mandate
Greater ProvincialExposures
Less LiquidExposures
Mortgages
Private Debt
Greater CorporateExposures
38
MERCER
Cost Of Annuities vs. LDI Bond Mandates
39
$70
$80
$90
$100
$110
Indexed Annuities Blend of BondIndices
LDI:Lower Yields
LDI:Higher Yields
Residual risks remain:deflation, longevity, credit,
reinvestment, etc.
Indexed annuities are muchmore expensive
MERCER
Options For Dealing With Indexed Pensions
Transform COLA?Bear the Risk
(particularly in respect ofpotential deflation)
40
MERCER
Reducing Risk Within Public Equities
Various StylesValue
Growth
Low volatility
Momentum
Small cap
Style neutral
Indexed
Factor biased
Etc.
Some Concerns• Benchmarking?
• Interest rate sensitivity?
• A crowded trade?
Solutions to Consider
Fundamental defensive-qualitylow volatility strategies
More active systematiclow volatility strategies
41
MERCER 42
The Role Of Alternative Asset Classes
Return-focusedInflation-sensitive
Diversifiers
Commodities
Tail riskhedging
strategies
Venture capital
Hedge Funds(Non-directional)
Real AssetsReal Estate
InfrastructureTimber
AgriculturePrivate Equity
MERCER
Hedge Funds Should Hedge
Short bias (equity and credit)
Tail risk hedging funds
Managed futures
Defensively oriented strategies
Hedging strategies:diversifiers against
systemic risk
Consistent return strategies:to build a core, low volatility absolute
return exposure
Performanceseeking
strategies
43
MERCER
4 GETTING THE MOSTOUT OF GROWTHASSETS
44
MERCER
The Return PerspectiveSearching For Yield
• Many institutional investors continue to seek ways to enhance returns– Emphasis on optimizing returns from growth assets
• Opportunity set available within:– Fixed income (growth-oriented)– Equities– Alternatives (return-enhancing)
4545
MERCER
Growth Fixed IncomeOpportunity Set
46
High YieldBonds
EmergingMarketDebt
PrivateDebt
BankLoans
UnconstrainedBonds
AbsoluteReturnBonds
Multi-AssetCredit
UnconstrainedBonds
MERCER
Unconstrained Bonds
• A “go anywhere” global fixed income portfolio
• No constraints on the sectors and types of securities
• No constraints on duration
• Not linked to any benchmark – focused on generating absolute returnsconsistently
47
MERCER
Unconstrained BondsStrategic Rationale And Return Drivers
48
Dynamic beta management
Capture best performing segments throughthe market cycle
Interest rate management
Security selection and currency positioning
Access to duration and credit risk premia
MERCER
EquitiesOpportunity Set
49
USEquities
CanadianEquities
GlobalEquities
SmallCap
Equities
LowVolatilityEquities
EmergingMarketEquities
EAFEEquities
MERCER
EquitiesOpportunity Set
50
USEquities
CanadianEquities
GlobalEquities
SmallCap
Equities
LowVolatilityEquities
EmergingMarketEquities
EAFEEquities
MERCER
Building Better Equity Portfolios
51
RECENT YEARS
Mercer’s Equity Portfolio 1.0
MERCER
Building Better Equity Portfolios
52
RECENT YEARS
Mercer’s Equity Portfolio 1.0
Bias TowardKey Return Drivers
Mercer’s Equity Portfolio 2.0
MERCER
Optimizing Equity StructureThe Style Factor Perspective
Better understanding of the drivers of return
PortfolioReturn
AlphaAlpha
FactorExposures
Market Beta Market Beta
53
MERCER
What Factors To Bias Toward?
54
Size Value Momentum
SustainabilityProfitability Low Volatility
MERCER
Diversification MattersFactors Move In And Out Of Favour Over A Market Cycle
55
Recession Recovery Expansion Contraction
ValueLow VolatilityMomentum
ValueLow VolatilityProfitabilityMomentum
SizeMomentumProfitability
MomentumProfitability
SizeValue
MERCER
Alternative InvestmentsOpportunity Set
56
Short-Biased Hedge
Funds
Tail RiskHedging
Diversifiers
DirectionalHedge Funds
NaturalResources
Shipping
Non-DirectionalHedge Funds
Private Debt
Private EquityCommodities
OpportunisticReal Estate &
GrowthInfrastructure
InflationSensitive
CoreReal Estate &Infrastructure
TimberAgriculture
ReturnFocused
Emphasis onReturn-Focused
Strategies
MERCER
Summary
• In the “quest for yield”, we forecast that:– Growth fixed income will garner greater
attention– Equity portfolio construction will further
take into account those factors that drivereturns
– Alternatives will continue to move into themainstream, with a re-focus on returnenhancement strategies
57
MERCER
5 DEFINED CONTRIBUTIONBUILDING BETTEROUTCOMES
58
MERCER
Defined ContributionDefining The Issues: Retirement Readiness
Average DC plan memberaccount balance
* Benefits Canada 2014 CAP Member Survey** Mercer DC client data as at June 30, 2014
59
Of DC plan sponsorsfeel that the averageemployee is financiallyprepared for retirement*
70%
On average, DCplan membersexpect to retireat age 63 with
$709Ksaved*
$47K=
Half of DC planmembers don’tfeel financiallyprepared forretirement*
MERCER
Defined ContributionDefining The Issues: Retirement Readiness
* Benefits Canada 2014 CAP Member Survey** Postmedia December 3, 2014
60
DC plan members whocontribute at a level toreceive the max employercontribution* 19%
Sun Life estimates thatCanadians are missingout on as much as
$3Billionin company matchedDC plans**
Employers paying out just
40-50%of available matching funds**
MERCER
DC Participants Have High Investment Return Expectations
61
17.8% Average long termexpected return ofDC participants*
* Benefits Canada 2014 CAP Member Survey
10 Yr. Annualized Performance to Dec. 31, 2014FTSE TMX Canada Universe Bond 5.3%
S&P/TSX Composite 7.6%
S&P 500 CAD 7.3%
MSCI EAFE CAD 4.6%
MSCI World CAD 6.2%
MERCER
Are DC Plan Members Taking Enough Risk? Appropriate Risk?
Mercer DC Plan Governance Report Exhibit
62
0%
20%
40%
60%
80%
100%
20 25 30 35 40 45 50 55 60 65 70
%in
Equi
ties
Age
Member Asset Allocation Benchmark Asset AllocationMaximum (Benchmark + 10%) Minimum (Benchmark - 10%)Linear regression of Individual Asset Allocation
.
MERCER
Misuse Of Target Date Funds Within DC Plans
• Are TDF’s being used appropriately?
• Simple solution may still be used inappropriately by “do it for me” investors
63
Mercer DC Plan Governance Report Exhibit
Step 2
IdealTargetDateFund Income 2015 2020 2025 2030 2035 2040 2045 2050
“Odd” TargetDate Funds
Under35 2050 3 12 8 4 7 9 19 22 11 62
35-44 2040 2 8 5 11 24 57 44 4 3 53
45-54 2030 11 19 38 107 95 18 13 2 4 87
55+ 2020 13 34 77 20 4 3 9 29
In this case 231 out of 720 members (almost one-third) were in “odd”target date funds
MERCER
What Should Plan Sponsors Do?
1
64
Ensure plan members have thetools and investment options toinvest appropriately
2
3
Develop strategies to help planmembers save enough forretirement
Use analytics to understandwhat is happening in your Plan
MERCER
Improving Savings Levels
Push communications to those not maximizingbenefit
* Benefits Canada 2014 CAP Member Survey
80% of DC plan sponsors feel auto-featureswould be effective in helping ensure planmembers have adequate retirement savings*
– Auto-enrollment– Auto-default contribution rate to maximize employer
contribution– Auto-escalation of contribution rate– Put onus on employee to opt out or reduce
contribution level
AUTOFEATURES
65
MERCER
Improving Savings Levels
• Few employees contribute above what is matched
• Consider making the match more attractive
Contribution segment ExistingUnmatched employer base 2%
Employee contribution range 0% – 3%
Employer match on above 100%
Maximum employer cost 5%
Total (employee + employer) 8%
66
Alternative0%
0% – 6%
100%
6%
12%
MERCER
Improving Savings Levels
• Which messages shouldbe emphasized, andwhen?
• Develop a writtencommunication strategy,and re-visit it regularly
• Think of it like an adcampaign
• Keep it fresh and fun• Use the right media and
messages• Make it personal and
relevant
• Assess plan memberbehaviour
• Develop targetededucation strategies toaddress gaps
Gen Y vs.Gen X vs.
BabyBoomers
Re-marketthe DC plan
regularly
BehaviouralFinance
Considerations
67
MERCER
Mercer ViewDC Investing Guiding Principles
Plan sponsor focusshould be on enabling
better outcomes byassisting plan members
to make the bestdecisions where
possible and defaultingthem to the best options
if they do not
68
MERCER
Types of Investors
69
Do It For MeINVESTORS
The focus of plan sponsors should be:
• Protecting them against the worstoutcomes
• Providing them with intelligentdiversification
• Providing them with exposure toan appropriate level of risk ateach life stage
• Target Date Funds – a smartinvestment default for DC plans
Support informed investment decision-making, in general:
• Less is more• Keep it simple• Use specialized funds with
caution• White labelling• Automatic re-balancing• Focus should be on the best
outcome, net of fees
Let Me Do ItINVESTORS
MERCER
Summary
70
• Building betteroutcomes for DC Planmembers is not simple,but not impossible
Our forecast (or hope) is that Plan sponsors will take an active role toaddress some of these issues to build better outcomes for DC plan
members and assist to get them “retirement ready”
MERCER 71
Thank You!
A copy of today’s presentationwill be emailed to all attendees.
Your feedback is important to us.Please take a moment to fill out
the feedback form.
MERCER
TODAY’S SPEAKERS
72
JONATHAN CROFTInvestments
DOUG BRAKERetirement
BENOIT HUDONRetirement
TODD SAULNIERInvestments
73
