Canadian Economic Growth Remains Fragile

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DB and DC plan sponsors look to improve portfolio efficiency

TORONTO, January 16, 2014 –  According to the Annual Survey of Economic Expectations by global professional services firm Towers Watson (NYSE, NASDAQ: TW), Canada’s top economists, strategists, and portfolio managers predict modest growth for both Canada and the United States, with Canada lagging the U.S. in both economic activity and job creation over the next few years. Global growth is expected to improve but remain relatively subdued, leading to continued low interest rates in most countries for at least another year, according to the survey. In addition, it shows that despite rising long-term interest rates, economic activity in Canada remains fragile and reliant on improvement in the United States and Europe and continuing strength in China.

In the near term, survey respondents expect Canadian GDP growth to remain around 2%, rising to 2.4% over the longer term. While the recent decline in the Canadian dollar may provide some welcome relief to exporters, however, the majority of survey respondents expect the Canadian dollar to appreciate to close to par over the long term.

Janet Rabovsky, Director of Investment Consulting at Towers Watson’s Toronto office said: “With a lower Canadian dollar, there is hope that manufacturing businesses, and certainly the export sector of the economy, can contribute to reducing the unemployment rate in the next few years. That being said, recent announcements about industrial plant closures in Ontario would indicate that the cycle has not yet turned.”

With inflation in check and the lower Canadian dollar, the Bank of Canada signalled a neutral stance on interest rates in 2013. Survey respondents expect the Bank of Canada’s overnight rate to increase from its current level of 1% to 2% in 2015 – 0.50% lower than last year’s forecast. While respondents expect short-term rates to remain relatively low over the next few years, they expect the ten-year government of Canada bond to rise to 3.8% by 2018.

“The increase in longer-term interest rates in 2013 provided welcome relief for DB pension plan sponsors whose funded positions benefited from this and strong capital market returns during the year,” said Rabovsky. “According to our data, the average solvency funded ratio for a typical Canadian pension plan reached 100% by December 31, 2013.”

Survey respondents are not overly bullish about equity market returns over any time period. The majority expect the S&P / TSX Composite Index to return between 6% and 10% over the short, mid and long term. The most surprising forecast is for emerging market equities, which the majority of survey respondents expect to return below 5% in 2014 and between 6% and 10% over the medium and longer term.

Improved Portfolio Efficiency

The increasing correlation between different equity markets, coupled with the forecast for lower returns, have DB pension plan sponsors seeking other ways to diversify their investment portfolio, according to Towers Watson.  This suggests that while many continue to look to alternative asset categories for diversification, there is renewed focus on more efficient and cost-effective implementation strategies, such as smart beta, which involves accessing markets in a more intelligent way through non-price indices, low-volatility equities or thematic investing. Towers Watson’s clients have already allocated US$20 billion of assets to smart beta strategies globally.

“These strategies have been around for more than 10 years and are now really getting some serious attention from pension funds given the expected low-return environment and desire to only pay for manager skill or alpha where it truly exists,” explained Rabovsky. “Over the past few years, investment characteristics that had once thought to be alpha have been identified and segregated and can now be quasi indexed or systematized.”

According to Michelle Loder, Towers Watson’s Canadian Defined Contribution Business Leader, smart beta strategies are not just for DB plans. They are increasingly being added to DC record keeper platforms, either as part of a portfolio solution or as a standalone option. “As benefit adequacy issues come into focus, the trend to institutionalize DC investment structures will continue,” adds Loder. ”In line with this, we will see more smart beta strategies in DC portfolios, such as listed infrastructure and REITs, as sponsors look to more sophisticated diversified solutions to target risk-adjusted return expectations and focus members on achieving retirement income goals.”

About the Survey

Towers Watson’s Annual Survey of Economic Expectations provides forecasts from leading business economists, strategists and portfolio managers from more than 128 organizations.  The results have been compiled to give a consensus opinion on Canada’s economic and market prospects over the short (2014), medium (2015-2018) and long terms (2019-2028).

Towers Watson Investment

Towers Watson Investment is focused on creating financial value for the world’s leading institutional investors through its expertise in risk assessment, strategic asset allocation, fiduciary management and investment manager selection. Towers Watson’s Investment business has over 750 associates worldwide, assets under advisory of over US$2 trillion and around US$60bn of assets under management.

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 consulting, technology and solutions in the areas of benefits, talent management, rewards, and risk and capital management.  Towers Watson has more than 14,000 associates around the world and is located on the web at www.towerswatson.com.

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