Economic Trends and Their Impact on Your Pension Plan

Transcription

1 Presentation To Economic Trends and Their Impact on Your Pension Plan May 24, 2007 By: Gordon Gibbons, CFA Head of Pension Services Leith Wheeler Investment Counsel Ltd.

2 AGENDA Coping with low interest rates Growth of private equity How Canadian equity has rescued pension plans Decline of the U.S. dollar Investing in China and India Economic Trends, May-07 1

3 Coping With Low Interest Rates Economic Trends, May-07 2

4 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Long Canada Yields INTEREST RATE TREND DECEMBER % 20% 18% 18% 16% 16% 14% 14% 12% 10% 12% 10% Inflation 8% 8% 6% 6% 4% 4% 2% 2% 0% 0% Long Bond Yield CPI Head line YoY Most Trustee and Investment Managers have experienced a one way trend in interest rates Investors have grown accustomed to capital gains from bonds Economic Trends, May-07 3

5 IMPACT ON ASSET CLASSES Declining Interest Rates Dec Dec % 10% 9.9% 10.2% Real Return = Nominal Return - Inflation 8% 7.7% Price/Earnings 6% U.S. 4% 4.0% x x 2% 0% T-Bills Real Return Long Bond Real Return TSE Real Return S&P 500 $C Real Return Pension plans have enjoyed strong real returns as interest rates declined Challenges assumptions behind asset/liability modeling Economic Trends, May-07 4

6 PREVIOUS ENVIRONMENT Inflation and Canadian Bond Yields (December 1960 December 1981) 18% 16% Bond Yield 14% 12% 10% 8% 6% CPI Inflation 4% 2% 0% -2% Dec-60 Dec-61 Dec-62 Dec-63 Dec-64 Dec-65 Dec-66 Dec-67 Dec-68 Dec-69 Dec-70 Dec-71 Dec-72 Dec-73 Dec-74 Dec-75 Dec-76 Dec-77 Dec-78 Dec-79 Dec-80 Dec-81 Very different environment Economic Trends, May-07 5

7 IMPACT ON ASSET CLASSES 5% 4% Rising Interest Rates % Real Return = Nominal Return - Price/Earnings Inflation 3% 2% 1% 1.0% 2.3% U.S x x 0% -1% -1.0% -2% T-Bills Real Return Long Bond Real Return TSE Real Return S&P 500 $C Real Return Between 1968 and 1978 the U.S. market was flat ($U.S.) Long bonds declined in real terms (good for liabilities) Economic Trends, May-07 6

8 PUTTING IT ALL TOGETHER 12% 10% 9.7% 9.7% 8% 6% 4% 4.0% 2.6% 4.5% 4.0% 7.3% 5.7% 2.3% 6.1% 2% 1.0% 0% -2% -1.0% T-Bills Real Return Long Bond Real Return TSE Real Return S&P 500 $C Real Return June 2006 Overall Economic Trends, May-07 7

9 IMPACT ON PENSION PLANS? Recognize that investment returns have been driven by declining interest rates for the last 25 years Long bond yield: 1982 = 14.8%; April 2007 = 4.1% Interest rates have been relatively stable recently Pension plans will have to consider higher equity content Equity managers will need to focus more on liabilities Economic Trends, May-07 8

10 WARNING Lenders are now actively pushing mortgage credit to illegal immigrants an estimated $85 billion business covering 375,000 households with no Social Security numbers & no documentation. A sheriff in Phoenix was quoted as saying "If I catch these people, they are going back to Mexico and the banks providing these loans will have a tough time collecting on these loans". Well, the banks are just going to package these into bonds and sell them off to institutions that only care about one thing, and it's not risk it's YIELD!!! Source. North American Morning Market Memo - Merrill Lynch May 3, 2007 Big Banks Loan Push: Illegal Immigrants - Wall Street Journal May 3, 2007 Investors are chasing low quality Fixed Income Investments in a desperate effort to find income This Never Ends Well!!! Economic Trends, May-07 9

11 Growth of Private Equity Economic Trends, May-07 10

12 CURRENT TAKEOVER FRENZY *Source: Economist: The Beat goes on May 10, 2007 Low Interest Rates and Accommodating Bankers Make Financing Easy 11

13 MERGERS & AQUISITIONS Takeovers are being financed with more & more debt Many of the takeovers are hostile Merger activity is very widespread Feeling like the 80 s!!! *Source: Economist: The Beat goes on May 10, 2007 Economic Trends, May-07 12

14 GROWTH OF PRIVATE EQUITY Definition Public Equity Listed on exchange (NYSE, TSX etc) Subject to strict rules from exchange Accountable to shareholders High standards of transparency Opportunity for active shareholders to vote for change Economic Trends, May-07 13

15 GROWTH OF PRIVATE EQUITY Definition Private Equity Traditionally used to fund smaller non-public companies before they list on exchange Increasingly used as a vehicle to purchase large public companies Offered to small number of large institutional shareholders Operated by limited partnership who receive a monitoring fee Much fewer regulatory issues No need to disclose financial information Economic Trends, May-07 14

16 IMPACT ON PENSION PLANS Threatens Progress on corporate governance achieved by activist shareholders Transparency of corporate financial reporting Accountability to stakeholders Investible universe for most pension plans Quality of investments due to increased leverage WARNING There is now more and more money chasing poorer and poorer investments Economic Trends, May-07 15

17 How Canadian Equity Has Rescued Pension Plans Economic Trends, May-07 16

18 FUNDING CRISIS TSX S&P 500 EAFE % -6.5% -16.6% % -22.7% -16.6% Equity market Weakness Pension funding crisis Dec 2003 March 2007 TSX vs. S&P 500 vs. MSCI EAFE 71% 21% 60% Canadian market performance has helped improve pension funding status over last 4+ years Economic Trends, May-07 17

19 STRENGTH IN CANADA TSX Sector Performance (5 Years Ending March 2007) Energy 172.6% Telecom Services 156.0% Financials 115.7% Materials 104.9% S&P/TSX Composite 85.0% Utilities 83.8% Consumer Discretionary 33.6% Consumer Staples 23.3% Industrials 20.4% Information Technology 5.4% Health Care -33.5% -50% 0% 50% 100% 150% 200% Not all commodity related Economic Trends, May-07 18

20 PROFITABILITY RETURN ON EQUITY 20 Year Median ROE 2006 ROE 2006 ROE/ 20 Yr Median S&P/TSX Composite Index 9.4% 16.3% 1.7x ENERGY 6.5% 18.3% 2.8X MATERIALS 4.7% 17.3% 3.7X INDUSTRIALS 8.9% 13.3% 1.5X CONSUMER DISCRETIONARY 7.7% 10.5% 1.4X CONSUMER STAPLES 12.2% 14.0% 1.1X HEALTH CARE 6.9% 10.6% 1.5X FINANCIALS 13.1% 17.3% 1.3X INFORMATION TECHNOLOGY 9.5% 14.0% 1.5X TELECOMMUNCATION SERVICES 10.6% 12.6% 1.2X UTILITIES 11.6% 9.7% 0.8x All sectors are posting higher than normal ROEs but Energy and Materials are having career years Source: BMO Capital Markets Economic Trends, May-07 19

21 IMPACT ON PENSION PLAN? The performance of the Canadian Equity market has rescued Pension Plans The Canadian equity market is now trading at record levels Many commodities are at record levels Recognize that commodity markets are cyclical in nature (fear and greed) Guess which phase of the cycle we are in? Hint, Where is the fear? Economic Trends, May-07 20

22 Decline of the U.S. Dollar Economic Trends, May-07 21

23 Dec-89 Mar-90 Jun-90 Sep-90 Dec-90 Mar-91 Jun-91 Sep-91 Dec-91 Mar-92 Jun-92 Sep-92 Dec-92 Mar-93 Jun-93 Sep-93 Dec-93 Mar-94 Jun-94 Sep-94 Dec-94 Mar-95 Jun-95 Sep-95 Dec-95 Mar-96 Jun-96 Sep-96 Dec-96 Mar-97 Jun-97 Sep-97 Dec-97 Mar-98 Jun-98 Sep-98 Dec-98 Mar-99 Jun-99 Sep-99 Dec-99 $US vs. $CDN The Ninety s $1.65 $1.60 During the 90's the US Dollar increased 24.6% in Canadian Dollar terms. $1.55 $1.50 $1.45 $1.40 $1.35 $C/$U $1.30 $1.25 $1.20 $1.15 $1.10 $1.05 Economic Trends, May-07 22

24 Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 $US vs. $CDN Jan 2000 to April 2007 $1.65 $1.60 Since January 1, 2000 the US Dollar is down 23.7% in Canadian Dollar terms. $1.55 $1.50 $1.45 $1.40 $1.35 $C/$U $1.30 $1.25 $1.20 $1.15 $1.10 $1.05 Economic Trends, May-07 23

25 DECLINE OF THE US DOLLAR Why Has This Happened? Declining US Trade Balance More demand for imports Less foreign demand for U.S. exports Growing Budget Deficit In U.S. Economic Trends, May-07 24

26 US MARKET 1990 s THE ONLY GAME IN TOWN US versus Canadian Equities US Equities (Dec 1989 vs. - Canadian Dec 1999) Equities (Dec 1989 Dec 1999) +20.8% per year Dec-89 Apr-90 Aug-90 Dec-90 Apr-91 Aug-91 Dec-91 Apr-92 Aug-92 Dec-92 Apr-93 Aug-93 Dec-93 Apr-94 Aug-94 TSX Composite Dec-94 Apr-95 Aug-95 Dec-95 S&P 500 (C$) Apr-96 Aug-96 Dec-96 Apr-97 Aug-97 Dec-97 Apr-98 Aug-98 Dec-98 Apr-99 Aug-99 Dec-99 In the 1990 s U.S. equity investments helped Canadian pension plans +10.6% per year Economic Trends, May-07 25

27 US MARKET 2000 s A MUCH DIFFERENT STORY US versus Canadian Equities US Equities (Dec 1999 vs. - Mar Canadian 2007) Equities (Dec 1999 Mar 2007) +8.3% per year Dec-99 Mar-00 Jun-00 Sep-00 Dec-00 Mar-01 Jun-01 Sep-01 Dec-01 Mar-02 Jun-02 Sep-02 Dec-02 Mar-03 TSX Composite Jun-03 Sep-03 Dec-03 Mar-04 Jun-04 Sep-04 S&P 500 (C$) Many pension plans questioning U.S. investments Dec-04 Mar-05 Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar % per year Economic Trends, May-07 26

28 IMPACT ON PENSION PLANS? Rear view mirror is a dangerous way of steering your pension plan US Equity Investments appear relatively more attractive now with a cent dollar Economic Trends, May-07 27

29 Investing In China And India Economic Trends, May-07 28

30 CORPORATE GOVERNANCE IN ASIA CLSA* (CG Watch 2005) CORPORATE GOVERNANCE CHINA INDIA Do financial reporting standards for listed companies compare favorably against international best practices? Do securities laws require disclosure of share transactions by directors, controlling shareholders and substantial shareholders within two working days? Do securities laws require adequate disclosure of material transactions, including major connected transactions? Must companies disclose the exact remuneration of individual directors and senior executives(top5) by name (or do they)? Somewhat Somewhat Somewhat Marginally Yes Yes Yes Yes Are audit companies mandatory and implemented? Somewhat Yes POLITICAL & REGULATORY ENVIRONMENT CHINA INDIA Is the media free to report on and investigate corporate governance abuses among listed companies? Marginally Yes *CLSA - France s Largest Bank Y=Yes; N=No; S=Somewhat; M=Marginally Economic Trends, May-07 29

31 CORPORATE GOVERNANCE IN ASIA CLSA* (CG Watch 2005) ENFORCEMENT CHINA INDIA Do the regulatory authorities have effective powers of investigation and sanction? Somewhat Yes Has the securities commission been investing significantly more financial and human resources in investigation and enforcement in recent years? Do the regulators disclose detailed and credible data on their enforcement track records? Are minority shareholders adequately protected during takeovers, privatizations, connected transactions and very substantial acquisitions or disposals? Somewhat Somewhat Marginally Yes Yes Yes IGAAP (or accounting & auditing ) CHINA INDIA Is the government of the accounting regulator taking account of and implementing new international best practices on the independence of external auditors? Somewhat Yes CULTURE CHINA INDIA Is there an up and coming group of small-and/or mid-cap stocks that is gaining a reputation for being well-governed and also going beyond compliance? Are large-cap stocks actively seeking to improve their communication with shareholders and providing more substantive disclosure? Does the media actively and impartially report on corporate governance reforms and developments? Marginally Somewhat Marginally Yes Yes Yes *CLSA - France s Largest Bank Y=Yes; N=No; S=Somewhat; M=Marginally Economic Trends, May-07 30

32 IMPACT ON PENSION PLANS? Yes; both China and India offer impressive growth opportunities Yes; pension plans can improve performance by investing in these markets Be careful of poor governance practices in emerging markets this can be a costly lesson Economic Trends, May-07 31

33 SUMMARY Low interest rates, rising commodity markets, record high equity markets are driving investors sentiment. Evidence is building that riskier investments are increasingly embraced by investors. Focus on investments with reliable, sustainable earnings and best governance practices will preserve capital going forward. Economic Trends, May-07 32