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Pension funds hit by higher loonie

Pension funds took a major hit last year from the soaring Canadian dollar, but some funds say they managed to reduce the impact with aggressive currency-hedging programs.

With many pension funds escalating their holdings outside of Canada since the removal of foreign content caps in 2005, pension holdings have become increasingly vulnerable to currency risks.

Funds must record their foreign profits on their financial statements in Canadian dollars, so a stronger dollar cuts into the returns.

Last year, the Canadian dollar climbed 17 per cent against the U.S. dollar, and also soared compared with most other global currencies.

Data prepared recently by pension consultants Morneau Sobeco show pension funds posted a median return of 2.1 per cent in 2007, pulled down significantly by the rise of the loonie. That number compares with two-year annualized returns of 7.2 per cent and five-year annualized returns of 10.2 per cent.

The survey examines returns of 350 pooled funds of pension fund managers with combined assets of $150-billion.

Fund executives say the impact of the dollar's climb has been both an opportunity and a challenge, giving Canadian funds growing clout as global buyers.

But that growing clout also threatens to diminish global investment returns once the profits are converted to Canadian dollars.

Michael Nobrega, chief executive officer of the Ontario Municipal Employees Retirement System, said OMERS believes the stronger dollar is a net positive, making foreign acquisitions more affordable.

"For an institution like ours, we operate in 35 currencies," he said.

"We have the professional expertise in-house to do what we have to do to hedge our currencies."

David Burke, director of the retirement practice at consulting firm Watson Wyatt Worldwide, said the importance of hedging programs in 2007 is illustrated by an analysis prepared by his firm showing a theoretical pension portfolio based on typical asset weightings, including 25-per-cent foreign content. Index returns for that portfolio were 3.2 per cent last year.

However, if foreign currency exposure in that portfolio were eliminated - that is, fully hedged against the U.S. dollar - the return for 2007 would more than double to 7.3 per cent, Mr. Burke said.

"Definitely most funds in Canada, all things being equal, will have been hurt in 2007 because of currency, no doubt about that," he said.

Mr. Burke said the hedging strategies of pension funds vary widely. He said some clients do not hedge at all, assuming that currency variations even out in the long term.

More typically, however, many funds try to hedge about half their currency exposure.

Bob Bertram, executive vice-president of investments at the Ontario Teachers' Pension Plan, said Teachers hedged about 60 per cent of its U.S. dollar exposure last year. The pension fund has 40 per cent to 45 per cent of its assets in foreign holdings, with a majority of those outside the United States.

Mr. Bertram said he does not believe Teachers faced a meaningful drop in returns last year, thanks to its hedging program. On average, however, he said he expects the range of returns among pension funds to vary more than usual in 2007 because of the significant currency variable.

Mr. Nobrega, meanwhile, said OMERS has greatly boosted its foreign holdings in recent years in part because investment rules in Ontario limit how much the pension giant can hold in various investments.

For example, Ontario's rules - which are currently under review by an expert committee - prohibit pension funds from owning more than 30 per cent of the voting shares of a company, owning more than 15 per cent of holdings in natural resources properties in Canada, or more than 25 per cent of total assets in real estate and resource properties combined.

He added the stronger dollar has made it easier to look to other countries to continue making 30-per-cent investments in a variety of companies, rather than bolstering investments to a higher level in Canada.

© 2007 The Globe and Mail. All rights reserved.

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