What missed benchmarks mean for pension plans

When recent annual reports from several of Canada's largest pension plans revealed pockets of underperformance - private equity in particular - it raised familiar questions: what does it really mean when a pension plan falls short of its benchmarks, and when should plan members start to worry?

The answer ultimately depends on whom you ask and, more importantly, over what time frame you measure it.

"Pension plan underperformance is obviously when it would perform below a benchmark for a certain period of time. And then that's where the debate really, I think, opens up, particularly around timing," said Dustin Reid, VP and chief fixed income strategist at Mackenzie Investments.

According to Reid, a pension plan that misses its benchmark for a single year within a 25- or 40-year investment horizon has not necessarily revealed a meaningful problem, particularly as different stakeholders will draw the line in different places. He added that one year, let alone one quarter, is too narrow a window to judge a vehicle built for decades.

"Maybe a three-year period, and you see consistent underperformance, then I would start to think about the idea of whether this fund, for whatever reason, is underperforming a benchmark, and obviously, why?" he added.

It should come as no surprise that Canadian pension plans have built a strong reputation through disciplined risk management, thoughtful asset allocation, and a willingness to expand into investment areas that were once considered unconventional.

After all, Bradley Hough, partner and senior consultant at PBI Actuarial, challenges the premise that pension plans are underperforming at all, underscoring that funded ratios are higher than they have been in 10 or 15 years, many plans have granted benefit increases, and returns, even in a softer year, remain at or above the discount rates that matter for long-term funding.

"In general, the pension industry is doing phenomenally well, and pension plans are outperforming. They're very well funded," he said.

Furthermore, when it comes to pension plan performance globally, Canada recently ranked high among its peers..

Hough acknowledged that certain asset classes - real estate and private equity among them - have come in below their benchmarks but also emphasized that falling short of an asset benchmark isn’t the same as failing to meet the discount rate a plan needs to stay on track.

According to Hough, private equity’s recent weakness reflects a slower deal market, delayed distributions, and broader uncertainty. He sees that as a normal part of the cycle.

In his view, pension plans already account for bad years in individual asset classes through long-term return assumptions built into their discount rates. That means missing an asset mix benchmark in a single year doesn’t necessarily damage a plan’s overall health, particularly when long-term returns remain on track.

The bigger point, he argues, is that pension plans are generally well funded and invest over decades, not short-term swings.

While Reid suggests that short-term swings are inevitable, he underscored they should be weighed against the larger record of a system that has been structured and managed to support both beneficiaries and the wider financial system.

Still, Reid sees the response to underperformance falling into two buckets: asset allocation and process. Getting the asset mix right is the primary driver of alpha, and a misaligned allocation will drag a plan below its benchmark whether for a quarter or for years. Running alongside that is a harder question about whether the investment process itself, everything from the philosophy, the culture and the rigour, still holds up.

When multi-year underperformance does surface, Reid noted the first step is to examine whether the plan is over-allocating to lagging asset classes while under-allocating to those that are performing. The severity of the problem, though, depends on the starting position. An overfunded plan has room to absorb a rough stretch without drastic action, whereas a plan that is already at par or underfunded faces a different impetus.

"You may be asking the plan sponsors to increase their contributions to try and make up for being underfunded and getting back closer to par," he said. “To me, it's really about making sure that you are getting the right, you have the right processes and procedures in place to get to the optimal asset mix that puts you above benchmark on a prolonged, multi-year basis. That's what everyone strives for.”

Meanwhile, John Cho, national private practice leader at KPMG Canada, and Mark Dowdell, national practice leader, defined contribution and investments at Gallagher, argues that underperformance should be judged against a pension plan’s ability to meet member obligations or what the plan sponsor is trying to achieve and not just whether a portfolio lags a benchmark in a given period of time. 

For some plans, that means beating a market benchmark. But for plans that manage both assets and liabilities, Cho sees the real test as funded status: whether current investments can cover future pension promises.

While for investment-only mandates, the standard is different, but over the long-term, however, the question is whether they continue to outperform alternative strategies over time.

He also underscored how short windows can distort the picture, noting that one or three years is too brief for institutional investors whose obligations are to invest across decades.

"These are all long-term focused investors … I think they always disclose 10-year average. That's where I would probably say that that feels right," he noted, adding that recent headwinds are not unique to pension plans. Particularly, any investor with meaningful private-markets exposure has faced a tougher environment, while long-only public investors have fared better – at least until the recent contraction in public equities.

However, Dowdell noted that while manager evaluation often leans on 10-year returns, pension plans tend to favour a middle ground.

"We typically look at success over, on average, over four years," he said, calling that a practical balance between short-term noise and long-cycle hindsight. Dowdell acknowledged 10-year returns matter for evaluating fund managers but structural issues can surface over shorter windows.

He highlighted how the retail mutual fund industry tends to use three- and five-year horizons, though he sees three years as too brief and a full business cycle as potentially too long.

"In the pension industry, we settled at that four-year mark. It's kind of a happy medium between the two," he explained.

Cho really sees performance as relative rather than absolute, noting that investors always have choices, and recent difficulty in private markets reflects a cyclical downturn, not a structural failure. In his view, the biggest misconception is a short-term focus that ignores the nature of those cycles.

He also pushes back on the assumption that private market investments carry weaker oversight, noting a misconception "that there's less governance in private markets investments. There's actually more governance and better governance," he said.

Rather than treating the current period as a crisis, Cho sees it as a reset.

"It's an opportunity for the room to rethink how they can maintain their competitiveness as a global investor, how they can rethink how they train up, hire and train up their talent and leverage technology," he added, suggesting plans that use this stretch to sharpen their operations will come out of it stronger.

Hough ultimately frames performance through a wider lens than investment returns alone.

"Performance is not just always maximizing return. It's making sure things are affordable, but making sure the system is stable, trustworthy and there for the long term," he said. “That's a key element of performance."