Steve Peacher: Hi, everybody, this is Steve Peacher, president of SLC Management, and this is another session of “Three in Five,” and I'm really happy today to have Ash Gopwani with me. Ash is a managing director and our client solutions team up in Toronto. Thanks for taking a few minutes.
Ashwin Gopwani: Thanks for having me, Steve.
Steve Peacher: So we were going to talk about inflation and pension plans today. So obviously inflation is the topic du jour. We're now running above, depending on how you measure it, in some cases, about 5% big change[1] from a few years ago. So when you think about defined benefit pension plans, which is who you spend a lot of time talking to, how have plan sponsors and their consultants thought about inflation risk historically? And do you see that changing in this environment?
Ashwin Gopwani: That's a great question, Steve. And before I answer this, we're talking about how inflation affects pension plans and for this purpose. There are really two groups of plants ones where pension payments are linked to inflation and ones where they aren't now. While they're slightly more common in Canada and the U.S., most corporate plans really don't have pension payments that are linked to inflation. But these are the plans in Canada where discussions about rising inflation really have centered for these plans. Really low levels of inflation volatility over the past 30 years or so has allowed this plan sponsors and their consultants to place less emphasis on the risk that inflation could rise, allowing them to leave that risk untouched. That's definitely changing. We've seen that these plans that the plans that did choose to hedge inflation are less worried about whether inflation risk is transitory or not. And ones that didn't are really starting to reconsider the strategy. Now for those plans, where our pension payments aren't linked to inflation starts a bit less clear. On the one hand, the rise and break even inflation rates has driven interest rates higher than that's really happened both in Canada and the U.S. and isolation that really has served to drive liabilities down and improve funded status. However, it's not necessarily all upside for these plans. For example, those plans that use a final average earnings to calculate the cost of benefits for their active members will still see some of the increases come through and their liabilities for those members. And also, there could be an impact on the return seeking assets that the plan holds to fund these liabilities. It really depends on how these assets perform in high inflation environments. I think what that means is that these plan sponsors also need to think about their strategy and if they if they take a look back and seemed to have fared fairly well based on the dynamics today, they might want to think about locking in some of the gains they've seen so far.
Steve Peacher: So it seems that most pension plans have some exposure to inflation one way or another. And as can you talk about the means by which pension plans have protected themselves from the inflation risk in the past? And are they looking at new and innovative ways to do this going forward?
Ashwin Gopwani: For plans that have benefits with a direct link to inflation, either in the form of links, pension payments or wage growth, indexing securities have been the gold standard for hedging inflation risk. However, these have tended to seem unattractive because they tend to be offered by federal governments in both Canada and the U.S. They don't tend to come with the same credit premium that you get from other forms of fixed income that are issued by corporate sponsors. So over the years, we've built capabilities, developing some novel solutions that can help hedge these risks while providing additional yield. The strategy tends to include creating synthetic corporate bonds. These are created by using credit overlays. This is something that we've done for our largest clients for quite a while, and it's something that we're seeing a lot more interest in from corporate pension plans. You know, inflation can cut both ways. On one hand, equity for companies, it can increase the top line. And there's an article in The Wall Street Journal recently about how its increased margins. Of course, that can mean rising interest rates, which can be a rising discount rate for cash flow.
Steve Peacher: So when you think about rising inflation and the potentially rising interest rates that can go along with that, what does that mean for return seeking assets like equities or like alternative asset classes?
Ashwin Gopwani: I think it really depends, Steve for equities it could be a mixed bag, rising inflation. You kind of referenced this, but rising inflation and the resulting rise in interest rates can make business harder to do. It can make financing more expensive. It can make the cost of goods sold and services go up. It really depends on the extent to which a company can pass on these costs to their consumer without impacting demand. What that's meant is historically, we've seen that high inflation and high interest rates environments tend to have not shared well and equity markets alternatives, on the other hand, that draw their value from payments that typically are linked to inflation, they tend to do a bit better. So if we think about real estate, for example, which draws its value from rental payments, which tend to go up with inflation and also bridge tolls as an example of infrastructure that also tends to increase with the increases in CPI, these assets tend to have a bit of a natural inflation hedge bill tend to them, so those will offset some of those additional costs that they that might be incurred. So in general, these assets tend to be pretty good diversifier in these kind of environments and also just in terms of other forms of alternatives. The fixed income space, when we think about floating rate notes, for example, floating rate note exposure either in the form of high yield bank loans or floating rate, you are securitized products. Those also tend to be pretty good
diversifier in the return second component and an environment like this one.
Steve Peacher: So as I think you know, at the end of these, I like to ask a question that has nothing to do with the topic du jour, and it's more just a personal question. So I found it interesting to talk to people about their experience during COVID, of course, and what new things they've picked up. So my question to you is when you look back on COVID, did you pick up anything new? Did you start doing more of something or stop doing something during COVID that, you know, that was different from what you used to do?
Ashwin Gopwani: Yeah, I think probably like a lot of people, I think I've definitely increased the amount of cooking that I do. I found that, you know, with a with a kind of, you know, a little bit of a hectic schedule in terms of some days whenever you're working out after work or not, you might not know whether you're going to be home for dinner or not. So more often than not, we used to just do a lot of takeout that was very easy to facilitate with COVID. Me and my partner have got a lot better at cooking at home. I think even if I think about what I did last weekend, I invited two friends over and we made pasta over the weekend, which was an amazing experience and something I don't really know if we would have ever had the skills to do before COVID. So definitely some good, interesting habits picked up, I think.
Steve Peacher: Oh, that's great. So new culinary skills and hopefully the price of all those ingredients in the food and everything isn't going up too much given our first discussion. Well, listen, thanks for that. I really appreciate your comments and thanks to everybody for listening in to this episode of “Three in Five.”
Ashwin Gopwani: Thank you very much.
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1 https://www.bls.gov/cpi/
