Canada’s major pension plans are facing rising losses in the real estate sector due to higher interest rates, according to a report by Fitch Ratings Inc. The report concludes that these pension funds are well-positioned to absorb near-term market fluctuations and will not be forced sellers of their assets. “Fitch believes Canadian pension fund investment portfolios will remain pressured by a challenging market backdrop, as the increased cost of debt and anticipated slower growth weigh on private asset valuations,” said Dafina Dunmore, senior director of the ratings agency.
Canada’s large pension funds, managing approximately $2.1 trillion of net assets as of Dec. 31, 2023, face a combination of factors affecting real estate property values. These factors include higher borrowing costs, scarcity of financing options, and a general repricing of assets.
The impact is especially pronounced within office properties due to the shift to remote work and other economic pressures. “The funds have exceptionally strong liquidity, which will provide sufficient cushion to absorb investment volatility and flexibility to work through troubled investments. They are not forced sellers of assets,” Dunmore explained.
The Fitch report focused on seven large Canadian pension funds, including British Columbia Investment Management Corp.
Pension funds face real estate challenges
(BCI) and the Public Sector Pension Investment Board.
It noted that while there have not been widespread private credit losses, defaults are likely to increase for the rest of this year and into 2025, given higher debt service burdens for underlying borrowers and slowing growth. “Pension funds that invest directly in private credit will be put to the test with respect to their workout capabilities,” Dunmore added. In response to market conditions, including higher interest rates, Canadian pension funds are reallocating inflows and sale proceeds increasingly towards government bonds.
The fund giants also shifted their strategy and were net sellers of private equity assets in 2023 after several years of strong returns. Fitch anticipates continued, albeit reduced, exposure to private equity. The report underscores that the appetite for deals has led some pension funds to become over-exposed to private equity within their larger investment portfolios.
Private equity investments typically require high leverage, which becomes burdensome when interest rates rise. Recent transactions reflect this trend. For instance, CPPIB, which invests on behalf of the Canada Pension Plan, sold a diversified portfolio of limited partnership fund interests to French buyout firm Ardian for around US$2 billion.
The Canadian pension sector continues to navigate a complex and evolving economic landscape, but Fitch remains confident in the funds’ long-term investment strategies and their ability to manage through current challenges without becoming forced sellers.
