Monday, February 23, 2009

OMERS Takes a Drubbing in Private Equity


The Ontario Municipal Employees Retirement System (OMERS) released its 2008 results today, emphasizing that it remains "top-quartile" among its peers (notes are mine):
Today OMERS announced a negative 15.3 per cent total rate of return for 2008, compared with a positive 8.7 per cent total rate of return in 2007. In spite of the negative results in 2008, a positive average rate of return for the past five years of 6.9 per cent was realized which is in excess of OMERS five year average funding requirement and benchmark.

[Note: Beware of those who emphasize the ' positive average rate of return for the past five years' even when they're losing billions! It will take them five or more years to recoup those losses!]

Net investment loss for 2008 totaled $8,013 million in 2008, compared with net investment income of $3,938 million a year earlier. The 2008 results place OMERS in the top quartile, both this year and over the past five year period according to a recent RBC Dexia Investor Services survey covering pension plans with assets in excess of $1 billion.

[Note: Top-quartile is meaningless when your peers are losing billions too!]

“The financial crisis that devastated world markets in 2008 happens once in a lifetime” said Michael Nobrega, OMERS President and CEO. “It drove stock markets to levels not seen in many years. Global equity markets fell by 30 to 40 per cent. OMERS did not escape the downturn, though we believe we fared relatively well as a result of the performance of our fixed income, real estate and infrastructure assets and our decision not to invest in certain high-risk financial products.”

“Since the adoption of our asset mix policy in 2003, we have reduced our exposure to public market investments from 82.2 per cent to 60.2 per cent,” said Patrick Crowley, OMERS Chief Financial Officer.

“We’re getting a better balance between our public and private investments, and although we have experienced losses in 2008, they were lessened by the shift toward private market assets.”

[Note: You are also able to ascribe bogus benchmarks in private markets so you can justify your bogus compensation. That is why OMERS bet big in private markets.]

The shift from public market investments to private market investments accelerated in 2008 with the acquisition of several private market assets and the sharp reduction in the global equity markets, which significantly reduced the value of public market investments.

OMERS avoided significant exposure to certain high-risk investments such as sub-prime mortgages, collateralized debt obligations and over-leveraged assets which contributed to the crisis that directly impacted many financial institutions and created a “downdraft” felt by investors around the world.

[Note: OMERS wants you to know that unlike the Caisse, PSP Investments and to a lesser extent, Ontario Teachers, they were "lucky" not to invest in ABCP and other risky securities that got whacked last year.]

“We’re in this for the long-term, and the results of any one year will not determine the future of the Plan,” said Nobrega. “Our members can remain confident their pensions are secure.”

[Note: What did Keynes say about the long-run? Rest assured that Mr. Nobrega won't stick around to see if his 'long-term' predictions come true.]

OMERS introduced a five-year strategy in 2008 to create wealth for the Funds by establishing an active management approach to a growing number of its assets and through increased capital growth and global expansion. This led to the introduction of the OMERS Worldwide brand and the creation of OMERS Strategic Investments, a new investment entity with a mandate in part to build long-term strategic relationships with like-minded global institutional investors and business partners. OMERS Strategic Investments will provide access to capital to invest and grow the funds managed by OMERS.

[Note: Ask the Caisse about "global ambitions". OMERS is biting off more than it can chew!]

“We must be ahead of the curve in our strategy to generate wealth for the Plan while continuing to diversify both by asset class and geographically,” said Nobrega. “In this way we will maintain the kind of strong and stable fund that will continue to meet the pension promise to OMERS members.”

[Note: Ahead of curve? You followed Yale's yardstick and got hit with Harvard's horror.]

OMERS is one of Canada’s largest pension funds with an established track record of strong and steady performance and with investments in a wide range of companies and assets around the world. OMERS provides retirement benefits to over 390,000 members from the local government sector in the province of Ontario, Canada.

Now, let's go back to look at last year's release of OMERS' 2007 results (notes are mine):
OMERS announced today that its total rate of return was 8.7 per cent in 2007, a top-quartile performance that exceeded its benchmark return of 5.6 per cent. The incremental value that OMERS generates above its benchmark is the direct result of the expertise of OMERS investment professionals. In 2007, this incremental value was approximately $1.4 billion and over the last four years OMERS active management has added approximately $4.2 billion of value to the Fund. This is the fourth consecutive year that returns have exceeded the benchmark by over 200 basis points.

Net assets grew from last year’s close of $47.6 billion to $51.5 billion in 2007. This increase was due to strong performance in real estate, infrastructure and private equity investments but was tempered by lower returns in the more volatile public market investments.

“OMERS strong 2007 returns were due to the successful execution of our active management investment strategy, anchored by the strong returns realized by the three private market lines of business - real estate, infrastructure and private equity,” said John Sabo, Chair of the OMERS Administration Corporation Board of Directors.

OMERS has an asset mix program designed to create a balance between its private investments and public markets while achieving stable returns over the long-term to meet its pension obligations. During 2007, OMERS increased the long-term asset mix target for private markets from 37.5 per cent to 42.5 per cent and decreased the target for public market investments from 62.5 per cent to 57.5 per cent.

Since 2003 OMERS has increased its exposure to private market investments from 17.8 per cent to 29.8 per cent at the end of 2007 and reduced its exposure to public equities and interest bearing investments from 82.2 per cent to 70.2 per cent. OMERS investment professionals are managing this shift by constantly monitoring the asset mix and making the necessary adjustments to investments to achieve the target investment levels in a prudent manner, subject to market conditions and investment opportunities.

[Note: OMERS' long-term asset mix envisions 42.5% in private markets (infrastructure - 20%, private equity 10%, and real estate - 12.5%)]

The OMERS Primary Pension Plan (the Plan) received $1.9 billion in pension contributions in 2007, compared to $1.8 billion in 2006. Pension and other benefit payments totaled $1.8 billion, an increase of $0.1 billion over 2006.

“In 2008, OMERS could experience a situation that underscores our need for greater access to and control over our investments to ensure stable, long-term cash returns. For the first time in our history, outside of times when there was a contribution holiday, our pension payments are expected to exceed contributions to the Plan.

As cash returns from investments will be required to cover this increasing demand, OMERS urgently needs the Ontario government to lift the investment rule that restricts pension funds from owning more than 30% of the voting shares of a company which, among other constraints, limits OMERS ability to control dividend distributions from our investments,” said Michael Nobrega, OMERS President and CEO, repeating the message he delivered to the Ontario Expert Commission on Pensions in October 2007 where he urged revision of the Pension Benefits Act to abolish costly investment rules for pension funds.

OMERS' agressive shift to private markets will end up costing them billions. The fissures are beginning to show as private equity returns were down a 13.7% in 2008 - a whopping 27.2% below the PE benchmark return of +13.5% (click on image above to enlarge).

And wait, this is only the beginning. As the bubble in private markets implodes, those private equity funds and private real estate funds will continue to write down their values. And as global pension funds move into public and private infrastructure, those returns will get compressed too.

OMERS does direct investment and fund investments in private equity. At the end of 2007, OMERS' private equity holdings were valued at $3.6 billion, infrastructure holdings at $8.4 billion and real esate holdings at $10.9 billion.

Real Estate underperformed its benchmark by 2.3% in 2008 (6% versus 8.3%) and Infrastructure outperformed its benchmark by 1.7% (11.5% versus 9.8%). But again, Private Equity severely underperformed its benchmark by a whopping 27.2%!!!

And to top it all off, OMERS plans on increasing it direct investments in private equity. You'll also notice they took no risk whatsoever in public markets where they delivered benchmark returns.

Can you imagine if private markets all underperform their benchmarks by double digits? You would wipe out any "added value" (even if it is bogus added value based on bogus private market benchmarks) built up over the past five years very quickly and dig yourself into one huge hole.

OMERS was lucky that they did not have a lot in Private Equity, but they are still taking big bets on private markets. I shudder to think about what will happen to private markets in the age of deflation, especially following one of the largest bubbles in private market investments fuelled by global pension funds pumping billions into alternative investments.

You might also ask what are the benchmarks used to evaluate private markets? I looked at OMERS' Statement of Investment Policies and Procedures but found nothing on benchmarks.

I did find some mention of benchmarks in the 2007 Annual Report where it states the following:

Asset Class

Benchmark

Interest bearing

Blended Scotia Capital 31 day Treasury Bill Index and Scotia Capital Universe

Real return bonds

Scotia Capital Real Return Bond Index

Canadian public equities

S&P/TSX Composite Index

Non-Canadian public equities

Blended hedged FTSE All World Index excluding Canada and U.S., hedged FTSE All Cap U.S. Index and hedged custom Derivative Index

Private equity, Infrastructure, Real estate

Absolute return set at the beginning of each year based on operating plans approved by the AC Board.



If the private market benchmarks are based on absolute returns then OMERS and other pension plans that use similar measures run the risk of severely underperforming their benchmarks in a deflationary environment.

[Note: See my posts - It's All About the Benchmarks, Stupid! and Why Can't We Properly Compare Pension Funds - for more details.]

If I were OMERS, I would start thinking long and hard about their long-term asset mix and their aggressive targets to private markets.

Importantly, the opportunities in private markets will lag those of public markets in the next few years so OMERS is better off focusing its attention on bolstering its Public Markets first, focusing on limiting downside risk.

Finally, Bloomberg reports that South Korea’s National Pension Service, the nation’s biggest investor with 225 trillion won ($151 billion) in assets, said its investments were close to breaking even last year:

“Key overseas pension funds posted heavy losses in their 2008 investments because of the global financial crisis, but our rough calculations suggest Korea National Pension fund escaped from posting such losses,” Jeon Jae Hee, the health and welfare minister whose ministry overseas the fund, said in a briefing in Seoul today.

The pension fund’s return fell less than 1 percent between January and August, the ministry said in September. The fund estimated in December that domestic stocks will make up 12 percent of total assets by end-2008 and local bonds will account for 77.7 percent.

“The fund performed relatively well last year, and that is mainly because of its defensive asset allocation where bonds take up a high proportion,” said Park Se Girl, a fund manager at Meritz Asset Management Co. in Seoul, which oversees the equivalent to $1.4 billion in assets. “Such a risk-averting strategy is likely to continue in the short-term amid still- unstable global financial markets.”

Public pension funds have been reporting declining returns amid a recession that has caused more than $1 trillion of losses at global financial institutions and prompted a 38 percent decline in the Standard & Poor’s 500 Index in 2008. The California Public Employees’ Retirement System, the largest U.S. public pension fund, reported a 26 percent drop last year.

The state fund may buy the nation’s treasury bonds to be issued to finance the government’s potential extra budget if the government guarantees both stability and profitability, Jeon said, without providing more information.

Finance Minister Yoon Jeung Hyun earlier in the month forecast the economy will shrink about 2 percent this year and said the government plans to allocate a supplementary budget to help revive growth.

So, while OMERS and all the big public pension funds in North America look to increase their allocations to private markets - and increase their risk if a long deflationary episode develops - South Korea is investing in good old government bonds, focusing on asset preservation.

[Note: The #1 asset class in Japan during their lost decade of deflation was government bonds.]

I think someone's got it right and it isn't the OMERS of this world. I wonder if South Korea can manage my pension too. Anyone know whether they accept foreign contributions?

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