OMERS Climbing Out of Pension Crater?
I went over the press release on OMERS's 2009 results website:
Ontario Municipal Employees Retirement System is slowly climbing out of the pension crater of 2008. The Ontario pension plan announced a 10.6% rate of return for the year ending December 31, 2009. OMERS -- like many other pension funds that received a terrible setback during the economic crisis -- is trying to wipe away the pain of posting a 15.3% loss in 2008.
But while the results it released this year are slightly higher than 10% investment return posted last week by the Caisse de dépôt et placement du Québec, OMERS rate of return is significantly below the average 16.2% investment returns of all Canadian pension funds, as reported in January by RBC Dexia.
The equities portfolio earned an 11% return last year, up from its devastating loss of 19% last year, and private-equity returned 13.9% -- beating its benchmark of 6.7% -- but the pension funds real estate portfolio, managed by its Oxford Properties Group, saw a return of 1.3% which is significantly off its 6.7% benchmark.
Stranger still was the pension fund's poor performance in its new strategic investments division. That group, led by new hire Jacques Demers, lost 1.2%, grossly under its 10.9% benchmark.
Another worrisome trend is the fact that OMERS pension obligations are increasing faster than its contributions, which mean the deficit has grown from $279-million to $1.5-billion.
Today, OMERS announced a 10.6 per cent total rate of return for the year ended December 31, 2009, compared with a negative 15.3 per cent total rate of return in 2008. The average rate of return for the past five years now stands at 6.6 per cent, above the five-year average benchmark return of 5.8 per cent.
Net investment income for 2009 totalled $4,310 million, compared to a net loss of $8,013 million in 2008 resulting from the global credit crisis and the subsequent meltdown of the global equity markets.
“In early 2009, we took a prudent and disciplined approach to investing in public equities as the global equity markets remained volatile and, in our view, presented undue risk to the Plan”, said Michael Nobrega, OMERS President and CEO. “This approach ensured that we retained the flexibility to preserve capital while providing the opportunity to participate in a rebound that occurred in the equity markets later in the year. The performance of our private equity and infrastructure investments also provided very strong returns, reinforcing our decision to continue to expand our holdings in the private market asset classes.”
OMERS remains on course with its five-year strategy introduced in 2008 which includes; (i) increasing the portion of the Plan’s assets that are internally managed; (ii) increasing the size of the OMERS Plan; (iii) managing the investments of other domestic and international funds, and (iv) establishing investment alliances with third-party investors. The implementation of this strategy will grow OMERS assets under management and will allow for further participation in larger-scale investments with strong cash flows which will help to address the growth in pension obligations.
“Like the majority of the large plans, pension obligations have been increasing at a greater pace than contributions,” said Patrick Crowley, OMERS Chief Financial Officer. “The downturn in the economy in 2008 reduced the value of our net assets, and changes in certain actuarial assumptions increased our pension obligations. This resulted in a Plan deficit of $1,519 million in 2009, with an additional $4,950 million of net losses from 2008 that will impact the deficit over the next four years. Enhanced investment returns in 2009 and in subsequent years will be one component in addressing this deficit.”OMERS is one of Canada’s largest pension funds and was awarded Pension Fund of the Year Canada, 2010 by U.K. based World Finance Magazine. With an established track record of strong and steady performance and with investments in a wide range of businesses and assets around the world, OMERS provides retirement benefits to over 400,000 members from the municipal government sector in the province of Ontario, Canada.
Pension fund of the year? Forgive me if I am not impressed, but from where I'm standing it's ludicrous to give any of the big pension funds in Canada such a silly award. And OMERS is no exception.
After taking a drubbing in private equity in 2008, the 2009 results are simply not impressive. Mr. Nobrega should have just come out and said that they missed the boat and were late going long stocks in late March/ early April 2009. They weren't alone. Most of the big funds were caught like deer in headlights, and then suffered severe performance anxiety for the rest of 2009.
But OMERS has a different game plan. In fact, they want to drastically move their asset mix into private markets:
OMERS said it plans to change its asset mix over the next three years. It is now 61 percent invested in public markets and 39 percent invested in private equity and is looking for a more even split.
"Our long-term objective is to migrate and end up with a result that would have 53 percent invested in public markets over the longer term and 47 percent in the private markets," Crowley told journalists at a press conference held to discuss OMERS' results.
In 2009, OMERS got an 11 percent rate of return from public markets, and 13.9 percent from private equity.
Indeed, as you can see below, the performance of private equity was better than the performance of public markets in 2009 (click on image to enlarge):
So why not go full force ahead into private markets? After all, OMERS Private Equity and Borealis Infrastructure claim to be leaders in their field. In fact, in a recent speech at the World Pension Forum, Mr. Nobrega made the following comments on infrastructure investments:
Government stimulus spending has given infrastructure celebrity status. Everyone is talking … though few are doing the walking.
The opportunities are almost immeasurable. Pick a study and the estimates add up to trillions of dollars on a global basis.
Governments are limited in what they can do. They need equity investment partners.
This is where pension funds come in.
In some cases … particularly at the state and municipal levels … they will choose to sell off … or be forced to sell off … vital assets to cover their large and growing budgetary deficits.
The biggest financial burden on governments is meeting ever-escalating entitlements for such things as health care and education … social security, welfare and safety nets for displaced workers.
Owning and managing infrastructure is not their biggest priority. Yet it is a capital source to help pay for rising entitlements.
Realizing this … governments prefer to sell community assets to investors that share their respect for public policy priorities.
Pension funds … with their prudent practices and long-term investment horizons … are ideal partners.
How can pension funds participate and, in doing so, solve their funding problems?
First, you have to commit to this asset class. Make the asset mix allocation.
I suggest a large … rather than tentative … allocation. The best opportunities require more than half-a-billion dollars of equity capital ... preferably with the risks and reward shared among like-minded investors.
Our proprietary research shows that large infrastructure assets make a substantial difference to investment returns.
The difference between investments greater than $500 million … and those of $200 million or less ... is 200 to 300 basis points annually.
Think what that means over 20 or 30 years to your plan members’ retirement security.
Second trustees need to think through the sectors most appropriate to their investment beliefs. The choice is diverse.
Sectors such as transportation, from roads and bridges to marine ports and airports.
Or energy supply, such as municipal and state utilities … renewable energy sources … and energy distribution, such as transmission lines and pipelines.
Or satellite communications … medical science … water treatment and distribution systems … and educational and institutional buildings.
These types of investments achieve social and economic benefits beyond rates of return. They deliver innovation, social services, environmental responsibility, economic sustainability … and jobs.
A Canadian study shows that a sustained 10 per cent annual increase in the stock of infrastructure spending reduces manufacturing costs by about 5 per cent a year.
The result? Higher labour productivity and increased economic competitiveness.
The third point to resolve is whether you want to control your investments – or not.
For many pension funds … the choice is either limited partnership structures …or shares in publicly traded infrastructure companies.
These are convenient options. They avoid the costs of developing staff investment expertise to manage a diversified and ultimately multi-billion dollar portfolio of assets.
Until global markets blew up last year … most pension funds were quite happy to pay hefty annual fees … as well as generous short-term exit incentives … to fund managers. The returns seemed to make financial sense.
That’s all changed.
The 2 & 20 private equity model … and the ownership of infrastructure as a relatively short-term over-leveraged profit play … has fallen out of favour … leaving pension funds wondering what to do next.
The alternative is to partner with like-minded and long-term investors that want reliable and sustainable long-term income to meet their long-term financial obligations.
This approach means either joining ad hoc investment consortia … or signing on to a programmed co-investment alliance. Either way, you have decision-making authority at the boardroom table and can actively engage in managing your capital.
Should you take this approach … your path will inevitably lead to a short-list of Canadian pension funds that actively manage infrastructure investments.
This is an ideal time to move capital into infrastructure investing.
Government deficits … and the magnitude of stimulus packages … will result in the divestiture of attractive large-scale assets.
The opportunities are real and plentiful.
After 12 years in this business … I am truly excited about aligning with prudent long-term investors who share our belief that active infrastructure investing is a proven idea whose time has come.
Let us seek out stable long-term returns for our plan members and give them the comfort for decades to come that their retirement years are secure.
The message is clear: when it comes to private markets, bigger is better. Partner up in a consortia that includes other big pension funds and powerful private equity funds to scour the planet for opportunities coming from cash-strapped governments looking to sell infrastructure assets to meet their fiscal obligations.
If this all sounds perverse, it's because it is. The benign language used in Mr. Nobrega's speech masks what is really going on in the background. These consortia made up of large pension funds co-investing along with private equity funds, picking up assets on the cheap are just taking advantage of some government's (state, municipal or federal) dire fiscal predicament. They privatize public assets and then profit from it by beating some bogus private market benchmark.
I am not sold on pension funds moving so aggressively into private markets. In fact, I note that while activity is picking up in secondaries, there are no bargains in private equity. And as everyone has "discovered" infrastructure, those assets have been bid up too.
Moreover, private-equity firms tell investors that the years following recessions offer the best opportunity to make money. This time may be different.
One last comment on OMERS' results is that the benchmark for Private Equity and Real Estate is a joke. Go back to read my comment on the Caisse's 2009 results and compare the returns of the benchmarks in private markets (real estate, private equity, infrastructure) of these funds (click on image to enlarge):
Ask yourself this: how come the Caisse's Private Equity and Real Estate benchmark returns were 25.6% and -5.8% respectively in 2009 while at OMERS the benchmark returns for both these asset classes was 6.7% (probably some spread over CPI inflation).
I'll tell you exactly why: when it comes to private market benchmarks, the Caisse got it right. Their private market benchmarks reflect the beta, liquidity risk, credit risk, and leverage of these asset classes. They also value these private market assets more rigorously than any other large Canadian pension fund.
Kind of makes you wonder who really should have been awarded Canadian pension fund of the year in 2009. In my opinion, OMERS has a lot more climbing to do before it gets out of its pension crater.
Finally, please note that I was invited by the Concordia School of Public Affairs to take part in a panel discussion on pension reform tomorrow evening (March 2nd) at 6:00 p.m. at 1590 Dr. Penfield (Samuel Bronfman Building). A reception will follow the discussion.
***Addtional Comments on OMERS' 2009 results***
A senior pension fund manager shared his take on the results:
The numbers certainly are excellent in the infrastructure/PE area. The fund as a whole results are terrible, must be fiascos in the public markets, currency losses, etc.
Real estate is way too good to true, there is no way their portfolio of properties is performing at that level, appraisal games big time going on.
On PE, they took some markdowns a few years ago, maybe bringing reserves back in. Their life IRR remains negative, but no one checks these things. I know some assets they own, and they are holding up ok, but I suspect the valuations are very mechanical and simply getting the benefit of multiple expansion.
This is why I debate your benchmarks, it leads to valuations devoid of judgement, but highly supportable by auditors and other who worry about process and not outcome.
Overall, the results seem to be directly supportive of their primarily illiquid strategy. To be charitable, they have a very clear strategy and belief system that underpins it, are staffed for the task, and are communicating well to the media, who don't know any better. I guess this is all characterized as success.