Friday, November 11, 2011

A Conversation With HOOPP's John Crocker

Part of the perks of publishing the best blog on pensions & investments is that I get to talk to some of the best pension fund managers in the world. On Thursday afternoon, after the market close, I spoke with John Crocker, chief executive of The Healthcare of Ontario Pension Plan (HOOPP), who last month announced he is stepping down in December and will be replaced by Jim Keohane:
Mr. Keohane, the pension plan’s chief investment officer and senior vice-president, is credited with playing a key role in the adoption of a liability-driven investment strategy that enabled the pension to maintain its fully funded status.

“Through the efforts of Keohane and HOOPP’s in-house investment team, the Fund has averaged returns of 6.28% over the 10-year period ending Dec. 31, 2010, adding more than $17-billion to the HOOPP Fund,” the pension plan said in a statement Monday.

Mr. Crocker, who has been chief executive of HOOPP for a decade, is credited with modernizing the pension plan’s investment and administrative systems and developing a client-focused culture. He has also been an outspoken advocate for the defined benefit pension plan model, which guarantees a calculated payout to workers when they retire.

Those of you who have been reading my blog over the last three years know that I consider HOOPP to be one of the best defined-benefit pension plans in the world. HOOPP's senior managers are no-nonsense, humble, competent pension fund managers who stick to what they do best -- manage pensions in the best interests of their plan members.

I called Mr. Crocker after market close. He was expecting my phone call and answered himself: "Hello Leo, how are you and how is my home town of Montréal?" We talked about our alma mater, McGill University, and Mont-Royal, the suburb where he lived and where I live. He asked me if the train still passes through the tunnel under the mountain because he wanted to show his wife and I said yes.

I immediately got the sense that I'm speaking with a very nice person who isn't full of himself. No pension ego here, just a nice guy who is willing to take an hour of his time to share some thoughts on HOOPP's success and the future of DB plans. Realize that I focus too much on pension "weasels" and not enough on pension "princes". But there are nice people in the pension world, people like John Crocker, Leo de Bever and many more who I have had the privilege to talk with.

Earlier this week, John Crocker received a prestigious Lifetime Achievement Award from Benefits Canada, a leading pension industry publication:

During Crocker's 10-year term as HOOPP CEO, the Plan has enjoyed great success on the investment and funding fronts. HOOPP is one of the few defined benefit plans anywhere that is fully funded, and despite two major market downturns in the first decade of the century, HOOPP's returns average 6.23 per cent for the 10-year period ending Dec. 31, 2010.

Crocker told the audience that the defined benefit pension plan model is the best there is for ensuring retirement income adequacy. "Throughout my career, the best way to deliver – effectively and efficiently – retirement income has been through a defined benefit pension plan. No other type of savings arrangement builds towards a specific income replacement goal," he says. "It's a collaborative effort between the member, the employer, and the investment strategy – and when it works, which is nearly all of the time, the result is dignity and independence for retirees."

The award, says Alyssa Hodder, Editor of Benefits Canada, honours "individuals who have demonstrated leadership and innovation – and who have made a real difference in the pension and investment industry."

So what has led to HOOPP's success? Mr. Crocker outlined these factors:

  • Need scale: With HOOPP's assets fast approaching $40 billion, scale allows them pool resources, lower costs, implement good technology, and hire competent people. He told me that they implemented SimCorp's investment management system, one of the best all in one front and back office systems which ties all operations into one flexible, transparent and efficient workflow. On risk management, they also use Ortec's system to run scenario analysis.
  • Good governance: Mr. Crocker stressed good governance as the key to running a successful pension plan. "There can be no conflicts of interest. You got to make sure everyone is on the same page and making the best decisions for the plan's members. You can't bury your head in the sand and hope things will turn out well." He told me HOOPP's trustees are fiduciaries and are required – by law – to act in the best interests of Plan beneficiaries as a whole. He told me that following the tech meltdown HOOPP changed its cost of living adjustment (COLA). "Emotional decisions were taken and board members faced some angry union members but they still made tough, courageous decisions."
  • Board's role: HOOPP's board is a policy board. It approves contribution and benefit payment levels, establishes investment policy, monitors investment performance and makes any Plan changes and benefit improvements. However, Mr. Crocker was very specific about who makes the investment decisions -- HOOPP's senior managers. I thought that was interesting because at other large Canadian pension plan and funds, their board has to have final approval on all investment decisions, which can be quite cumbersome. HOOPP is a private trust and even though the board has independent legal, auditing and actuarial advisors, the ultimate responsibility for investment decisions lies with HOOPP's senior managers. They inform the board, educate the board, exercise moral suasion on important matters. Mr. Crocker told me that he knows of one major Canadian corporate pension plan which wants to move in HOOPP's direction and even though they have extremely competent board members, the pension fund manager "can't get face time with his board." I told him that at the IQPC conference in NYC last week, one senior risk officer from Citi's pension fund told me that in the UK, board members of the pension plans are completely independent from board members of the corporate entity to ensure that the pension plan is managed in the best interests of plan beneficiaries.
  • On getting the comp right: Mr. Crockers believes that compensation is important and cited the US model where they're not paying their pension fund managers properly and "throwing idiotic money to pension consultants making idiotic investment decisions." He added: "If you're paying monkey salaries you'll get monkey decisions." I couldn't agree more and have long thought that buy-side managers are grossly underpaid relative to their sell-side counterparts. But I did raise concerns on pension fund managers using bogus benchmarks in alternative investments to pad up their bonuses. Told him that I'm an economist and just like Leo de Bever, believe that the opportunity cost of investing in private markets is a spread over public markets which properly reflects the liquidity risk. I also told him that compensation is all about benchmarks and that I've seen monkey business at all the major Canadian funds in both public and private investments. Mr. Crocker agreed and told me "even though we shifted the portfolio to an liability-driven investment (LDI) model, there is still a lot of work to be done to reward risk-adjusted returns."
  • On internal controls: At the IQPC pension risk conference in NYC last week, I got a chance to meet Brian Anderson, HOOPP's senior director of investment management reporting. Brian told me something interesting. At HOOPP, it's the middle office which prices instruments and if the front office people have a problem, it's brought up to a committee. Told Mr. Crocker that at other pension funds, the front office guys have all the power, and they'd go crazy if the middle office had the final say on their pricing. He told me that this is done to "balance out the testosterone in the front office and make sure people are not being mistreated." Other pension funds and even banks should take note. I can write books on rogue traders at Canadian pension funds, stuff that will make pension fund presidents and their legal counsels sweat bullets (so far I've been nice but one day I will reveal all the skeletons at large Canadian pension funds). And let me remind people that HOOPP has comprehensive whistelblowing policies. I can't stress enough the need to protect whistleblowers in any organization, especially at pension funds.
  • On escaping the 2008 carnage: Mr. Crocker discussed what led to the asset mix shift into bonds which allowed HOOPP to escape much of the carnage which ravaged most pension funds in 2008. He told me that after the internet meltdown, HOOP went from fully funded to underfunded status. Jim Keohane, HOOPP's CIO soon to be CEO, went to Europe to talk to some funds about liability-driven investments. As HOOPP implemented LDI, it slowly shifted its asset mix away from the traditional 60/40 split. In the Fall of 2007, they sold $6B in equities, dropping the asset mix weighting to 46%. Mr. Crocker told me: "Q4 2008 was our payday but we still lost money that year (-12%). People were saying we were lucky but we were able to make 15% in 2009 and 14% in 2010, outperforming our benchmark and peers. And in 2008, the accountants forced us to take writedowns on certain fixed income investments or else our performance would have been 2 percentage points better."
  • On infrastructure: Mr. Crocker is skeptical of infrastructure as an asset class: "It's either an equity deal, a debt deal or a combination of both. The problem with infrastructure deals is that the government can move the goal post on you. I prefer structuring it as a debt deal because if you structure an equity deal and make too high returns, the government will want a piece of those returns." I too am increasingly skeptical of infrastructure as an asset class and think most pension funds don't have a clue of what they're investing in. Even Leo de Bever, the godfather of infrastructure, has cautioned investors against infrastructure.
  • On managing risk: Mr. Crocker told me that HOOPP's AAA balance sheet and tax free status allows them to engage in "lucrative tax arbitrage transactions. " HOOPP uses derivatives extensively and knows how to properly manage risk. They look at deals with asymmetric payoffs, offering them big returns with minimum downside risk. "We always ask how much money can we lose in any deal."
  • On internal operations: HOOPP manages assets almost exclusively internally. They do not invest in hedge funds and mostly co-invest in private equity in the mid sized space. Mr. Crocker told me that everyone at HOOPP manages a piece of the pie: "roughly 36 managers for $36 billion." And he added that they're a relatively small group so traders have the ability to shift and make money where the opportunities lie. "This keeps our investment people focused and motivated."

We then shifted focus from investments and operations to the bigger picture, delving into the challenges that lie ahead for defined-benefit plans during this era of deleveraging/deflation:

  • Like me, Mr. Crocker firmly believes in the defined-benefit model, stating that even though it's not perfect, it's far better than defined-contributions. "The current system doesn't work. The average Canadian has $60,000 in RRSPs (registered retirement savings plans) and Stats Canada estimates 3/4 of a trillion dollars in unused RRSPs contributions. Even if you increase the limit on RRSP contributions, it won't make a difference. Moreover, the cost structure of mutual funds doesn't work as excessive fees eat away at performance."
  • According to Mr. Crocker, "large, transparent DB plans work." They aren't perfect because people are retiring earlier and living longer but you can make plans more sustainable by raising the retirement age and adjusting the benefits. When I told him about US plans using an 8% discount rate based on rosy investment projections, he told me that's just "goofy governance."
  • The bottom line for Mr. Crocker is that RRSPs "demonstrably don't work" and that the way to go is through large public or private multi-employer DB plans. When I raised scale concerns about expanding the Canada Pension Plan by giving all the money to CPPIB, he agreed stating "I don't want a trillion dollar elephant managing Canadians' pensions."
  • Another very interesting point that Mr. Crocker brought up was on understanding the value of a HOOPP pension. He told me that many HOOPP members who were making less than $30,000 a year are retiring with an average pension of $1,500. "I talk to doctors, pharmacists and other healthcare professionals who we don't cover and they're working way past 65 years old to try to get those type of benefits." My humble father would agree as most doctors are notoriously terrible investors and wish they had an entity like HOOPP managing their pensions.
  • Finally, Mr. Crocker stressed that communication is important as there is a "huge amount of misinformation" on defined-benefit pension plans. "People think the government will need to top up our plan but we are fully funded and are likely going to close the year out with double-digit returns once again."

Barring a market meltdown, HOOPP is on track for another stellar year. Most Canadian pension funds are reeling after Q3. The success of this organization is a true testament that DB plans can work if you get the governance right. I thank Mr. Crocker for taking the time to discuss his views with me and wish him a great retirement.

I hope he doesn't fully retire, however, as I would like to see him replace Paul Cantor as the Chair of the board at PSPIB and continue his advocacy on the benefits of defined-benefit plans. We need more John Crockers in this world. You can watch this BNN interview where he discusses the success of HOOPP and benefits of DB plans in a volatile world. Finally, my heartfelt thoughts and prayers go out to all veterans and their loved ones on this Remembrance Day.

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