Wednesday, April 3, 2013

Ontario Teachers' Returns 13% in 2012

Barbara Shecter of the Financial Post reports, Teachers’ pension returns 13% in 2012, but continues to battle demographics:
The Ontario Teachers’ Pension Plan delivered a 13% rate of return for the year ended December 31, but the multibillion-dollar plan continues to face pressure from sustained low interest rates and challenging demographics.

The results last year drove net assets up to $129.5-billion from $117.1-billion at the end of 2011.

“Returns earned above our benchmark directly support the goal of pension security and demonstrate the value of our approach to active investing,” said Jim Leech, chief executive of Teachers, who also announced Tuesday that he plans to step down at the end of the year.

Mr. Leech said he has informed the board of Canada’s largest single-profession pension plan about his planned retirement on Dec. 31, and a search is being conducted for his replacement.

“They’ve been running a very intensive process, looking externally and internally,” said Mr. Leech, who is turning 66 in June.

He said the plan’s investment team “successfully navigated significant risks and turmoil in the global economy” to earn “excellent” returns in 2012. Investment earnings were $14.7-billion, compared to $11.7-billion in 2011.

The 10-year annualized rate of return is 9.6% and the fund’s total value has nearly doubled since 2002, when net assets were $66.2-billion.

But despite a recent string of double-digit returns, the Teachers’ pension plan was only 97% funded as of Jan. 1, 2013.

Just last year, changes were made by the plan’s sponsors to balance plan assets and liabilities. The Ontario Government and the Ontario Teachers’ Federation agreed to make inflation protection on service credit earned after 2013 conditional on the plan’s funded status.

However, a preliminary shortfall of $5.1-billion was projected due to declining interest rates which drove up the projected cost of future benefits.

Many plans face challenges from sustained low interest rates, but the Teachers’ pension plan faces unique challenges related to demographics and years of service.

Longevity rates for teachers are among the highest in the country, and the pension plan now has 2,800 pensioners over the age of 90, including 107 who have reached or passed age 100.

The average number of years worked is 26, compared to an average 31 years on a pension.

Mr. Leech said he is encouraged that the plan’s sponsors are “committed to address the imbalance for the next valuation filing with the regulator.”

“While the defined benefit pension is far and away the superior and least expensive model for retirement financing because it pools funding, longevity and asset mix risk, it must evolve to this new demographic and financial reality,” said Mr. Leech.

“This means building flexibility into the cost of benefits to ensure their affordability for pension plan members and sponsors alike for years to come.”

Since 1990, investment income has accounted for 77% of the funding of members’ pensions, with the balance coming from member and government contributions.
I've already discussed how the Oracle of Ontario uses a discount rate of 5.4% to determine the value of future liabilities. This is one the lowest in the world. Most U.S. plans still use 7.5% to 8% and most Canadian plans use a discount rate closer to 6.3%.

Given the different demographic profile of Ontario Teachers' Pension Plan (older members), it would be appropriate for them to use a lower discount rate than most other Canadian and U.S. plans, but some experts have told me the discount rate they use is extremely conservative, overstating their liabilities and understating their funded status. 

For all intensive purposes, 97% funded status is excellent, as close to fully-funded status as you can get. I don't consider this deficit unmanageable or troublesome in the least. A small rise in interest rates will wipe it out completely, especially if it is coupled with the strong investment gains Ontario Teachers' consistently delivers.

As far as investments, Doug Alexander of  Bloomberg reports, Ontario Teachers’ Pension Fund Returned 13% on Stocks:
Ontario Teachers’ Pension Plan, Canada’s third-biggest retirement-fund manager, posted a 13 percent return on investments in 2012, led by real estate, private equity and stocks.

Net investment income rose to C$14.7 billion ($14.5 billion) from C$11.7 billion in 2011, the Toronto-based pension- fund manager said today in a statement. The fund managed C$129.5 billion in assets as of Dec. 31, up from C$117.1 billion a year earlier.

“The investment team successfully navigated significant risks and turmoil in the global economy again in 2012 to earn an excellent rate of return,” Chief Executive Officer Jim Leech, 65, said in the statement. “This was an oustanding achievement during a challenging year.”

Ontario Teachers’ beat the 9.4 percent median return of Canadian pension funds in 2012, based on a Jan. 29 report by Royal Bank of Canada’s RBC Investor Services unit. In comparison, Caisse de Depot et Placement du Quebec, Canada’s largest pension-fund manager, returned 9.6 percent, Ontario Municipal Employees Retirement System gained 10 percent, and Healthcare of Ontario Pension Plan rose 17 percent.

Teachers’ is responsible for investing and managing pensions for about 303,000 active and retired teachers in Canada’s most populous province.

Teachers’ said public and private equity investments returned 14 percent in 2012, while fixed income holdings returned 5.1 percent. Commodities lost 1.9 percent last year.

Investments held by Teachers’ private-equity unit returned 19 percent in 2012, the pension fund said. Teachers’ Private Capital managed C$12 billion of assets at the end of the year, compared with C$12.2 billion a year earlier.

Real assets such as real estate, infrastructure and timberland returned about 15 percent. The fund’s real-estate portfolio, which had C$16.9 billion of assets, returned 19 percent for the year.

Teachers’ estimated funding shortfall was C$5.1 billion, down from C$9.6 billion a year earlier, after changes to inflation-protection guarantees for plan members were announced in February.
Readers can download Ontario Teachers' full 2012 Annual Report by clicking here. You can also download the Commentary and Management Discussion & Analysis portion by clicking here. Both documents are excellent, providing details on assets and liabilities, examining the funding shortfall and state of the plan.

On the investment front, the main story was strong outperformance in private equity and real estate, but public markets and absolute return strategies also delivered exceptional results. Below, you can view the rates of return of various asset classes compared to benchmarks (click on image):

Moreover, these strong results were delivered on a cost effective basis, which is where the real value of a well governed DB plan comes into play. Total investment costs were $302 million or 25 cents per $100 of average net assets, compared to $289 million or 27 cents per $100 in 2011.

There is an interesting discussion (page 37) on absolute return strategies, which are conducted internally and through allocations to external hedge fund managers:
We use absolute return strategies to generate positive returns that are constructed to be uncorrelated to the returns of our other asset classes. Our internally managed absolute return strategies generally look to capitalize on market inefficiencies. We also use external hedge fund managers to earn uncorrelated returns, accessing unique strategies that augment returns and diversify risk.

Assets employed in absolute return strategies totalled $12.3 billion at year end, unchanged from December 31, 2011 (click on image below). Money-market activity provides funding for investments in all asset classes, and is comparable to a treasury department in a corporation. Derivative contracts and bond repurchase agreements have played a large part in our investment program since the early 1990s. For efficiency reasons, we often use derivatives to gain passive exposure to global equity and commodity indices instead of buying the actual securities. We use bond repurchase agreements to fund investments in all asset classes because it is cost effective and allows us to retain our economic exposure to government bonds.

When it comes to delivering added value in absolute return strategies, Teachers' uses a similar approach to the Healthcare of Ontario Pension Plan (HOOPP) which gained 17.1% in 2012. Derivatives, bond repurchases, tactical asset allocation and fixed income arbitrage strategies are all used to add value.

The only difference is HOOPP delivers alpha internally whereas Teachers' will allocate significant amounts to external managers providing unique strategies that are not easily replicated internally, leveraging off these relationships to gain an informational edge. And as I mentioned in a recent comment, Teachers' got the green light to absorb more risk, allowing them to put more money at risk in emerging markets, stocks and private equity.

Below, Jim Leech, CEO of the Ontario Teachers’ Pension Plan, on BNN discussing 2012 performance.Want to congratulate the entire team at Ontario Teachers' for another outstanding year and wish Jim Leech a happy and healthy retirement when he steps down at the end of the year.

Still remember my last trip at Teachers' offices when Jim asked me and a commodities manager who we were waiting to see. He then proceeded to find them himself. Very nice and classy move from the CEO of one of the world's best pension plans, which goes to show you values of an organization are set from the top down.