Friday, March 7, 2014

Overfunded HOOPP Gains 8.6% in 2013

Jacqueline Nelson of the Globe and Mail reports, HOOPP puffs up financial cushion in 2013:
The Healthcare of Ontario Pension Plan (HOOPP) posted investment returns of 8.6 per cent last year, below the industry average but enough to fatten even further its already significant surplus.

The pension fund, which represents 286,000 members working within the province’s health-care sector, had a funding ratio of 114 per cent at the end of 2013, meaning it has more assets than it would need to pay all of its pension obligations if it were wrapped up immediately.

“It gives you a lot of safety in the pension plan, so if 2008 happened again we’d still be fully funded,” said Jim Keohane, chief executive officer of HOOPP, in an interview. “It gives you a real cushion for problems down the road, which will inevitably happen again.”

Many Canadian pension plans made major investment gains in 2013, as stronger global equity markets helped make up for the low interest rates that have persisted in recent years. Plans earned an average of 14 per cent on their investments last year, according to RBC Investor & Treasury Services.

HOOPP’s net assets reached a record high of $51.6-billion at the end of the year, but its latest annual results fall short of its 2012 performance, when the plan posted a 17-per-cent return – its best results in more than a decade.

The drop in returns can be attributed to the plan’s liability-driven investment (LDI) strategy, which focuses on matching the plan’s assets with its future liabilities in a way that reduces volatility and risk. To meet that goal, the plan owns a hefty amount of long-term bonds, but holds fewer equities. It also uses complex derivatives strategies to enhance returns.

Since rising interest rates caused bond prices to fall last year, the plan’s returns were lower than previous years. Meanwhile, strong stock market performance benefited HOOPP’s peers that hold more equities.

The average Canadian pension plan was more than 99-per-cent funded at the end of last year, according to a report by consulting firm Mercer. That was a major improvement from a year earlier, when 60 per cent of pension plans were less than 80-per-cent funded. Mercer forecast that more strong investment gains this year could vault many funds into surplus status.

While HOOPP didn’t benefit as much as some of its peers from big stock market gains, the funded status of the plan rose as much in 2013 as during the year prior, when its investment returns were much stronger. That’s because rising interest rates caused the present value of the pension plan’s liabilities to decline.

HOOPP said its annual rate of return has averaged 9.7 per cent over the past 10 years. It is off to a good start this year, but it’s too soon to predict how 2014 will turn out, Mr. Keohane said.

Right now, HOOPP’s managers are cautious about investing in equities, which Mr. Keohane said appear to be expensive in general. “Valuations drive a lot of what we do, and valuations are the highest we’ve seen since 2007,” he said of the global markets. “Risk premiums, in general, are getting pretty skinny.”

Its emphasis on buying assets at the right price has kept the fund from investing in infrastructure, which has been an area of increasing focus for other pension funds and asset managers in recent years. Mr. Keohane doesn’t rule out infrastructure investment, but said the price would have to be right for him to tie up money in these illiquid assets.
And Katia Dmitrieva of Bloomberg reports, HOOPP Returns 8.6 Percent as Assets Reach Record:
The Healthcare of Ontario Pension Plan, one of the country’s largest pension funds, returned 8.6 percent in 2013 as real estate and equity investments rallied.

Assets rose to a record C$51.6 billion ($46.9 billion) and investment income was C$4 billion last year, compared with C$6.8 billion in 2012, according to the Toronto-based firm.

The result was below a 17 percent return on investments in 2012 when assets were at C$47.4 billion. HOOPP, as the fund is known, also missed the 14 percent median return for Canadian pension funds in the year ended Dec. 31, according to Royal Bank of Canada’s RBC Investor & Treasury Services unit.

“The results were led by equities -- they did quite well,” Jim Keohane, HOOPP chief executive officer, said by phone today. “Now we’re a bit more cautious on equity markets than we’ve been for the last few years because valuations are high.”

HOOPP’s U.S. equities portfolio returned 28 percent, private equities returned 27 percent, and its real estate holdings gained 14 percent, bolstering the pension manager’s performance in 2013, Keohane said.

The pension manager reached a funded ratio of 114 percent, HOOPP said in a statement today.
Shopping Malls

HOOPP purchased two shopping centers in Ontario and an office tower in Edmonton, Alberta, last year through partner Morguard Real Estate Investment Trust. The firm also announced it was investing alongside closely-held real estate developer Menkes Developments Ltd. in a new Toronto office property that began construction Jan. 15 last year.

HOOPP oversees retirement funds for about 275,000 nurses, medical technicians, food services staff, laundry workers and other healthcare workers.
You can read the press release of HOOPP's 2013 results here. There is also an excellent Management’s Discussion & Analysis which goes into detail on their performance and funding surplus. The annual report will be made available in a couple of weeks.

I had a chance to talk to Jim Keohane, President and CEO of HOOPP, yesterday afternoon. Jim is one of the most ardent supporters of my blog and he was gracious enough to take the time to discuss HOOPP's 2013 results (I thank Martin Biefer, Director, Public Affairs at HOOPP for setting up the call and giving me a heads up on their results).

The first question I asked Jim was why the headline number came in well below the 14% median return for Canadian pension funds. Jim told me he has a hard time believing that figure from RBC Dexia but in any case the main reason why is that HOOPP holds a lot more bonds than any other pension fund and is focused on asset-liability management, not shooting the lights out in terms of performance.

In his own words: "Our liability hedging portfolio is made up of 12.5% real estate, 12.5% real return bonds and 70% nominal bonds. We add an equity overlay on top of that."

He added: "We hold a lot of bonds and expect to under-perform our large peers when interest rates rise and stocks soar, which is what happened in 2013. But we don't care because that is the best environment in terms of our funding status."

Indeed, HOOPP is in an enviable position because unlike others, it's not only fully funded, it's overfunded. That 114% funded ratio is based on a regulatory 5-year smoothing. Moreover, the Canada Revenue Agency forces them to cut that surplus by increasing benefits, cutting contribution rates or derisk the plan.

Also, Jim pointed out "there are intergenerational issues with maintaining current contribution rate when you're fully funded as the current generation is subsidizing future generations of the plan."

Jim and I talked about that. I told him I don't believe in contribution holidays or cuts in the contribution rate. He told me the last time they did that, it was a painful lesson. "Members don't react well when they see contributions rising from 2% of their paycheck to 8%."

We both agreed the smartest move is to fully index cost of living adjustments from the current 75% index and this way if they need to cut benefits in the future, they can cut the COLA. In any case, HOOPP's members are in an enviable position as their plan is in excellent shape. In fact, HOOPP is arguably the best defined-benefit plan in the world and Harvard's Business School should do a case study on them so U.S. public pension funds can understand their success in managing assets and liabilities.

In fact, I really got into a good discussion with Jim on liability hedging. I told him I'm firmly in the deflation camp and don't understand why any Canadian pension fund bought real return bonds in 2013 (OMERS got killed on RRBs in 2013).  Jim told me that RRBs are a good hedge against CPI inflation but he prefers real estate to hedge against wage inflation. "With real estate, 1/3 of the cost of a building are materials and 2/3 are labor costs."

All true but if my prediction turns out right and deflation eventually swamps the global economy despite central banks' efforts to reflate risk assets and introduce inflation into the system, all these inflation-sensitive assets are going to get killed, including real estate. Still, if deflation takes hold, HOOPP will outperform its peers because of its higher allocation in nominal bonds.

I told him I'm bearish on Canada and recommended heavily shorting the loonie back in December and see our currency falling back to 70 cents U.S. in the next two years (hardly surprising to me, the loonie fell sharply today after disappointing jobs numbers).  Jim agreed and told me he wouldn't be surprised if our currency "overshoots" to the downside. He also told me that shale gas production is booming in the U.S. and we are going to be exporting less oil to our southern neighbor, which will weigh heavily on our Canadian dollar.

As far as return drivers in 2013, strong gains in private equity (26.8%), real estate (14.1%) and their internal absolute return strategies (added $123 million) all helped HOOPP deliver another strong year in terms of value-add, gaining 209 basis points over their target rate (click on image below):


The performance and value-add wasn't as strong as in 2012, when HOOPP gained 17.1% and added 289 basis points over its benchmark target rate but it was still another outstanding year in terms of value-added. Any time you see 200 basis points+ in terms of value-add over benchmark, it's impressive (and HOOPP's benchmarks aren't easy to beat).

Jim told me they continued making money off their long-term option strategy. In fact, it added $1.7B to the $4.5 B in net investment returns.

Overall, these are excellent results. It's important to understand why HOOPP didn't outperform its peers that are more heavily weighted in equities but still managed to deliver a solid 8.6 % net gain (not 6.5% gross like OMERS) and a top decile performance in terms of value-added, adding 209 basis points over their target rate of 6.5%.

One thing I did learn is that while HOOPP does all absolute return (hedge fund) strategies internally, it does invest in funds and co-invest in private equity. In the past, they used to be sole investors in smaller less well known funds but given their size, they will be forced to invest in bigger brand name funds as assets under management grow.

And keep in mind what ultimately matters for any defined-benefit pension plan is funded status and long-term performance. Thanks to solid funding, the contribution rates made by HOOPP members and employers have been stable for a decade. HOOPP’s rate of return over the past decade is a solid 9.66%, which places is one of the best among its large peers. Take the time to read read HOOPP's Management’s Discussion & Analysis, it is excellent.

Below, Jim Keohane, President and CEO of HOOPP, discusses their 2013 results and why even though their results are lower than their peers, they're in better shape due to their enviable funded status. I thank Jim Keohane, Martin Biefer and Chris Allen, the IT whiz who graciously showed me where their embed code so I can embed this video.

All the employees at HOOPP should be proud of these results and they're lucky to have Jim as their leader. He understands how important it is to have engagement from all of HOOPP's employees and agrees with me that money alone isn't enough to attract and retain great talent. You need the right culture and HOOPP has it.