Friday, April 4, 2014

Ontario Teachers Gains 11% in 2013

Janet McFarland of the Globe and Mail reports, Teachers rides hot markets to first pension surplus in a decade:
The Ontario Teachers’ Pension Plan has moved into a surplus position for the first time in a decade, underscoring the dramatic improvement in the funding of Canadian pension funds over the past year.

The pension plan, which manages pension assets for 307,000 active and retired teachers in Ontario, said higher long-term interest rates and investment returns of 10.9 per cent last year have left it with a $5.1-billion surplus as of Jan. 1. It is the first surplus the plan has recorded since 2003.

The reversal in fortunes is part of a broad trend that has seen most pension plans in Canada largely eliminate their deficits over the past 12 months as a result of strong markets and higher interest rates.

Teachers turnaround also reflects the fact it has been a leader in making structural changes to its benefits. The Ontario Teachers’ Federation and the Ontario government – which jointly oversee the plan – agreed to increase contributions in recent years and reduce inflation indexing to cut the cost of funding the plan.

Since 2006, government and employee contributions to the pension plan have climbed from 8.9 per cent of annual income above the Canada Pension Plan pensionable earnings limit to 13.1 per cent. The two sides also agreed to eliminate a guarantee that pension benefits will be fully adjusted for inflation until the plan has enough surplus to afford full indexation again.

The surplus announced Tuesday means the plan would be 103-per-cent funded if it were wound up today.

However, Teachers chief executive Ron Mock called the new surplus “preliminary” and warned the pension plan could still face funding challenges. If full inflation protection were reintroduced and contributions were cut back to their 12-per-cent level from 2011, the plan would be just 91-per-cent funded.

“It’s a great result for this year, but that doesn’t mean that all the risks are gone as we look forward,” Mr. Mock told reporters Tuesday. “Interest rates and stock markets can go up and down with great volatility, so I believe we’re going to be managing through volatility on a going forward basis.”

Among its challenges, Teachers has had to grapple with funding for a membership – including a high proportion of women – who live longer than the general population. On average, members of the Teachers’ pension plan are working for 26 years and collecting pensions for 31 years, a ratio that has reversed from 1970 when members worked an average of 27 years and were retired for 20 years.

Mr. Mock said the Ontario government and the Ontario Teachers Federation will make the decisions about what will happen with the surplus in the fund, including when benefits or contributions will be adjusted.

Mr. Mock became CEO of Teachers on Jan. 1 following the retirement of former CEO Jim Leech. The fund’s salary disclosure, released Tuesday, shows Mr. Leech earned total compensation of $8.6-million last year due largely to a $6.5-million payout of long-term incentive units. Mr. Mock’s total compensation was $2.9-million.

Teachers said a 27.6-per-cent return on its equity investments was responsible for much of the improvement in its financial position in 2013. The gains helped the fund increase its total assets to a record $140.8-billion from $129.5-billion at the end of 2012.

The equity returns were partly offset by fixed income holdings, such as long-term bonds, which lost 7.9 per cent in 2013.

Chief investment officer Neil Petroff said the bond portfolio was hit by rising long-term interest rates last year, which he said had become “unrealistically low” in 2012.

“I think we have seen the low,” he added. “After 30 years of rates dropping, the short end will stay low for probably another year. The long end we’re starting to see that there could be some sort of stronger growth.”

Although higher interest rates hurt the bond portfolio, they helped Teachers’ overall funded status because the present value of a pension fund’s liabilities is calculated using long-term bond rates. The higher that rates climb, the lower the amount of money that must be set aside to cover future pensions.

Other pension funds have also benefitted from higher rates and strong markets. The average funding of 275 Canadian plans reached 95 per cent as of March 31, according to a review released this week by pension consulting firm Aon Hewitt.
Barbara Shecter of the National Post also reports, Ontario Teachers’ Pension Plan posts first surplus in 10 years:
The Ontario Teachers’ Pension Plan posted its first funding surplus in 10 years on the back of strong investment returns and an increase in interest rates.

The plan was 103% funded as of Jan. 1, with a preliminary funding surplus of just over $5-billion. But Ron Mock, the pension giant’s new chief executive, says that would not be the case if the plan’s sponsors had not adopted changes to sustain the plan — such as making inflation protection dependent on the plan’s financial health.

Teachers’ posted a return of 10.9% for the year ended December 31, boosting net assets to $140.8-billion from $129.5-billion at the end of 2012.

The plan exceeded its consolidated investing benchmark of 9.3%, with investment income contributing $13.7-billion, $1-million less than the prior year. Much of the plan’s growth in 2013 was delivered by the equities portfolio, which registered a one-year return of 27.6%.

Despite the double-digit returns, Mr. Mock, who took the top job at the Teachers’ pension plan on Jan. 1, said the plan would have been only 91% funded at the start of this year if full inflation protection were restored and contributions were reduced to their base level of 12%.

“Other plans and jurisdictions can look to our sponsors [the Ontario government and the Ontario Teachers’ Federation] as among the most practical and prudent in adopting changes to sustain the plan’s strength in the face of a number of challenges,” he said.

Mr. Mock called preliminary surplus good news, but he cautioned that the plan “continues to face demographic challenges as well as market uncertainty.”

Teachers tend to live longer than the general population and, as a result, the average member of the pension plan is retired for five years longer than he or she contributed to the plan. There are currently 2,900 pensioners who are 90 or older, including 126 who are at least 100.

Since the plan’s inception in 1990, investments have generated income that has accounted for 77% of the funding for pensions. The remainder has come from contributions from the government and plan members.

“Our portfolio of assets performed very well in 2013 and outperforming our benchmark further adds to the sustainability of our plan and supports our goal of retirement security,” said Mr. Mock, who took the reins as president and chief executive of Teachers’ when Jim Leech retired in December.

Mr. Mock said he expects the next decade at Teachers’ will differ from the past because it will be marked by competition among pension funds and other large pools of capital, including sovereign wealth and private equity funds.

“I never thought I’d say these words — pension plan and competition — in the same sentence,” he said, adding that other large capital pools have nevertheless begun to make the kinds of investments in infrastructure and real estate popularized by pension funds such as Teachers.

“Clearly, the competition has heated up in these areas,” he said.

Teachers’ won’t be tempted into overpaying for investments, Mr. Mock said. Instead, the Canadian fund will seek out individual investments and unique “one-off” opportunities through its network of relationships and partnerships in geographies including Europe, Asia and South America.

“We have to continue to cultivate them [to] drive the return profiles we need,” he said. “It’s not easy these days to find value.”

The new path, including a pledge to avoid large competitive auctions, might draw the Canadian pension plan operator into new areas, but Teachers’ already has a “culture of being an early adopter,” he said. It was the first pension plan operator to make a large real estate investment through the purchase of Cadillac Fairview, as well as the first to invest in hedge funds in the mid-1990s, and derivatives.

“Our history has been one of trying things; they haven’t all worked out,” Mr. Mock acknowledged. But some, like Cadillac Fairview, have paid off handsomely for the pension plan.

“Quite frankly, you’re not going to get it right on each and every investment,” he said. “But we always start slowly. We don’t jump in with both feet.”
And Katia Dmitrieva of Bloomberg reports, Ontario Teachers’ Posts 11% Return on Equity Rally:
Ontario Teachers’ Pension Plan, the largest pension in Canada’s most populous province, returned 11 percent in 2013 as stocks rallied and real estate investments rose.

The pension manager reached a record C$140.8 billion ($127 billion) in assets for the year, according to a statement today. Investment income was C$13.7 billion, down from C$14.7 billion in 2012.

“It’s a great result but it doesn’t mean the risks are gone,” Chief Executive Officer Ron Mock, who succeeded Jim Leech on Jan. 1, told reporters today. “We’re going to be managing through volatility on a go-forward basis. We cannot be complacent in managing assets.”

Ontario Teachers’ missed the 14 percent median return for Canadian pension funds last year, according to Royal Bank of Canada’s RBC Investor & Treasury Services unit. Like other Canadian pensions, the fund is struggling to meet liabilities of an aging population. The pension said 126 of its members are older than 100.

“The next decade will not be like the last one,” Mock said at the fund’s headquarters in Toronto. “’Pension plan’ and ‘competition’ in the same sentence sounds like a bit of an oxymoron but with large pools of capital all looking for investment opportunities globally now, the next decade will be marked by competition.”
Hedge Funds

The fund was the first Canadian pension manager to invest in hedge funds in 1996 and the first to have an active real estate unit. Over the next decade, the fund will focus on discovering new industries and investments, hiring and training new employees to drive quick deals, and on expanding abroad, Mock said. It opened a Hong Kong office last year and is deciding on its next international location.

Ontario Teachers’ will be maintaining its asset mix in the near term, Mock said. The fund decreased its equities allocation to 45 percent of its total portfolio and increased its real estate holdings to 14 percent. Meanwhile, the fund dropped fixed-income exposure to 41 percent from 48 percent in 2012.

The Toronto-based fund’s equities portfolio gained the most last year, returning 28 percent as stocks gained, with the Standard & Poor’s 500 Index surging 30 percent. The pension’s private capital unit returned 27 percent and infrastructure assets gained 17 percent. Cadillac Fairview, Ontario Teachers’ real estate arm, rose 13 percent.

Bonds lagged, with the fixed-income portfolio declining 7.9 percent. Ontario Teachers’ will continue seeking longer-duration bonds to closely match the liabilities of their 307,000 working and retired members, Chief Investment Officer Neil Petroff said.
You can read the press release of Ontario Teachers' 2013 results here. The results were released earlier this week but I wanted to speak with Ron Mock,  OTPP's President and CEO, before posting a comment. I had a chance to squeeze into 30 minutes of Ron's busy schedule this morning before my workout and provide the key points of our conversation below:
  • DB pensions with risk sharing: Ron believes the way forward for bolstering retirement security is through defined-benefit (DB) pensions. But he rightly added that in order to sustain these plans for the long-run, DB plans have to evolve and benefits have to be a lot more flexible and tied to the reality of markets. In particular, he rightly notes that inflation protection is very costly and for every 1% or 100 basis point decline in real rates, the liabilities of Teachers' plan goes up $30 billion. Their discount rate is tied to real rates plus a spread of 100 or 140 basis points, which is one of the lowest discount rates in the world. Some say this is too conservative but Ron calls it "realistic."He emphasized that all stakeholders "need to work together"to ensure the sustainability of a pension plan. Importantly, he rightly notes investment gains alone will not ensure the sustainability of Teachers' plan but it will "ease the burden." He added: "There needs to be a pressure release valve" if things go wrong and partially or fully removing inflation protection is one way to relieve the pressure of underfunded plans when markets get whacked and plans experience deficits. (See comments from HOOPP's CEO,Jim Keohane, here and read about the mess Chicago's pension plans are here).
  • DC pensions are a disaster: We both agreed that defined-contribution (DC) plans and RRSPs are a disaster. Ron brought up his sister who like millions of other Canadians invests in mutual funds. These people are getting raped on fees, the performance is lousy and they have no guaranteed income when they retire, only savings that are tied to the vagaries of the market. At least Ontario's teachers retire with a decent income of over $40,000 a year until they die. Very few Canadians in DC plans or with RRSPs can say the same. 
  • Demographic of Teachers' plan: Ontario Teachers' Pension Plan has an older profile than most other plans. Teachers, god bless them, live five years longer on average than average Canadians. What this means is that Teachers' plan has more longevity risk to deal with. Also, there are more retired Ontario teachers than working members. Ron brought up a good point: "If you have ten active working members for every one retiree, you can spread an $100 million loss more easily to working members than if you have one working member for every ten retirees." I told Ron that Jim Keohane of HOOPP told me that Teachers' older demographics means they should be taken less risk than HOOPP, which he agreed with (but truth is Teachers takes more equity risk than HOOPP which is why they outperformed them in 2013). 
  • On deflation vs inflation: We talked about deflation and inflation. I told him that I'm in the Michael Hudson camp and think the world will experience a prolonged period of debt deflation once central banks pull the liquidity punch bowl. He told me he's not in the deflation camp but "the risks of deflation have risen significantly over the last year" and that the status quo of job creation isn't enough. "If we meander like this for years, it will be the worst outcome." We both agreed with Soros that Europe is in a prolonged period of stagnation.
  • Eike Batista and Brazil's bust: I asked Ron flat out, did Eike Batista burn Ontario Teachers? Ron reiterated what Jim Leech, his predecessor, told me, that Eike's bankruptcy "did not hurt a lot because we got in and out at a very good point." He added: "We've had nothing but great experiences in Brazil." (Teachers invests in Brazilian real estate, private equity and hedge funds).
  • On managing liquidity risk: I asked Ron to give me his thoughts on private market investments and managing liquidity risk. He said Teachers' portfolio in real estate and infrastructure has excellent long-term assets but he raised pricing concerns in private equity where many deals "are expensive." He's not willing to engage in bidding wars with other pension funds and sovereign wealth funds on pricey deals. In terms of asset allocation, he told me Teachers' manages liquidity risk very carefully and they don't over-invest in private markets because "when the next 2008 hits, and it will happen again, we want to withstand that market disruption and make sure we can cover all our obligations." He rightly notes that pensions that do not monitor liquidity risk and invest too much in private markets will get caught when the next market disruption hits (returns on private markets are higher than stocks or bonds, so you have to be careful when running asset allocation models not to allow private markets to take over your entire portfolio). The same goes with hedge funds, where Teachers has a sizable allocation, and got slammed hard in 2008. Since then, they shifted mostly into managed accounts to "manage liquidity risk, have more transparency and control." You can read more on their hedge fund strategy here.
I invite you to carefully read Ontario Teachers' annual report here.  The Annual Meeting for pension plan members takes place Thursday, April 10, 2014. You can attend or listen to a live webcast.

I thank Ron Mock for taking the time to discuss Teachers' results. Every time we talk, I realize how lucky Teachers' employees and members are to have him at the helm.


Below, Ontario Teachers' new President and CEO Ron Mock goes over 2013 results. Ron is more of an introvert than his predecessor but listen to him carefully, he's a great communicator and sharp as hell.