Monday, March 9, 2015

Fully Funded HOOPP Surges 17.7% in 2014

The Canadian Press reports, HOOPP reports 17.71% return in 2014, drives net asset to $60.8 billion:
The pension fund that invest on behalf of health-care workers in Ontario reported a 17.71 per cent rate of return for 2014.

The Healthcare of Ontario Pension Plan says the $9.1 billion in investment income exceeded its portfolio benchmark by more than $1 billion, and drove net assets to a record $60.8 billion from $51.6 billion at the end of 2013

HOOPP said the funded position of the pension plan remained stable at 115 per cent, up from 114 per cent in 2013.

President and CEO Jim Keohane attributed the results to the “liability driven investing” approach that the plan adopted several years ago.

“2014 was a year that highlighted the merits of the LDI approach,” Keohane said. “Sharp declines in interest rates, that were highly beneficial to our fixed income portfolio, offset the negative impact of the rate declines on our pension obligations.”

HOOPP’s approach utilizes two investment portfolios: a liability hedge portfolio that seeks to mitigate risks associated with pension obligations, and a return-seeking portfolio to help to keep contribution rates stable and affordable.

In 2014, the liability hedge portfolio provided about 72 per cent of HOOPP’s investment income. Nominal bonds and real return bonds provided most of the income within this portfolio, generating returns of 30.2 per cent and 13.4 per cent respectively. The real estate portfolio provided a 9.8 per cent return.

Within the return-seeking portfolio, public equities returned 10.4 per cent, while private equity posted a return of 16.3 per cent.
Barbara Shecter of the National Post also reports, HOOPP credits ‘liability-driven investing’ for 17.7% return in 2014:
The Healthcare of Ontario Pension Plan (HOOPP) posted a return of 17.7% for the year ended December 31, with net assets rising to a record $60.8 billion from $51.6 billion in 2013.

Investment income for the year more than doubled to $9.1 billion from $4 billion in 2012, and exceeded HOOPP’s portfolio benchmark by more than $1 billion.

The plans 10-year and 20-year returns are now 10.27% and 9.98%, respectively.

HOOPP’s funded position is stable at 115%, up slightly from 2013.

Jim Keohane, the pension manager’s chief executive, credited the plan’s “liability driven investing” approach for the results.

The approach uses two investment portfolios. The first, a liability hedge portfolio, is intended to mitigate risks associated with pension obligations, while the second, a return-seeking portfolio of public and private equities, is designed to earn “incremental” returns to help keep contribution rates stable and affordable.

In 2014, the liability hedge portfolio provided about 72% of the investment income. Nominal bonds and real return bonds provided most of the income within this portfolio, generating returns of 30.2% and 13.4% respectively.

“Sharp declines in interest rates, that were highly beneficial to our fixed income portfolio, offset the negative impact of the rate declines on our pension obligations,” Mr. Keohane said.

HOOPP has 295,000 members including nurses, medical technicians, food services staff and housekeeping staff that work for 470 employers in the health care field.
And Adam Mayers of the Toronto Star reports, Why this Ontario pension plan can afford to boost its benefits:
Ontario’s nurses, social workers, lab technicians and other hospital staff have a lot of reasons to smile today.

At a time when most pension plans are cutting benefits, their Healthcare of Ontario Pension Plan (HOOPP) has just increased inflation protection for its 295,000 members. Instead of covering 75 per cent of the annual increases in the cost of living, HOOPP is raising the bar to 100 per cent.

While many plans struggle with underfunding, Ontario’s third-largest pension fund has $1.15 on hand for every $1 it must spend. Stocks on the Toronto market returned 7.4 per cent on average in 2014, while HOOPP returned a record 17.71 per cent. The plan’s average return in each of the last 10 years is 10.27 per cent.

CEO Jim Keohane seemed almost embarrassed Wednesday as he discussed his annual results. He noted somberly, “We have the highest 10-year return of any global pension plan.”

Hey, let me in. Where can I get a pension plan like that? Well, in the private sector, nowhere.

The surest way to rouse readers from slumber to red hot anger is to suggest that anything in the public sector can be better than the same thing done privately. The profit motive is the only way to breed efficiency, some say. Let the market decide. Government and quasi-government agencies are fat, wasteful and largely corrupt. You can add lazy, unproductive and incompetent.

But when it comes to pensions, that’s not true. Ontario’s big public-sector funds are the top of their class. While companies want 110 per cent of our effort, they’ve largely rewarded workers by abandoning the sort of pension plans that provide security and let people sleep easy in retirement.

Some 76 per cent of private-sector employees don’t have a pension of any kind. Of those who do have a pension, less than half have defined benefit plans. When you do the math, only about one in 10 people working in the private sector has a defined benefit plan.

Such plans pay a monthly amount for life, putting the onus on companies to come up with the money. Corporate Canada doesn’t like that idea and has been bailing out, moving to defined contribution (DC) plans where they can throw some money in the pot to match workers’ contributions (if they’re lucky) and then wash their hands.

That leaves workers with all the risks and stress of investing and managing the money on retirement. These are skills most people don’t have.

The public sector still believes that collective effort can give a better outcome. So, 86 per cent of workers for provincial and local governments — people such as firefighters and police, those at universities and colleges and workers in health care — are covered by pension plans, mostly the defined benefit kind.

Pensions provide a broader social benefit beyond the cash in a pensioner’s pocket. According to HOOPP, 7 per cent of all income in Ontario comes from defined benefit pensions, which pay out about $27 billion a year, money that supports the communities where people live.

Keohane says 20 per cent of all income in Collingwood, for example, comes from pensions.

He says it’s a myth that taxpayers are footing the bill. In HOOPP’s case, 80 cents of every dollar in the $61 billion fund come from investment returns.

There are several reasons why an individual can’t hope to match the performance of a big fund with an RRSP. Big funds bring investing expertise and economies of scale to bear in a way that individuals cannot. It is precisely because they lack a “for-profit” motive that such funds can keep fees low and returns high.

Think of how many fees you might pay along the way when investing — for advisors, buying and selling stocks and funds, trailer fees, management expense ratios, fees you can’t see.

Big funds are also “patient money”, which means they can weather market ups and downs and not be forced to sell. The next “quarter” for HOOPP is 25 years, not three months.

OMERS, Ontario’s largest pension plan, also reported strong results last week. OMERS manages the assets of 450,000 municipal employees and earned a 10 per cent investment return in 2014.

The fund stumbled during the financial collapse of 2008 and has been working its way out of a hole. In 2014, OMERS made more progress, increasing its funding level to 91 cents per dollar needed, up from 88 cents a year ago. There’s still a long way to go to catch HOOPP, but it’s going the right way.

Our frayed faith and anger with our public institutions is well-deserved, and that general discontent spills over to public pension envy.

But a better target would be private-sector employers who have abandoned their workers because it’s expedient, leaving them to make financial decisions in retirement they are often ill-equipped to make.
You can read the press release HOOPP put out on their 2014 results here. As shown below, in 2014, the liability hedge portfolio provided approximately 72% of our investment income. Nominal bonds and real return bonds provided most of the income within this portfolio, generating returns of 30.2% and 13.4% respectively (click on image):


The real estate portfolio was also a contributor during the year, with a 9.8% return. Within the return seeking portfolio, public equities were the largest contributor to investment income, returning 10.4%. Private equity posted a return of 16.3%.

Now, you might be wondering how did HOOPP post such exceptional results, beating out OMERS which gained net 10% in 2014 and the Caisse which gained 12% in 2014? The answer is good old boring bonds! HOOPP's LDI approach means it's much more weighted in fixed income (44%) than its larger Canadian peers (click on image below).

And remember what I wrote when I discussed whether longevity risk will doom pensions:
.... I've got some very bad news for you, when global deflation hits us, it will decimate pensions. That's where I part ways with Mauldin because longevity risk, while important, is nothing compared to a substantial decline in real interest rates.

Importantly, a decline in real rates, especially now when rates are at historic lows, is far more detrimental to pension deficits than people living longer.

What else did Mauldin conveniently miss? He ignores the brutal truth on DC pensions and misses how the 'inexorable' shift to DC pensions will exacerbate inequality and pretty much condemn millions of Americans to more pension poverty.
In a world of historic low rates, any decline in rates disproportionately impacts pension deficits and that is why HOOPP will keep outperforming its peers if deflation sets in and rates keep falling.

Of course, there were skeptics on why HOOPP outperformed in 2014. One pension expert shared this with me:
HOOPP put up good numbers, especially with fully hedged USD investments. When they outline returns in the table, it looks like must have seriously leveraged bonds to get the returns, and it is weird how they identify only a couple of pieces the risk seeking equity bucket, some type of strategy cost them a lot of return, probably S&P put protection, and/ or their old option strategy that laid off equity risks for insurance companies at the time. Also, Jim Keohane alludes to moving out of bonds due to low rates, how can one actually do that and still claim LDI? It is important, in that those who seek to copy HOOPP, especially the LDI idea, need to understand the execution details.
There are a few things here that we need to clear up. First, did HOOPP seriously leveraged its bond portfolio in 2014? i will come back to this below but when you look at the returns the Caisse posted for its long-term bonds in 2014 (click on image below), HOOPP's returns look awfully suspicious:


How did the Caisse post an 18% return for long-term bonds while HOOPP posted 30%? Did leverage factor into the equation? This is something the Caisse's CIO, Roland Lescure, discussed with me when I went over their 2014 results:
You are right, we have significantly lowered leverage at the Caisse since 2009. Leverage is now solely used to fund part of our real estate portfolio and the (in)famous ABCP portfolio which will be gone by 2016. As you rightly point out, most Canadian pension funds use leverage to different degrees. Further, we also have significantly reduced risk by focusing our investments on quality companies and projects, which are less risky than the usual benchmark-driven investments. And those investments happen to have served us well as they did outperform the benchmarks significantly in 2014. You probably have all the details for each of our portfolios but I would point out that our Canadian equity portfolio outperformed the TSX by close to 300 bps. And the global quality equity portfolio did even better. 
Why do I bring this up? Because I hate when people look at headline returns and get all impressed without digging deeper into how those returns were achieved. Also, keep in mind what one senior pension portfolio manager shared with me when I went over the list of the highest paid pension CEOs:
"First and foremost, various funds use more leverage than others. This is the most differentiating factor in explaining performance across DB plans. In Canada, F/X policy will also impact performance of past 3 years. ‎It's very hard to compare returns because of vastly different invest policies; case in point is PSP's huge equity weighting (need to include all real estate, private equity and infrastructure) that has a huge beta."
I actually emailed Jim Keohane, CEO of HOOPP, today and last week to discuss how leverage contributed to their results. Jim cleared up any confusion sharing this with me:
With regard to the difference in returns between our bond portfolio and the Caisse, I can't comment on the Caisse portfolio, but our portfolio benefited from a significant holding in US Treasuries which materially outperformed long Canada's. Leverage was not a factor in this return.
There is no question that HOOPP took the right duration bet in 2014, going long Treasuries relative to Canada long bonds (the Caisse was short duration which is why they underperformed in Bonds in 2014). If you add in currency gains from a surging USD, HOOPP got an added return on its long U.S. bonds position in 2014.

On leverage, Jim also added this last week when I reached out to him:
A significant amount of the "leverage" we have results from the fact that we do all of our securities borrowing and lending in house rather than outsourcing the function to the custodian. Other funds have this same leverage but because they have outsourced the activity it shows up on the custodian's balance sheet instead of their own balance sheet. These types of activities significantly increase the size of the balance sheet but they contain very little risk.

We also run a number of funding strategies and long/short strategies and other absolute return strategies. Many of these strategies inflate the balance sheet but contain very little risk. Pursuing these strategies enables us to earn sufficient returns which enables us to reduce our exposure to public equities where the return streams are much more volatile and unpredictable. This reduces our overall funding risk.

The main driver of returns was our LDI approach. Several years ago our modeling showed us that a major decline in long term interest rates would impair our ability to meet our pension obligations. We knew that we needed to increase the interest rate sensitivity of the portfolio to hedge against this risk. We accomplished this by selling our physical equity portfolios and used the proceeds to buy long term bonds, then used an equity derivative overlay to maintain our equity exposure. When this risk played out in 2014, the present value of our liabilities increased materially, but our holdings in long term bonds increased the value of our assets to offset the increase in liabilities and allowed us to maintain our surplus. I guess you could call these synthetic positions that better match our liabilities leverage. I call it anticipating what could go wrong and taking actions to hedge against that risk - in other words risk management.

We are not using leverage to boost returns, we are using it to reduce risks. Our objective is to meet our pension obligations regardless of the economic backdrop and the restructuring of our balance sheet is what has enabled us to do this.
I also asked Jim about the S&P put strategy, which really helped them deliver great results in 2012, and whether it subtracted from their overall results. I also asked him how others can copy their approach. Jim replied:
On the equity side, the only strategy that subtracted value was a small tactical underweight in US equities we put on in the latter half of the year.

The returns reported for equities is the return on the derivative overlay position without the underlying assets. The underlying assets are bonds.

With regard to LDI, I believe that all plans should be managed with their liabilities in mind. LDI is not simply about owning long bonds, it is more about understanding the risks inherent in the liabilities and creating a portfolio which most effectively reduces those risks. Those risks are not constant over time so the portfolio has to be managed in a dynamic fashion. Very low interest rates mean that your interest rate sensitivity is lower so the need to hedge that risk is diminished.
To be honest, I'm not sure what he meant by that last sentence. In a low rate environment, your interest rate sensitivity (in terms of duration risk) is much higher as is the need to hedge that risk. I think what he meant is in a low rate environment, the risks of rates rising are bigger, which will help reduce liabilities.

But Jim is right, the LDI approach, when done correctly and dynamically, can significantly reduce funding risk, ie. the risk that your plan won't have enough assets to match liabilities.

Eric Fontaine of Pavillion Advisory Group confirmed some of what Jim discusses above, sharing this with me:
As you can see from the table below (click on image), it was also possible for an investor to achieve a return of over 30% in 2014 by investing in ‘unlevered’ super long term (20+ Strips) bonds, a strategy we have recommended to some of our clients not comfortable with leverage (although you get some curve risk).
Other investors could have achieved the same by using leverage and invest the proceeds in LT bonds (eg. 2 X LT BOND return, less marginal cost of borrowing gives you over 30%). Both are nice approaches to better match the duration of your assets and those of your liabilities (of 12-15 years) without given up the upside of the risky assets. The main risk though is an increase in the short-term rates combined with the decline of the risky assets, which we haven’t seem for a while now, so as HOOPP is saying, it is important to be dynamic about it and, I would add, to properly manage the risk inherent in risky assets!
On the funding side, it's important to keep in mind that HOOPP is a shared-risk plan, which means the stakeholders share the risks of any shortfall equally. If there are deficits, they cut benefits. Conversely, if there is a surplus, they increase benefits, which is the case this year (notice however, they are increasing cost-of-living adjustments, which are easier to cut down the road if there is trouble and pose less risk to the plan, especially if deflation sets in).

HOOPP actually does a great job communicating to its members through their regular newsletters putting pensions in perspective. I wish they had a lot more information on their strategies and compensation but it's a private plan catering to public sector employees (in my opinion, it should be turned into a public plan).

There are a few other interesting tidbits I read when I went over HOOPP's 2014 year in review. First, as is widely known, HOOPP manages almost everything internally, which is why they highest five-year net return in CEM's database of Canadian peer funds and the highest 10-year net return among 124 global funds (click on image):


In this regard, HOOPP follows the Oracle of Omaha who warned public pensions to stop pouring money into expensive, high-end money managers (this is why Buffett delivered exceptional long-term returns and one reason why PE firms are trying to emulate his long investment horizon approach).

Also, check out some quick facts on their members (click on image below):


You'll notice 84% are female and the average age of their active members is 45, which means they're a relatively young plan compared to Ontario Teachers' Pension Plan which is why they don't have to use as low a discount rate as the Oracle of Ontario and can take on more risk than Teachers.

More importantly, notice the average unreduced pension is $23,500, which is good but hardly as high as all the pension scaremongers keep harping on when they spew their ridiculous myths on DB pensions

Lastly, I've tried to write a very balanced and objective comment on HOOPP's solid returns. If you have anything to add, feel free to email me at LKolivakis@gmail.com. The results are impressive and HOOPP's members are in an enviable position but there are risks to such a high fixed income exposure, especially if rates rise considerably.

Having said this, a rise in rates also means liabilities will fall commensurately and HOOPP will still be able to maintain its fully funded status if it adds value over its overall benchmark. Jim and I discussed this in the past here.

Below, a video HOOPP put out on its website where Jim Keohane, its CEO,  explains 2014 results. I suggest other pensions copy HOOPP with similar videos explaining their results with an embeddable code for blogs (get on it, we're in 2015 and live in an era of social media! There are no excuses for not doing this!). HOOPP's Annual Report will be available soon and I look forward to reading it once it's available.

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