Tuesday, March 10, 2015

OMERS Gains 10% in 2014

Janet McFarland of the Globe and Mail reports, OMERS earns 10% return in 2014, reduces funding shortfall:
The pension plan for Ontario municipal employees earned a 10-per-cent investment return in 2014 and reduced its funding shortfall as it continued to implement a new lower-risk investment strategy.

The Ontario Municipal Employees Retirement System reported its assets climbed to $72-billion in 2014, up from $65-billion at the end of 2013. The plan is now 90.8 per cent funded, up from 88.2 per cent a year earlier.

OMERS, which manages assets for 450,000 Ontario employees and retirees, has faced a significant funding shortfall since the financial crisis in 2008 when it reported a 15-per-cent loss that cost the fund $8-billion. In 2010, OMERS implemented a plan to eliminate the deficit by 2025, including a contribution increase for members to be phased in over three years.

The 2014 results are the first reported by new OMERS chief executive officer Michael Latimer, who replaced retiring CEO Michael Nobrega last year.

“Given that I’ve come in on April 1 of last year, we have an opportunity to take a view of our strategy, and so we’re doing that with our board,” Mr. Latimer said. “I think once we establish that road map … we will put the pin in the map, and we’ll be focused.”

In the mean time, OMERS has already pledged to increase its exposure to infrastructure investments in countries such as Canada and the U.S., as well as Australia.

“We’ve got more appetite for infrastructure. We like the stable cash flows that infrastructure provides to the portfolio,” said Jonathan Simmons, chief financial officer at OMERS.

Mr. Latimer added that out of the opportunities he sees to invest in private equity, real estate and infrastructure, “the one that sits on the top of the priority list for us is … infrastructure.”

OMERS said its Borealis Infrastructure division posted gains of 12.7 per cent, Oxford Properties real estate earned 8.7 per cent and OMERS Private Equity investments earned 14.4 per cent.

As of 2014, OMERS’ portfolio was weighted towards the public markets, which made up 58 per cent of investments. Within a few years, Mr. Latimer intends to reduce that to about 53 per cent.

OMERS needs to earn a long-term 6.5-per-cent annualized return on its investments to meet its pension obligations. The fund currently has a net five-year annualized rate of return of 7.9 per cent, and a 10-year annualized return of 7 per cent. OMERS says that 2014 results beat its benchmark of 7.7 per cent.

The fund’s 10-per-cent return for 2014 is an improvement from 6.5 per cent earned in 2013, when OMERS introduced a new investment strategy that lost money. The strategy is aimed at reducing public market investments such as stocks and plain-vanilla bonds, replacing them with a lower-risk portfolio with holdings such as inflation-linked bonds and commodities, reducing the risk of losses from major market crashes.

The portfolio lost $407-million in 2013, however, due to a sudden spike in interest rates. OMERS did not detail the results for the new portfolio in 2014, but the fund said its $41-billion capital markets portfolio in total earned returns of 10.7 per cent for the year. Investments in bonds performed well, helping boost returns this year.

The only negative return for a major investment group was posted by OMERS Strategic Investments, which lost 10 per cent last year.

Strategic Investments is the smallest of OMERS main divisions with $2.2-billion in assets invested in alternative areas, including resources and energy, venture capital and emerging new markets such as airport management and lottery operations. OMERS annual report last year said 53 per cent of the division’s holdings at the end of 2013 were in the Alberta oil and gas sector, which drove returns down in the year.
John Tilak and Euan Rocha of Reuters also report, Canada's OMERS posts solid 2014 results, targets asset mix shift:
Canadian pension plan OMERS said on Friday it generated a 10 percent return in 2014 on the back of big gains in investments in public and private markets, and it plans to make a gradual shift in its portfolio asset mix over the next 3 to 5 years.

OMERS, or the Ontario Municipal Employees Retirement System, said net assets rose to C$72 billion ($57.71 billion) at the end of 2014, from C$65.1 billion at the end of 2013.

The company is seeing momentum in infrastructure investments and also recorded higher investment returns in its real estate and private equity segments.

"My own view is that the story will continue to be around the alternative asset space," Chief Executive Michael Latimer said at a press conference. "And that is a reflection of the flow of capital."

Alternative assets from office buildings to rare stamps, or infrastructure assets to artwork, are typically less liquid and harder to value than publicly traded assets, but they allow big investors like pension funds to diversify their portfolios and avoid the perils of market volatility.

The pension fund manager said its public-sector investments returned 10.7 percent on the back of strong bond prices, while its private market investments returned 9.5 percent on the year.

Its portfolio in 2014 was 58 percent in the public markets and 42 percent in private investments.

Latimer expects that to eventually shift to 53 percent in the public markets and 47 percent in the private markets. That target portfolio asset mix could be realistically achieved over the next 3 to 5 years, he said.

"We are still trying to migrate to what we describe as our target mix," Latimer said. "We are not there yet, but we're very comfortable with the progress that we've made in getting there."

OMERS, which has over 450,000 members, said it received some C$3.7 billion in contributions from plan members and employers in 2014, and paid out C$3.1 billion in benefits.
You can read the press release on OMERS 2014 results here. The Annual Report is not available yet so I can't delve deeply into the individual portfolios. I suspect it will be available on Monday April 13th when OMERS does its Spring Information session.

In any case, both public and private markets delivered solid returns and it appears that bonds, which OMERS was touting earlier this year, delivered decent gains. It's also worth noting that OMERS worked with Bridgewater to implement a risk parity approach that many U.S. pensions have been implementing in the last couple of years to make bonds act like stocks:
Pension funds across the U.S. are desperate to overcome low interest rates and churn out returns big enough to pay future retirees.

Now some hedge funds and money managers are pitching something they see as a Holy Grail: a strategy that often uses leverage to boost returns of bonds that usually occupy the low-risk, low-return portion of pension-fund investment portfolios.

Leverage relies on borrowing money or using derivatives to make large investments while putting up less cash. The tactic's widespread use helped inflate the world-wide debt bubble that burst during the financial crisis, and it was blamed for ruinous losses at banks and securities firms.

But money managers such as Bridgewater Associates, the world's largest hedge-fund firm, and a growing number of pension funds say this type of leverage is different. By using leverage through derivatives, such as bond futures, and by investing in commodities, some pension funds believe they can reduce their typically large exposure to the turbulent stock market and still earn solid returns.

Other proponents of this strategy, known as "risk parity," include AQR Capital Management and Clifton Group, a Minneapolis-based investment firm.

In Virginia, officials at the Fairfax County Employees' Retirement System have revamped the entire $3.4 billion portfolio around a risk-parity approach. About 90% of the pension's portfolio now is exposed to bonds, when factoring in leverage.

"We think we can improve returns while reducing the risk level of the portfolio,'' says Robert Mears, the pension fund's executive director.

Fairfax County had an annual return of 19% as of Sept. 30, for the latest 12-month period for which figures are available. In the same period, the median return for public pensions in the U.S. was 17%, according to Wilshire Trust Universe Comparison Service (article was written in January 2013).

Critics worry that leverage, by its very nature, magnifies profits when trades go well and increases losses when they go sour.

"The minute there is leverage involved it is going to kill you on the downside,'' says Ashvin Chhabra, chief investment officer at the Institute for Advanced Study, a research center in Princeton, N.J.

Pension officials that employ risk parity say they are using a modest amount of leverage, and nowhere near what investment banks used leading up to the crisis. They also are trading in large, liquid markets, and say they have ample liquidity should they ever need to settle trading losses with cash.

Bridgewater is known as a pioneer of risk parity. Executives from the Westport, Conn., firm have pitched the idea to pension trustees across the U.S., even making a documentary-style online video about risk parity featuring founder Ray Dalio.

Pension funds and other institutional investors typically take most of their risks in the stock market. Mr. Dalio says risk parity spreads the risk to a pension's bonds and other holdings.

"Ironically, by increasing your risk in the bonds you are going to lower your risk in your overall portfolio,'' he said in an interview.

A core tenet of risk parity is that when stocks are falling, bond prices typically rise. By using leverage, bond returns can help make up for losses on stocks. Without leverage, bond returns in a typical pension portfolio of 60% stocks and 40% bonds wouldn't be large enough to compensate for low stock returns.

Stocks have much higher volatility than bonds, meaning returns are higher but losses also can be larger. Leverage creates more volatility in bonds.

Risk parity can involve investments in commodities and Treasury-inflation- protected securities, derivatives known as TIPS.

Proponents say it is risky not to use leverage. "It means you are going to have huge equity risk,'' says Michael Mendelson, a principal and portfolio manager at AQR, an investment firm based in Greenwich, Conn.

Risk-parity investments make up about a third of AQR's $71 billion in assets under management, according to a person familiar with the matter.

Risk parity's growing popularity comes at a fragile time in the bond market. Some critics warn the strategy may fizzle if interest rates rise and erode bond returns.

There is "reasonable concern" that could happen once the bull market for bonds cools, says Mark Evans, a managing director at Goldman Sachs Asset Management, a unit of Goldman Sachs Group Inc. That factor "isn't likely to be there going forward for a number of years."

The basic concept of risk parity has been around for years. Mr. Dalio first experimented with the idea in 1996 when he applied the strategy to his family's trust. "What is the asset allocation mix that when I am dead and gone is going to last for generations?'' Mr. Dalio recalled asking himself back then.

Bridgewater started offering risk parity broadly to clients in 2001 through its All Weather fund. For the trailing 10 year period since Sept. 30, All Weather has had an average annual return of about 10%, compared with a median 10-year return for all public pension funds of 6%.

Mr. Dalio said risk parity has proved to generate returns in just about any economic condition. In the near term, if bond values begin to sink as the economy grows, risk-parity proponents expect stock and commodity holdings to offset those losses.

The strategy isn't invincible. In 2008, the fund sank 20%, a big decline but not as bad as overall losses at most pension funds.

The All Weather fund uses leverage of about 2 times, which means for every dollar of cash invested it obtains about $2 of exposure.

The employee pension fund of United Technologies Corp. has gradually increased its risk parity-related investments to $1.8 billion, or about 8% of its total assets, up from an initial 5% allocation in 2005.

At the San Joaquin County Employees' Retirement Association, in Stockton, Calif., risk parity now amounts to 10% of the pension's overall portfolio of approximately $2 billion.

In an email, the pension fund's chief investment officer said the fund "is aware of the leverage being utilized in their risk-parity strategies and has no misgivings."
The article above was written in January 2013 but I mention it because OMERS did implement a risk parity approach in recent years which it outlined in an older background paper covering all their investments.

Some funds, like HOOPP, implement risk parity internally, forgoing to pay fees to outside money managers. But as Jim Keohane, HOOPP's CEO, explained in my last comment going over their spectacular 2014 results, their use of leverage is minimal and appears to be larger than it truly is because they don't use custodians to repo their bonds. Instead, they do their securities lending in-house.

As far as OMERS is concerned, they are determined to forge ahead and shift a substantial portion of their assets into private markets, especially infrastructure. OMERS Borealis is a global leader in infrastructure, arguably one of the best infrastructure outfits among global pensions. It invests directly in infrastructure projects around the world.

Still, infrastructure is risky and some rightly argue we're reaching a bubble phase. Moreover, many institutional investors are increasingly concerned about regulatory risks and transparency, which is why the approach they take matters a lot.

OMERS, like the Caisse which just bought a 30% stake in Eurostar International Ltd., owner of the “Chunnel” rail service that runs between London and Paris, wants to focus on prime infrastructure assets in Europe, the U.S. and Australia. They have a great team to invest in these projects directly but they too will have to judge the merits of each deal very carefully, walking away when they are too pricey.

As far as funding, OMERS hasn't reached the enviable status of HOOPP but it's on its way to bolstering its funding requirements, which is very important to keep the cost of the plan down for all stakeholders.

Finally, I had a chance to discuss HOOPP's great results with Brian Romanchuk, publisher of the Bond Economics blog and a former senior quantitative analyst at the Caisse's Fixed Income group. Here is what Brian shared with me:
I did not calculate the exact numbers, but I had moved most of my bond position into US Treasurys last year. The gains were pretty impressive once you added up the capital gains in USD plus the gain on the currency. I believe you also had decent returns on long-dated CAD government bonds, which they own as a result of their LDI positioning. Equity returns were good to, especially unhedged S&P 500.

I did not look at the Caisse results, but I believe Fixed Income under performed the index. I would note that 2014 was their first full year Romanchuk-less.

But to be fair, the Fixed Income team at la Caisse would not be allowed to take forex risk; that would be done at the asset mix (Superposition) level. This makes the returns between funds not completely comparable. To my mind, buying USTs unhedged was a screamingly obvious trade to put on as a strategic position, but it is something that could not easily be implemented because of modern portfolio management techniques.
Brian is one of the nicest and smartest people I ever had the pleasure of working with. The Caisse's Fixed Income team just isn't the same without him or Simon Lamy, a former fixed income portfolio manager and another great guy that I loved working with (but the Caisse's HR department assures me they are busy hiring "the best and brightest and real team players"...../sarc, roll eyes!).

Anyways, all this to say, when you look at results at these large Canadian pensions, it's very difficult to make direct comparisons because you need to understand key differences in investment policies, benchmarks they use to measure value-added, leverage, and currency hedging policies and how these factors impact overall results (by the way, I called the decline in the loonie back in December 2013 and warned all of you in October 2014 that euro-USD parity is coming this year).

Below, Jacques Demers, President and CEO of OMERS Strategic Investments, addresses the Australia-Canada Infrastructure Symposium, hosted by Infrastructure Partnerships Australia and the Australia-Canada Economic Leadership Forum, held in Melbourne on the 24th February 2014.

No comments:

Post a Comment