Thursday, March 31, 2016

Ontario Teachers' Gains 13% in 2015

Jacqueline Nelson of the Globe and Mail reports, Ontario Teachers’ Pension Plan posts 13% return in 2015:
Ontario Teachers’ Pension Plan’s 13-per-cent rate of return in 2015 was buoyed by growth in its private market assets, where investing conditions have grown increasingly challenging.

The pension plan, which supports 316,000 of the province’s teachers and retirees, earned $19.6-billion through all of its investments in a year peppered with deals – from toll roads to seniors’ housing.

“This was the year of the privates, whether it’s real estate, private equity or infrastructure,” Ron Mock, chief executive officer of Teachers, told a media briefing on Wednesday. He noted that just a few years ago, fixed income had been a similar bright spot for the portfolio.

Teachers’ private capital group posted a soaring 32.3-per-cent investment return in the 2015 calendar year. And infrastructure and real estate returned a collective 16 per cent in 2015. Each category exceeded the benchmark Teachers had set by a wide margin.

But the pension plan’s executives are now approaching these same sorts of assets with heightened vigilance.

“A lot of assets have seen unprecedented global competition for the time being. … We think prices are high, and there’s a risk the fund will not get compensated taking that risk going forward,” said chief investment officer Bjarne Graven Larsen, who joined the pension plan in February.

This attitude doesn’t mean the fund thinks asset prices are set to fall in the near future, Mr. Graven Larsen added, but indicates caution is required to ensure Teachers can add enough value to anything it buys to make up for the high prices those businesses and structures command.

Last year, Teachers completed a re-evaluation of its investment strategy with a special focus on how best to grow internationally. The review highlighted a need not only for outperforming benchmarks in different asset classes, but also for bringing those specialties together under a more unified strategy to boost total returns overall.

Teachers has created a new group called “portfolio construction” under Mr. Graven Larsen to look at possible risks across the global portfolio – from the implications of a British exit, or “Brexit,” from the European Union, to investment areas that should potentially be developed or receive more funding.

This effort to unify its asset classes comes as Teachers manages more capital than ever. The pension fund had $171.4-billion in assets under management, up from $154.5-billion in 2014.

The pension plan has steadily moved to oversee more of its investments, with 80 per cent of assets now managed internally by teams in Toronto, London and Hong Kong. Mr. Mock said these offices all performed well in 2015, and the pension plan was considering adding another base in South America.

The 2015 financial results included a 17.7-per-cent return in equities, with non-Canadian investments significantly outperforming those made in the country. The fund’s fixed-income portfolio, including bonds, had a one-year return of 5.9 per cent. Meanwhile, natural-resource investments were a dark spot, down by 1.3 per cent last year amid the commodity downturn.

Teachers ended last year 107-per-cent funded, with a surplus of $13.2-billion. That positions the plan to meet future pension liabilities over time, with money to spare.

With the ratio of active teachers to pensioners currently hovering at around 1.4 to one, the pension plan is paying out more in benefits than members are contributing. At the end of 2015, paid benefits reached $5.5-billion and new contributions stood at $3.3-billion.

Teachers has posted an annualized 10.3-per-cent rate of return since its founding as an independent organization in 1990. Since that time, pensions have been funded primarily through investment income. Only 21 per cent of assets have come from contributions from the province’s educators and government employer contributions in that time.
The Ontario Teachers' Pension Plan put out a press release, Ontario Teachers' earns 13.0% return for 2015:
Ontario Teachers' Pension Plan (Ontario Teachers') today announced a rate of return on investments of 13.0% for the year ended December 31, 2015, resulting in an increase in net assets to a record $171.4 billion from $154.5 billion at the end of 2014.

Investment earnings for the year were $19.6 billion, up from $16.3 billion in 2014. Measured against a consolidated investment benchmark of 10.1%, the plan's excess return of 2.9 percentage points resulted in $4.2 billion in value added. Since the plan's inception in 1990, total investment income has accounted for 79% of the funding of members' pensions, with the other 21% coming from member and government contributions.

"We are pleased with our Toronto, London and Hong Kong teams' performance this year," said Ron Mock, President and Chief Executive Officer. "This, in combination with the plan sponsors' 2008 adoption of condition inflation protection, which improved our investment risk tolerance, resulted in a successful year," he said.

Bjarne Graven Larsen, who assumed the Chief Investment Officer role on February 1, credits the plan's ongoing success to an evolving investment strategy with a global outlook. He noted: "Despite volatile market conditions, Ontario Teachers' global, diversified portfolio produced strong investment returns."

Ontario Teachers' continues to show strong performance in pension services, according to two independent, annual studies. The plan's Quality Service Index (QSI), which measures members' service satisfaction, was 9.1 out of 10 in 2015, and the plan was ranked second for pension service in its peer group and internationally.

Funding position
The plan had a preliminary funding surplus of $13.2 billion at January 1, 2016, the third surplus in as many years. It was 107% funded at the start of the year, based on current contribution and benefit levels.

2015 investment return highlights by asset class
The value of the plan's public and private equity investments totaled $77.5 billion at year-end, up from $68.9 billion at December 31, 2014. The investment return in the equities portfolio of 17.7% was ahead of the 14.7% benchmark.

Private Capital investments rose to $28.4 billion at year-end from $21.0 billion a year earlier. Private Capital's investment return was 32.3%, compared to the 18.1% benchmark.

Fixed Income had $69.1 billion in assets at year-end, compared to $65.6 billion at December 31, 2014. The one-year return of 5.9% was in line with the benchmark return of 6.0%.

Natural Resources investments were $10.2 billion at year-end, compared to $11.9 billion at December 31, 2014. The one-year return of -1.3% was ahead of the benchmark return of - 6.1%.

Real assets, a group that consists of real estate and infrastructure, had total assets of $40.6 billion at year-end, compared to $34.7 billion a year earlier. The real estate portfolio, managed by the plan's subsidiary Cadillac Fairview, totaled $24.9 billion in assets at year-end and returned 12.9%, exceeding the 8.0% benchmark. The infrastructure portfolio had $15.7 billion in assets at year-end, up from $12.6 billion a year earlier. Infrastructure's investment return of 21.4%, compared to the 14.3% benchmark.
You should download and read OTPP's 2015 Annual Report to gain better insights on the performance and operations at Teachers.

I had a chance to talk with Ontario Teachers' CEO Ron Mock late Wednesday afternoon to go over the 2015 results. Ron had a very busy day but was gracious enough to call me back and I thank him for doing so.

Below, I summarize some of the points from our discussion:
  • I began by congratulating him on these stellar results. Teachers outperformed all its large Canadian peers, including the Caisse, OMERS, AIMCo, and HOOPP. It also outperformed the average Canadian pension which returned 5.4% in 2015 (keep in mind, a big part of Teachers' relative outperformance comes from the clever use of leverage which others can't use).
  • More importantly and more crucially, Teachers' funded status improved to 107%, placing it just below HOOPP's 122% super-funded status. This is why I keep referring to HOOPP and OTPP as the two best pension plans in Canada and the world
  • The first thing that struck me from Teachers' 2015 results was the unbelievable performance of Teachers' Private Capital led by Jane Rowe. That group delivered 32.3% in 2015, trouncing its benchmark which gained 18.1% last year. 
  • Ron called it the "year of the privates" as Private Equity, Real Estate and Infrastructure all performed well, handily beating their respective benchmarks (which aren't that easy to beat). But he added: "We take a total portfolio approach. This year it was privates, three years ago, bonds kicked in for us."
  • On Private Equity, Ron told me they're focusing on "long-term value creation" which means good old fashion rolling-up-your sleeves PE, none of the financial engineering of the past where funds leveraged companies up to wazoo to bleed them dry as they pay themselves dividends. Teachers Private Capital has a long-term focus and a longer investment horizon than PE funds, giving it an advantage over its fund competitors. 
  • In terms of currency hedging, Ron told me that Teachers doesn't hedge currency risk, which helped with some investments, "but we had other investments in currencies that got hit" (probably in Brazil). So yes, FX gains added to our overall return but it wasn't the primary factor."
  • In terms of funds, I noted on my blog that Teachers sold stakes in global private equity funds in the secondary market. As I thought, this was to rejig the total portfolio to fund other investments like infrastructure. Ron confirmed this: "You got it, it's about looking at the total portfolio and investing in the best opportunities."
  • On the recent London City Airport consortium deal which I questioned on my blog, Ron had this to say: "We have deep expertise in airports. We can place a board quickly to monitor these investments and focus on value creation over a very long investment horizon. And our investment horizon for an asset like this isn't ten years, it's more like 20 to 30 years."
  • On the Maple Financial scandal which I also covered on my blog, Ron shared this: "I can't get into details as the investigation is still ongoing but we have pledged to repay dividends if the allegations are proven." But he added: "It's not a traditional operational screw-up like a hedge fund blowing up, it's more complex, an interpretation of [German] tax law." As far as whether Teachers took a writedown on this asset, Ron didn't say yes or no but he said "it's fully reflected in 2015's results."
  •  On Teachers' massive external hedge fund portfolio, Ron said 2015 was a "scratch year" for external hedge funds and internal absolute return trading activities. "In a volatile market like 2015, you wouldn't expect outperformance in these activities but they didn't dent the total portfolio either."
  • On Teachers' 107% funded status, Ron shared a few interesting tidbits with me. First, the discount rate set by the Board currently stands at 4.7%, one of the lowest in the world for any public pension, reflecting the fact that Teachers' is a mature plan paying out more in benefits than it receives in contributions and its members live a lot longer (bigger longevity risk attached to the plan). 
  • Ron told me the decision of what to do with the surplus (like fully restore inflation protection) lies entirely with the stakeholders of the plan, ie. the Ontario Teachers' Federation and the Ontario government. But he added: "They are very sophisticated and in the past, they didn't spend all of it but saved some for a rainy day, understanding these are very difficult markets and the focus must always be on the plan's sustainability." 
  • On that last point, Ron added this: "Our focus in on the long-term but we don't lose sight on short-term trends either because we are very path dependent. Our short-term is ten years and we always gauge the risks of a serious drawdown to the total portfolio. The last thing you want is to be piling on risk when you have a big drawdown." (this is why most US public pension funds are doomed). 
  • I also commended Ron for taking leadership role in implementing gender diversification at Teachers. I noted that Jane Rowe and Barbara Zvan were two of the highest paid officers at Teachers in 2015 (see compensation table below). Ron told me this: "It's important and I made a point to place Jennifer Brown, Rosemarie McClean and others in key positions. But beyond their gender, they are wickedly smart and highly ethical professionals who add value to our organization."
  • Lastly, a more philosophical question to a man who has experienced some harsh hedge fund lessons in the past and is now running one of the world's best pension plans. I asked Ron if he's happy and if he could have ever imagined being in the position he is right now. He told me: "I'm very happy, work with a great group of professionals, meet interesting people all over the world and I feel like there's a social purpose to what we're doing. I worry about aging demographics and people retiring with no pension. We do our part in ensuring a small subset of the population has their retirement needs addressed for the future."
That was a great way to end our conversation, one that should give many of you working at public pensions some food for thought in terms of why what you're doing is a part of something much bigger and much more important than your paycheck and bonus.

Once again, please take the time to carefully read Ontario Teachers' entire 2015 Annual Report. It is very well written and explains investments, operations, funded status and a lot more in great detail.

One thing I will bring up is executive compensation of senior officers (from page 30, click on image):

As you can see, Teachers' senior officers enjoy some generous payouts, a bit higher than what other large Canadian pensions pay their senior officers.

But I caution you to keep two things in mind: Teachers' four-year results are better than their large peers and people like Ron Mock, Barbara Zvan, Wayne Kozun and Jane Rowe have been there for a long time and they're delivering outstanding results. This compensation is explained in great detail in the Annual Report and it's in line with the results they produced.

Sure, Ontario's hard working teachers might be looking at these hefty payouts and questioning whether they're fair and need to be so excessive. I myself have done so on my blog on a few occasions but in the end, attractive compensation which is based primarily on long-term performance is part of good governance, and that's why Ontario Teachers sets the bar and has delivered outstanding results, ensuring the sustainability of the plan for years to come.

We should be openly discussing compensation at Canada's large pensions. I have no problem with an open, transparent discussion on compensation, but keep in mind the long-term results that come with this compensation. This money isn't given to them for free, they have to beat tough benchmarks to earn that compensation, so don't just look at compensation in a vacuum. Try to understand how it's determined and why these individuals are being paid top dollar. It's because they're producing stellar long-term results, ensuring the long-term sustainability of the plan and lowering its cost for all stakeholders.

On that last point, there is one chart I really like in the Annual Report, one that exemplifies Teachers' long-term performance (click on image):

When people ask me why I'm such a stickler for large, well-governed defined-benefit plans, I point out charts like the one above to make my case. If you're looking for a solution to the global retirement crisis, this is it, right there in that chart.

Below, Ron Mock, president and CEO of the Ontario Teachers’ Pension Plan, joins Bloomberg TV Canada’s Pamela Ritchie to discuss the plan's 39 percent stake in Brussels airport and how geopolitical risks impact the group’s investment strategy.

I also embedded another recent Bloomberg interview with Pamela Ritchie where Ron discussed Teachers' approach to global investments (this one is posted on Teachers' site). Lastly, I embedded a BNN interview with Ron Mock discussing Teachers' 2015 results.

Take the time to listen to all these interviews. Ron is a very smart guy and he's a genuinely good guy, which is why I thank him for taking the time to talk to me, going over Teachers' 2015 results.

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