Monday, February 27, 2017

OMERS Gains 10.3% in 2016

Barbara Shecter of the National Post reports, OMERS investment returns surge 10% as net assets hit $85 billion:
OMERS, the pension plan for Ontario’s municipal employees, posted an investment return of 10.3 per cent for 2016, net of all expenses.

The return beat both the benchmark of 7.9 per cent and the previous year’s return of 6.7 per cent. Net assets grew to $85.2 billion, up $8.1 billion.

“Our strong investment returns in 2016 reflect the value of our well-diversified portfolio of high-quality assets, which we are continuously building,” said Michael Latimer, chief executive of OMERS. “All of our asset classes produced solid returns.”

One of Canada’s largest defined benefit pension plans, OMERS invests and administers pensions for more than 470,000 members from municipalities, school boards, emergency services and local agencies across Ontario.

The pension’s funded status improved last year for the fourth year in a row, increasing to 93.4 per cent. It was boosted by both the strong investment returns and member and employee contributions.

The OMERS portfolio includes investments in public markets, private equity, infrastructure and real estate.

Latimer said OMERS is content with a mix of 45 per cent private and 55 per cent public investments, adding that he feels no pressure to make investments in increasingly competitive sectors such as real estate and infrastructure where many pension, private equity and sovereign wealth funds are chasing the same assets.

Jonathan Simmons, the pension fund’s chief financial officer, said OMERS would be open to investing in infrastructure in Canada under the federal government’s ambitious plan, but only if certain conditions are met.

The projects would have to have scale, the pension fund would need to have governance rights over the asset, and there would have to be specific risk criteria, he said, adding that these specifications have been communicated to the government.

“These are political decisions that need to be made at the political level,” Simmons said.

OMERS executives said diversification will be the key to maintaining a sustainable pension in the current climate of geopolitical uncertainty.

This could involve selling assets in situations where valuations are high.

“We could sell into that markets place — crystallize real capital gains for the fund,” Latimer said.

OMERS executives also plan to continuing pushing into growth areas, such as funding small and medium-sized business loans. The fund’s credit book has grown to $15 billion from $9 billion.

Another large Canadian pension fund, the Caisse de depot et placement du Quebec, reported solid investment gains for 2016. On Friday, the Caisse disclosed a 7.6 per cent gain for the year ended Dec. 31.

Net investment results were $18.4 billion and net deposits totalled $4.3 billion. The fund’s assets totalled $270.7 billion at year end.
Jacqueline Nelson of the Globe and Mail also reports, OMERS mulls best approach for investing in emerging markets:
The pension plan for Ontario municipal employees is mapping out a strategy to invest in developing economies, after retooling its investment portfolio to produce a 10.3-per-cent return in 2016.

The Ontario Municipal Employees Retirement System (OMERS) said Friday that broad increases in both its public and private market portfolios strengthened the plan last year, narrowing its funding shortfall.

After rejigging its investment portfolio through the addition of more private assets such as infrastructure, as well as rethinking its public-market investment strategy, the pension plan is mulling the best approach for expanding into new markets.

“What we’re undertaking today is thinking about just what do emerging markets mean to us,” said Michael Latimer, chief executive officer of OMERS. Once the pension fund identifies the regions that hold the most opportunity, the next step will be to decide where to put people on the ground to source investments. It will also assess which asset classes the capital should flow into.

OMERS has built up an investment portfolio heavily weighted toward North America, with 40 per cent based in Canada, 37 per cent in the United States, 17 per cent in Europe and 6 per cent everywhere else.

That amounts to, “for now, a developed market strategy,” said Jonathan Simmons, OMERS chief financial officer, adding that the fund is content with the investments that it has made in these markets. Now, OMERS is actively looking to expand globally.

OMERS is looking to diversify its investments geographically after undergoing a retooling of its public-markets portfolio in the past year. The fund’s total returns got a boost from public market holdings, which produced a 9.5-per-cent return last year, up from just 0.7 per cent in 2015.

To achieve that, the fund reduced its investments in low-yielding government bonds, while boosting its stake in higher-yielding credit investments. It also zeroed in on stable individual stock investments that pay healthy dividends.

OMERS has also worked to spread its assets more evenly between public investments, which now make up 55 per cent of the portfolio, and private investments, which account for 45 per cent. Net assets grew by $8.1-billion in to $85.2-billion as of Dec. 31.

Private investments, including infrastructure, real estate and private equity produced a 12 per cent return in 2016, down from 14.5 per cent in 2015.

“There’s no question that the flow of capital into alternative asset classes continues,” Mr. Latimer said, adding he expects competitive conditions to persist.

OMERS, which manages assets and administers pensions for 470,000 Ontario employees and retirees, paid out $3.6-billion in monthly benefits last year.

The plan also continued to reduce its funding shortfall and is now 93.4 per cent funded as a result of investment returns and member and employer contributions, compared with 91.5 per cent the year before. In 2010, OMERS said it planned to eliminate the deficit by 2025 and this is the fourth consecutive year that the fund has moved towards closing the shortfall gap.
The most important thing OMERS has accomplished under the leadership of Michael Latimer is to reduce its pension deficit significantly.

This is by far the most important thing because as I've mentioned plenty of times, pensions are all about managing assets and liabilities, and some of the sharpest Canadian pension executives argue that funded status is a better measure of success.

I mention this at the top because the news media loves looking at headline figures and how OMERS  reached highest investment return in years, which is true, but it's more important to focus on OMERS's funded status.

Second, the media loves to compare returns of various large pensions in Canada as if they are comparing apples to apples. In his article on the Caisse on Friday, Radio-Canada's Gérald Fillion notes:
C’est vrai que le rendement pour 2016 peut paraître un peu décevant à 7,6 %. C’est une troisième année de baisse, la stratégie d’investissements en actions mondiales a déçu au cours de la dernière année, les obligations rapportent peu et la Caisse fait moins bien que le fonds ontarien OMERS, ce qui est assez rare.
For those of you who do not read French, he notes the overall returns of the Caisse have been falling as bonds bring in little gains and global stock returns disappoint and that the Caisse returned less than OMERS last year which is "rare".

Please repeat after me: "I don't care what AIMCo, bcIMC, OMERS, OTPP, HOOPP, CPPIB, PSP, and others returned relative to each other, it's meaningless." I know we are a society obsessed with making relative comparisons but in this case penis pension envy is just plain dumb.

Why? Well, for one, pensions are all about managing assets and liabilities so if OMERS gains 10% in 2016 and OTPP or HOOPP gained less last year, it doesn't matter because their funded status is better (it should be noted that unlike OTPP and HOOPP, OMERS guarantees inflation protection, and so does OPTrust).

Also, there are key differences in the asset allocation, leverage, F/X hedging policy, benchmarks used to evaluate underlying portfolios at all of Canada's large pensions. OTPP and HOOPP are allowed to use a lot more leverage -- which they use wisely -- than their counterparts. OMERS has a higher allocation to private markets than its counterparts.

What else? Some pensions are managing a lot more assets than others, some are more mature than others and they have different liabilities to contend with as they chart their investment strategy. And some pensions are plans, managing assets and liabilities (OMERS, OTPP, HOOPP, OPTrust, CAAT, etc) while others are pension funds managing assets only keeping liabilities in mind (AIMCo, bcIMC, Caisse, CPPIB, PSP).

In other words, stop comparing the performance of large Canadian pensions, it's just plain stupid because you are comparing apples to oranges. If you look at the clip of Michael Sabia speaking with Mutsumi Takahashi which I embedded in my last comment going over the Caisse's 2016 results, you'll see he tells her "we are focusing on hitting singles, not home runs".

[Note: I updated my last comment on the Caisse's 2016 results to correct some basis point figures I got wrong and added an interview with Macky Tall, executive vice president, infrastructure at Caisse and president and CEO of CDPQ Infra,which you can watch here.]

Back to OMERS, there is no question its 2016 results are excellent. The 2016 net investment return was 10.3% (after all expenses), compared to a benchmark of 7.9%, and a net return of 6.7% in 2015. Net assets grew $8.1 billion in 2016 to $85.2 billion.

Any time a pension beats its benchmark by 240 basis points (2.4%) on any given year and manages to reduce its funding shortfall (or increase its surplus), it's a great year.

You can read OMERS's press release here. The key message is this:
"2016 marks the fourth consecutive year that our funded status has improved," said Jonathan Simmons, Chief Financial Officer. "Good investment performance enabled us to strengthen our balance sheet. We have also reduced the discount rate on our pension obligations by five basis points."

...

"I am proud of the strong progress OMERS made in 2016 to deliver on our five-year strategy – the key objective being to ensure the long-term sustainability of the Plan for our members," said Mr. Latimer.
It's worth noting, as at December 31, 2015, OMERS maintained its real discount rate at 4.25%, but lowered the assumed future inflation from 2.25% to 2.00% to reflect updated long-term expectations for this assumption (see details here).

In the press release, OMERS breaks down the returns by asset class (click on image below):


As you can see, the mix between Public and Private markets is 55% to 45%, with the net return on Public markets being 9.5% and that in Private markets being 12%, giving an overall net return of 10.3% in 2016.

Within Private Markets, Private Equity delivered net gains of 12.6%, followed by Real Estate (12.4%) and Infrastructure (11%).

The 2016 Annual Report is not out yet (it will be here in roughly a month) but you can read OMERS's 2015 Annual Report which is available here.

From last year's Annual Report, I bring this to your attention the long-term returns (click on image):


Remember, for any pension, it's long-term returns that count most, not the returns on any given year.

What else did I notice from OMERS's 2015 Annual Report? They do not provide details on the benchmarks they use for each asset class (click on image):


Instead they say this: "We measure our performance against an absolute return benchmark, which is an absolute return based on operating plans approved with due regard for risk before or at the beginning of each year by OMERS Administration Corporation Board. Our goal is to earn stable returns for OMERS that equal or exceed these benchmarks."

Even OMERS latest statement of investment policies doesn't provide any details whatsoever on the benchmarks governing each investment portfolio, which is quite odd but I did find the same table from above on page 40 of last year's Annual Report with some more details in a footnote (click on image):


As you can see, in 2015, Real Estate and Infrastructure significantly outperformed their respective benchmarks. So, what are these benchmarks and are they accurately capturing the risks of the underlying portfolio?

Footnote 2 reads: "We measure our performance against an absolute return benchmark approved before or at the beginning of each year by the OAC Board. Our goal is to earn stable returns for OMERS that equal or exceed these benchmarks. Benchmarks are based on absolute return targets by asset class. The benchmark for the RCA Investment Fund is a weighted average blend of 5% FTSE TMX Canada 30-Day T-Bill + 23.75% S&P/TSX 60 Index + 23.75% MSCI EAFE Index + 47.50% MSCI USA All Cap Index."

Are you a bit confused? Yeah, so am I, but it's the way they measure things and I'm not saying it's wrong to have absolute return targets but your asset class benchmarks also need to reflect the risks of your underlying portfolios.

I mention this because in the Globe and Mail article above, Jacqueline Nelson notes:
OMERS is looking to diversify its investments geographically after undergoing a retooling of its public-markets portfolio in the past year. The fund’s total returns got a boost from public market holdings, which produced a 9.5-per-cent return last year, up from just 0.7 per cent in 2015.

To achieve that, the fund reduced its investments in low-yielding government bonds, while boosting its stake in higher-yielding credit investments. It also zeroed in on stable individual stock investments that pay healthy dividends.
So, similar to the Caisse, OMERS reduced its allocation to government bonds and increased credit risk, loading up on corporate debt, and allocated more to high dividend stocks.

That is all fine -- most bond managers take credit risk, not duration risk, to beat their benchmark -- but is it reflected in the benchmark they use to gauge the underlying portfolio? That is far from clear.

And this is important, because compensation is based on value added over the short and long-term (click on image; from 2015 Annual Report):


Anyways, I'm not going to get into a whole discussion on benchmarks, leverage, compensation and other things but it's important to really understand value added is not based on the same benchmarks across Canada's large pensions. Some of them have much harder benchmarks to beat than others.

Having said this, there is no question that OMERS delivered great returns in 2016. I reached out to Michael Latimer to have a chat with him but he declined my request. That's fine, he's a busy man.

Those of you who want to understand the change in OMERS's investment strategy in recent years should look at this April 2014 information session which is excellent and provides a lot of information.

I would suggest Mr. Latimer goes over my recent comment on the CFA Montreal lunch with PSP's André Bourbonnais as I think PSP's "platform approach" is the best way to expand globally and scale up relatively quickly across public and private markets (forget about opening offices around the world and staffing them, just find the right team, seed them with a huge cheque, you own 100% of the platform assets, and let them focus on performance and delivering the required returns).

What other advice can I give to Mr. Latimer? I had a discussion with Réal Desrochers, the head of CalPERS private equity on Friday and he told me "the money pouring into private equity from sovereign wealth funds is unbelievable." This just tells me returns in private equity (and other private asset classes) are coming down in the years ahead.

Below, Satish Rai, CIO of OMERS Public Markets talked with Bloomberg TV Canada's Amanda Lang back in November where he expressed interest in Trudeau's plan for a $35 billion infrastructure bank. But first, he discussed the biggest challenge for money managers these days, which is achieving return in this era of low yield. Great discussion, well worth listening to his views.

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