Monday, July 17, 2017

OPTrust Diversifying its Returns?

Colin McClelland of Bloomberg reports, Pension plan OPTrust seeks illiquid assets to diversify returns:
In a world of lower returns, OPTrust Chief Executive Officer Hugh O’Reilly is moving into riskier investments as contributors to the retirement pot age.

“We can’t just match cash flows, we have to take risks,” O’Reilly, whose company oversees $19.2 billion of investments for Ontario government workers, said in an interview. “We don’t want to increase contributions or reduce future benefit accruals where the active members will bear the whole risk.”

OPTrust is starting a $300 million venture-capital portfolio and is considering derivatives linked to insurance risk, O’Reilly said. The firm has allocated 1.5 per cent to these riskier assets and 3 per cent in hedge funds, though the latter is under review, O’Reilly said without elaborating. The fund more than doubled assets in hedge funds in 2016 compared with the previous year, according to the 2016 annual report.

“We want to allocate relatively small amounts of capital into new and different investment areas,” O’Reilly said. OPTrust will then “see if they’re viable, see if they make sense, see if we can incubate them and bring them back and put them where they best belong on the investment team.”

Falling Returns

OPTrust, which manages pension assets for almost 90,000 former and current members of the Ontario Public Service Employees Union, generated a return on investment of 6 per cent for last year. That was down from 8 per cent in 2015 and was less than half the 2016 return of Canada Pension Plan Investment Board, the country’s largest pension plan.

“Investment returns are unpredictable and can result in a wide range on any one year basis,” O’Reilly said. “We know that our portfolio can deliver on our pension sustainability objectives over the long run.”

O’Reilly declined to say what OPTrust targets in returns, saying the company is focused more on the amount of risk exposure it can tolerate.

The new venture-capital fund, known as the Incubation Portfolio, will target late-stage startups that are mostly already profitable, O’Reilly said. Another large Canadian pension fund and a venture-capital firm, which he declined to name because the details are still being worked out, will help fund and guide some of the investments, he said.

‘It’s the Future’

“Venture capital is where the future is in terms of Canada, understanding risk and disruption,” O’Reilly said. “We’re going to get active in this area.”

The strategy tweak comes at a time when the number of workers that support the Toronto-based fund is falling. Between 2007 and 2016, its retirees rose 60 per cent to more than 36,000, while its active members fell 8.7 per cent to almost 44,000, according to the pension fund.

The pension will keep outside management for most of its equity trading because of attractive pricing and the ability to learn from industry experts, O’Reilly said.
Let me begin by stating something you should all note whenever you read anything on OPTrust or OMERS. Unlike HOOPP and OTPP, these pension plans do not have conditional inflation provisions when their plans suffer a deficit.

What this means is that when there is a deficit, active members of the plan bear all the risk because they cannot partially or fully remove inflation protection which impacts retired members.

This is the basis of what I call a shared risk model. I have discussed it in my comment on the pension prescription which you all need to read, and it allows plans like HOOPP and OTPP to restore their plan to a fully-funded status a lot quicker when they run into trouble.

Now, what about the article above? It certainly caught my attention for many reasons which is why I emailed OPTrust's president and CEO, Hugh O'Reilly, to see if the statements are accurate.

Hugh was on vacation last week but put me in touch with Darcy McNeil who got in touch with managers at OPTrust to answer three questions of mine:
  1. $300M in venture cap, isn't this a bit risky given how hard it is to make money in VC (albeit this is late stage which is less risky)? We established an Emerging Alternatives Investment Group with a mandate to investigate and incubate strategies in the illiquid asset space where we currently do not have exposure. This currently includes Insurance Linked Securities, Agriculture and Emerging Growth (or late stage venture). This is the incubation portfolio which totals $300million. It is not exclusively VC. Also, at $300M it constitutes a fairly small portion of our total portfolio.
  2. Derivatives linked to insurance products? Can you please explain. Insurance Linked Securities have attractive characteristics that could potentially help improve risk efficiency in the Total Fund portfolio. We are considering the full spectrum of ILS related strategies. It is a relatively new asset class and we are taking our time in fully understanding the underlying risk profile.
  3. Doubled your allocation to hedge funds last year? Please explain which strategies you favor. We don’t think about hedge funds as a standalone program but in the context of how they fit into our Total Fund portfolio. Hedge Funds are valuable to pension plans because they offer uncorrelated risk premia to provide diversification to traditional asset classes (e.g. equities, fixed income). As a result, the Total Fund portfolio becomes more balanced from a risk exposure standpoint. Hedge Fund strategies are risk efficient (e.g. attractive return per unit of risk employed) which is aligned with our overall MDI investment philosophy that focuses on managing risk. We think about Hedge Funds not as a standalone program but in the context of how they fit into our Total Fund portfolio. It is our intent to build this portfolio to about 10% of the Total Fund – over a protracted period of time.
I thank Hugh O'Reilly and Darcy McNeil for answering my three questions and clarifying this article. It's clear the Bloomberg reporter didn't get what the Incubation Portfolio is all about (maybe it wasn't communicated well or maybe he just didn't understand what it's all about).

Apart from that, let me publicly recommend four absolute return funds in Montreal that fit well into OPTrust's portfolio or the portfolio of other institutional investors:
  1. Crystalline Asset Management: Founded in 1998 by Marc Amirault who formerly worked at the Caisse, this is one of Canada's oldest hedge funds running a great arbitrage fund.
  2. OpenMind Capital: Founded by Karl Gauvin and Paul Turcotte (the latter is also formerly of the Caisse), this fund is performing exceptionally well using very smart option strategies. They don't charge hedge fund fees and offer a lot more than just great returns.
  3. Razorbill Advisors: Founded by Pierre-Philippe Ste-Marie, a veteran of the National Bank of Canada and someone who was a classmate of mine in Honours Economics courses at McGill, this fund offers beta+ and portable alpha products and offers great risk-adjusted alpha at low cost. The alpha over bond indexes is particularly exceptional. Denis Senecal, the fomer SVP Fixed Income at the Caisse recently joined the fund to help them with their business development.
  4. LionGuard Capital Management: A L/S fund founded by Andrey Omelchak, an experienced investment professional. Prior to founding LionGuard in April 2014, Andrey worked as a Portfolio Manager, Canadian Equities, at a Montreal-based buy-side investment management company. The fund uses fundamental bottom-up research & analysis and offers industry leading investment products focused on small and medium capitalization equities. Their performance since inception is exceptonal.
Now, there are larger, more well-known funds in Montreal like Jarislowsky Fraser, Letko, Brosseau and Associates, Fiera Capital and Hexavest which are all excellent asset managers but they are mostly long-only shops (except Fiera is expanding its absolute return strategies and Hexavest uses rigorous macro analysis to help build its portfolios).

I have nothing againt the big shops in Montreal and think highly of all of them. But we need to bring attention to some of the smaller shops, including Jean Turmel's Perseus Capital, a macro fund run by a legend of the National Bank who also happens to be the Chair of the Board at Ontario Teachers' Pension Plan. If anyone can weather the storm ahead, it's Jean Turmel.

Now that I am done plugging Montreal asset managers, let me conclude by congratulating OPTrust's President and CEO Hugh O’Reilly for having been elected to the Board of Directors of the Canadian Coalition for Good Governance (CCGG).

The Chair of CCGG's board is Julie Cays, the Chief Investment Officer at the Colleges of Applied Arts and Technology (CAAT) Pension Plan which is the jointly sponsored, defined benefit pension plan for 43,000 members from 38 employers in the postsecondary sector in Ontario. I think very highly of Julie and need to cover CAAT more closely.

OPTrust's President and CEO is also very active on LinkedIn where he posts great articles and pension related stories even from fellow plans, like HOOPP's recent post on the changing retirement landscape (read it here, a must read).

I covered how OPTrust is changing the conversation and how it's boosting its internal management. This is another great Canadian pension plan which is focused on risk-adjusted returns and remaining fully-funded, which is the ultimate measure of success at any pension plan.

Below, Ontario eased its rules for its pension funds as years of low interest rates, poor equity returns and a looming retiree glut pressure companies. The biggest of a complex series of proposals would reduce the so-called “solvency funding” requirement of certain plans to 85 percent from 100 percent. That means companies would be in compliance if they had enough to pay 85 cents on the dollar if they were wound-up immediately. Hugh O'Reilly, president and CEO, speaks with Lily Jamali on "Bloomberg Markets Canada."

And OPTrust unveilled a brand new trading floor recently, as part of its plan to bring the management of foreign-exchange, fixed-income and derivatives portfolios in-house. The pension fund's Capital Markets Group will oversee about half of the company's $18.4 billion of assets. CEO Hugh O'Reilly speaks with Lily Jamali on "Bloomberg Markets Canada."


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