Tuesday, March 13, 2018

OPTrust Delivers 9.5% in 2017

Martha Porado of Benefits Canada reports, Equities boost OPTrust return to 9.5% in 2017:
The OPSEU Pension Trust posted a 9.5 per cent return for 2017, an increase on its six per cent return in 2016 and its eight per cent return in 2015.

“We were strong across all the asset classes,” says Hugh O’Reilly, president and chief executive officer of OPTrust, noting the fund saw a 22.9 per cent return in public equities and a 21.6 per cent return in private equities. Alternatives also performed strongly, he says, with real estate returning 14.7 per cent and infrastructure returning 11 per cent. The fund’s fixed-income investments gained a 4.6 per cent return.

The one problematic area for the year was currencies, says O’Reilly. “We had a slight drag on our portfolio from foreign currency, U.S. dollar exposure.”

O’Reilly notes that good investment returns are increasingly difficult to achieve in the current market environment. “We believe in taking risk efficiently and purposefully,” he says. “We think that overall returns going forward are going to be more and more difficult to achieve.”

O’Reilly notes, however, that OPTrust “will not be taking more risk in order to gain greater returns.”

One area of concern is climate change, he adds. “Climate risk is a significant risk to us as investors and we want to make sure that the entities that we invest in disclose their climate risks, so that will allow us to engage with them, so we better understand the risks being taken. We can make better investment decisions and as appropriate, we can get them to change direction.”

But the pension fund isn’t divesting from certain sectors where climate change is concerned. “We believe in improving practices in the oil and gas industries,” says O’Reilly. “We’ve also done an accounting of what our exposure is in renewables and we’re better beginning to understand our real estate portfolio in terms of its green effects.”

Another challenge OPTrust will continue to address is the likelihood of an ongoing increase in its members’ life expectancy, which will further add to the plan’s obligations. “We have to make sure that our assumptions reflect those improvements,” says O’Reilly says. The plan’s discount rate was lowered to 3.3 per cent in 2017, from 3.4 per cent in 2016, reflecting increased actuarial margins.

All in all, the fund now holds new assets of $20 billion. Its funding status increased slightly, to 111 per cent compared to 110 per cent in 2016.
OPTrust put out a press release, OPTrust Takes Measures to Reduce Risks for Members:
OPTrust today released its 2017 Funded Status Report, which details the Plan’s ninth consecutive fully funded position and financial results. OPTrust achieved an investment return of 9.5% for the total fund, net of external management fees. The organization also received high scores, with members and retirees rating their service satisfaction as 9 out of 10. In addition, OPTrust is one of the first plans to report in accordance with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).

"Last year, we started a conversation within our industry about what we believe matters most to our members,” said Hugh O'Reilly, President and CEO of OPTrust. “Our answer hasn’t changed: it’s the Plan’s funded status. That’s why this year, we are continuing the conversation.”

“The funded status is the foundation on which secure, sustainable retirement futures rest, and for us, it is the measure that matters," O’Reilly added. “We are working in an environment where investment returns are increasingly difficult to achieve without taking excess risk, and we are dealing with the effects of the ongoing maturation of the Plan. These challenges require constant innovation on our part. We also share our ideas and successes with others, which is an important part of being good pension citizens.”

The Plan remained fully funded in 2017 on a regulatory filing basis, while the organization continued to strengthen its actuarial assumptions to enhance long-term funding health. The Plan’s real discount rate was lowered to 3.30%, net of inflation, from 3.40% in 2016, reflecting increased actuarial margins and reducing the risk of future losses due to investment returns falling short of the expected cost of members’ future pensions.

With an update of assumptions regarding member longevity, the Plan has addressed the likelihood that members’ life expectancy will continue to increase, thereby increasing the Plan’s pension obligations. The funding valuation confirmed deferred investment gains of $885 million at the end of 2017, which should further improve funded status in the years to come.

OPTrust introduced its member-driven investing (MDI) strategy in 2015 with a singular focus to increase the likelihood of plan certainty by balancing the objectives of sustainability and security to better align the Plan’s outcomes with members' needs. Superior risk management has helped the Plan to improve its funded status, maintaining stability and helping to ensure the Plan can weather a severe market downturn, like the one experienced by the global economy in 2008. The Plan's net assets increased to over $20 billion at 2017 year-end, up from $19 billion as at December 31, 2016.

More detailed information about OPTrust's 2017 strategy and results is available in its Funded Status Report at optrust.com.

About OPTrust

With net assets of over $20 billion, OPTrust invests and manages one of Canada's largest pension funds and administers the OPSEU Pension Plan, a defined benefit plan with over 92,000 members and retirees. OPTrust was established to give plan members and the Government of Ontario an equal voice in the administration of the Plan and the investment of its assets through joint trusteeship. OPTrust is governed by a 10-member Board of Trustees, five of whom are appointed by OPSEU and five by the Government of Ontario.
Take the time to carefully read through OPTrust's 2017 Funded Status Report which is available here. This is their version of their Annual Report but the title reflects where their priorities lie.

Below, I provide you with an image which goes over the main highlights of this report (click on image):


As you can see, OPTrust had another solid year and is delivering outstanding services to its members. Moreover, the focus remains squarely on the funded status and the Plan is taking the lead on many initiatives.

I had a brief conversation with OPTrust's President & CEO Hugh O'Reilly yesterday going over the results and some of the initiatives the Plan is taking a lead on.

Before I get to our conversation, I note the following from his Message on pages 12 and 13 of the 2017 Funded Status report on enhancing their investment capabilities:
Our Member-Driven Investing (MDI) strategy has a simple idea at its heart: the primary goal of a pension plan must be to maintain its funded status. Above all, members want pension certainty, stability and sustainability. Our job is to balance those goals by achieving sufficient investment returns to support plan sustainability without taking on excess risk that could undermine the stability of contribution and benefit levels. We view risk as a scarce resource that must be carefully allocated.

The effectiveness of this approach continues to be validated as we have once again successfully maintained a fully funded plan for our members. In 2017, we internalized a significant portion of our public markets assets and activities as part of our overall MDI strategy. Our new internal capabilities in these asset classes complement our long-standing internal capabilities and sophistication in private equity, infrastructure and real estate.

By the end of the year our new trading desk had completed over 2,850 trades. Internalization has enhanced our ability to dynamically manage risk in our portfolios.
And this on promoting new ideas in the pension industry:
At OPTrust, acting in the best interests of our members and being good pension citizens are one and the same. One of the best ways to create long-term sustainability is to foster new thinking and industry dialogue that can strengthen all aspects of the defined benefit model. In 2017, we undertook innovative research on climate change in partnership with Mercer, and in so doing, furthered our industry’s understanding of the need for investors to better measure, model and mitigate the risks that climate change presents.

We also continued our work to promote and defend defined benefit pensions globally, as we discussed retirement innovation with the Washington D.C.-based Brookings Institution and participated in a World Bank report on the Canadian pension model. Closer to home, we launched a new advocacy and education program, People for Pensions, which has engaged our members in an ongoing conversation about the advantages and importance of the defined benefit pension model.
Those of you who read my blog regularly know I'm a big defender of  well-governned defined-benefit plans and believe that any country which is serious on tackling the ongoing retirement crisis should be bolstering DB plans, not weakening them.

Anyway, back to my conversation with Hugh O'Reilly. Hugh noted that the funded status is what counts most to them because it allows them to maintain the current benefits and contribution rate.

It’s worth noting the Plan’s real discount rate was lowered to 3.30%, net of inflation, from 3.40% in 2016, reflecting increased actuarial margins and reducing the risk of future losses due to investment returns falling short of the expected cost of members’ future pensions.

Hugh noted they use one of the lowest discount rates among large public pensions and are prudent which is why they lowered it to increase the cushion in case another crisis hits the Plan's assets and liabilities.

In terms of overall results, he told me the 9.5% return had contributions from all asset classes but there was a small drag from currency exposure as unlike HOOPP, they don't fully hedge their foreign exchange risk and are exposed to depreciating foreign currencies, in particular the US dollar (click on image):


Hugh told me they do some hedging on the foreign exchange but are mostly unhedged on safe haven currencies which leaves them exposed for years where the Canadian dollar outperforms them.

Interestingly, after reading my last comment on HOOPP's 2017 results, HOOPP's President and CEO Jim Keohane shared this with me on HOOPP's currency hedging policy: "There is no right answer when it comes to FX. We do pursue some active strategies in FX derivatives but we do hedge our translation risk. It is just not where we want to use our risk budget."

Hugh told me the same thing, "we don't get compensated for taking F/X risk", but they prefer taking the opposite side of the hedging spectrum like AIMCo, OTPP, CPPIB, and PSP, ie. they prefer to mostly stay unhedged, especially on safe haven currencies.

All I can say is that at least they're honest about the foreign exchange drag and every single pension plan should include a similar chart to the one above showing how F/X swings impacted their overall return, whether it's good or bad (reporters never ask this question, drives me crazy!).

Now, the big contributors to overall returns were Public Equity (22.9%), Real Estate (14.7%), and Private Equity (21.6%). Hugh told me that the value-added over the benchmark portfolio was 2.6% (260 basis points) which is excellent.

In private equity, they are almost exclusively focusing on co-investments, a form of direct investments, to lower overall fees paid to funds. They have a similar structure in real estate but in infrastructure, over 90% is purely direct investments.

Below, I embedded pages 28-30 of the Funded Status report going over the returns of the main asset classes (click on each image):




In terms of weighting, Hugh told me Public Equity represents 15-18% and the rally in emerging market equities last year helped lift that portfolio. Fixed income represents 30%, Private Equity 8%, Real estate and Infrastructure each 12-13%.

Unlike HOOPP, OPTrust does allocate to external absolute return funds and tries to leverage off these relationships as much as possible to bolster and enhance their internal absolute return activities.

Interestingly, Hugh told me they fully hedge their interest rate risk and like HOOPP, are in a good position if rates start to rise (liabilities will fall if rates rise). He told me if rates rise, they too will buy more long bonds to fully hedge interest rate risk which represents the biggest risk to the Plan.

Like Jim Keohane, Hugh is very cautious on markets and has publicly voiced his concerns on skyrocketing valuations:



In many ways, HOOPP and OPTrust are very similar which is why their presidents focus on funded status as the real measure of a pension plan's success, but they have quirks and differences too. Hugh told me: "We worship the same god but practice different religions."

Two things stand out to me:
  1. OPTrust has a greater concentration in alternatives and they are more open to allocating to external managers across public markets and leverage off these relationships. They have opened up offices in London and Sydney to develop relationships with partners in public and private markets.
  2. Like OMERS, OPTrust has guaranteed indexation which means their active members bear most of the risk of the plan. HOOPP and OTPP have ad hoc or partial indexation which allows them to spread the risk of the plan across active and retired members (this makes most logical sense to me).
 We ended our conversation by talking about some intitiatives OPTrust is taking the lead on:
  1. Hedging for longevity risk: Hugh told me demographics are changing and OPTrust is taking the lead to reflect the new report from the Canadian Institute of Actuaries which shows Canadians are living longer.
  2. Taking climate change seriously: If you read pages 16-17 of the Funded Status Report, you will understand how OPTrust is taking the lead on responsible investing in terms of taking climate change seriously. Hugh emphasized that unlike tobacco where they are butting out for good, they don't want to divest from energy companies but want to work with them to focus on better ways to address global climate change.
Lastly, I note executive compensation of OPTrust's senior officers below (click on image):


A full discussion on compensation is available in the Funded Status Report. All I can say is that Hugh O'Reilly and James Davis are doing a great job and are being compensated in line with their peers (even below them).

Below, Hugh O'Reilly sits down with members of the Plan to discuss why OPTrust’s mission is paying pensions today, preserving pensions for tomorrow.

This was another excellent year for OPTrust and just like HOOPP, their members are very lucky to have a solid team of professionals making sure their pension plan is sustainable over the long run.

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