OMERS Loses 2.7% in 2020
Ontario Municipal Employees Retirement System, one of Canada’s largest pension funds, posted its worst result since the global financial crisis after suffering big losses in its private equity and real estate holdings.
The pension fund, known as OMERS, lost 2.7 per cent on its investments last year, pushing assets to $105 billion (US$84 billion). It’s the worst result since 2008, when it lost 15.3 per cent.
“We have been hit very hard by COVID and we’re not making excuses, but the fact is most of our difficulties this year were directly related to COVID,” Blake Hutcheson, who became chief executive officer on June 1, said in an interview.
The pension fund fell far short of its 6.9 per cent return benchmark, and also trailed the average 20 per cent increase of Canadian pension plans, as estimated by Bank of New York Mellon Corp.
Losses in its consumer-facing investments, including retail properties and transportation and entertainment holdings, explain more than half of the overall performance gap versus the benchmark, Chief Financial Officer Jonathan Simmons said.
OMERS’ 20-company private equity portfolio had a negative return of 8.4 per cent, compared with a gain of 4.6 per cent in the previous year. The lion’s share of that loss came from two holdings, Hutcheson said -- a movie theater chain and a recruiting company in Europe. Together, they constituted about 90 per cent of the drop.
“These companies have delivered double-digit returns consistently, and all of a sudden there are these COVID-related losses,” Hutcheson said.
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OMERS’ portfolio of “old economy” public equities, which includes significant allocations to dividend-paying financial services and energy companies, also weighed on performance, according to Simmons.
“We had a positive return in our equities this year, but they didn’t rise quite as much as some of the new-economy stocks,” he said. “Some of our other private investments are very new-economy oriented, but the equity portfolio has been very focused on dividend-producing income stocks.”
Looking ahead, the pension fund will focus on increasing allocations to new-economy stocks and expand its investments in the Asia-Pacific region, where demographics and economic growth are attractive.
The pension fund is also making changes to its hedging strategy.
“After a year like this one, the big lesson is it’s the balance sheet
you have to preserve and protect as opposed to the shorter-term
fluctuations,” Hutcheson said. “We took off about 30 per cent of our
hedges, and we’re going to have a long-term program to get us down to
closer to maybe 20 per cent of the portfolio hedged at any given time.”
2020 was dominated by the COVID-19 virus and its impacts across the globe and here in Ontario. Many OMERS members served on the front lines and provided essential services to our communities across Ontario. Many continue to do so. We thank them and are proud to come to work every day for them.
The effects of the global COVID-19 pandemic negatively impacted our portfolio in 2020, particularly our business- and consumer-facing investments, contributing to an investment return net of expenses of -2.7% for the year. Widespread lockdowns in investments that included retail properties, and the transportation and entertainment sectors explain more than half of our shortfall to our benchmark in 2020.
“We are a long-term investor that pays pensions over decades, and with a strong team and strategy in place, this single year will not define us,” said Blake Hutcheson, OMERS President and CEO.
“Over the ten-year period leading up to 2020, OMERS investment portfolio performed well by any measure, averaging an annual return of 8.2%, and in 2019 alone OMERS delivered 11.9%. We are active investors and asset managers with high-quality assets diversified globally and we believe in the strong investment future that our portfolio represents for over 500,000 members and our more than 1,000 employers in Ontario,” he added.OMERS funded status on a smoothed basis remains at 97%, with a lower discount rate of 5.85%. “Over the past five years OMERS has lowered its discount rate by 40 basis points, to improve resilience to risks we see on the horizon,” said Jonathan Simmons, OMERS CFO.
We are making the appropriate changes to better position our platform for the future. Pension payments continue as usual and OMERS paid pension benefits of $5.1 billion in 2020 to more than 180,000 members.
“As announced early in January we are entering a new year with a refreshed senior team to shape our way forward,” said Mr. Hutcheson. “Collectively this new team brings deep experience from inside and outside of OMERS, multiple countries, perspectives and backgrounds, and it achieves much greater gender diversity. I would confidently put this new team up against any other to deliver on OMERS commitment to our members in the years ahead.”
“The fundamentals of our strategy remain sound. In any year, regardless of result, we would evolve our approach to adapt to current realities. Given the disruptions we experienced this year, we have made a number of important adjustments that lend additional strength to our approach,” said Mr. Hutcheson.
As we look to the future, we are making key decisions within our investment portfolio that enhance diversification, growing our exposure in new economy stocks, high-demand sectors in real estate, profitable investments with lower carbon intensity and more. These changes will help to position the Plan strongly to capitalize on the opportunities before us and to deliver on our commitments to members.
Detail on further activities will be provided in our Annual Report, which will be issued later today.
Further detail on our portfolio:
* For disclosure purposes, we present our investments and our performance by asset class. As such, Oxford Properties’ real estate credit business and public equity investment into HKSE-listed ESR Logistics is presented under ‘credit’ and ‘public equity’ respectively, and not in ‘real estate’. Including the performance of its credit business and investment in ESR Logistics, the Oxford Properties 2020 net return is -6.8%.
Late this afternoon, I had a chance to speak with Blake Hutcheson, President & CEO of OMERS.
I want to thank Blake for taking some time to talk to me and also thank Neil Hrab and Ann DeRabbie of OMERS' Communications team for setting this call up.
Blake began by telling me they have an amazing organization, team and global platforms and even though last year was a tough one, they are looking forward to turning the page and moving forward to continue delivering excellent returns.
On the 2020 results, he was disappointed but stated COVID-19 hit them harder than others directly and indirectly (more on that below).
Still, he reminded me that prior to entering 2020, OMERS had three, five and ten year annualized returns of 8.5%, 8.5% and 8.2%.
More importantly, the pension plan remains 97% funded on a smoothed basis and as the press release states, they have lowered the discount rate by 40 basis points over the last five years to "improve resilience to risks they see on the horizon".
So, from a funded status point, the plan remains solid and that's what counts most.
Now, what happened last year? Where did they get hit and why?
Blake reiterated the three main points in the press release, namely:
- Widespread lockdowns severely affected the business- and consumer-facing investments in their portfolio, particularly in retail properties and in the transportation and entertainment sectors. The lockdowns severely impacted the performance of Private Equity and Real Estate and explain over half of the overall performance gap.
- OMERS invests its public equities in high-quality companies that pay dividends, particularly in financial services and energy and they were out of favor last year as growth stocks ripped higher (that contributed another 20% to the overall performance gap).
- And third, the reduction in their F/X hedging following the events of March and April cost them serious performance as the US dollar lost ground to most currencies, including the loonie. That reduction in foreign currency hedging contributed another 20% to the overall performance gap.
Now, I understand points 2 and 3 very well. Most pensions invest in high-quality value companies and last year the Fed and other central banks increased their balance sheets by trillions, opening the speculative floodgates.
I called it a liquidity orgy and that's exactly what is was, a giant global Risk On trade that benefited growth stocks, small cap growth, biotech, commodities, commodity currencies,
That's all reversing this year as long bond yields back up and you can see it in the S&P sector performance year-to-date:
As far as the loonie and US dollar, soaring oil prices have helped the loonie but the downtrend in the US dollar is coming to an end and I seriously doubt we will revisit 2018 lows:
Basically, if the loonie hits 79-80 US cents, it's time to start shorting it in my opinion but you have the commodity supercycle folks that tell you it will hit parity (no chance!!).
I'll cover more macro stuff tomorrow when I go over markets.
Back to OMERS and where they got hit last year.
Blake and I spoke about real estate. They got hit in Retail and Offices in Calgary and New York City.
Interestingly, Blake told me Retail represents 16% of the real estate book and diversification (both geographic and sectors) helped mitigate some of the fallout.
Still, the lockdowns impacted malls, hotels, offices, airports, toll roads, and two of their 20 private equity companies -- Cineplex and a recruiting agency -- both of which accounted for 90% of the losses in PE (-8.4%).
Blake admitted that they need more diversification in Private Equity and "smaller ticket sizes" but the damage was done, the global pandemic wreaked havoc on some private businesses.
Think about it, companies cannot function with a no revenue model, some of OMERS portfolio companies were severely impacted by the lockdowns, more than their peers which were also impacted.
Some of their tenants went belly up, that impacted their real estate revenues.
Also, the footnote in the press release is important:
* For disclosure purposes, we present our investments and our performance by asset class. As such, Oxford Properties’ real estate credit business and public equity investment into HKSE-listed ESR Logistics is presented under ‘credit’ and ‘public equity’ respectively, and not in ‘real estate’. Including the performance of its credit business and investment in ESR Logistics, the Oxford Properties 2020 net return is -6.8%.
Blake told me Oxford lost 7% last year but because REITs are shifted to capital markets, the real losses in Real Estate were not as bad as reported (-11.4%).
Now, the big question is in a post-pandemic world, will certain segments of Real Estate bounce back? That's a huge topic, one I've covered here and here.
The truth is nobody knows, we are entering uncharted territory and we will likely see a hybrid model evolve to balance WFH and WFO.
Still, it's fair to say the writedowns OMERS took on some of their real estate holdings are to be expected but they are not recurring, so I expect that asset class to bounce back over the next five years.
The same thing with Private Equity, their strategy is shifting, they are going to diversify more globally and among sectors and that takes time.
As far as losses in Credit, Blake explained it was not on a cash flow basis, more on a mark to market basis.
Private debt is typically a hedge against rising rates and last year rates plunged to historic lows but they didn't suffer defaults, the way the accounting rules are, it showed up as a loss but it exaggerates what is truly happening there.
This activity will also bounce back nicely this year which is why global pensions doubled down on it.
Also worth noting is the performance of OMERS' infrastructure portfolio, which generated C$1.9bn in investment
income in 2020, while the rest of the portfolio lost C$4.7bn.
Infrastructure has generated very stable returns for OMERS and will continue to do so.
Lastly, a lot of comparisons will be made between the performance of OMERS and other large Canadian pensions.
As tempting as this may be, I caution my readers to avoid making such direct comparisons.
OMERS has a unique portfolio, it has a huge allocation to Private Markets, there were specific reasons as to why it's Real Estate and Private Equity portfolios got hit last year.
Last month, Blake Hutcheson revamped his executive team, they are ready to move forward and I am confident they will do so and continue delivering great long term returns.
As Blake reminded me what Mark Wiseman always says: "In the pension world, a quarter is measured over 25 years."
The pandemic disproportionately hit OMERS for all the reasons I cited above but it's time to forget about last year and move forward.
I hope this comment helps clarify some issues and to all the critics, and there are a few, I can assure you after speaking with Blake, I'm much more understanding of what went wrong and I do not think there is anything fundamentally wrong at OMERS or with their long-term strategy, quite the contrary.
Before I forget, this year OMERS released its Annual Report at the same time as it released its results. It can be found here and I urge all of you to read it carefully because I cannot cover all the details here.
I will end as I always do when covering annual results, with the summary compensation table for senior officers:
As you can see, last year's negative results impacted compensation which is based on the four year annualized returns. Details are available in the annual report here.
Let me once again thank Blake for taking the time to speak with me earlier, if there are any changes or additions that need to be done, I will update this comment as soon as possible.
Below, Blake Hutcheson, president and chief executive officer of Ontario Municipal Employees’ Retirement System (OMERS), discusses the pension fund's investment strategy amid Covid-19, and how OMERS integrates ESG factors into its investment decision-making processes (October 2020).
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