OTPP's CEO Jo Taylor on Inflation, Real Estate and Where They See Opportunities
Geopolitical uncertainty and macroeconomic headwinds pushed some of Canada’s top institutional investors into negative territory in 2022, but not the Ontario Teachers’ Pension Plan. The country’s largest single professional pension eked out a respectable four per cent return for the year, leaving it with $247.2 billion in assets and on track toward its goal of $300 billion by 2030. The Financial Post’s Barbara Shecter sat down with Teachers’ chief executive Jo Taylor to discuss the fund’s strategy, how it’s navigating inflation and where it’s finding opportunities in uncertain times. This interview has been edited and condensed.
Financial Post: Teachers’ seemed prepared to weather macro-economic trends such as rising inflation and interest rates in 2022. What was your strategy?
Jo Taylor: I took over as CEO around about three years ago, beginning in 2020. I think it’s fair to say life’s been pretty volatile over that three-year period, starting with the pandemic, then moving into both political and economic changes that have been quite material. The headline strategy for me is to be pretty bold, and to be as agile as we can be. Despite being relatively large, we felt we could make money within our capital allocation — and by avoiding areas where we thought we didn’t want to be exposed.
FP: Where have those decisions paid off, in terms of shifting in and out at the right time?
JT: We’ve been very thoughtful about how much allocation we want to fixed income as an asset class: bonds, etc. And also into public equities, where we’ve taken the view for a little while that valuations look relatively full. And what we’ve essentially counterbalanced that with is a stronger allocation to private assets, particularly more recently to things like infrastructure where, last year, we invested the better part of $14 billion. We saw it as a stable, productive asset class for us and a good alternative to fixed income.
FP: What’s your thinking now on fixed income? Short or long duration bonds?
JT: We’ve probably moved them all into the shorter end of the bond duration curve that, at the moment, seems to give us the most manageable amount of risk. The interesting question for us is: When are interest rate rises going to sort of settle out? That’s not only relevant to bonds; it’s also relevant very much to equities in terms of how the markets price in those interest rate rises. The way we tried to think to this is: What’s our view of inflation? Because that will give you some idea of where interest rates may go. We’ve been, for a little while, more conservative. We would be more in the camp of expecting inflation to be higher for longer and therefore probably expecting it would be logical for interest rates to continue to rise through 2023.
FP: How does inflation affect a fund like yours?
JT: Inflation for a defined-benefit pension plan is a very meaningful factor in terms of the impact it has. It increases our exposure to our liabilities because they’re generally inflation linked, and it also has an impact on our assets because the inflation can erode the profitability and growth ability of those companies. So for us, what we’re trying to do is acquire assets that give us some inflation protection. That’s why we like infrastructure, because it’s got inflation pass-through on a lot of those assets. For us, the optimal way forward probably would be that interest rates continue to rise a little bit and stay where they are, rather than start to go back again too early, to fully manage inflation risk.
FP: The federal government cancelled the real return bond (RRB) program that many defined-benefit pension providers relied on to help manage inflation risks. How is that affecting you?
JT: We found that program very helpful. It is one of the means to actually match some of your assets to your liability profile. And we’ve seen that becoming more evident in the U.K. and some other parts of the world as an issue if you don’t get the right matching. Discussions are being held to see if there would be adequate demand for RRBs if they were reintroduced and certainly, from our point of view, we would be an active participant. So our hope would be to see in a period of time that they are reintroduced, which would allow us to get access to bonds which actually have a closer correlation to our liabilities.
FP: What are your thoughts on equity markets. Are you planning any changes there?
JT: On the public equity side, we have exposure both through individual stocks (and) indices. The thing we’re thinking more carefully about on buying an index is actually what sort of climate allocation do you acquire, and we do that through those investments.
FP: What about private markets? There’s some concern that private assets haven’t been adequately written down to reflect what’s gone on in public markets since late last year.
JT: Firstly, the portfolio is performing well. Our performance across that portfolio in 2022 was very strong relative to 2021. Second thing I would say is that when we look to valuations, we don’t just develop our own personal view, we actually get it reviewed by a number of other professional parties, which would be Deloitte as well as specialist advisers around some segments of the portfolio such as airports or other things where it’s quite specialized. We try to take a pretty measured, conservative view of what looks like the right carrying value for those companies.
FP: How do you give pensioners faith those valuations will hold up?
JT: The best test of your carrying value for private assets is actually when you sell them — that you can sell assets at a 15 to 20 per cent premium to carrying value. If you’re not able to do that and you’re selling your assets broadly at carrying value, where is the good news outcome? We have a large portfolio of private assets that is performing well, we’ve been specializing in that for a while and we did a very exhaustive review of those as we do every year at year end — not just ourselves, but through third-party experts, and they came back with the view that they’re fairly valued.
FP: One private asset class that’s generating a lot of discussion amid rising interest rates is real estate, particularly commercial real estate. Are you seeing problems there?
JT: If you look at Cadillac Fairview (the $40-billion real estate firm owned by Teachers’), which is an excellent developer and operator of assets, it’s been historically quite heavily focused on office and retail — both of those segments of the real estate market have more recently had their challenges. Cadillac Fairview, I think, has done extremely well through the pandemic and beyond to make sure that we have good occupancy of both our shopping malls and retail real estate, but also in our offices in Toronto and Vancouver particularly, being the cities we concentrate on. And in both of those areas, operationally, they’re doing really well at the moment so they have good retail sales through the shopping malls, probably driven more, I would say, by higher spend than necessarily fully recovered from before the pandemic. And on the office side, we’ve maintained higher levels of occupancy with good covenants (and) professional firms, particularly because they’re class A buildings, so they’re actually at the more desirable end where people would like to occupy office space.
FP: Do you plan any changes in light of the challenges?
JT: How to get some balance or better balance into our overall real estate portfolio is really a journey we started a few years ago. What the Cadillac Fairview team is largely focusing on is providing more multifamily real estate opportunities in Canada, which is something that everybody is looking for because there is not enough available housing for people to rent. And we can do that at some of our retail sites because we have the land, subject to planning, to be able to develop there. We also have the potential for some industrial development on sites where it’s appropriate. So we can try and move away a little bit from those two segments (office and retail) that I mentioned.
FP: Any other diversification plans?
JT: The other thing we’re trying to do is move away to some extent from Canada into other international markets, which the team has been doing for a while, but we’ve accelerated that over the last three or four years. So to that end, we’ve been investing in places like Europe and the U.S. And generally what the team has done, I think quite well, is to invest in operating platforms where we can then invest in assets that we like. So you take Lincoln, which is one of the platforms we did down in Texas that does a lot of multifamily development within the U.S. And we also did a platform investment in Stanhope in the U.K. where we’ve done two or three developments with that team in quite interesting industrial and office properties in that part of Europe.
FP: What are the biggest challenges you see in real estate as an asset class?
JT: Real estate is like all private asset classes. It’s not necessarily that liquid. If you look around Canada at the moment, there haven’t been that many marquee disposals so no recent indication of pricing for either retail or office where we’re probably most active. And really the issue for us, because we are long-term investors, is to say, How do we enhance and improve our real estate portfolio over time? And that’s really what we’re going to do by taking a measured and a patient approach to try and get it slightly better balanced — but also making sure it continues to operate with good returns.
FP: What about the lending side of commercial real estate, and mortgage renewals? That’s where pressure is expected to build as a result of rising rates.
JT: I would say the model we operate in real estate is with low levels of borrowing. Whilst I would say honestly that market is quite challenging at the moment in terms of finding access to lending and capital from third parties, our model isn’t predicated on that. So it’s not as if we need that to be able to be competitive. And we distinguished between ourselves and other investors by actually being able to operate through good local partners where we can then actually find the right sites and, with the right level of financial support from us, we can develop those out when the market is suitable. So, you know, with real estate, you can either press the green button today or you can wait a little bit and I think in some cases we’ll probably be reflecting on when is the right moment to push forward (with) more development versus today.
FP: What would make you push the green button? Lower rates and inflation?
JT: I think for us, it’s more looking at the returns available and the demand side of the equation because it will be a mix of multifamily and office. So we should have to figure out how that is looking relative to some of the uncertainties that are out there in the world at the moment. I would guess for real estate, one of the uncertainties is return to office. So how many people are going to be back in offices on a fairly permanent basis in the future and that’s one of the things you know, it’d be wise for us to just to try and get a better handle on for sure.
FP: Where are you seeing the most deal opportunities?
JT: The most activity we probably have at the moment is on the private equity side, helping our existing portfolio (companies) to acquire bolt-on companies to grow. That’s been something that is easier to execute at the moment and we can still generate good value with the business. We know, in terms of how well it’s executing, where the risks are. So in many ways, that’s an attractive alternative to doing a new proposition where you have to get up to speed on all those issues.
FP: You did have to write down one venture investment entirely, and took some heat for having invested alongside other sophisticated institutional investors in now-defunct crypto platform FTX. Any more plans for crypto?
JT: FTX was a learning experience for us. We wanted to look at crypto. We chose an exchange (because) we thought it was a business of scale that would allow us to look and learn. It didn’t turn out as we hoped. We’re still processing some of the learning from that and until we have done, I think we’re probably unlikely to do anything new.
FP: Is there anything that keeps you up at night?
JT: ‘Not much’ is probably the honest truth. But if you asked what is the risk that is difficult to fully identify, but could have a significant impact on many international investors and their activities, it would probably be the current situation in Ukraine. Because I think if that went the wrong way, that could be a catalyst for a material change in confidence in international markets at a time when there are already some risks in play.
Excellent interview with OTPP's president and CEO Jo Taylor.
Let me quickly summarize the main points:
- Since 2020 when Jo took over the helm, OTPP is focusing on "capital allocation" meaning strategic and tactical allocation across and within public and private markets. They continue to allocate heavily into privates, especially core infrastructure and within Fixed Income, they have shortened duration considerably when rates were low and increased it recently as rates rose back to historic norms and long bonds became attractive again from a liability-hedging standpoint.
- As far as private assets, their portfolio is "going extremely well"and Jo mentioned they value assets very conservatively using third party appraisers like Deloitte and others. He said the proof is when they go to sell (dispose) assets and get 15-20% premium above the "carrying value".
- Real estate remains the private market asset class which is undergoing significant changes, both sector and geographic diversification. This started fur years ago and has accelerated since 2020 when Jo took over the helm. It is going well but it takes time and that portfolio will continue to primarily invest abroad and into logistics (industrial) and multifamily (residential) properties. In Canada, they are looking to convert some Retail and Office assets into mixed-use properties to take advantage of demand for residential properties.Again, this is going well but it takes time.
- Given OTPP provides indexed benefits, inflation remains a cost and they look to hedge this cost through infrastructure assets with "inflation passthrough clauses" and commodities which OTPP is active in. It seems like the organization is betting higher for longer is here to stay.
- As far as crypto exchanges, OTPP is still learning from the FTX debacle and isn't going to invest there in the near future. They screwed up and want to learn from this experience.
- In private equity, they understand their portfolio companies well and are looking to help them grow. In public equity, they're focusing more on ESG risks.
- Geopolitical concerns, the Russia-Ukraine conflict in particular, remain a huge concern.
I recommend my readers take the time to read my comment going over OTPP's 2022 results here.
OTPP and OMERS are two large Canadian pension plans that delivered the best results last year, both up 4%, but there are slight twists in their asset mix:
- OMERS has a more developed private debt program, lending very conservatively to private companies that meet their underwriting standards. It also has a much more diversified Real Estate portfolio having started its international platforms earlier, investing across the world and into logistics, medical services, multifamily all over the world.
- OTPP is only now diversifying its real estate portfolio which is does mark down very conservatively. In order to hedge again inflation, it invests in commodities which performed well last year.
Last week, I discussed how CDPQ's $70 billion real estate subsidiary, Ivanhoé Cambridge, is talking up agility and evolution and mentioned this:
Last week, I had a chat with OTPP's CEO Jo Taylor who told me: "We are very comfortable with our real estate valuations. Unlike our large peers, our real estate asset values reflect the challenges in that market."
That was a direct swipe at OMERS's real estate arm, Oxford Properties, and CDPQ's real estate arm, Ivanhoé Cambridge, which posted 10% returns last year while OTPP's real estate subsidiary, Cadillac Fairview, was down 4% in 2022, underperforming its benchmark of 6.7%.
But it's a little more complicated than this because as I explained when I went over Teacher's 2022 results, its real estate portfolio isn't as diversified geographically and by sector as its large peers:
As far Real Estate, Cadillac Fairview is still struggling to diversify outside of Canada and Retail but it;'s happening ever so slowly, and this will benefit OTPP's members over the long run.
But it's slow, that portfolio should have followed Oxford Properties back when Blake Hutcheson was running it, diversifying out of Canada and into Industrials and Multi-Family.
In fact, while both Oxford and Ivanhoe Cambridge delivered strong double digit gains last year, Cadillac Fairview was down 3.5% significantly underpeforming its benchmark of 6.7%.
For this to change, it needs to go full speed ahead with its geographic and sector diversification strategy but Jo Taylor told me they aren't going to sell assets at fire-sale prices.
Ziad Hindo sits on Cadillac's Board and makes sure they're executing ion their strategy, which they are but it will take time.
Having said this, I do think Cadillac Fairview takes a more conservative approach in valuing its real estate assets relative to its peers and this is the right thing to do.
If REITs go down another 20% this year and I see clear signs of a global recession and Canada's large pensions start posting solid real estate returns, my BS antennas will go up.
It's not going to happen.At one point, the economic forces of gravity take over.
Today, I learned Gateway Capital and Cadillac Fairview announced a new partnership to invest in the Australian Industrial and Logistics sector:
- Gateway Capital and Cadillac Fairview have launched a new investment vehicle, Gateway Capital Urban Logistics Partnership, which will focus on urban core plus, value add and development opportunities, and will focus on assembling a A$1 billion portfolio along and across the east coast of Australia
- Alongside the new investment vehicle, Cadillac Fairview has acquired a strategic stake in Gateway Capital
Gateway Capital has deepened its focus on the Australian industrial and logistics sector through a new partnership with Cadillac Fairview (CF), the real estate arm of Ontario Teachers’ Pension Plan, with the formation of a new vehicle to acquire and develop Australian industrial and logistics assets.
The new investment vehicle, Gateway Capital Urban Logistics Partnership (GULP), will focus on urban core plus, value add and development assets on the east coast markets of Australia, targeting a A$1 billion portfolio. GULP will seek opportunities in areas that are forecast to benefit from strong tenant demand linked with the growth of e-commerce, together with other structural tailwinds supporting the industrial and logistics sector.
In addition to the formation and equity investment in GULP, Cadillac Fairview has also acquired a stake in the Gateway Capital operating platform. Through this investment, Cadillac Fairview will join Grosvenor Group as strategic investors in Gateway Capital, cementing strong support from institutional capital for the Company.
Stuart Dawes, Gateway Capital co-founder and CEO, commented:
“We are delighted to be partnering with Cadillac Fairview on the GULP strategy, whilst also welcoming them to Gateway Capital as a shareholder. The global expertise and broad investment capability of Cadillac Fairview provides significant strategic value to Gateway Capital, supporting the Company as we execute our real estate strategies.
“We believe strongly in the urban industrial and logistics markets and are confident that our track record and deep experience in these markets will identify assets where we can add value to create attractive core assets and ultimately deliver strong investor returns. The GULP strategy is well set to take advantage of these opportunities.”
Karl Kreppner, Regional Head of APAC at Cadillac Fairview, said:
“Our partnership with Gateway Capital marks our second direct investment in Australia, and we are excited to work alongside such a high-quality management team. The industrial and logistics sector continues to be highly attractive with strong fundamentals, and the changing macro-environment positions us well to take advantage of opportunities as they arise. We are looking forward to working with Gateway Capital to build up a portfolio of scale.”
Jun Ando, Managing Director, APAC at Cadillac Fairview, said:
“Stuart, Peter and the entire Gateway Capital team have an excellent reputation in the industry for hands-on, value-add investing throughout Australia. We are confident this will mark the first of many direct investments in the industrial and logistics asset class across Asia Pacific as we continue to expand our footprint in the region.”
Peter McDonald, Gateway Capital Co-founder and Managing Director - Property, said:
“Never have we witnessed such low vacancy rates in the Australia industrial and logistics sector. This is driven by the supply constrained market, which is further being impacted as new developments are delayed, whilst demand remains strong. This dynamic has led to unprecedented rental growth over the past 24 months, which is expected to continue in the short to medium term.
“The trend of e-commerce continues to represent a large proportion of the occupier demand, evidenced by these users accounting for 46% of all floor space leased in Australia in 2022. This is forecast to continue with e-commence penetration rates estimated to grow from 13% currently to 17% over the next four years.
“The strong thematic of the sector, coupled with our active and dynamic approach across both existing assets and new development opportunities, places Gateway Capital in a great position to take advantage of this market. Gateway Capital will continue the approach of driving value from assets that are underutilised and under managed.”
As I stated plenty of times, Cadillac Fairview is finally utilizing all its platforms across the world to properly diversify across geographies and sectors and this is going to bolster OTPP's real estate portfolio over the long run.
Still, Cadillac Fairview has a long way to go before it reaches the sector and geographic diversification of Oxford properties (OMERS), Ivanhoé Cambridge (CDPQ), QuadReal (BCI) and other large Canadian pension funds.
It takes time to properly diversify that portfolio and Jo Taylor has told me they're not interested in selling great Canadian assets at fire sale prices.
Alright, let me wrap it up there.
Below, Colin Lynch, head of global real estate Investments at TDAM, joins MoneyTalk to discuss the challenges facing commercial real estate. Great interview, listen carefully to Colin's insights.
Also, Mohamed El-Erian, Allianz and Gramercy advisor and president of Queens' College, Cambridge, joins 'Squawk Box' to discuss the higher yields, how sticky inflation will be, and more.
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