Ontario Teachers' Returns 11.2% in 2011

Doug Alexander and Colin McClelland of Bloomberg report, Ontario Teachers’ Pension Fund Posts 11% Return in 2011:

Ontario Teachers' Pension Plan, Canada’s third-biggest retirement-fund manager, posted an 11 percent return on investments in 2011, led by fixed income, private capital and infrastructure assets.

Net investment income rose to C$11.7 billion ($11.8 billion) last year from C$13.3 billion in 2010, the Toronto- based pension said in a statement today. The fund managed C$117.1 billion in assets as of Dec. 31, compared with C$107.5 billion a year earlier.

“Performance was especially impressive given the market volatility and economic uncertainty that accompanied the Eurozone debt situation, and was compounded by last year’s natural disasters,” Chief Executive Officer Jim Leech said in the statement.

Ontario Teachers’ results beat the 0.5 percent return of Canadian pension funds last year, as estimated in a Jan. 23 report by RBC Dexia Investor Services Ltd.

Canada’s biggest pension-fund manager, Caisse de Depot et Placement du Quebec, on Feb. 23 reported an annual return on investments of 4 percent. Ontario Municipal Employees Retirement System, a Toronto-based pension fund manager, said Feb. 24 it had a 3.2 percent return last year.

Ontario Teachers’ said equities had a loss of 0.8 percent last year, driven down by Canadian equities, compared with a return of 10 percent in 2010. Canada’s benchmark S&P/TSX Composite Index fell 11 percent last year.

Fixed Income Returns

Fixed income returned 20 percent in 2011, double the rate from the year earlier. Real assets such as real estate, infrastructure and timberland returned 13 percent, down from 14 percent in 2010. Commodities lost 2.3 percent, compared with a 3.2 percent return the prior year.

“Real estate performed extremely well this year, private capital and fixed income did very well,” Neil Petroff, chief investment officer, said in a press conference. “Where we had large dollars we did well.”

Private-equity investments returned 17 percent in 2011, the pension fund said. Teachers’ Private Capital managed C$12.2 billion in assets at the end of the year, up from C$12 billion a year earlier.

Ontario Teachers’ estimated funding shortfall narrowed to C$9.6 billion, from C$17.2 billion a year earlier.

Economic Uncertainty

“The deficit was really caused by the uncertainty of the economy and interest rates, and demographics,” Leech said in a press conference. “We still have a legacy of the 2008 loss that haunts us.”

Ontario Teachers’ needs “a small course correction” to ensure the plan is solid and sustainable, Leech said, adding that a committee has been created to investigate how. “This isn’t crisis time, this is sitting down and being smart about what are the changes we can make now.”

The pension fund manager’s stock and private-equity holdings rose to C$51.7 billion at the end of 2011 from C$47.5 billion, the fund said. Fixed-income assets climbed to C$55.8 billion from C$45.9 billion a year earlier.

The fund’s commodities investments totaled C$5.7 billion at year-end, up from C$5.2 billion. Real assets, which includes real estate, infrastructure and timberland, fell to C$25.8 billion at the end of 2011 from C$26.2 billion in 2010.

Ontario Teachers’ is responsible for investing and managing pensions for about 300,000 active and retired teachers in Canada’s most populous province.

Andrea Hopkins of Reuters also reports, Ontario Teachers' returns climbed again in 2011:

Ontario Teachers' Pension Plan, one of Canada's top dealmakers, said on Tuesday it had an 11.2 percent rate of return on its investments in 2011, bringing net assets to a record high C$117.1 billion ($117.9 billion) despite market volatility.

The third straight year of double-digit returns on its massive investment portfolio failed to close Teachers' funding shortfall, which narrowed to C$9.6 billion from C$17.2 billion in 2010. The funding gap measures the shortfall between the projected cost of providing pensions to Teachers' 300,000 active and retired teachers and its projected asset growth.

Strong returns in private equity, fixed-income and infrastructure drove 2011 gains while returns in commodities and real estate pulled overall returns lower, Teachers said in a statement accompanying its annual report.

"Our team's 2011 performance was especially impressive, given the market volatility and economic uncertainty that accompanied the euro-zone debt situation, and was compounded by the year's natural disasters," Jim Leech, Teachers president and chief executive, said in a statement.

Teachers, Canada's largest single-profession pension plan, has emerged as one of the world's most powerful dealmakers, investing in infrastructure and real estate projects around the globe and harnessing top-notch talent to manage its huge investment portfolio to ensure high returns.

It abandoned a passive investment strategy - which focused mainly on Canadian stocks and bonds - in recent years and has since put its money to work in global equity, seeking projects and assets that promise long-term income and gains.

The fund said active management has added C$53.0 billion to the plan's asset size since it was freed from government control in 1990. In a report released in 2011, CEM Benchmarking, the world's leading authority on pension plan benchmarking, said Teachers had the highest 10-year total fund and value-add returns of the pension plans they study around the world.

Still, demographic trends means Teachers must grapple with trying to provide benefits to an increasing number of retired teachers while the number of active educators paying into the plan declines.

Even with higher contribution rates and lower benefits, persistent low interest rates and longer retirements mean Teachers has not been able to close its funding shortfall.

"Accordingly, we are working with our sponsors, Ontario Teachers' Federation and the Ontario government, to advise them on the various options for closing this gap at a reasonable cost," Leech said.

The 2008 global financial crisis and economic downturn swung most big pension funds into deficit, as huge stock market declines erased the value of investments. In 2008, Teachers suffered an 18 percent investment loss.

Last year marked the third year of recovery for the plan administrators.

The combined value of public and private equity assets rose 8.8 percent in 2011 to C$51.7 billion. Private equity assets totaled C$12.2 billion at year-end, up from C$12 billion in 2010, and private investments returned 16.8 percent, Teachers said.

Fixed income assets rose to C$55.8 billion, up from C$45.9 billion at the end of 2010, and returned 19.9 percent, while commodities investments rose to C$5.7 billion from C$5.2 billion and notched a negative return of 2.3 percent.

Real assets, which comprise real estate, infrastructure and timberland, fell to C$25.8 billion at year-end from C$26.2 billion at the end of 2010.

Infrastructure assets returned 7.7 percent, while timberland investments returned 0.8 percent.

Real estate properties and investments managed by the plan's wholly owned subsidiary, Cadillac Fairview, were valued at C$15.0 billion at year-end, down from C$16.9 billion the previous year. The drop was mostly due to the issuance of new debt and sale of Teachers' stake in Hammerson Plc, offset by a rise in real estate assets values. The portfolio notched an 18.2 percent return.

Ontario Teachers' released a statement on its website, 11.2% rate of return boosts Teachers’ net assets to all-time high of $117.1 billion:

The Ontario Teachers’ Pension Plan (Teachers’) today reported that net assets reached an all-time high in 2011. Its 11.2% rate of return added $11.7 billion to the plan’s net assets, reaching $117.1 billion at December 31, despite the crisis of confidence and market volatility that followed the European debt crisis.

Overall, the pension fund earned 1.4% above its 9.8% benchmark, or $1.4 billion in value-added returns (returns above the fund’s composite benchmark). Private capital, fixed income and infrastructure were the fund’s asset class leaders. Active management has added $53.0 billion to the plan’s asset size since inception in 1990. In a report released in 2011, CEM Benchmarking, the world’s leading authority on pension plan benchmarking, said Teachers’ had the highest 10-year total fund and value-add returns of the pension plans they study around the world.

“Our team’s 2011 performance was especially impressive, given the market volatility and economic uncertainty that accompanied the Eurozone debt situation, and was compounded by the year’s natural disasters,” said Jim Leech, Teachers’ President and CEO.

Mr. Leech highlighted that the Member Services division enjoyed similar success, serving more members during the implementation of a record number of plan changes. “We ranked first among our North American peers for exceptional pension service, and have maintained service scores in the 9 out of 10 range for many years,” he noted.

Funding shortfall

Even with this success, however, and the plan sponsors’ having raised contribution rates and lowered benefits to balance the fund as of January 1, 2011, the issues of persistent low real interest rates and changing demographic trends continue to affect the plan.

“The result is a preliminary $9.6 billion funding shortfall, as of January 1, 2012,” said Mr. Leech. “Our liabilities, that is, the projected cost of providing future pensions, continue to outpace our projected asset growth. Accordingly, we are working with our sponsors, Ontario Teachers’ Federation and the Ontario government, to advise them on the various options for closing this gap at a reasonable cost.”

“Teachers’ has a reputation for leadership in investment innovation, service delivery and pension fund governance. I am confident that we can continue to lead the way by helping our sponsors deliver fair, realistic and sustainable pension funding solutions for the long term,” he stated.

Asset class summary

The combined value of the plan’s public and private equities was $51.7 billion at year-end, compared to $47.5 billion as of December 31, 2010. Private equity assets managed by Teachers’ Private Capital totaled $12.2 billion at year-end compared to $12 billion at December 31, 2010. These private investments returned 16.8% for $1.6 billion in value added, compared to a benchmark return of -0.2%. See table

Fixed income assets rose to $55.8 billion at year-end, compared to $45.9 billion at December 31, 2010, and returned 19.9%, compared to a benchmark return of 19.5%, for $163.4 million in added value.

The fund’s commodities investments totaled $5.7 at year-end compared to $5.2 billion at December 31, 2010, returning -2.3% compared to the -1.5% benchmark return.

Real assets, which comprise real estate, infrastructure and timberland, totaled $25.8 billion as of December 31, 2011, compared to $26.2 billion at the end of 2010.

Infrastructure assets returned 7.7%, compared to a benchmark return of 6.1%, for $176.9 million in added value. Timberland investments totaled $2.1 billion at year-end compared to $2.2 billion in 2010, returning 0.8% in 2011, compared to the 10.2% benchmark.

Real estate properties and investments managed by the plan’s wholly owned subsidiary, Cadillac Fairview, were valued at $15.0 billion at year-end, compared to $16.9 billion the previous year. The net decrease is primarily due to the issuance of new debt and disposition of our investment in Hammerson plc, offset by an appreciation in value of our real estate assets. The portfolio earned an 18.2% return, compared to a benchmark of 21.8%.

With $117.1 billion in assets as of December 31, 2011, the Ontario Teachers' Pension Plan is the largest single-profession pension plan in Canada. An independent organization, it invests the pension fund's assets and administers the pensions of 300,000 active and retired teachers in Ontario.

For more information, including our 2011 and archived annual reports, visit www.otpp.com.

I spent a good part of evening going over OTPP's 2011 Annual Report. It's an amazing read for pension junkies like myself but I strongly urge everyone to sit down and read all the sections very carefully. The section on the plan's liabilities alone is priceless, but so is everything else.

I also noted the following statement in Eileen Mercier's Report From the Chair, which should be noted by all pension skeptics: "We believe that the closure of defined benefit plans is a regressive trend and fear it will lead to many seniors struggling to make ends meet in their later years." It's about as political as Ontario Teachers' will get but I'm glad they put it on their annual report and hope they'll keep hammering this point.

The overall results are nothing short of spectacular. In 2008, I blasted Teachers' for crashing and burning. Well they obviously learned a lot from that experience because in the last three years they've recovered and in 2011, they hit a home run, handily beating their peers in Canada and the United States (I expect HOOPP will post similar results).

The table below summarizes the returns of various asset classes relative to their benchmark (click on image to enlarge):

As you can see, Equities (Public + Private), Fixed Income and Infrastructure beat their respective benchmarks, bolstering Teachers' overall results. There is another table on page 32 of the Annual Report which is worth noting:

Clearly Ontario Teachers' is delivering on active management, producing absolute returns internally and from external hedge funds (from page 32):

Our internally managed absolute return strategies generally look to capitalize on market inefficiencies. External hedge fund assets are used to earn uncorrelated returns or access unique strategies that augment returns.

By using several hedge fund managers, we diversify risk across multiple managers, strategies and styles. Assets employed in absolute return strategies totalled $12.3 billion at year end compared to $11.4 billion at December 31, 2010, reflecting strong performance throughout the year.

When it comes to alpha, Ontario Teachers' doesn't pay fees for strategies they can replicate internally. Ron Mock who runs Fixed Income and External Hedge Funds and Wayne Kozun, who runs Public Equities, both did an outstanding job in 2011, which is why they were both highly compensated (still, nowhere near as much as their external hedge fund partners).

But it wasn't just Ron and Wayne who delivered, everyone at Teachers', including the Board, should be commended for these outstanding results. Jim Leech and Neil Petroff are right to commend their employeese as these results put them in a league of elite global funds.

Unfortunately, no matter how good these results are, they're insufficient to cover the plan's structural deficit. Jim Leech, OTPP's President and CEO, underscored this point when he said investment returns alone cannot close the deficit gap. Teachers' plan sponsors need to sit down and figure out how they'll tackle their deficit.

On this point, Tara Perkins of the Globe and Mail reports, Ontario teachers’ pension benefits ‘have to be cut, ’ Duncan declares:

The pension fund for Ontario’s teachers is $9.6-billion in the red, and the province wants to fix the shortfall by cutting benefits, not hiking contributions.

The heavily indebted province is seeking to shift the onus for solving shortfalls away from taxpayers as part of its plan to put its finances back on a solid footing.

The move is part of a trend in which governments are taking steps to make pensions more sustainable as low interest rates and aging populations threaten retirement funds. Beyond Ontario’s public sector plans, that includes proposed federal changes to Old Age Security, and potential reforms to MPs’ pensions.

“We are saying benefits have to be cut,” Finance Minister Dwight Duncan said in an interview on Tuesday after the new shortfall was announced. “We are not agreeing to contribution increases.”

The idea of decreasing the degree of inflation protection for teachers’ pensions is already on the table, but Mr. Duncan suggested that the measures might have to go further, citing the formula that allows teachers to retire with a full pension when their age plus qualifying years add up to 85.

“A change in age plus years of service – you could change that and get fairly substantial savings, but the province is not in a position to raise contributions,” he said.

Up until now, when the pension fund needed solvency relief, the default mechanism was first to increase contributions (the province matches what teachers put in), and cut benefits second. The province said in the budget that it will be introducing legislation to reverse that.

While contribution increases would still be possible, Mr. Duncan clearly suggested in the interview that they are off the table.

The funding shortfall that existed as of Jan. 1 happened despite recent contribution increases, benefit cuts, and solid investment returns.

Ontario Teachers’ Pension Plan CEO Jim Leech emphasized to reporters in a press conference on Tuesday morning that the plan is still 94 per cent funded.

“This is not a crisis,” he said. “This is our 10th year that we have faced a preliminary deficit.”

The plan’s sponsors – the Ontario Teachers’ Federation and the provincial government – are required to bring the plan into balance every few years. They did so last year, solving a deficit of more than $17-billion, and are not required to do so again until 2014. However, the government has signalled that it would like to tackle it this year.

The teachers’ federation declined to comment on Tuesday.

Mr. Leech said he thinks both the government and the teachers’ federation would like to deal with demographic challenges to prevent shortfalls in future years. The plan has been paying out more in benefits than it has received in contributions since the end of the 1990s. Teachers work on average 26 years and collect a pension for 32 years.

The rules of the plan currently allow the sponsors to increase contributions to 15 per cent of salaries (contributions are already scheduled to rise to 13.1 per cent), with those contributions matched by government, or to decrease some of the guaranteed inflation protection.

But doing both of those things “would not quite cure this deficit,” Mr. Leech said.

I agree with Jim Leech, the funding gap isn't a crisis but increasing contributions and decreasing inflation protection is not a cure for this deficit. Sponsors need to tackle it head on. Below, Jim Leech discusses 2011 results and the deficit (transcript available here).