OPTrust Boosts Internal Management?
The OPSEU Pension Trust is boosting its efforts to internalize the management of certain assets by launching an in-house trading floor on Wednesday.OPTrust put out a press release explaining its decision to internalize public market assets:
The move to internalization provides the pension plan with many benefits, says Hugh O’Reilly, president and chief executive officer at OPTrust. “By being in the market in an active way, it gives us better perspective. . . . It allows us to more quickly execute our decisions.”
As well, managing assets in-house will help the pension plan scale back its management fees and transaction costs, he says.
OPTrust has been working on managing its own public market assets, which represent about 40 to 50 per cent of the fund’s holdings, for about a year, says O’Reilly. He notes the process will be gradual with the plan initially assuming management of money markets, foreign exchange, bonds and repurchase agreements and then eventually taking helm of other public assets such as fixed income and derivatives until it ultimately takes responsibility for 16 types of securities.
In addition to cost savings, the change aligns with the plan’s mandate of member-driven investing, says O’Reilly. He notes that while low interest rates have pressured many pension plans to assume more risk, OPTrust is looking to ensure a calculated approach. “We want to make sure we’re paid for risk we take, that we understand the risk we take and that we invest in a way that we reduce volatility in the fund. . . . In order to do that most effectively, we need to internally manage certain investment activities . . ..”
OPTrust is already managing real estate, private equity and infrastructure investments internally, and its ultimate goal is to do so for 70 to 80 per cent of its assets, says O’Reilly.
He notes building internal capacity to manage investments reflects the plan’s evolution. “This plan is 22 years old and in that 22 years, it’s gained expertise . . .. So [internalization] is another milestone along the way that demonstrates the increasing sophistication and maturity of the plan.”
Today marks a major step towards OPTrust’s plan to internalize public market asset management of approximately 40 to 50 per cent of the fund’s $19 billion in assets over time with the launch of its in-house trading floor and its first internal trade.I had a chance to discuss this latest development at OPTrust with its President and CEO, Hugh O'Reilly, on Thursday afternoon.
Over the past two years, OPTrust has been implementing a member-driven investing (MDI) strategy with a singular focus to increase the likelihood of plan certainty by balancing the objectives of sustainability and stability to better align the Plan’s outcomes with members’ needs. Internalizing facets of public market assets supports this strategy through the ability to execute trades and to customize investment solutions with enhanced liquidity.
“The move to internalization provides us with direct access to the markets and greater insight into changing conditions to customize our investment strategies in a more agile way,” said Hugh O’Reilly, OPTrust President and CEO. “Internalization is a natural evolution for OPTrust and a key enabler of our MDI strategy to achieve purposeful risk allocation and deliver on our promise to members.”
Internalizing investment processes creates opportunities for OPTrust to further improve risk management, increase the operational skills of personnel and build internal capacity, allowing for a deeper understanding of risk and public markets.
OPTrust is taking a measured approach to internalization to ensure its success. The goal is to internally manage the majority of the fund’s public market assets and strategies, including foreign exchange, fixed income and derivatives with the initial focus on money markets, bonds, foreign exchange and repurchase agreements.
About OPTrust
With net assets of $19 billion as at December 31, 2016, OPTrust invests and manages one of Canada's largest pension funds and administers the OPSEU Pension Plan, a defined benefit plan with almost 90,000 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.
Before I get to those comments, let's go over an article that Bloomberg's Maciej Onoszko wrote at the beginning of the year, OPTrust joins Canada pension peers by bringing trading in-house, hiring up to 10 portfolio managers:
Canadian pension plan OPTrust is catching up with its bigger domestic peers by setting up a trading floor and adding as many as 10 portfolio managers to oversee about half of its $18.4 billion of assets in-house.The article above gives you a great background as to why OPTrust is moving ahead to internalize its public market assets, mostly fixed-income assets.
The move to internalize oversight of foreign-exchange, fixed-income and derivatives strategies is meant to improve the pension plan’s risk management by getting “closer to the coal face,” said James Davis, OPTrust’s chief investment officer, who’s handling the transition. The fund, ranked 18th by assets in Canada according to a research of pension funds by London-based Willis Towers Watson Plc, currently has external firms managing its market assets.
“We’re a maturing pension plan and in that environment, our tolerance for risk isn’t as great as a pension plan that is younger,” Davis told Bloomberg News in an interview from his office in Toronto. “Having direct access to the market allows us to manage risk in a far more agile way.”
Canada’s pension funds have led the world with their active approach to investing, buying real assets, as well as using sophisticated financial instruments and leverage. OPTrust’s effort to take more matters into its own hands, with the first trade expected in the second quarter of this year, is an “evolutionary” move for the fund, according to Davis.
Management Skill
It may also be something of a necessity. The fund, which manages pension assets for almost 87,000 former and current public-service employees in Ontario, is aging. Between 2005 and 2015, its retirees rose 57 per cent to almost 34,000 while its active members fell 1.6 per cent to nearly 44,000. That ratio of 1.3 contributors for every retiree compares with about 1.4 for the Ontario Teachers’ Pension Plan and 2.7 for Canada Pension Plan Investment Board, the country’s largest pension plan.
OPTrust returned 8 per cent in 2015, Teachers’ returned 13 per cent and Canada Pension 16 per cent.
“We will be looking not just to manage risk but to be able to earn some returns through the skill of our portfolio managers,” Davis said.
The fund is at the low end in terms of assets to move management in-house but it makes sense to internalize some of their activities, said Donald Raymond, chief investment officer and managing partner at Alignvest Management Corp., who built the public markets investments department at Canadian Pension more than a decade ago. “They’re looking at what other larger pension funds have done and they’re following in those proven footsteps.”
Complex Process
Canadian pension funds oversee around C$1.5 trillion of assets, which accounts for about 15 per cent of all assets in the country’s financial system, according to a June study by the Bank of Canada. Around 75 per cent of their assets are managed internally, a report by the Boston Consulting Group shows.
Setting up a trading platform from scratch is not an easy thing to do, Davis said. The process at OPTrust began in June (2016).
“It’s a quite complex process with a lot of interdependencies,” Davis said. “We don’t want to do anything in a rush, but rather take our time and make sure that everything is working perfectly before we go forward.”
OPTrust has already hired seven of the 10 portfolio managers. They will be involved in both formulating trade ideas as well as executing the trades. Several more people will be employed to handle compliance and other roles such as the settlement of trades and custody, Davis said.
OPTrust’s public markets portfolios are managed by a number of advisers, including Royal Bank of Canada’s PH&N Investment Services and Beutel, Goodman & Co, Hugh O’Reilly, OPTrust’s chief executive, said in March. Equities will remain managed externally, Davis said.
As I stated above, I had a chance to speak to OPTrust's CEO Hugh O'Reilly yesterday afternoon to discuss this big move to internalize public market assets.
Hugh told me a "strategic decision" was taken last June to move forward with this project. He said the decision wasn't just about lowering fees and costs but that OPTrust wants to be an "active participant" in the market to take intelligent risks in their tactical asset allocation portfolio.
James Davis, OPTrust's CIO featured in the picture at the top of this comment, is in charge of this mammoth project. James is a very nice and knowledgeable asset manager. I didn't get to speak with him yesterday but we have spoken before and he really knows his stuff.
Anyway, Hugh O'Reilly who is equally nice and sharp told me that the intitial focus will be on four areas: money markets, bonds, repos and F/X. They will continue to outsource active management in public equities where there is "intellectual cross-fertilization."
I asked Hugh how the external bond managers reacted to the news and he told be they were "very understanding and supportive" of this strategic decision and even helped them set these operations up.
In effect, OPTrust is doing what HOOPP and OTPP did years ago. The latter two funds are older and have more experience in this area, and they both use leverage intelligently, something I am sure OPTrust will be doing as well as they set up their repo operations.
As far as the operational setup, it was a lot of work bringing the back, middle, and front office up to speed to handle this internalization process. They did "extensive testing" and continue to do so to make sure they are running a tight ship.
One thing I know from experience, whenever pension funds implement a new system or take major operational decisions such as this one, there is always a big risk of an operational screw-up.
Projects of this scale and scope are huge and a million things can go wrong along the way. But it seems like things are moving along fine now.
I recommended to Hugh that his CFO contact my friends over at Phocion Investments here in Montreal to do a thorough performance audit now that they have implemented their new approach.
I spoke to Ioannis Segounis, one of the principals at Phocion, earlier this week and asked him to think about writing a guest comment on performance which is a topic very few institutional investors think about in a holistic way, much to their detriment.
Ionannis mentioned something about how pensions are thinking about performance all wrong, and that it should be based on managing assets and liabilities, which is exactly Hugh O'Reilley and Jim Keohane's message in their article on looking for a better measure of a pension fund’s success.
There is little doubt OPTrust is changing the conversation to focus first and foremost on the plan's funded status. In fact, OPTrust further improved its fully funded status and has done so without Conditional Inflation Protection which has helped HOOPP and OTPP obtain and maintain its fully-funded status.
[Note: Unlike OTPP and HOOPP, OPTrust and OMERS have not adopted Conditional Inflation Protection which is something I firmly believe they should do because it will allow them to maintain fully-funded status if something goes wrong in the future. It's basic risk-sharing as with minor adjustments to inflation protection, a plan can regain and maintain its fully-funded status.]
The other part of this process to internalize assets is compensation. As assets are brought internally, you need to compensate people properly for taking appropriate risks and delivering the requisite risk-adjusted performance.
Hugh told me compensation was changed to maintain focus on the plan's funded status and delivering absolute return targets.
[Note: OPTrust's long-term incentive plan (LTIP) was redesigned to align to the three key MDI metrics that measure: 1) Maintaining the fully funded status of the Plan 2) Managing risk in an efficient and effective manner and 3) Preserving the surplus in the Plan. Details can be found on page 38 of its 2016 Funded Status Report.]
On delivering absolute return targets, I also mentioned to him two Montreal alpha managers that are not hedge funds per se (they definitely don't charge hedge fund fees and have better alignment of interests) and can help OPTrust a lot as they develop their internal absolute return operations.
The two firms I am talking about are Razorbill Advisors run by Pierre-Philippe Ste-Marie and OpenMind Capital run by Karl Gauvin. These two firms are complementary as they both run highly liquid quantitative alpha strategies and the respective teams have extensive experience in asset management.
In short, they are brilliant, hard-working and are delivering excellent results. I would highly recommend James Davis and his investment team come to Montreal to meet them and really get to know the people, process, and performance.
Who else would I recommend meeting in Montreal? Quebec's oldest hedge fund, Crystalline Management, run by Marc Amirault. There is a beautiful fit here for a fund like OPTrust.
These are the alpha funds in Montreal I know and trust and have no qualms recommending to OPTrust or any other pension plan or institutional investor. They deserve a serious closer look and I guarantee you it's worth the visit.
Anyway, I am going to attend the International Pension Conference of Montreal on Monday and will be back on Tuesday.
If you have anything to add on this topic, feel free to reach out to me at LKolivakis@gmail.com.
Below, Canadian pension plan OPTrust is unveiling a brand new trading floor this week, 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 $19 billion of assets. CEO Hugh O’Reilly speaks with Lily Jamali on “Bloomberg Markets Canada.”
Hugh also spoke with Lily Jamali recently on Ontario's new rules for pension funding. Listen carefully to what he says as he makes a lot of excellent points.
I thank Hugh O'Reilly for taking the time to speak with me yesterday and thank Claire Prashaw, Manager of Public Affairs, for setting this up.
Also, since I will be busy at the Montreal pension conference on Monday and I am on the topic of internalizing asset management, I embedded a clip where OTPP CEO Ron Mock spoke at the recent Bloomberg Investment Summit on Ontario Teachers' strategy for investing and attracting top talent.
Lasty, I embedded a clip from earlier this year where HOOPP's President & CEO Jim Keohane explains how HOOPP investment management and its liability driven investing (LDI) approach helps minimize investment and inflation risks in the Plan, as well as the risks that can come from investing in equities. Jim also explains why it’s important to focus on the right metric when considering the success of a pension plan.
Listen carefully to Hugh O'Reilly, Ron Mock and Jim Keohane, they are exceptional investment and pension managers who are sharing important insights that can benefit any pension plan.
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