OPTrust’s Safe Space for Innovation?

Sarah Rundell of top1000 funds.com reports, OPTrust’s safe space for innovation:

Pension plans are not designed for innovation, they are designed to be efficient. Yet Canada’s C$20 billion ($15.3 billion) OPTrust, the pension fund for Ontario’s blue-collar civil servants, is challenging that idea.

OPTrust president and chief executive Hugh O’Reilly told delegates at the Fiduciary Investors Symposium at Stanford University about the pension fund’s new entity, OPTrust Labs, where an internal research and development team will nurture and integrate innovation across administration and investment processes.

In a panel discussion with Ashby Monk, executive director of the Stanford Global Projects Center, O’Reilly said the inspiration for the idea came from an observation that OPTrust needed to be part of the innovation economy. He observed that many pension funds’ administrative processes were still rooted in the mid-1980s. The fund’s beneficiaries needed an experience like what they had with other service providers, he said, adding that innovation was about “unleashing human activity” and allowing people to take risks. It also demands a culture in which leadership listens to ideas.

For OPTrust Labs to succeed, the pension fund will have to be ambidextrous – adding innovation to ongoing efficiency. O’Reilly said OPTrust would still celebrate its “main jobs”, related to ensuring a well-funded plan and a strong investment record, but also would have a new organisation prepared to make mistakes and fail.

You can’t ask people engaged in efficiency to be innovators as well, he said. Hence OPTrust Labs comprises a separate staff of six, whose main job is innovation. They are tasked with seeking out start-ups and innovative companies developing technological solutions that could help the pension fund’s “pain points”. These technologies could include innovative ways to measure climate risk across the portfolio or help with data gathering.

OPTrust Labs will oversee the testing of new software. Money for investment will be unlocked if a software pilot transitions to a fully deployed contract. O’Reilly expects failures and aims to share OPTrust’s experience publicly via documents and case studies.

The entity will be governed by an investment committee; however, the governance will be more nimble and agile than that surrounding the fund’s wider investment decision-making process. O’Reilly also noted that OPTrust was well positioned to fund innovation because of its ability to write smaller cheques. He added that investment in innovation would help start-ups scale, something that’s a challenge for Canada’s innovative companies. Start-ups would also be able to tap into OPTrust’s network and apply their technologies across the portfolio, he said, citing how a portfolio company in Canadian general partner Yaletown Partners’ Innovation Growth Fund, in which OPTrust is a limited partner, has been able to do just that.

O’Reilly said introducing innovation at the pension fund required a change in culture. He explained that some parts of the organisation could feel threatened by the new entity and an important part of his role has been assuring people of the positive sides to greater automation.

Reading this article, it reminded me of something AIMCo's former president and CEO Leo de Bever said at the Montreal pension conference two years ago: "Like Gretzky says, you miss 100% of the shots you don't take."

Leo de Bever has been imagining a better world for a long time and he believes pensions and other institutional investors are too conservative in their risk-taking and following the herd won't set you apart over the long run.

I'm glad to see Hugh O’Reilly and OPTrust starting this new initiative, OPTrust Labs, which will be a small group focusing on innovation.

I believe in innovation and personally invested in a few biotech stocks (XBI) over the last five years. Some were home runs, many were dogs, all were exciting.

By its very nature, innovation is exciting but fraught with pitfalls. Whether it's in healthcare, energy, AI or whatever sector, innovation requires a different risk appetite and it's far from easy. I'm glad Hugh said they are willing to make mistakes and fail and the governance will be more nimble.

This is especially true now more than ever because there is a bubble going on in venture capital as a bunch of amateur hedge funds are throwing money at every idea coming their way in Silicon Valley.

Go back to read my comment, In Defense of Private Equity, where I wrote about my experience with VC at PSP and the Business Development Bank of Canada (BDC):

[...] I'm highly skeptical on venture capital ("VC") funds and wouldn't invest in most of them, even the so-called cream of the crop.

That goes back to my old days at PSP in 2004 when I was helping set up private equity there and called Doug Leone of Sequoia three times to secure a brief meeting with Gordon Fyfe and Derek Murphy. "Listen kid, I like your persistence and will meet your top guys for 15 minutes but we're fighting over whether Harvard or Yale will receive an allocation. We don't want or need pension money. Our last $500 million fund was oversubscribed by $4.5 billion. I'll save your pension a lot of time and money, don't invest in VC, you will lose your shirt."

I remember Gordon and Derek loved that meeting, they both came to see me when they got back and told me it was "awesome". Derek grumbled something like "I've never felt so poor in my life".

Later, during the financial crisis, when I worked at the Business Development Bank of Canada (BDC) for two years, I saw huge losses in the venture capital portfolio. It was a disaster. The guy who hired me, Jérôme Nycz, eventually took over that department and he was appointed Executive Vice President, BDC Capital in 2013. Last I heard, they are doing well.

But make no mistake, VC is very competitive and it's extremely difficult to make money even for the Sequoias of this world. I'm pretty sure they'd gladly jump on pension money these days instead of thumping their chest, bragging about internal disputes over whether Harvard or Yale gets an allocation.

In terms of the overall private equity industry, VC is peanuts and it will always remain peanuts. I foresee a major, MAJOR, shakeout in the VC world over the next three to five years and it will rock Silicon Valley to its core.

How do I know there's a major shakeout coming in VC land? Because a close friend of my brother's lives out there, has a big position at a very successful tech company and he told me "they're all ill-prepared for the coming downturn, it will be brutal."

He has been warning his employees to upgrade their skills or risk becoming "obsolete very fast" and he's extremely worried about the rise of AI and secular long-term unemployment. The last time we spoke, I got really depressed because he wasn't painting a very rosy picture of the future of the US and global economy.

Anyway, my point here is OPTrust is taking a conscious risk with OPTrust Labs but one that may very well prove very worthwhile if their home runs swamp the effects of their dogs, and there will be many dogs. It's the nature of the game.

Still, OPTrust isn't afraid of innovation and being innovative and fiercely independent in its pension administration. Whether it's with OPTrust Select, climate change, or starting a new pension plan for Ontario's non-profit sector, it isn't afraid to "go where no other pension has gone before."

Alright, I'm being corny, laying it on thick, but I will give credit to the folks at OPTrust for thinking outside the box and expanding the limits of what is possible and more importantly, sharing the knowledge of their findings and experience with others for the betterment of the larger pension community.

What else? I wanted to congratulate OPTrust's CIO, James Davis, for being a finalist in the Institutional Investor Allocator's Choice Awards for technology use.

James, who you see above, is one sharp guy and he's extremely nice too. He recently sat down with Rick Baert of Pensions & Investments to go over how OPTrust is pushing climate change into LDI framework:

OPTrust, Toronto, which has put climate change risk management front and center with its C$20.3 billion ($15.7 billion) in investments, is working to align its pledge to reduce climate risk with its version of liability-driven investing, said James C. Davis, chief investment officer.

"This is evolutionary," said Mr. Davis, adding that metrics that work in the public markets don't necessarily apply to climate risk measurement. "For us, we've said there's been a lot of talking about climate change but not a lot being done about it," he said. "Our ability to apply innovation has put us on the leading edge, but we're not anywhere near done on this."

He said member-driven investing — OPTrust's version of LDI that focuses on maintaining full funding for the Ontario Public Service Employees Union Pension Plan, Toronto, instead of targeting a plan termination date — "is about pension certainty, that our members get the pensions they're promised at the current cost. When I look at that, I look at all the risks that can affect that today — equity risk, interest-rate risk, longevity risk. But I can also look at it in terms of longer-term risk, like climate change. It's not acceptable to pick and choose the risks you want to price. You can't do that with climate-change risk, but that doesn't give you an excuse to ignore it."

Hugh O'Reilly, president and CEO of OPTrust, agreed that measuring climate risk is a long-term endeavor. "When it comes to climate change and LDI, I think it's more like a cricket game than a baseball game," Mr. O'Reilly said. "Baseball games usually end after nine innings, but cricket games can go on for days. We think in the long run, our position on climate action fits with our member-driven investing strategy."

But for now, Mr. O'Reilly said, the inability to currently price climate-change risk is a major issue for a plan that was 111% funded as of Dec. 31.

"With our member-driven investing strategy — our LDI — we must get properly rewarded for the risk we take," said Mr. O'Reilly. "We find the issue we need to grapple with is how do we price climate change. With investors like us, even with the information and the technology we can apply, it's hard to properly price it, so that affects us as investors."

Some reinforcement

Mr. O'Reilly reinforced that point in a Sept. 25 presentation to a New York seminar organized by MSCI Inc. in partnership with the United Nations-supported Principles for Responsible Investing.

"As a pension management organization, OPTrust looks at investments over a long time horizon," Mr. O'Reilly said at the seminar. "Funded status is our key measure of success — it is the measure that matters. In order to preserve our funded status and fulfill our pension promise to our members, we endeavor to fully understand and price our risk exposure. That includes climate risk. Accurately pricing risk, however, in a world without commitments to proper climate-related disclosure from corporations is almost an impossible task. That brings us back to the need for action."

OPTrust in June announced its own action plan to manage climate-change risk, focusing on eight points — of which three directly deal with measurement issues.

Mr. Davis said the points of the action plan dealing with measurement present the biggest challenge. "As investors and accountants, there's a lot of emphasis in getting the numbers and looking at things around those numbers," Mr. Davis said. "Well, I'd like to know the price of carbon, but I don't. Accountants don't, investors don't — but that doesn't mean we don't consider carbon in choosing what we invest in."

Without data to price climate change, Mr. Davis said OPTrust is finding more holistic ways to measure it. "What in the investments we're making is being affected by climate change?" he said. "Maybe not in dollars and cents, but maybe by looking at peer groups, we can compare firms in a given sector and see which are looking at climate change more than others. It's also important to see what the boards of companies we invest in, the management of those companies, are doing in considering climate change in their daily operations. There's not some kind of metric to do that."

'One step further'

Along with comparing companies' management and boards, Mr. Davis said, "We take it one step further. We're looking at how we and our partner companies can look to incorporate climate change in investments."

Mr. Davis said OPTrust just asked the boards and management of companies in which they invest what they're doing to measure or monitor climate-change risk, which could guide how OPTrust measures it.

"We're hoping to get standards that can serve as a baseline, not only to compare companies but also to decide on specific company investments," he said. "That way, we have something we can track. That way, we're not fixated on one measure, like greenhouse gas emissions, but we can look at that as one aspect of climate-change risk and look at the entire risk in a more holistic way."

Artificial intelligence can also help, Mr. Davis said. OPTrust works with ClimateAI, a Palo Alto, Calif.-based enterprise software platform provider that uses AI to make quantitative and qualitative evaluations of climate change-related impacts, particularly geographic.

"Geography also matters," Mr. Davis said, adding that ClimateAI can help assess "the impact of climate change on a geographic area as well as an individual company. It can look at downtown Toronto and determine the risk of flooding; it also can look at how wind pattern changes could affect a wind farm in Australia. That provides us with better information and better ways of determining the effects of climate change on our investments."

The issue with pricing risk isn't only with public markets, Mr. Davis said. "The advantage we have here is that attention has been paid to public markets, but the private market is a great place to try new things, especially since we have a seat at the boardroom table," Mr. Davis said. "We get to see the impacts directly."

While using climate change as a factor in determining investments, Mr. Davis said companies that do take climate-change risk into account doesn't automatically ensure an OpTrust investment with them.

"You can argue that you're making a thematic play," Mr. Davis said, "but if it's not good for us, we won't invest in it. This theme will play out as we move forward. Technology and climate change are likely to be overlapping. We're not just looking at impacts on oil and gas and wind farms, we need to know where we are with all investments from a risk-return view when it comes to climate change. It's everybody's problem, everybody's challenge. The more pension funds, regulators and companies talk about this, the more likely we are to resolve this issue."

This is an excellent interview. Last week, I attended a CAIP conference here in Montreal and wrote about how Canadian pensions have crossed an ESG threshold.

I will remind you what Stéphanie Lachance, Vice President Responsible Investing at PSP, said at that conference. She emphasized that ESG integration isn't just about due diligence, the focus is shifting on actively monitoring these risks once the investment is made across public and private markets.

She also told me that every large Canadian pension has integrated ESG in their investment framework even if they do not all advertise it. She also said that perceptions are changing because ESG used to (wrongly) be considered a money-losing operation but now investors see the added value and how it can enhance risk-adjusted returns.

One thing is for sure, James Davis is right, technology and climate will likely overlap. Better technology will lead to new innovation in the energy sector and better data on climate change across public and private markets. Data which pensions and others will desperately need to assess their climate change risks.

Lastly, OPTrust shared this on LinkedIN:

We believe a winning culture embraces #diversity, #inclusiveness and different perspectives. We are proud to collaborate with the Canadian Gender & Good Governance Alliance as an extension of our goal to help drive gender-balanced boards and organizations in Canada and globally.

Details are available here and as I stated, I'm all for inclusiveness of more women at all levels of an organization and of minorities, especially people with disabilities where there is virtually no effort to hire and promote them (it's scandalous).

Below, Sequoia Capital Managing Partner Doug Leone during his Stanford GSB View From The Top talk on November 4, 2014. Leone discussed luck and taking risks, the venture capital industry, what his team looks for in entrepreneurs, and more. Listen to what he said about private markets being in bubble land three years ago.

And since I began with a quote from the Great One, I will end with a nice clip from the NHL on the Great One. Just remember, you miss 100% of the shots you don't take!