OTPP Gains 2.5% in 2018

Martha Porado of Benefits Canada reports, Ontario Teachers’ posts 2.5% return for 2018 amid volatile investment environment:
The Ontario Teachers’ Pension Plan posted a net return of 2.5 per cent for 2018, down from 2017’s net return of 9.7 per cent.

The pension fund outperformed its benchmark by 1.8 per cent, remained fully funded for the sixth consecutive year and increased its assets by $1.6 billion to a total of $191.1 billion.

“Our balanced portfolio approach helped us navigate one of the most volatile investment environments in recent years, particularly in the last half of last year,” said Ron Mock, president and chief executive officer of Ontario Teachers’, in a conference call on Tuesday.

On the equities side, the plan lowered its exposure slightly, moving down from 19 per cent in 2017 to 17 per cent of the total asset mix for 2018. Private equity, however, rose slightly from 17 to 18 per cent. The proportion of the plan’s fixed income component rose in 2018, with bonds moving from 22 to 31 per cent of the overall portfolio, while real rate products fell from 11 to 10 per cent.

Ziad Hindo, chief investment officer at Ontario Teachers,’ noted the significant increase in fixed income held by the plan was a defensive move intended to limit the plan’s exposure to potential economic slowdowns. “When markets are turbulent, we protect our capital,” he said during the call, noting there were also rises in yields to take advantage of in the asset class.

Further, Hindo said the plan continues to maintain enough liquidity to allow it to jump on investment opportunities when they appear.

The report’s standout was a strong performance of the pension fund’s alternative asset classes, which resulted in positive returns during a challenging year, he added. “We actively manage our assets with a mix of assets designed to perform well against a variety of economic environments and that is paying off.”

Private equity was the major outperformer, yielding 19.5 per cent. Real assets also performed well, with infrastructure contributing an 8.8 per cent return and real estate 5.8 per cent.

Private equity and real assets are becoming increasingly competitive areas, where more capital is chasing fewer available opportunities, said Hindo, noting the plan is focused on continuing to foster its global footprint to enable strong geographic diversification.

Inflation-sensitive assets stayed roughly the same in terms of portfolio construction, as did real assets, making up 15 per cent and 26 per cent of the portfolio, respectively, in 2018. Meanwhile, credit and absolute-return strategies each rose slightly, to make up eight and seven per cent, respectively.
OTPP put out a press release, Ontario Teachers’ net assets at $191.1 billion at year-end 2018:
Ontario Teachers' Pension Plan (Ontario Teachers') today announced net assets of $191.1 billion as of December 31, 2018, a $1.6 billion increase from December 31, 2017. The total-fund net return was 2.5% for the year.

"In 2018 we were able to generate positive returns even as we navigated some of the most volatile markets in years, thanks to the work we have done to build a diversified investment portfolio that can perform across market scenarios," said Ron Mock, President and Chief Executive Officer. "Concurrently, we are pleased to report that as of January 1, 2019, we were fully funded for a sixth consecutive year, with 100% inflation protection being provided on all pensions."

As at December 31, 2018, the Plan has had an annualized total fund net return of 9.7% since inception. The five- and ten-year net returns, also as at December 31, 2018, were 8.0% and 10.1%, respectively.

During the year the plan's volatility was subdued compared to what would have been experienced by a more traditional asset allocation. Portfolio diversification – across asset class, geography and other factors – resulted in the Fund outperforming its benchmark by 1.8% or $3.5 billion, demonstrating the value Ontario Teachers' members realize with active management.

"Times like these show how continuing to rebalance the portfolio for stability is paying off," said Ziad Hindo, Chief Investment Officer. "In 2018, our private assets carried the day. Despite a more difficult environment, we were able to conclude a number of significant, complex transactions during the year."

Total fund local return was 1.3%.The Plan invests in 35 global currencies and in more than 50 countries, but reports its assets and liabilities in Canadian dollars. In 2018, currency had a positive, +1.5% impact on the total fund, resulting in a gain of $2.8 billion that was mainly driven by the appreciation of the U.S. dollar. The positive impact followed negative currency impacts in 2017 and 2016.

About Ontario Teachers'

The Ontario Teachers' Pension Plan (Ontario Teachers') is Canada's largest single-profession pension plan, with $191.1 billion in net assets at Dec. 31, 2018. It holds a diverse global portfolio of assets, approximately 80% of which is managed in-house, and has earned an annual total-fund net return of 9.7% since the plan's founding in 1990. Ontario Teachers' is an independent organization headquartered in Toronto. Its Asia-Pacific region office is located in Hong Kong and its Europe, Middle East & Africa region office is in London. The defined-benefit plan, which is fully funded, invests and administers the pensions of the province of Ontario's 327,000 active and retired teachers. For more information, visit otpp.com and follow us on Twitter @OtppInfo.
Before I begin my analysis, please see the following attachments:
The most important attachment is OTPP's 2018 Annual Report but I also enjoyed reading the 2018 Responsible Investing Report.

Take the time to read OTPP's 2018 Annual Report, it's truly excellent and packed with great information. I obviously cannot cover the entire report here but will highlight some key sections.

I also had a brief discussion with OTPP's CEO Ron Mock earlier this afternoon but he was getting ready to jump on a conference call with Jim Leech, Claude Lamoureux and the Ontario Teachers' Federation for an event celebrating its 75 year anniversary.

Ron was polite, however, and asked me to call back tomorrow if I need to cover more material but we went over the key points and I will be sharing them below.

First, let me begin with the Report from the Chair. Steve McGirr wrote the following:
Maintaining a well-funded plan is an important measure of a pension’s success. I am proud to report that as at January 1, 2019, the plan remained fully funded for the sixth straight year.

This funding status was achieved with a nominal discount rate of 4.8%. The board is responsible for setting the discount rate, and we feel it reflects a realistic and prudent outlook. The plan had a preliminary surplus of $10.0 billion based on an average contribution rate of 11% and 100% inflation protection being provided on all pensions.

The plan sponsors, Ontario Teachers’ Federation and the Ontario government, will determine how to allocate this surplus if they choose to file this valuation with the regulators, including whether or not to classify the surplus as a contingency reserve.

Recent surpluses are a welcome outcome; however, they should not be taken for granted. Headwinds for investors intensified over the last year. Global trade and cooperation are under strain. Populism and protectionism are on the rise. On top of this, the 10-year bull market for equities is tapering off and the outlook for future returns is uncertain.

Considering the complex global environment in which the plan operates, it is prudent to be cautious. Today’s difficult and volatile markets demonstrate the value of a buffer that enables the partners to keep benefits and contribution rates stable.
I couldn't agree more in terms of using the surplus as a buffer because when the storm hits, that buffer will come in very handy. Mr. McGirr also praised his predecessor, Jean Turmel, who I think did an outstanding job for 12 years.

Next, this is what Ron Mock had to say in his report that caught my attention:
We have a history as leaders in the pension industry; however, our future success will not be built on past results. To continue to fulfill our mission, we need to look ahead and abroad. We must continue to attract and nurture aligned partnerships and world-class talent.

Enhancing our global perspective and capabilities remains a high priority for the organization. Doing this benefits us in many ways. We diversify our portfolio, gaining access to new opportunities and decreasing risk. We gain local knowledge and relationships, which help us navigate complex markets. This approach also helps us source, develop and motivate talent.

Strong, long-lasting partnerships have been a key element of our success. We continue to partner with the best from around the world, establishing new relationships and enhancing existing ones. We put our efforts into a select number of partnerships that are mutually beneficial and long term, and that allow us to learn from one another.

Our business is, at its essence, a people business. The people who work at Ontario Teachers’ are the engine of this organization. They generate the insights that shape and sharpen our thinking. They foster the trusted relationships that drive our success.

A case in point are the new appointments to our executive team this year. Ziad Hindo was named Chief Investment Officer and Jo Taylor was named Executive Managing Director, Global Development. Ziad and Jo have been strong contributors for many years. They have brought their insights and a greater international perspective to the executive team.

In 2018, we announced that we would be moving our headquarters to downtown Toronto. After much thought and analysis, it was clear that this move will help us attract and retain top talent.

We are not content with yesterday’s performance. We balance learning with action to stay one step ahead and deliver on our commitments over the long term.
That last part is classic Ron Mock. Years ago, I had invited him to the Caisse to discuss hedge funds with Henri-Paul Rousseau, Gordon Fyfe and others and he had forgotten some notes on a paper napkin he scribbled on the flight to Montreal.

Anyway, he left the building with Gordon and forgot the napkin with the notes. Gordon called me at my office, told me to got to the conference room, find the napkin with notes and bring it down to Ron. I did and Ron said: "Thank you so much, I had jotted my strategy for the next two years on that napkin on the flight over and this is critically important to me."

That's how he is, always thinking ahead 18 to 24 months. The first time I met him, he really impressed me with his knowledge of hedge funds and since then, he has expanded his knowledge considerably to include private markets.

During our brief conversation this afternoon, he reiterated some key points:
  • The plan remained fully funded for the sixth straight year. They will maintain 100% inflation protection and reduce the contribution rate by 1.1%. The $10 billion in surplus is a true measure of success.
  • The portfolio is well-diversified. From the way he described it, OTPP is taking a Bridgewater All-Weather approach, looking to be hedged against four economic scenarios: Low growth/ low inflation or deflation, high growth/ low inflation, high growth/ high inflation, and low growth/ high inflation. 
I noted that in 2018, currency had a positive, +1.5% impact on the total fund, resulting in a gain of $2.8 billion that was mainly driven by the appreciation of the US dollar.  The positive impact followed negative currency impacts in 2017 and 2016.

Ron told me they have done a lot of work to lower the volatility of currency swings, noting currencies aren't an asset class with a risk premia they can harvest so they thought of ways of minimizing the swings.

He said in the past, currency could impact the total fund anywhere between 2-7% and that wasn't acceptable so they figured out ways to hedge currency risk and target no more than 40% F/X exposure.

For the total fund, they are targeting "9-10% volatility and a Sharpe ratio that is pretty darn solid."

In other words, it's all about minimizing downside risk for the total fund, be it from currency swings or other factors.

This explains why they increased their bonds from 22% to 31% in 2018, hunkering down, preparing for any negative shock.

In fact, OTPP's CIO, Ziad Hindo, shared this in his report:
Continuing to rebalance the portfolio for stability is paying off, as the plan’s volatility was subdued compared to what would have been experienced by a more traditional asset allocation. Portfolio diversification – across asset class, geography and other factors – helped us outperform our benchmark result by 1.8% or $3.5 billion, demonstrating the value our members realize with active management.
I also noted Private Equity had an outstanding year, delivering 19.5% last year, trouncing its benchmark (click on image):

Ron told me "Private Equity had a very, very strong year" but all their private market assets, including Cadillac Fairview (Real Estate) and Infrastructure delivered solid returns last year (click on images):

In Private Equity, Jane Rowe's team did great deals in Europe and the US focusing on executing on the value creation plan which includes everything from "HR, IT, and other processes that drive EBITDA growth".

Interestingly, he shared this with me: "Writing a cheque isn't good enough, you got to have capacity. Also, you can't leverage or recapitalize your way to create value like the past, you need to have the right team in place to help companies transform themselves and grow."

He said they took advantage of high valuations to sell some assets and lock in solid gains.

He also said the focus over the next five years is Asia as countries like China, India and Singapore grow, they have boots on the ground to capitalize on opportunities there and are providing them with all the necessary resources to support them.

He told me we are in a "lower return environment" and are constantly thinking of how they will attract and retain talent, not just investment talent, but "data analytics, IT and AI talent which we are competing with great tech companies."

That's a great point, the complexity and scale of their operations, these large pensions don't just need top notch investment talent, they need top notch talent across all fields to support their investment professionals.

I told him: "Thank God Teachers' will soon move their offices downtown near HOOPP" (Jim Keohane showed me where last week). Ron said that will help in terms of attracting and retaining talent.

I asked him what he's worried about and he said "exogenous political events like unresolved tariff disputes". 

I had to leave him there to join his former colleagues, Jim Leech and Claude Lamoureux but appreciate the time he took to chat.

Again, take the time to read OTPP's 2018 Annual Report, it's really a great read. I particularly enjoyed reading the Plan Funding Report as it's packed with great insights.

For example, take a look at how the plan's funding variables have changed (click on image):

Ontario's teachers are living longer and they're enjoying very decent pensions for a lot longer.  The plan is mature with 1.3 active teachers to pensioners which explains why they are looking for stability in the total portfolio (less room for errors).

Given this profile, it only made sense to introduce conditional inflation protection, a measure that will make Teachers' young again (click on image):

Anyway, take the time to read the entire 2018 Annual Report, including the detailed discussion on OTPP's compensation program (starting on page 52) to understand how executive and other compensation is determined (click on image):

No doubt, OTPP definitely pays their senior managers extremely well but given the challenge pension funds face in recruiting talent, it needs to and the plan's long-term results and funded status speak for themselves.

Below, OTPP CEO Ron Mock discusses 2018 annual results with BNN's Amanda Lang. Good discussion, listen to Ron explain how managing volatility with a balanced portfolio and how increasing their fixed income weights helped reduce the total portfolio's volatility last year.

He also explains how diversifying in Asia in private markets is critically important for them since that is where they see opportunities but they "have to be selective given where asset prices are."