HOOPP's Smartest Guy in the Room?

Barbara Shecter of the National Post reports on the smartest guy in the room: How a pension guru worked his magic, beat the market and saved Home Capital:
There are seminal moments in any career and Jim Keohane’s is a doozy. He knew something was wrong when his lowball offer for Canadian Pacific Railway shares, lobbed in at $1 below the asking price, was instantly accepted.

It was October 1987 and by the time the shares he had traded overseas opened on the Toronto Stock Exchange hours later — on what would become known as Black Monday — they had dropped a further $5 per share.

Keohane, who will step down next year after a widely praised 20-year run as chief investment officer and then chief executive of the $79-billion Healthcare of Ontario Pension Plan (HOOPP), recalls that his loss on that day’s trade was painful as markets historically tumbled to a depth and at a speed few thought possible, but it was far from the worst thing that happened.

The firm where he worked, Wood Gundy & Co., had just agreed to underwrite a large stock issue by British Petroleum Co. at a guaranteed price, and the loss triggered by the market collapse nearly toppled the independent investment dealer, and pushed the previously well-capitalized 82-year-old firm into the arms of Canadian Imperial Bank of Commerce.

“They were trying to get out of the (BP) deal, but they couldn’t … and they were practically bankrupt,” Keohane recalled during a lengthy and wide-ranging interview at HOOPP’s new headquarters on Toronto’s rapidly developing waterfront. “That’s why Wood Gundy did the deal with CIBC, because they were effectively bankrupt.”

What Keohane took from Black Monday and its aftermath was a resolve to always conjure up a scenario where “the worst case plays out” and to visualize “what that looks like” for every investment.

“That was quite an insightful experience with risk,” he said, reflecting on the unexpected turbulence more than 30 years ago and the lesson that stuck with him. “Sometimes that does play out, so you better understand what you’re getting into.”

Balancing risk and reward is something Keohane has become known for: using sophisticated derivatives to help produce benchmark-beating returns since 2008, usher HOOPP into the upper echelons as Canada’s fifth-largest public-sector pension, and save mortgage lender Home Capital Group Inc. along the way. But as the nearly 65-year-old enters his final nine months in charge, the question arises of whether a successor can walk the line of risk management as successfully.

At stake are the pension nest eggs of more than 325,000 active HOOPP members and pensioners that include hospital workers, community health-centre employees and family health teams.

The ability to scan for and spot anomalies that could lead to trouble or opportunity has been the key to Keohane’s success as a pension manager, said Hugh O’Reilly, who was outside counsel to HOOPP’s board of trustees for about a decade before becoming chief executive of another Ontario pension manager in 2015.

“He sees things before others do,” said O’Reilly, now a senior fellow at the C.D. Howe Institute and executive-in-residence at the Global Risk Institute. Keohane, he added, pairs that ability with an eagerness to look “under the hood” and deeply analyze the nuts and bolts of complex investments.

For example, it was Keohane who, as chief investment officer, led the push to turn HOOPP into a liability-driven investment plan, based on his concern that a simultaneous drop in both stock markets and interest rates could doom the fund’s ability to pay out future benefits that had been guaranteed by the defined-benefit plan.

The transition began after the dot-com bust in the early 2000s, and included a shift to extensively use derivatives — including futures, options and swaps — both as a hedge to limit losses when markets do poorly, and to increase returns.

The strategy helped HOOPP weather the financial crisis better than other pension funds in Canada and around the world. In 2008, the fund lost 12 per cent compared to losses of between 15 and 25 per cent at other large pension funds, according to a World Bank Group report in 2017.

The fund’s “timely reduction of its equities allocation… in 2007 protected roughly $2 billion in asset value,” the report said.

O’Reilly said HOOPP also appeared to benefit from some prescience in 2009 when it boosted stock holdings at the time later identified as the bottom and the best time to buy equities.

“In my opinion, Jim is the best pension investment person on planet earth,” said O’Reilly, who until March was chief executive of OPSEU Pension Plan Fund (OPTrust), which administers the pension plan of public service workers in Ontario.

In the pages of the HOOPP’s financial statements, there are references to derivatives tied to credit, currency, equity, and interest rates, and terms for instruments including options, futures, swaps, and even “swaptions.”

Keohane has built a reputation over the years as an expert in controlling and exploiting the financial instruments that gained notoriety during the financial crisis for their inherent riskiness and potential to magnify both gains and losses.

“HOOPP is a top performer both short term and long term,” said Canadian pension expert Keith Ambachtsheer.

The fund’s 10-year annualized return is 11.2 per cent and its 20-year annualized return is 8.5 per cent.

But using derivatives to free up money to invest and generate returns is a strategy that has also drawn critics.

Malcolm Hamilton, a retired pension actuary who is a senior fellow at the C.D. Howe Institute, told the Financial Post in 2016 that HOOPP and other Canadian pensions were “levering up and hoping for the best.”

So far, though, HOOPP has been prospering under Keohane.

In 2018, the pension’s funded status stood at 121 per cent, meaning there was $1.21 on hand for every dollar needed to pay out a pension. Net assets, which totalled less than $20 billion when Keohane joined the pension two decades ago, more than quadrupled to nearly $80 billion by the end of last year.

Sitting in a boardroom high in HOOPP’s gleaming office tower on a recent spring day in Toronto, Keohane, who lives not too far away in the tony neighbourhood of Forest Hill, is farther from his childhood home of Ottawa than the kilometres between the two cities would suggest.

His younger brother Ed, a senior vice-president in Bank of Nova Scotia’s wealth-management division, recalls a story about the teenaged “Jimmy” — the third of eight siblings — taking apart and reassembling a Toyota Celica because he knew it would fall to him to do any repairs.

“It was scattered all over the garage and we were all amazed that he was able to get it back together,” said Ed, who is three years younger than Jim. “At that time we didn’t have much money — you know, eight kids — we had to fix our own cars. We learned how to manage with not a lot of beans.”

Jim and Ed, like their siblings, got part-time work and summer jobs that included pumping gas and doing outdoor yard work for Ottawa’s National Capital Commission to pay for their post-secondary education — in Jim’s case, a science degree followed by an MBA.

“We grew up fine. We didn’t know we didn’t have money,” Ed said.

Despite the number of mouths to feed, summers were spent at a cottage on the Quebec side of the Ottawa River with their mom, a teacher, who had her first three children within three years of one another, and went on to earn a university degree part-time while working.

During his youth, Jim developed a lifelong passion for skiing, according to his brother, one that nowadays reveals an appetite for risk that might seem incongruous for someone who works so scrupulously to control it in his professional life, though Ed said his brother also revels in remote heli-skiing adventures.

“I wouldn’t do it. But he does,” he said with a mix of awe and concern creeping into his voice.

The large family still gathers at least once a year in the cottage community of Norway Bay, Que., where they summered. The usual occasion is to honour their father at a golf tournament in his memory. Brian Keohane passed away at 61 in 1988, a year after Jim’s formative Black Monday experience.

Jeff Johnson, a long-time family friend who would later seek out advice from Jim Keohane when he was considering getting into the pension industry after working in the banking and energy sectors, recalls Keohane’s mother, Enid, who turns 90 on July 12, stepping in seamlessly as the family’s figurehead after Brian died.

“I’ve worked for six organizations over 35 years, and I did speak to Jim before I joined OPTrust,” Johnson, who is now director of enterprise risk management at the pension manager, said. “I just wanted to get his perspective on this organization and get a sense of the profession and whether he enjoyed it. I’m here, so it’s reflective of how positive that conversation (was).”

Johnson still goes to Norway Bay and said many members of the Keohane family have bought their own summer getaways there, but Jim Keohane is putting the finishing touches on a large retirement home in Caledon, Ont., where he plans to spend time with his wife when he retires, between trips they hope to take, like one to Asia earlier this year. The home will also have room for his four sons, all now in their 30s, from a previous marriage.

“I wouldn’t call him extravagant or anything like that,” Ed said, describing his brother instead as “very goal-driven.”

It was Keohane’s ambition to rise through the ranks that led him into the world of derivatives. He said he began learning about the sophisticated financial instruments early in his career, after moving to Toronto, because he reasoned that developing a rare specialization would propel him above the crowd of “junior” bankers in Canada’s largest city.

The decision guided Keohane as he moved on to jobs with Pemberton Securities, Royal Bank of Canada, HSBC and Deutsche Bank before landing at HOOPP in 1999. His first job there was to set up a derivatives program.

In March, Keohane told Pension Pulse blog writer Leo Kolivakis he was very happy to leave the “toxic culture of investment banks” to join HOOPP because “after awhile making more money doesn’t get you out of bed.”

It didn’t take long, though, for the lessons of Black Monday to influence his decision-making at HOOPP. Keohane considers it one of his career highlights that he was able to steer the pension fund away from serious exposure to Canadian heavyweight Nortel Networks Corp.

At its peak in 2000, Nortel accounted for more than a third of the Toronto Stock Exchange’s benchmark index As a result — and the fact that and Nortel ownership was also embedded in Bell Canada at the time — the data networking equipment manufacturer had come to represent a sizeable chunk of the portfolios of HOOPP and other institutional investors.

Keohane found the concentration “disproportionately high” and worried about the impact should something go wrong, so he instituted a process to ease Nortel holdings down to less than five per cent of the portfolio using — not surprisingly — a complex set of derivative investments.

“We used an option strategy known as a costless collar,” Keohane said, explaining that put and call options were purchased and sold at prices that fully covered HOOPP’s costs. As Nortel spiralled from high flyer into bankruptcy protection in 2009 in one of the largest corporate failures in Canadian history, “the put options we held protected us from taking a loss on those Nortel sales.”

Now, 20 years into his tenure at the pension fund, and in his seventh year at the helm, he boasts that HOOPP has one of the largest derivatives portfolio of any pension in the world. But he is quick to point out that the high concentration of derivatives is in just one of the fund’s two portfolios, the one designed to use excess funds to seek returns. The liability hedge portfolio, by contrast, is largely made up of bonds and short-term fixed-income investments, as well as real estate.

Though praised for his smarts, the task of relaying complicated financial details and manoeuvres has not always been easy. HOOPP is governed by a board of trustees, which draws its 16 members from appointees of the Ontario Hospital Association and four unions including the Ontario Nurses’ Association and the Canadian Union of Public Employees.

“Jim’s style was quiet and he was always viewed as being exceptionally smart and having the pensioners’ best interests at heart, so that carried him a long way,” said Marlene Puffer, a former HOOPP trustee who was chair of the asset-liability management committee during her nine-year term.

“The board was always, I would say, confident in the ideas that were being presented, but Jim’s quiet approach also meant that he was sometimes difficult to understand.”

Puffer, the first board member appointed by the hospital association with investment and derivatives expertise, became a translator of sorts.

“It was always a bit amusing to watch the dynamic in the room because he would speak in the way he does, which is (to give) an extremely intelligent answer that I would understand and maybe a couple of other people in the room would understand,” Puffer explained. “And quite often my role was to take his answer and repeat it in plain language. So we had that dynamic going all the time.”

The sophistication of HOOPP’s investment strategy has led to speculation — and a bit of concern — about who will replace Keohane when he officially steps down next March.

“It’s going to be a real challenge,” said Paul Litner, head of the pension practice at Toronto-based law firm Osler, Hoskin & Harcourt LLP, who also serves as external counsel to HOOPP’s board of trustees. “The board has its work cut out for it now. It’s big shoes to fill.”

Even Keohane himself acknowledged — rather sheepishly — that there are only one or two managers on the bench at HOOPP who would be logical successors.

Observers outside the pension, such as Claude Lamoureux, who ran Ontario Teachers’ Pension Plan from 1990 to 2007 and knows Keohane as a friendly rival, suggest he’s not just being modest.

“He will be hard to replace,” Lamoureux said. “He has done a great job at HOOPP and … even helped save (mortgage lender) Home Capital with a line of credit that no one wanted to grant.”

Lamoureux and Keohane almost crossed paths on the board of Home Capital Group, one of the few times that has stoked controversy during Keohane’s career.

Lamoureux joined in early May 2017 to help shore up governance at the mortgage lender, which was struggling with a crisis of confidence after the Ontario Securities Commission levelled allegations of misleading disclosure against Home Capital and a handful of executives.

Keohane had left the board in late April that year, a move that was announced amid scrutiny of a high-interest emergency loan extended to Home Capital by a HOOPP-led syndicate of lenders as investors and depositors fled the troubled mortgage company.

At the time, Keohane defended the loan as a win-win for Home Capital and HOOPP, and said he had properly recused himself from discussions where there could have been a conflict.

Koehane more recently added that the pension fund had expertise in the type of lending required by Home Capital, having made similar, though less publicized, loans to other companies.

Puffer, who is now chief executive of the CN Investment Division, which runs Canadian National Railway Co.’s corporate pension, said Keohane “was right that there was an opportunity for a win-win” in the Home Capital loan, adding that everything was handled the way it should have been from a governance perspective.

“For Jim, unfortunately, the media attention was not rational … It had kind of put him in a place where no matter what sort of explanation he offered, it wasn’t going to be satisfying,” she said, alluding to the widespread coverage of Home Capital’s regulatory run-in and subsequent panic. “I think in the end, he handled it very well and it died down, because it was a good deal. It was a good, beneficial transaction.”

Warren Buffett was widely praised as Home Capital’s saviour a short time later, observers note, when the HOOPP-led lifeline was replaced with a loan from his Berkshire Hathaway Inc. that carried a rich — albeit lower — interest rate of nine per cent, plus one per cent on undrawn funds.

Puffer said the Home Capital affair highlighted the depth of HOOPP’s deal team, which, combined with sophisticated operations and technology to keep track of the myriad investment strategies, should ease the transition from Keohane’s tenure.

In addition, the board has always relied on outside advisers with pension expertise to ensure that the board is asking the right questions to keep managers focused on providing promised pensions down the road, she said.

“It’s a critical thing to keep educating the board, so they’re going to have no choice but to continue to do it because HOOPP’s approach is very much, at its heart, reliant on these sophisticated strategies, and it’s so much a part of the DNA of the organization,” Puffer said.

Many strands of that DNA can be attributed to Keohane, and his successor will inherit that legacy.

“He’s a tough act to follow,” said Ed Keohane, someone who ought to know, echoing many across Canada’s pension industry. “Everybody knows him. I get asked often if he’s my brother. I proudly say yes.”
Jim Keohane is definitely a tough act to follow, not only because of his sophisticated investment acumen which is displayed in this article, but also because of his leadership and along with Hugh O'Reilly, advocating hard for defined-benefit plans in Canada, extolling the value of a good pension.

There are many smart and sophisticated investment managers at Canada's large pensions but very few have the ability to switch from complex investments to public policy on pensions.

That's why I always enjoyed my conversations with Jim, he sees the bigger picture and is able to understand how important sound pension policy is to the overall economy and well-being of Canadians looking to retire in dignity and security.

That's what I will miss the most from Jim, great discussions on public policy as it pertains to pensions (although he will still be around in retirement).

Does he have critics? Sure, Malcolm Hamilton has told me on several occasions he doesn't deny HOOPP's excellent long-term results but thinks Jim is "intellectually dishonest" when it comes to the true cost of Canada's large defined-benefit plans.

Jim and others think Malcolm is wrong, overestimating the true cost of defined-benefit plans by using the riskless rate to discount future liabilities and stating taxpayers are subsidizing them to the tune of billions, and not acknowledging the benefits of the Canada model and how it has helped sustain pensions over the long run.

Another senior pension manager told me that "Jim used to have a bad temper but has mellowed over the years." I've met and spoken with him on a few occasions over the last ten years and he always struck me as a very nice, humble, wickedly smart, and mild-mannered man.

Still, behind the mild-mannered man, there is a competitive side to Jim so it doesn't surprise me if he can be intense at times, after all, he is responsible for managing the pensions of more than 325,000 active HOOPP members and pensioners.

Also, coming from the investment banking side of the business where most people are self-centered jerks looking to backstab their colleagues, it probably took him some time to get accustomed to the culture of the pension world (not that there aren't any self-centered, backstabbing jerks in the pension world but the culture is infinitely better than banks which suck you dry).

But he did adjust nicely and has built the right culture at HOOPP where many senior employees are fiercely loyal to him, and rightfully so.

When I last met Jim in late March, we discussed his 20 years at HOOPP and I can tell it was a bittersweet moment announcing his retirement.

Jim definitely cares a lot about HOOPP and its members and wants to make sure his successor continues on with the great tradition he has helped build.

My sources tell me HOOPP's current CIO, Jeff Wendling, is in the running to become the next CEO, and Michael Wissell, HOOPP's Senior Vice President, Portfolio Construction and Risk, is likely to become the next CIO.

Both are excellent candidates but it remains to be seen who will be named to these critical positions (there are other excellent candidates).

One thing I can tell you, when we spoke back in March, Jim praised former CIO David Long saying "he's definitely brilliant and was instrumental in setting up several successful strategies" but Mr. Long departed HOOPP to start his own family office.

All this to say, there were several "smart men (and women)" who contributed to HOOPP's long-term success, so I don't think it's fair to claim it was all due to Jim and he's the first to give credit to many people for the organization's long-term success.

Lastly, I was recently asked "which are the best pensions in Canada?" and while they're all excellent, there's no doubt HOOPP deserves its place at the top, but CPPIB is impressing the hell out of me given its latest results, and this managing over $400 billion in assets (it's not true that size hampers performance, when you have the right strategy and people, bigger is better).

What I have publicly stated is HOOPP will necessarily change under its new leadership and that's not a bad thing. As the plan grows over the next decade, they need to revisit their approach to infrastructure and external managers and make sure they are still getting the best bang for their buck while fulfilling their fiduciary duty.

Still, there's no question Jim has left his mark on the organization and  whatever they can do internally, they will, and that includes many sophisticated "hedge fund" strategies.

Below, an older Canadian Club discussion on the evolution of Canadian pensions featuring Jim Keohane, Hugh O’Reilly, Kevin Uebelein, and Kim Thomassin (November 2017). Great discussion, take the time to listen to it.