Defensive Strategies Help CNID and ATRF

Martha Porado of Benefits Canada reports on how defensive strategies played out for CN's pension and ATRF as markets crashed:

When the coronavirus pushed equity markets off a cliff, Canadian defined benefit pension plans had to mobilize to address a number of concerns.

The Canadian National Railway Co. pension recently shifted towards a more defensive investment strategy, said Marlene Puffer, president and chief executive officer for the CN investment division of the company, at a webinar hosted by the Association of Canadian Pension Management last week.

As a highly mature plan, with about $18 billion under management, it pays out around $1 billion each year, she noted. “Being a corporate plan that’s federally regulated, solvency matters. So we were well positioned for this kind of situation. Obviously, we didn’t predict the pandemic, but we were concerned about equity valuations. And we were concerned about interest rates falling further, so we shifted our asset mix to have additional interest rate hedging in place. And we also had in place a sophisticated downside protection program related to the equity markets . . . and shock absorbers within almost every asset class that we have. And with that, we came through this period quite strongly.”

After making it through a dramatically difficult couple of quarters, the CN Rail plan’s return for the year is still in the green, added Puffer. “It seems strange to be talking to my members and saying, ‘I’m delivering a modest, positive number and I’m very excited about that.’ But that’s exactly where we are.”

Prior to the pandemic, she noted, the plan addressed its traditional home-bias in its equity portfolio and switched to using an all-country world index as its benchmark portfolio. “At the time, we really thoughtfully did that with the thought that, should there be any form of crisis in the global economy, it would be a defensive play relative to our previous positioning.”

Unhedged U.S.-dollar exposure also boosted the plan’s returns through the crisis as the U.S. dollar appreciated, boosting equity returns in local currency terms here in Canada.

In addition, as the crisis roiled through markets, the plan had sufficient liquidity to take on some rebalancing efforts, said Puffer. “The good news is that means, as equities were falling, we were actually buying and as equities would recover, we would sell a bit at these sorts of mini peaks. So that activity over the past couple of months has added value to our fund.”

In order to perform this strategy, the plan had to manage its liquidity concerns very carefully, she added, noting that, while the fund has made rigorous use of derivatives as a method of liquidity management for some time, other factors came into play. “It was important though that, for example, our government of Canada portfolio was almost unencumbered coming into the crisis and was our source of extra liquidity through the repo market. And the Bank of Canada stepped in as well to offer pension plans direct access. That was important as a second backstop to give us additional reassurance that, should we need some additional liquidity, it was easy to access.”

Liquidity was notably less of a concern for a less mature plan like the Alberta Teachers’ Retirement Fund, said Derek Brodersen, its chief investment officer, also speaking during the webinar. While the ATRF is about the same size as the CN Rail plan, it still has net cash inflow of about $300 million a year. “That’s really helpful in a stressful market because we actually don’t need to sell anything to pay pensions because we’re actually collecting more money in contributions than we need to pay every month.”

Nevertheless, he said, aspects of the portfolio required careful managing in terms of maintaining adequate liquidity. “We have a lot of unhedged exposure to foreign markets. Our public equity portfolios and our private equity portfolio is entirely unhedged, but some of our private market asset classes, we’ve hedged those back to Canadian dollars by policy. As the Canadian dollar fell, we needed liquidity to fund some of those currency hedges.

“We spent a lot of time thinking about that and how we could ensure we had available liquidity without having to impact our asset mix in any meaningful way — without having to sell something we didn’t want to sell. And I think we managed to do that pretty effectively. We tapped the repo market when it was still available and made sure we had lots of liquidity.”

Marlene Puffer is one of the smartest CEOs in the Canadian pension industry and she's also one of the most down to earth people you will meet.

Established in 1968, CN Investment Division (CNID) is based in Montreal, manages one of the largest single-employer defined benefit pension funds in Canada and holds a long track record of solid performance.

Approximately C$18 billion is actively managed in-house by about 80 employees for the CN Pension Plan’s approximately 50,300 pensioners and pension plan members. CNID also manages the assets of the CN Pension Plan for Senior Management and the BC Rail Pension Plan.

On their website it states: "The Division’s culture is nimble, innovative, collaborative and risk-aware. Pensioners are always at the heart of what we do."

Back in January, I discussed how CNID is on the hunt for talent, especially tech talent. I actually put a friend of mine who is a data analytics expert in touch with them but nothing came out of it (lost in the HR shuffle!).

Anyway, I last met Marlene at the Toronto annual spring pension conference last year where she shared this:

[...] she oversees a very mature $18 billion pension plan at CN where there are 3 retired workers for every active member and she needs to make sure they have the $1 billion a year they need to make payouts every year.

She said she was balancing out liability hedging component with return seeking component. They hedge a lot of interest rate risk and they have their board's approval to prudently leverage their balance sheet (her experience sitting on HOOPP's ALM committee for years came in handy there).

She stated they are trying to generate the same return using less risk using all the tools available and are investing across public and private markets and anything that falls in between but are managing their liquidity very tightly.

Because their plan is very mature, their portfolio is a little lower on public equity and private and illiquid return-seeking assets than other plans, and higher on fixed income. They also include absolute return strategies as a core part of their long-term asset mix (portable alpha strategies).

The high bond exposure allowed them to weather the storm in March and their use of leverage also allowed them to take advantage of opportunities as stocks got whacked hard.

As she states, even though they couldn't predict the pandemic, they were well positioned going into the crisis and etching out a small gain is great news for the plan and their members.

More importantly, I'm sure the plan remains fully funded which is the true measure of success in the pension industry.

As far as the Alberta Teachers’ Retirement Fund Board (ATRF), take the time to read their latest annual report here but be aware, their fiscal year ends at the end of August and the new annual report isn't available yet.

Still, you can see their asset mix and performance below:

Over the last four years, Private Equity and Infrastructure have been the best-performing asset classes, returning 16% and 18% respectively. As I've explained before, ATRF invests in mid-sized PE and Infrastructure funds which have done very well over the last four years.

ATRF allocates 21% of its assets in Fixed Income and 36% in Global Equity so it likely got hit harder than CNID in March.

Still, as Derek Brodersen, its CIO, explains above, they also tapped into the repo market (leveraged their bond portfolio) to make sure they had enough liquidity at hand to take advantage of opportunities and I'm sure they also rebalanced aggressively in March, snapping up equities as they declined precipitously.

Also, unlike CNID, they hedge currency risk on private market asset classes and that cost them performance as the Canadian dollar tanked in the first quarter:

My buddy in Toronto who trades currencies is getting ready to short the loonie again above 74 cents and I can't say I disagree with him: 

Anyway, ATRF's plans are fully funded (95% and 102%) so they too were in a great position prior to the pandemic hitting:

Lastly, as I stated in my last comment on calls to reverse public sector pension changes in Alberta, I firmly believe it is in the best interests of all Albertans to amalgamate AIMCo and ATRF, making sure you have talent from both organizations at all levels.

Below, take the time to watch Fed Chair Jerome Powell's press conference after the FOMC released its June statement where it basically said rates are staying near zero through 2020.

It's official, Jay Powell just made Ben Bernanke look like Paul Volcker. "We're not thinking about raising rates. We're not even thinking about thinking about raising rates."