OTPP's CIO on How They Are Navigating an Uncertain World

Amanda White of Top1000funds reports on how OTPP is positioning the fund over the next decade:

“It’s an interesting time to be an investor,” says chief investment officer of Ontario Teachers’ Pension Plan, Ziad Hindo in an interview with Top1000funds.com from Toronto.

He’s reflecting on the past 30 years where many countries and markets have benefited from globalisation and related tailwinds, the unwinding of which has led to a different environment going forward. How he positions the fund to take advantage of the opportunities of that new environment, while minimising the risks, is where he spends most of his time.

There are three neat themes contributing to the new investment environment: sustainability; policy uncertainty; and the end of (hyper) globalisation.

“Climate is not just an environmental issue it’s an existential issue for all of us,” he says pointing to the impact on economies, policies, energy security and the depletion of natural capital. “The combination of this is going to present challenges and risks and we think that these risks may be reaching a tipping point beyond what many people appreciate, with far reaching consequences for countries, societies, communities and investors.”

“We are looking at this in the context of how we are investing to protect the fund, but also the opportunity set for a decarbonised world and our role as an active investor to help the world decarbonise.”

Another characteristic of the new investment environment will be short-term economic policies creating continued uncertainty for long term investing. Added to this is what Hindo calls the end of the hyper globalisation, noting that globalisation over the past 30 years saw the entry of a massive labour force into the global economy and related beneficial disinflationary impacts, as well as optimization of the supply chain, trends that are now reversing.

“There are a lot of changes as the world moves away from hyper globalisation to probably a more fragmented political system. And embedded in that is increased geopolitical risk and the hegemony of the US being challenged, particularly by China. The world doesn’t know how to absorb that, so this will be a major focal point for investors, to navigate the complexity of transitioning to perhaps a very different world that what we were used to for the last 30 years,” he says.

“When you put those things all together – the environmental, political and social issues – with the digital disruption taking place they are all interacting together in ways that are very hard to predict.”

Because of this lack of linearity, and the increased probability of more shocks to come, investment organisations need to be resilient, he says.

“We are humble enough to know we can’t predict these shocks,” he says. “But we are confident we will be resilient, we have good talent, we trust each other, and we are agile enough to pivot and change when we have to allocate differently.”

Resilience and agility in the asset mix

Given these deep-seated changes in the economy and continued inflation volatility, he believes that agility and the ability to mix up the active/passive mix as well as dynamic asset allocation will be key. “Organisations need to be more resilient to deal with ambiguity and unpredictability and have a culture that is resilient to constant change,” he says.

“It also requires internal expertise to manage the total fund, mix the top-down and bottom-up, and act with conviction in dynamic asset allocation, and ultimately invest differently in a more agile way than most organisations are used to. And you need organizations that will put sustainability at the centre of everything they do – this doesn’t mean less return, I would say it delivers as much return as well as delivering the social licence to operate and attract talent.

OTPP, which is 107 per cent funded, has generated a total-fund net return of 9.6 per cent since the plan’s founding in 1990. It has always been actively managed, with more than 80 per cent of assets in house.  OTPP’s governance structure, and the delegated authority, means it has an ability to be agile which Hindo believes positions it well for the current environment.

But he says the agility in the asset mix is not about short term or being tactical. “It’s hard to know for how long that environment will last,” he says.

As an example, he points to the changes in the fund’s fixed income allocation over the past few years, peaking at 46 per cent in March 2020. By the end of 2020 the allocation was down to 16 per cent.

“With rates rising in 2018 and 2019 fixed income looked attractive for the first-time post GFC and we had ramped it up significantly. When Covid hit rates fell significantly so we acted quickly to almost completely unwind the interest-rate sensitivity of the portfolio. That was a lot of capital to move around. We didn’t know for how long they would be low, but we acted with conviction.”

With aggressive hikes in interest rates by central banks, OTPP has just started to buy back fixed income and build the position again. “We had to be ready. It’s about how you manage the balance sheet, the derivatives exposure, budget risk and have the right governance to do that. All this provides you with an ability to be agile, so you are not scrambling for capital, approvals or balance sheet room.”

Leader in private assets, more to come

While OTPP has a private assets allocation of more than 50 per cent there is no set public to private asset target, rather the asset class ranges are viewed through a lens of liquidity.

“We are more focused on the building blocks of the seven asset classes we have, and how to mix and match them to design a portfolio to withstand shocks, without having the full benefit of knowing what the future will look like,” he says.

“Many outsiders think we are well-known for private assets, but actually how we mix and match the public and private, and active and passive together seamlessly has been one of our secret sauces.” It means that both private and public assets are levers and can provide diversification if there is dislocation in one market.

OTPP has a long and prestigious history investing in private equity, most recently expanding that to include venture capital and growth equity, building an internal team and strong portfolio in the past three years.

“Three years ago, venture capital was restricted to external managers and was a smaller component of our portfolio. But we saw that the disruptions that we were likely to see over the next decade from technology, would not just disrupt selective industries but the whole economy,” he says. “So, we created an internal team as a defence mechanism to understand the potential disruption in the sectors we were in and to understand where they were headed.”

In three years, the fund has built an internal team of 25 people in venture capital and growth equity, and an $8 billion portfolio with 24 holdings including SpaceX.

Private credit the missing piece

But while it has a skilled team and impressive portfolio in the context of most asset owners, Hindo believes there is a missing link in the private assets portfolio which will allow it to be a more “seamless full capital solutions provider” to portfolio companies.

“We need deeper capabilities in private credit. We have been good in public credit, but private credit has been a missing link in our private asset capabilities.

“We have been addressing that and we are in the process of putting together an internal private credit team in London. We mostly had exposure through external managers but there was opportunity to build internal capabilities. Bridging the gap allows us to be a full capital solution provider to the portfolio companies we invest in. Just like we moved quickly in venture and growth capital, we will do that with private credit.”

London seemed like a natural fit for the team, given the opportunities and expertise available, as well as the fund’s head of EMEA, Nick Jansa, having deep credit expertise. Geographically OTPP has teams in Toronto, London, San Francisco and New York with Asia covered with offices in both Singapore and Hong Kong.

A couple of years ago OTPP did a massive deep dive into India. OTPP had already invested in the market, noting the attractive investment fundamentals contributing to increased interest in the country by sovereign wealth funds and others.

To date it has completed four major investments, and will now open an office later this year. Hindo says it is in the process of starting up a much larger presence in the country. “We were struck by how quickly the SWFs had set up shops and got on with it.”

Sustainability and purpose

Hindo, who became CIO in June 2018, has been with the fund for 22 years. It’s a lived ethos that human capital is the biggest asset at OTPP, and employee incentives align with the long-term performance of the fund.

“There is a lot of passion to be here,” he says of the staff. “My mom was a university lecturer, and we all have a story to tell that links us to education. Genuinely and authentically people who work at OTPP have a purpose when they come to work.”

He says the investment program was set up to think about how to invest for a better future, and that resonates throughout the organisation. It started with the retirement of teachers and is now a broader purpose.

“Organisations must put sustainability at the centre of everything they do. Having that social licence to operate will mean you can attract talent,” he says.

OTPP’s climate strategy is multi-faceted with net zero at the heart of it.

In September last year it committed to the ambitious targets of reducing portfolio carbon emissions intensity by 45 per cent by 2025 and 67 per cent by 2030.

“When we designed the interim targets, we wanted to make them industry leading on purpose. That’s who we are,” he says. “We have never shied away from being leaders and doing things differently and taking calculated risks. We know our actions can influence peers.” Hindo says the targets are also aimed at demonstrating the urgency needed.

“A ton of carbon abated now is worth a lot more than one abated in 10-years’ time,” he says. “1.5 degrees is unattainable without active, focused efforts. The longer you delay the less likely it will be achieved. If we had waited and did every bit of planning needed, we’ll never get there. We did a lot of robust work and I’m very proud of how the asset class groups and responsible investment group came together. We are good investors, and we are passionate about this and will get there one way or another.”

OTPP developed the Virtual Energy and Renewables Team (VERT) made up of members of each of the asset class groups to look at sustainability holistically as a thematic for the fund, the first time it has taken that approach.

OTPP is heavily focused on investing in green assets with VERT looking at sustainable fuels, electrification, industry 4.0, sustainable resources and enabling solutions. “VERT allows all our investing capabilities to come together and discuss what they are seeing in things like hydrogen and renewables which are very fast moving.”

Some of its investments include offshore wind, battery storage, waste management, bioenergy, and a carbon credit platform. OTPP has also been an anchor investor in the Brookfield Global Transition Fund and in TPG Rise Climate fund. “We are leaving no rock unturned here,” Hindo says. “We are in a capital deployment mode, and we are also wanting to learn with some of the best investors out there.”

Hindo believes capital allocators have a keen role in the energy transition, especially encouraging investee companies to set targets – the fund is working with 100+ portfolio companies to also set ambitious targets for them. “Internally we are saying by 2030 we want 90 per cent of the emissions of our portfolio companies to be covered by a credible net zero plan,” he says. “The ball is rolling on this, and we are in active dialogue with companies and sharing information. This is a massive risk and a massive opportunity as the entire world economy figures out how to retool itself to net zero.”

This is a fascinating, in-depth interview with Ziad Hindo, OTPP's CIO.

Ziad covers a lot here focusing on three critical themes -- sustainability; policy uncertainty; and the end of (hyper) globalization-- and how they are addressing the challenges of an uncertain world.

I really like what he says: “Organizations need to be more resilient to deal with ambiguity and unpredictability and have a culture that is resilient to constant change,” adding "you need organizations that will put sustainability at the center of everything they do – this doesn’t mean less return, I would say it delivers as much return as well as delivering the social license to operate and attract talent.”

What I find striking is just how good Teachers' is at being agile, nimble in their dynamic asset allocation (they have the right governance, skill set and total fund approach) and how they are proactive in their approach, taking some risks through Teachers' Venture Growth (TVG) and recently creating VERT which takes a pan-fund approach to climate investing:

Tackling climate change is one of the biggest challenges of our time. The International Energy Agency estimates that global investment in clean energy initiatives will need to triple to around US$4 trillion each year—and soon—if the world is to reach net zero emissions by 2050. Clean energy investment won’t only slow climate change; it’s an economic imperative as well, improving competitiveness, boosting global economic growth, and creating millions of jobs. But scaling clean energy and helping carbon-intensive businesses reduce their emissions requires tremendous efforts—from businesses, governments, and individuals. It requires new technologies, and new ways of thinking and operating. This underscores why funding the energy transition presents both opportunities and challenges for investors.

Earlier investments aimed at mitigating climate change focused on developing and scaling renewables. That work continues. But more sweeping change is needed. This includes decarbonizing industrial processes across sectors; electrifying more aspects of human activity; developing renewable fuel alternatives to power our economy; investing in low-impact, next-generation agriculture; and transitioning our society to a circular economy that minimizes waste and maximizes recyclability. For investors, that means adopting less conventional approaches to assessing and executing on climate investments.

Recognizing the unique nature of this opportunity, Ontario Teachers’ created a team—the Virtual Energy and Renewables Team, or VERT—devoted to understanding the energy transition and how we can best support and invest in it. VERT represents a new avenue for the fund—embracing a thematic approach to investing that complements our existing asset-class-based approach. The VERT team is represented by members from each of Ontario Teachers’ asset-class groups, drawing on expertise from each in order to bring a holistic approach to the fund’s climate-related investments.

VERT’s role is to identify, assess, execute, and manage investment opportunities providing sustainable alternatives that drive towards our net zero ambition. VERT does this through extensive and coordinated research and knowledge-sharing, business development, relationship-building, and targeting and triaging investment opportunities for OTPP as one team.

While the universe of climate investment opportunities is large, VERT has identified five focus areas, including:

VERT is focusing on:

  • Sustainable fuels: next-generation fuel alternatives made through organic and/or decarbonized means that support sustainability and climate impact;
  • Electrification: extending from investments in electrical infrastructure (such as transmission lines or solar power) to enabling products and services to improve energy efficiency, reduce emissions and support the rollout of the energy transition;
  • Industry 4.0: transitioning industry to sustainable, circular, decarbonized models through use of new energy, production, and waste-management systems;
  • Sustainable resources: reimagining our relationship with the natural world and resource-based industries; and
  • Enabling solutions: the services, equipment, software, and other supporting industries that help drive all of this forward.

VERT’s work has informed several of our recent investments on everything from biofuels to foodtech. One example is our recent investment in the ACES Delta platform, a major green hydrogen production and storage hub currently under construction in Utah. Other examples include our investments in Fulcrum BioEnergy, which produces sustainable aviation fuel through the consumption of garbage, and Green Collar, an Australian-based carbon-credit platform.

VERT’s work supports OTPP’s long-term investment focus and bolsters our ability to actively work alongside our portfolio companies to shape a better future. VERT is part of a larger suite of OTPP initiatives to support decarbonization. These include setting aggressive interim net zero targets, issuing green bonds and looking for opportunities to decarbonize other areas such as industrial processes.

The VERT team will play a critical role in helping Teachers' drive towards its net zero ambitions.

[Note: Read my coverage on OTPP's Annual Responsible Investing and Climate Strategy Report.]

Ziad also discusses how important partnerships are when he states:

Some of its investments include offshore wind, battery storage, waste management, bioenergy, and a carbon credit platform. OTPP has also been an anchor investor in the Brookfield Global Transition Fund and in TPG Rise Climate fund. “We are leaving no rock unturned here,” Hindo says. “We are in a capital deployment mode, and we are also wanting to learn with some of the best investors out there.”

After reading this interview, you really do get a sense that Teachers' is delivering on all fronts: diversifying its portfolio, striking the right balance between risks and returns, putting sustainability at the center of everything they do and acting in an agile and nimble way to seamlessly mix and match the public and private, and active and passive together. 

Ziad makes it sound easy but there is an incredible amount of collaboration, work and sophistication taking place to make all this happen. And they have the right governance to do this properly.

There is a great team backing him up and he's right, they trust each other and are focused on delivering the best risk-adjusted returns over the long run for their members.

[Note: See my coverage on their mid-year results where I spoke to Ziad and Jo].

Lastly, I note Deborah Stein and Timothy Hodgson were just appointed to OTPP’s Board:

Steve McGirr, the Chair of the Ontario Teachers’ Pension Plan, is pleased to announce the appointment of Deborah (Debbie) Stein and Timothy Hodgson to the Board, effective January 1, 2023. Ms. Stein and Mr. Hodgson will succeed John Murray and Bill Chinery, who are retiring after serving their maximum terms as board members.  

Ms. Stein has held several senior finance leadership roles, including most recently Senior Vice President, Finance, and Chief Financial Officer of AltaGas Ltd. She is an experienced corporate director and serves on numerous public and private company boards, including current directorships at Aecon Group Inc., Parkland Corporation, NuVista Energy Ltd., and Trican Well Service Ltd. She is a Fellow of the Institute of Chartered Accountants of Alberta (FCA, FCPA) and holds the ESG Global Competent Boards Designation (GCB.D) and the Institute of Corporate Directors designation (ICD.D).

Mr. Hodgson is a senior investment executive and was most recently Managing Partner of Alignvest Management Corporation. Previously he was a senior advisor to the Governor of the Bank of Canada and had a long career at Goldman Sachs. He is an established corporate director and currently serves as Chair of Hydro One and Chair of the New Self-Regulatory Organization of Canada for investment products, and is a former director of the Public Sector Pension Investment Board. Mr. Hodgson holds a Master of Business Administration from the Ivey School of Business at Western University, is a Fellow of the Institute of Chartered Professional Accountants (FCPA) and holds his ICD.D.

The Ontario Teachers’ Pension Plan is jointly sponsored by Ontario Teachers’ Federation and the Government of Ontario. Each sponsor appoints five directors and they jointly appoint an eleventh person to serve as Chair.

Two great additions to OTPP's Board of Directors

Some final tidbits to note on my last comment on CPP Investments and OMERS Infrastructure selling their stake of Chicago Skyway to Atlas Arteria:

  • CPP Investments told me they decided to sell and value the asset at $4.4 billion including debt (the articles in that post do not incorporate debt in their figures). 
  • Toll rates are set by the Skyway Concession Company and must abide by the Skyway Concession and Lease Agreement. Under the agreement, tolls were allowed to be hiked to $2.50 by 2008, $3 until 2011, $3.50 until 2013, $4 until 2015, $4.50 until 2017, and $5 in 2017. Since 2017, tolls are rising annually, equal to the greater of 2% (floor), the increase in CPI, or the increase in nominal GDP per capita.
  • Atlas Alteria has released a long and detailed presentation on why it is acquiring a majority interest in Chicago's Skyway. You can view it hereTake the time to read this, it demonstrates why they are committed to acquiring this asset and owning it alongside OTPP.  

Below, take the time to listen once again to Jo Taylor's recent speech at the Canadian Club Toronto followed by the Q&A with Andrew Willis. I also think it is worth reading an earlier interview with Jo to really appreciate how they are navigating an uncertain world. 

Also, earlier this month, historian Niall Ferguson warned that the world is sleepwalking into an era of political and economic upheaval akin to the 1970s — only worse.  

Hope he is wrong but if the last three years taught anything is to be prepared for anything, a long period of stagflation or a deflationary shock unlike anything we have seen in decades (central banks tend to overreact both ways). Either way, be prepared and remember Ziad Hindo's advice on resilience and putting sustainability at the core of everything you do.