A Conversation With UPP's CIO Going Over Their 2022 Results
UPP’s portfolio posted a 9.1% net loss in 2022, outperforming median defined benefit pension returns in Canada by 3.3%*. The performance primarily reflects UPP’s transitional portfolio state amid the strained macroeconomic environment.
While we never want to incur negative returns, our focus is sustainable long-term performance and a well-funded Plan that delivers benefit and contribution rate stability through time. Despite last year’s market challenges, the Plan maintained a healthy funding and liquidity position, staying well-equipped to pay members’ pensions over the long term and agile to investment opportunities as markets evolve.
In 2022, we maintained a strong focus on completing the foundation of our investment approach, putting the building blocks in place to ensure our portfolio meets the needs of members today and in the years ahead.
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*The average annual net rate of return among median DB plans was -12.4%, according to RBC Investor & Treasury Services, the Financial Services Regulatory Authority of Ontario (December 2022), and Northern Trust Pension Universe Data.
I recommend you take the time to read UPP's 2022 Annual Report here.
Here are the highlights for 2022:
There was no big press release which is somewhat surprising to me (the three Cs of good governance 101 are Communication, communication and communication!) but Zandra Alexandre did reach out to me yesterday morning to tell me the annual report would come out later that day.
I was busy yesterday so I asked if Barb Zvan would be available to talk to me today.
Unfortunately, Barb had a full day today as she was testifying in the Standing Committee of Finance but Zandra suggested I talk to UPP's CIO Aaron Bennett and that's exactly what I did earlier today.
Before I get to our discussion, let's go over the letter from UPP Chair Gale Rubenstein:
I note:
My gratitude extends to UPP’s Joint Sponsors for their continued support, invaluable contributions, and partnership in service of UPP’s members. We’re proud to work in concert with the Joint Sponsors to ensure the Plan is run efficiently, strategically, prudently, and in the best interest of all Plan members, exemplifying best practices as set out in the joint governance model. In 2022, Cynthia Messenger concluded her term as a representative on the Employee Sponsor Committee. I offer my sincere thanks for her unwavering commitment and efforts in helping to create UPP from our earliest stages, as well as her contributions as a Joint Sponsor. We welcomed Lisa Kramer as a new employee representative, appointed by the University of Toronto Faculty Association.
Barbara Zvan and UPP’s entire Executive Leadership team have demonstrated exemplary leadership and agility in balancing the short-term foundational needs of an organization with the long-term vision needed for a pension plan. We have full confidence in their ability to deliver progress against UPP’s organizational strategy and continued success for UPP’s members.
This exceptional leadership did not go unnoticed outside the organization, as Barbara was honoured by the Globe and Mail’s Report on Business magazine as both Corporate Citizen and CEO of the Year in 2022. On behalf of the Board, I would like to congratulate Barbara for these well-deserved awards. Her tireless efforts as an ambassador for defined benefit pensions and a sustainable finance advocate are an inspiration for us all at UPP.
You can read more about Barb's well deserved award here.
Next, take the time to read CEO Barbara (Barb) Zvan's letter:
Here is the most important part:
This past year brought unprecedented challenges for individuals and investors alike, with far-reaching impacts. While conditions like these can certainly be stressful, I want to assure our members there is no impact to the security of their pensions. Despite a drop in net assets in 2022, the Plan maintained a healthy funding and liquidity position, staying well-equipped to pay members’ pensions today and over the long term.
While we take short-term investment performance seriously, UPP’s investment strategy is purposely designed for long-term results. Over the last 12 months, UPP’s team has worked hard to complete the foundation of our investment approach, putting the building blocks in place to ensure our portfolio meets or exceeds the needs of members today and in the years ahead. Looking forward to 2023 and beyond, we are primed to make new investments and take advantage of opportunities to create added value for the portfolio in a changing economic landscape.
In years like 2022 when inflation is running at a 40-year high and both stocks and bonds are getting slaughtered, you need a miracle to post positive returns, especially if your a plan like UPP which doesn't have 50% of its assets in private markets like some larger peers (where valuations are lagged and therefore do not always reflect true market conditions).
Barb also notes this:
The past year was also marked by significant progress in UPP’s maturation as an organization. With our 2022–2025 organizational strategy now in place, we are establishing the foundations for service,investment, and operating excellence.
As we work to complete our member services infrastructure and prepare to deliver a full suite of exceptional member services, I want to recognize the role of member feedback in shaping our approach—both today and in the future. The voices of our members continue to be important inputs, helping ensure we meet and exceed their needs at every point in the pension journey. Prior to beginning our search for a partner to help build our pension administration system, we embarked on a two-part member engagement series throughout 2021 and 2022 to better understand our members’ expectations, values, and priorities.
With these necessary insights from surveys and town halls in hand, we selected Vitech as our partner in creating a secure, digitally enabled pension administration platform, with enhanced tools and self-service features. With Vitech on board, the development work is well underway to ensure a seamless transition in service for employers and members alike. We will continue to share progress on this transformational project in the months ahead.
A couple of quick points here. First, UPP is and will remain very engaged with all its members.
In the case of UPP, its members include university professors which are highly intelligent and often highly opinionated people.
I know, I have them blasting me in emails sometimes about my views that I do not believe in divesting out of oil & gas but I go after these people in emails twice as hard and put them in their place.
You see, university professors are very smart people but when it comes to what's best for the long-term sustainability of their plan, they're often totally and utterly clueless.
When I read nonsense from the National Observer on how now is the time for Ontario’s University Pension Plan to lead the way on phasing out fossil fuels, I can't help but cringe and remember some of my feisty socialist professors at McGill back in my day and how they too had it all wrong on Big Oil.
Importantly, divestment is a lazy strategy which is counterproductive in many ways.
In fact, it's not even a strategy, it's a surefire way to pass the risk on to another fund that couldn't give a damn about ESG and I would go further and claim pension funds that are not engaging with oil & gas companies are neglecting their fiduciary duties.
I know CDPQ got out of oil production (not gas and pipelines) but it doesn't change my mind that I think they were wrong to do this even if I consider them leaders in responsible investing (has nothing to do with divesting).
Today, I had a proud leftist send me an article on how CDPQ investments in Israeli war crimes is approaching 5% of the portfolio (Les investissements de la CDPQ dans les crimes de guerre israéliens approchent les 5 % de son portefeuille).
Boy, he sent it to the wrong person because this is total nonsense and more importantly, I support the state of Israel, its Prime Minister Benjamin Netanyahu (when he respects democracy) and its right to defend itself against internal and external terrorists. (I'm a center right conservative, don't' send me articles against Israel or how Canadian pension funds support war crimes there, which is a farce, akin to saying if they invest in Lockheed Martin, they're supporting the ongoing war between Ukraine and Russia).
Anyway, back to UPP and Barb.
She writes:
Last year, we introduced our commitment to achieve net-zero portfolio emissions by 2040 or sooner via our Climate Action Plan, with an emphasis on decarbonizing the real economy. We see this systems-level approach as an essential step in meeting our fiduciary duty to our members, ensuring that every decision we make contributes to the Plan’s sustainability and the health of the capital markets on which our fund relies. Since launching the Climate Action Plan, we’ve made considerable progress in its implementation, including the development of our Climate Transition Investment Framework, which will allow us to evaluate the transition alignment and readiness of our current portfolio and new investment opportunities, set a target for climate solution investments, and refine our approach to climate-related investment exclusions. We look forward to introducing this framework and our climate solution targets in 2023.
At UPP, we know that every team member is deeply connected to our purpose of bringing greater retirement peace of mind to the university sector by investing with integrity and serving members with care. This shared purpose unites and motivates the team, creating the foundation for a thriving and inclusive culture, where all employees feel embraced, rewarded, and empowered to perform at their peak. In 2022, we made important progress in the build of our intentional culture, including conducting employee engagement and culture surveys to ensure our core values and behaviours position the organization for future success.
Culture is critical at UPP, something I discussed with Aaron Bennett.
I urge everyone to read about UPP's strategic plan starting on page 9 of the annual report:
Discussion with UPP's CIO, Aaron Bennett
As I stated above, earlier today I had a nice discussion with Aaron Bennett, CIO of UPP.
I want to thank Aaron for taking the time to talk to me and also thank Zandra Alexandre for setting up this call on short notice.
For those of you who do not know, Aaron used to work at OTPP and has excellent experience on global active equities and as a portfolio manager for the Natural Resources group. He then worked at Jarislowsky Fraser as a Managing Director, Sustainable Investment Strategies and Research before joining UPP.
By talking to him, I was struck by three things: his breadth of knowledge, his clear and effective communication skills and his healthy skepticism.
Anyway, Aaron began by giving me an overview of last year’s performance:
First, we remain in a fully funded position. We are well-positioned to deliver our members' pensions today and over the long term. Our funding position was 103%. The challenge, of course, it was an incredibly volatile year, one of the more challenging ones in my investment career. Lack of diversification opportunities, things traded in ways we haven't seen in decades so the end result for us was we were focused on the on-year rate of return which isn't really our focus and we were down 9.1%. On an absolute basis, that's a challenging thing but on a relative basis, the defined benefit peer group was down 12.4% and another benchmark, the 60/40 portfolio was down 16-17%. And that in the context of difficult economic conditions and the fact we were transitioning through a portfolio state, that's a pretty good result.
I told Aaron I think it's fair to say that and noted UPP is still very much in its ramp-up stage and it could take 3-5 years to complete the portfolio transition.
I also mentioned that speaking to Barb last year, they inherited a 60/40 or 70/30 portfolio and had legacy investments in private equity/ private debt and many external managers in fixed income and public equities.
So, UPP is still very much in a transition phase and it's not fair to compare its performance to larger more established peers.
Aaron replied:
I think that is a fair way of putting it and I appreciate you recognizing that. We didn't benefit from having established positions but we did have considerable consolidation. As far as 3 to 5 years to reach our portfolio transition, I think that's a good estimate but we want to do better.
The team has a done a phenomenal job pushing through in areas where we can consolidate and really focus our investment strategy on resilience, so largely in public markets. We have been able to do a lot in a short period of time and build those infrastructure foundations to do those things and continue to grow from there. So I'm really, really happy on what the team has been able to do on that.
The other side of it is the private side. We did inherit a substantial portfolio of private managers which is an interesting position to be in but it's an illiquid one and given where the secondary markets have been trading, I'm not keen on being a seller right now.
That leaves us in a position of getting to know our managers really well and seeing opportunities there but really focusing on new investments and executing on strategy that the private team has in place. We are really happy to report we did our first infrastructure investment the year ended in 2022. That's ahead of schedule.
I think the more we are able to implement our private market strategy and mesh it with our public market strategy with our private market one, that puts us in a position to provide our members with what we wanted which is the benefits of scale.
So going back to what you said, 3 to 5 years to transition the portfolio, I think that is a reasonable number, but at UPP we strive to be better than that. I certainly hope to be on the lower end of that range and maybe aspire to do it little quicker. Given what the team has done so far, I'm confident we will well positioned with a resilient portfolio sooner rather than later.
Aaron told me the private portfolio was more heavily weighted toward private equity/ private debt so one of the things they did when they did their asset allocation study was to focus deploying capital in infrastructure and real estate.
I told him they were lucky in a way that real estate and infrastructure had low weightings to begin with because they didn't get stuck with a massive real estate portfolio which wasn't properly diversified by sector and geography and can deploy capital in interesting areas around the wold if they have the right partners.
Aaron responded:
Absolutely. You hit it right on the head. It's about partnerships. There's lots of people who want to take our money and charge us fees on our behalf but we want partners. We want partners who are going to come to us with ideas, co-investments, direct investments potential, niche strategies which are aligned with our investment beliefs but also appropriate for a fund of our size. We are not a Teachers or CPP Investments so we don't have to write these big cheques. The risk of us rushing into heavily capitalized areas and need to deploy half a billion dollars at a time, we don't have those pressures.
We have other pressures but as a medium-sized fund we have a really interesting position where we are able to build a team that can do co-investments, that can be a partner and I think Peter Larsen on the private side has done a fantastic job building that out and building the pipeline of partners to help us with that. And we have been able to find in a number of cases really interesting opportunities to help us to replicate some of the advantages the large funds have been able to replicate with regards to buying a platform and executing all their real estate investments through a platform or other infrastructure investments through a certain platform. We're obviously of the size where it doesn't make sense to buy a platform but we can get access to platform if we find the right partners. And that really allows us to be a lot more flexible, a lot more aligned with what our liabilities mean and a lot more dynamic within areas where there is opportunities and challenges. Infrastructure and real estate have been easier areas to make money for last 10 to 15 years and I think it's more challenging going forward but I think if you're focused on the opportunities on what is aligned, there are really interesting opportunities out there.
As far as areas where they're focusing on, he said this:
I'd step back one step just to say first and foremost it goes back to this idea of finding the right partners that we believe have ability to add value through means beyond buying something, merging a couple of companies n there and levering it up. We want to avoid the beta of real estate and infrastructure. We want to find the folks that have the operating teams that allow them to add value through operations, development and engagement and that are more fully integrated in that way as well.
With those partners, as you suggested, it's finding the right niche. What the right area where a find of our size can deploy $100 to $200 million of capital in a strategy and find that value that will protect us -- not completely insulate us but protect us from some of the issues and challenges that are coming up through real estate and infrastructure.
I think in real estate, multi residential is very interesting and there are tons of opportunities there. You have to be careful in terms of regions you go into and you have to find the folks that have that skill set for the development side and that pipeline on the development side because time to build is always an issue in this space that can really help you execute on those projects. If you can find someone that has got management capabilities after the fact too, that gives you another important tool that gives you flexibility on things so you are not forced to exit at the end of life of a fund, you can carry through more difficult times to make sure you're exiting at the right time.
We then spoke about diversification and Aaron explained they want the diversification and are building out through co-investments and partnering up with people who have the platform that gives them access to that platform and development pipeline, then you're mitigating risks like blind pool risk, J-curve drag, etc.
They found a couple of areas in real estate they are working on right now. In infrastructure, their first investment was in digital infrastructure with a "great partner that has operating history, that has tons of capabilities there". They closed a second deal in May of this year was access to a platform with a development pipeline of permanent projects for a global leader in renewable energy.
"We are really excited about those because then we can create that diversity on the on infrastructure side in a way that is fit for purpose for a fund that is UPP's size."
We then talked about private debt and I shared with him that the asset class makes me nervous because a lot of the newer funds are taking a lot of risks.
Aaron shared this:
It's an area that isn't on the top of our list in terms of near term capital deployment or extensive near term capital deployment driven by a couple of things. One, we took on a significant private debt portfolio that had a significant amount of capital commitments outstanding. We are working through that, it's a great list of interesting managers that really provide a diversified exposure in what is considered private debt. We have a really interesting and diversified portfolio to build on and to think about.
Some of your comments on private debt, I agree it feels like where real estate and infrastructure were at 10-15 years ago, and as capital flows in, they're taking more risks but returns aren't going up.
What is interesting for me, as a mainstream asset class, it's not an asset class that has gone through a full credit cycle. So when I think it about it as asset allocation portfolio construction perspective, working with my portfolio construction team to build the most resilient portfolio, it's a little difficult to calibrate private debt because it hasn't gone through its existential moment yet.
I completely agree with his insights there and that's why you really need to pick your partners right in this space.
Aaron told me they were in the mid to high teens in private markets -- 15 to 17% and then 12-13 was PE/ private debt in return enhancing bucket and balance of that was evenly split between real estate and infrastructure in the inflation sensitive bucket.
He told me that ideally they want to reach “high 20s or low 30s in private markets.”
"You really have to be on your game from a liquidity perspective if you want to be 50% in private markets, even 30% is challenging. I want to be the great partner that is there when I have to be."
They put private markets under one individual (Peter Larsen) and that's intentional because they want to avoid some things that can happen where some people say it's real estate but its really private equity and manage liquidity and capital calls a lot more tightly.
On the public side, Aaron told me they consolidated a lot of managers and they see more dispersion and volatility if higher for longer persists. He told me a new paradigm is happening where dispersion will present better opportunities in terms of active management and they are careful where they take passive risks too given the concentration risk in some indexes.
He also told me they are able to do their responsible investing better in public markets through different means like proxy voting.
Moreover, he told me hedge funds produced great returns in 2022 and they're finding the right partners and looking to create a “resilient portfolio of uncorrelated liquid returns.”
Lastly, we talked about culture and how UPP is able to attract and retain quality people who believe in the mission and are engaged and focused.
I told him they believe in Barb and UPP's leadership and Board and the mission of the plan.
Aaron told me they have been able to build an impressive team:
We are are recruiting people from great places and want to come here because there is the opportunity to build something, there is the opportunity to grow something, and there is that purpose to serve the community, to run a pension plan that is designed by and for the university community and do it in a a way that is purposeful, to really take seriously some of our commitments around climate change, equity, diversity & inclusion, and long term sustainability of pension plans because we are really committed to that and are able to attract people that support that.
He told me they don't take culture for granted because they've seen how it can evaporate at large shops and want to avoid this at all cost.
I will end it there and likely revisit this comment to add some additional comments but I covered the main points and thank Aaron for a very insightful discussion, I really enjoyed talking to him.
Below, Toni Sacconaghi, Bernstein senior research analyst, joins 'Power Lunch' to discuss tech stocks dominating the markets.
Beware, this is the most concentrated and overbought market ever!
And CNBC's Kristina Partsinevelos joins 'Power Lunch' to report on the most overbought stock on Wall Street.
Well, you know my thoughts on Tesla, short this ESG pig when the time is right (soon) and make a real killing (I prefer trading TSLQ when I think a major selloff in Tesla shares is about to occur).
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