Monday, March 12, 2018

HOOPP Gains 10.88% in 2017

Martha Porado of Benefits Canada reports, HOOPP returns 10.88%, maintains funded status:
The Healthcare of Ontario Pension Plan posted a 10.88 per cent return for 2017, up very slightly on its 10.4 per cent return in 2016 and exceeding its portfolio benchmark by 2.99 per cent or $2 billion.

According to the pension fund’s annual results, it also maintained its funded status at 122 per cent, its investment income grew from $6.6 billion in 2016 to $7.6 billion in 2017, and its net assets rose from $70.4 billion to $77.8 billion.

However, looking ahead through the lens of current market conditions, very rich valuations make this a problematic time to add to HOOPP’s portfolios, says Jim Keohane, president and chief executive officer at HOOPP. “You think about an organization like ours, we’re very long term. If you have a 25-year-old worker coming into the plan today, we might be paying them benefits when they’re 95. So the best time for us to buy assets is when they’re on sale, which is not today.”

This environment is cause for caution, he notes. “I think it’s a good time to be patient and wait for better opportunities,” he says.

HOOPP holds its investments across two portfolios within its liability-driven investing model: a liability hedge portfolio and a return-seeking portfolio. In 2017, the former accounted for about 48 per cent of the pension fund’s investment income.

By asset class, real return bond returns were essentially flat for the fund, while nominal bonds returned 10.5 per cent. Real estate bolstered returns, achieving an 11.9 per cent currency hedged return. Within the return-seeking portfolio, which provided 52 per cent of the fund’s income, public equities returned 14.8 per cent and private equities returned 19.6 per cent on a currency hedged basis.

“We had strong returns across the board,” says Keohane. “Probably the standout was private equity, which had very high returns last year, but public equities also did very well.”

Keohane also expects to continue to see strong growth in HOOPP’s membership. “That’s really a reflection of the continued growth in the health-care sector,” he says, noting that the baby boomer generation is coming into their peak use of the health-care system.
Chris Butera of Chief Investmnt Officer also reports, HOOPP Grows to $77.8 Billion, Remains 122% Funded:
Following a 10.88% rate of return, the Healthcare of Ontario Pension Plan (HOOPP) increased its assets by more than C$7 billion, retaining its 122% funded status at the end of 2017.

“Our investment return for 2017 was 10.88%. While we had strong returns pretty much across all asset classes, our public and private equities, fixed income, and real estate all provided significant contributions to our investment income,” HOOPP President and CEO Jim Keohane said in a statement.

At the end of 2017, the Canadian pension fund’s assets climbed from 2016’s C$70.4 billion to C$77.8 billion ($62 billion), keeping its funded status on-par with the previous two years.

Investment income was C$7.6 billion ($5.9 billion, beating 2016 by C$1 billion, with the fund’s 10.88% return exceeding HOOPP’s benchmark by 2.99%. According to a news release, the 10-year return is at 9.55%, just above the 20-year return of 9.01%.

HOOPP utilizes a liability-driven approach to its investment strategy. With two portfolios—a liability hedge portfolio and a return-seeking portfolio—the fund is able to continually reap returns while minimizing risk. The liability hedge portfolio consists of real estate and fixed income, while the return-seeking portfolio handles public equities, private equity, corporate credit, short-term money market and foreign exchange, and other return-seeking strategies.

In 2017, 48% of the liability hedge portfolio contributed to HOOPP’s returns. Although real return bonds were basically unchanged, nominal bonds returned 10.5%. According to the release, the real estate section of the portfolio saw an 11.9% currency hedged return—a major contributor during the year.

Returning the remaining 52% of HOOPP’s income, the return-seeking portfolio saw public equities as the top contributor with a 14.8%. Private equity returned 19% on a currency hedged basis.

“HOOPP exists to pay pensions for members. We invest with that objective in mind to ensure that we can meet our pension obligation regardless of the economic backdrop. We also continue to reinvest in our personnel and our systems in order to maintain the sustainability of the Fund and support growth going forward,” Keohane said.
HOOPP put out a press release going over its 2017 results, HOOPP tops $77.8 billion in net assets with a 10.88% rate of return:
The Healthcare of Ontario Pension Plan (HOOPP) announced today that its Funded Status at the end of 2017 was 122%, unchanged from the prior year.

The Fund’s net assets reached $77.8 billion, up from $70.4 billion in 2016, following a rate of return on investments of 10.88% in 2017. After several years of stellar investment performance resulting in funding surpluses, the Board of Trustees approved enhancements to members’ benefits during the year and committed to maintain contribution rates made by HOOPP members and their employers at the same level until at least 2019. These rates have remained unchanged since 2004.

Investment income for the year was $7.6 billion compared to $6.6 billion in 2016, and the Fund’s 10.88% investment return exceeded its portfolio benchmark by 2.99% or $2.0 billion. The Fund’s 10-year annualized return is 9.55% and its 20-year annualized return is 9.01%.

“Our investment return for 2017 was 10.88%. While we had strong returns pretty much across all asset classes, our public and private equities, fixed income and real estate all provided significant contributions to our investment income,” says HOOPP President and CEO Jim Keohane.

“HOOPP exists to pay pensions for members. We invest with that objective in mind to ensure that we can meet our pension obligation regardless of the economic backdrop. We also continue to reinvest in our personnel and our systems in order to maintain the sustainability of the Fund and support growth going forward,” added Keohane.

HOOPP’s pioneering investment model of liability driven investing has proven to be a foundation of the organization’s ability to provide adequate and predictable retirement security to its members and being able to deliver on the pension promise. This risk management approach to investing ensures that HOOPP can effectively adapt to changes in the market to ensure stability and avoid negative impact on the Fund. The success of HOOPP’s funding and investment strategy can be attributed to the organization’s focus on long-term vision and approaches.

HOOPP’s financial results available here.

2017 Return Highlights

HOOPP’s liability driven investing approach utilizes two investment portfolios: a liability hedge portfolio that seeks to mitigate certain risks associated with our pension obligations, and a return seeking portfolio designed to earn incremental returns to help to keep contribution rates stable and affordable.

In 2017, the liability hedge portfolio provided approximately 48% of our investment income. Nominal bonds returned 10.5% while real return bond returns were essentially flat. The real estate portfolio was a significant contributor during the year, with an 11.9% currency hedged return.

Within the return seeking portfolio, which provided 52% of the Fund’s income, public equities were the largest contributor to investment income, returning 14.8%, while private equity investments returned 19.6% on a currency hedged basis.

About the Healthcare of Ontario Pension Plan

Created in 1960, HOOPP is a multi-employer contributory defined benefit plan for Ontario’s hospital and community-based healthcare sector with 548 participating employers. HOOPP’s membership includes nurses, medical technicians, food services staff and housekeeping staff, and many other people who work hard to provide valued Ontario healthcare services. In total, HOOPP has more than 339,000 active, deferred and retired members.

As a defined benefit plan, HOOPP provides eligible members with a retirement income based on a formula that takes into account a member's earnings history and length of service in the Plan. HOOPP is governed by a Board of Trustees with representation from the Ontario Hospital Association (OHA) and four unions: the Ontario Nurses' Association (ONA), the Canadian Union of Public Employees (CUPE), the Ontario Public Service Employees' Union (OPSEU), and the Service Employees International Union (SEIU). The unique governance model provides representation from both management and workers in support of the long-term interests of the Plan.
Take the time to carefully read over HOOPP"s 2017 Annual Report here and its 2017 Year in Review here. You should also take the time to read my coverage of HOOPP"s 2016  results here.

HOOPP delivered another stellar year in 2017, beating its benchmark by 299 basis points (2.99%), but it's the long-term results which are particularly exceptional. With the 10-year return at 9.55% and a 20-year return of 9.01%, HOOPP easily figures among the best defined-benefit pension plans in the world, if not the best, and it delivers these results at a fraction of the cost of its larger peers (click on image):


In fact, HOOPP states this on page 11 of its Year in Review on its approach to investing for the future (click on image):


More importantly, the funded status remained unchanged at 122% and after several years of stellar investment performance resulting in funding surpluses, HOOPP's Board approved enhancements to members’ benefits during the year and committed to maintaining contribution rates made by HOOPP members and their employers at the same level until at least 2019. These rates have remained unchanged since 2004.

What does this mean in practice? The image below taken from page 7 of the Year in Review explains the steps the Board took to increase benefits to its members (click on image):


Basically, unlike most other defined-benefit plans struggling with chronic deficits, HOOPP is in the enviable position of having experienced several years of funding surpluses and can afford to increase benefits to its active and retired members and still keep a cushion for the Plan in case another financial crisis hits its assets and liabilities.

I was on vacation last week but had a chance to discuss HOOPP's 2017 results with its President and CEO Jim Keohane. Jim and I had a long discussion on Thursday afternoon and I jotted down some notes for my readers, stuff that isn't covered in the media [Hint, hint: If you haven't donated to my blog yet, please be gracious and do so].

Anyway, here are some of the things I covered in my conversation with Jim Keohane:
  • On the fixed income portfolio: HOOPP's nominal bond portfolio returned 10.5% in 2017, accounting for the bulk of the returns in the Liability Hedged portfolio. Jim told me they were long 30-year US Treasury bonds and short 10-year and under bonds, effectively betting on a flattening of the curve in 2017. I believe he told me they sold over $2 billion in bonds last year. I also remember him telling me that at 3.75% yield on the 30-year US Treasury bond "there are natural buyers" so they're looking to load up on US long bonds if rates rise further (by the way, I'm still not convinced we will cross 3% on the 10-year Treasury bond yield this year; read my comment on the bond teddy bear market for more details). He also told me that HOOPP repos its bond portfolio (a form of leverage) to enhance its returns and engages in spread trades internally which also adds yield.
  • On private equity: HOOPP Capital Partners (HCP) had a stellar year in 2017, delivering 19.6%. Jim told me HOOPP invests and co-invests with private equity funds to lower overall fees and has a few purely direct investments. One of their direct investments, a pet food company, saw a bump in its valuations after a competitor was bought out by a strategic investor. Also, HCP’s invested capital has increased by over $5 billion in the past few years and now includes credit and structured investments with lower risk/return attributes (read my comment on HOOPP's new CLO risk retention vehicle). Lastly, HCP's geographic exposure is mostly in developed markets (Canada, US, Europe) but they did invest in funds investing in Southeast Asia.
  • On real estate: In 2017 the HOOPP real estate portfolio produced a return of 11.86% on a currency hedged basis. This represents an outperformance of 5.04% relative to the Canadian Investment Property Databank (IPD) benchmark. There was $700 million in property acquisitions, including the purchase of a 1.2 million square foot fully leased industrial property in the Greater Toronto Area, a 515 unit high rise residential project in Chicago, and an interest in a 1.7 million square foot mixed use redevelopment in downtown Los Angeles. Moreover, commitments to new developments totaling $660 million, including a 370,000 square foot office development in central Vancouver, a 1.1 million square foot logistics warehouse for Amazon in Germany, and a 750,000 square foot build to suit industrial building for Mars Canada in the Greater Toronto Area which is slated to begin development in early 2018, and a commitment of $330 million to real estate investment funds globally. Jim told me that One York tower which is the newly built LEAD certified building HOOPP built from scratch is now fully leased with "class A tenants like CIBC and other top companies" and these are long-term leases. This too helped the real estate portfolio in 2017.
  • Other return seeking strategies: HOOPP's long-term option strategy, a strategy in which equity index exposure is combined with equity index options, decreased in value by $496 million during the year, compared to a gain of $90 million in 2016. In terms of asset allocation strategies, HOOPP engages in the strategic re-weighting of major asset class risks (equities, fixed income and corporate credit) in order to manage the risk and return of the Fund. In 2017, this program generated a loss of -$28 million compared to a gain of $103 million in 2016. Lastly, HOOPP engages in absolute return strategies designed to earn positive returns with minimal sensitivities to interest rates, credit or equities. These strategies contributed $158 million in investment income in 2017, compared to $503 million in 2016. All gains or losses on these strategies contribute to the value-added of the Fund. 
  • On the funded status and increase in benefits: Jim told me that by law Revenue Canada does not allow any defined-benefit plan to exceed a 125% funded status, so surpluses are capped by law. HOOPP's 5-year smoothed status was 122% and unsmoothed, it was 130% even after the Board approved the increase in benefits. He told me that HOOPP's discount rate is now 5.5% and it's based on market rates. Interestingly, he told me that in the past, HOOPP did increase the contribution rate and cut benefits three times when the plan experienced a deficit and this was typically by partially or fully removing inflation protection (COLA). This spread the risk of the plan across active and retired members. But once the plan experienced surpluses, HOOPP reset the pensions and paid back the inflation protection that was previously lost. Also, it's important to note that HOOPP fully hedges interest rate risk and even if rates go up, its liabilities go down, so the plan's funded status won't deteriorate.
  • On risks in the market: Jim told me flat out "things are pricey" and that "it's a good time to be defensive". He said there is a limit to how high rates can rise without a negative feedback loop to the economy. He still likes the Canadian energy sector longer term but thinks there could be some short-term bumps due to NAFTA negotiations. In terms of emerging markets, Jim said HOOPP invests in countries where the rule of law is paramount and some emerging markets (like China and India) just don't have the legal protection/ swift court system that is available in developed markets and likely never will so HOOPP is "reluctant to invest in the countries directly". 
  • On currency hedging: HOOPP fully hedges its foreign currency exposure which proved to be a wise decision last year. Jim told me "we don't get compensated for taking currency risk" and said that even partially hedging F/X risk leaves the fund open to a drag on returns due to currency risk. I told him that I agree with what AIMCo, CPPIB, PSP, OTPP and the Caisse do in terms of not hedging currency risk because over the long run, I'm long US dollars and the likelihood that the Canadian dollar hits parity again over the next five years is extremely low (I’m not bullish on the Canadian economy over the next decade). I personally believe a lot of Canada's large pensions don't manage currency risk well and many are losing money (or not gaining by fully hedging) because they don't have the right resources to make money in currencies. Even HOOPP which can claim long-term success in terms of returns can add significant value in currencies over the long run but to do so requires them to hire the right people (they will claim success fully hedging currency risk because of their funded status and long-term results but I still think they're wrong to fully hedge currency risk over the long run just like I think that other funds that don't hedge but don't take opportunistic risks in currencies are equally wrong. It's not as simple as to hedge or not to hedge or partially hedge!!!).
  • On Home Capital Group: Jim told me a significant source of alpha (299 basis points above benchmark) came from the line of credit HOOPP provided to Home Capital Group last year. Jim sat down with BNN to explain why this loan wasn't a risky investment for HOOPP and the risk-return payoff was very favorable for HOOPP and its members.
  • On one CIO departure: It's no secret that David Long, the former Senior Vice President and Chief Investment Officer, asset-liability modeling, derivatives and fixed income at HOOPP was recently released by the organization. Jim didn't provide details but told me that for now, Mr. Long's responsibilities will be handled by Jeff Wendling, Senior Vice President & Chief Investment Officer, Equity Investments. No word yet on when or if Mr. Long will be replaced.
That pretty much covers what I had to say for HOOPP's 2017 results. I thank HOOPP's CEO Jim Keohane for taking the time to talk to me and going over some important points.

Below, HOOPP's President & CEO Jim Keohane discusses HOOPP’s 2017 investment returns and explains how the Plan’s surplus acts as a cushion for the Fund.

I've said it before and I'll say it again, HOOPP is one of the best defined-benefit plans in the world and its members should thank their blessed stars that their pensions are being managed so well by a group of dedicated professionals who are producing stellar long-term results.

Update: After reading my comment, Jim Keohane shared this with me on HOOPP's curency hedging policy: "There is no right answer when it comes to FX. We do pursue some active strategies in FX derivatives but we do hedge our translation risk. It is just not where we want to use our risk budget."

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