Wednesday, April 4, 2018

OTPP Gains 9.7% in 2017

David Paddon of the Canadian Press reports, Ontario Teachers’ Pension Plan ends 2017 with fifth consecutive annual surplus, CEO says:
Ontario Teachers’ Pension Plan is closely monitoring the potential for higher tariffs to slow the global economy, but it thinks that “cooler heads are going to prevail” before that happens, OTPP chief executive Ron Mock said Tuesday.

Ontario Teachers’ core portfolio is well-diversified and in good shape to deal with unexpected developments, having ended 2017 with 9.7 per cent return on investment and a fifth consecutive annual surplus, Mock said.

Referring specifically to the ongoing NAFTA talks between Canada, the United States and Mexico and the recent exchange of tariff threats between the United States and China, Mock said there’s a lot of “noise” in the news.

“While there’s a lot of blustering and negotiating that’s going on, we’re firmly convinced that cooler heads are going to prevail as we roll forward,” Mock said on a conference call with reporters.

If that doesn’t happen and there’s higher taxation on trade in the form of tariffs, there could be an economic slowdown that would cause central banks to take actions such as lowering interest rates.

But Mock said OTPP currently thinks “that it’s not going to get that far at this point in time.”

He added that OTPP’s investment team continues to look at deals on a case-by-case basis, he said.

“I cannot think of anything that has caused us to pause in here,” Mock said.

Mock’s comments came after the Ontario Teachers’ Pension Plan reported that it ended 2017 with net assets of $189.5 billion.

The plan said it was 105 per cent funded as of Jan. 1.

The OTPP said the strength of the fund is allowing for a reduction of the contribution rates for the Ontario government and active teachers, which pay equally into the plan.

The new rate of 11 per cent of pensionable earnings, which is down from 12 per cent, will reduce the Ontario government’s costs by an estimated $150 million per year and an equal amount for employees.

Investment returns provide more than three-quarters of the plan’s funding, with the remainder provided by the Ontario government and contributions of working plan members.

The pension fund also reported Tuesday annualized five-year total net returns of 9.6 per cent and annualized 10-year total net returns of 7.6 per cent.

The OTPP serves Ontario’s 323,000 active and retired teachers.
Rick Baert of Pensions & Investments also reports, Ontario Teachers' CIO resigns:
Bjarne Graven Larsen resigned as chief investment officer of the C$189.5 billion ($151 billion) Ontario Teachers' Pension Plan, Toronto, said Ron Mock, OTPP president and CEO.

Mr. Mock said he would take on the CIO duties.

Mr. Larsen wanted to return to his native Denmark, Mr. Mock said.

"He made a difficult decision with his family and his kids in school" in Denmark, Mr. Mock said. "Bjarne made great contributions to (the pension plan) ... There were no disagreements over strategy."

Mr. Larsen joined OTPP in January 2016. He had been chief financial officer of Novo A/S, the majority shareholder of Danish drugmaker Novo Nordisk, and previously was CEO of Danish bank FIH Erhvervsbank. He was CIO of the 768.6 billion Danish kroner ($123.6 billion) ATP pension fund, Hilleroed, Denmark, until 2011.
In her article on the executive shake-up at Teachers', the Globe & Mail's Jacqueline Nelson notes the following:
Mr. Graven Larsen will exit as the heavy lifting needed to reshape the fund’s investment strategy is wrapping up. The strategy put a greater focus on active management and asset classes such as private equity, where the pension fund has built up deal-making and operational expertise.

Mr. Mock said this approach is already producing good results. On Tuesday, Teachers reported a 9.7-per-cent investment return in 2017, after factoring in expenses. This amounted to $17-billion of income generated by investments, as net assets in the fund reached $189.5-billion as of the end of December.

Many of Mr. Mock’s top priorities now aren’t investment-related. He’s thinking about the pace of change in areas such as technology, as well as the geopolitical backdrop. “And quite frankly, the global focus on how to manage talent [and] acquire talent – these are areas that I think are critically important for an organization such as ours, where our assets go up and down the elevator each day,” Mr. Mock said.

Teachers’s CIO hunt comes amid a widespread shakeup across the executive ranks of several of the largest plans in the country. Major recent changes include Public Sector Pension Investment Board’s CEO André Bourbonnais leaving to join BlackRock Alternative Investors. The CIO of the Caisse de dépôt et placement du Québec left to enter politics in France. And, last month, Ontario Municipal Employees Retirement System (OMERS) promoted its capital markets leader Satish Rai to the role of chief investment officer and elevated real estate veteran Blake Hutcheson into the new role of president and chief pensions officer. Teachers also parted ways with its infrastructure and natural resource head Andrew Claerhout earlier this year and has appointed an interim leader.

The challenge to find and keep top performers could become more pressing as Canadian demographics shift. Mr. Mock pointed to Canadian census data that indicates seniors are now outnumbering children. “All you have to do is roll that forward a decade and a half and you can see very clearly that talent has to be high on the priority list,” he said. Right now, about 80 per cent of Teachers’ portfolio is managed in-house by about 350 investment professionals.
There is a lot to cover today and I just got off the phone with Ron Mock, Ontario Teachers' President & CEO, who was gracious enough to take some time to talk me through many points. We covered it all, including HR issues, but before I get to that coversation, I want to bring to your attention a few more things.

Ontario Teachers' put out a press release on its 2017 results, Ontario Teachers’ Pension Plan is fully funded for fifth consecutive year:
  • Net assets reach $189.5 billion, up tenfold since the Plan's inception
  • Plan was 105% funded as at Jan. 1, 2018
  • Surplus to be allocated to contingency reserve
  • Net investment income of $17.0 billion
  • Bjarne Graven Larsen resigns, Ron Mock acting as interim CIO
TORONTO - Ontario Teachers' Pension Plan (Ontario Teachers') today announced it was 105%-funded as of January 1, 2018. This is the fifth consecutive year that the Plan is fully funded, underscoring its long-term financial health and sustainability.

The Plan had a total fund net return of 9.7% for the year ending December 31, 2017, bringing net assets to $189.5 billion and marking approximately a tenfold increase since the Plan's inception in 1990.

"That we were able to achieve this funding surplus while using a prudent discount rate of 4.8%, one of the lowest in the pension industry, testifies to the financial health and sustainability of the Plan," said Ron Mock, President and Chief Executive Officer. "Being in a surplus position in the Plan is the true measure of success."

Balancing assets and the cost of future pensions is fundamental to meeting the needs of pensioners today, without compromising the financial health of future generations.

The Plan sponsors – Ontario Teachers' Federation (OTF) and the Ontario government - chose to file the January 1, 2017 valuation restoring 100% inflation protection on all pensions and reducing contribution rates by 1.1% for all active members – both measures being effective January 1, 2018.

The Plan sponsors have decided to file the January 1, 2018 valuation and to allocate the $10.3 billion Plan surplus to a contingency reserve that would buttress the Plan in the event of a severe market event. The feature of Conditional Inflation Protection, introduced by the Plan sponsors in 2010, is also a powerful support to plan sustainability.

In 2017 Ontario Teachers' progressed in the evolution of its investment strategy to better combine a proven bottom-up approach to asset selection with a robust, top-down approach to risk management and asset allocation. This work has been led by Chief Investment Officer Bjarne Graven Larsen, who after two years at Ontario Teachers' has resigned and plans to move back to Denmark with his family.

"I want to thank Bjarne for his many contributions over the past two years, and wish him all the best," said Mr. Mock, who will act as interim CIO during the process to find Mr. Graven Larsen's replacement.

The Plan exceeded its total fund benchmark of 8.2% in the year to December 31, 2017. Net investment income for the year of $17.0 billion nearly matched the size of the entire Plan when it started its direct investing program.

"This year we lowered our exposure to passive investments and moved further into active strategies where we can add value by leveraging our experience as well as our capital," said Mr. Mock. "Our investment strategy is built to last; it guides us through the changing markets landscape."

Ontario Teachers' five- and 10-year total fund net returns as at December 31, 2017 were 9.6% and 7.6% respectively. Since inception, the Plan has had an annualized total fund net return of 9.9%, as at December 31, 2017. More than three quarters of the Plan's funding comes from investment returns, with the remainder coming from member and government contributions (click on image).


Ontario Teachers' asset classes were redefined in 2017 as part of the OneTeachers' investment strategy. From five asset classes in 2016, we now have six: Equities (public and private), Fixed Income, Credit (includes corporate and emerging market debt), Inflation Sensitive (includes natural resources, commodities, inflation hedge), Real Assets (real estate and infrastructure), and Absolute Return Strategies (seeks returns with low correlation to markets; includes hedge funds).


In local currencies, the return on our investments in 2017 was 11.9%, marking an uptick from the same year-ago period of 7.2%. Converting the return back into Canadian dollars had a -1.8% impact on the Plan's total fund net return. This, combined with administrative expenses, brought the net return to 9.7%.

Foreign currency exposure is part of our overall portfolio construction, and we take the risk associated with currency into consideration. In certain circumstances, we will take hedging measures to reduce our exposure to the currency risks which come from investing globally. This dynamic approach, rooted in risk management, supports our comprehensive OneTeachers' investment strategy.

Ontario Teachers' continues to show strong performance in pension services. Our Member Services division again was ranked in the top two globally for service, and earned high satisfaction scores in member surveys. The plan's Quality Service Index (QSI), which measures members' service satisfaction, was rated 8.8 out of 10, and the plan was ranked second, by CEM Benchmarking Inc., for pension service in its peer group and internationally.

About Ontario Teachers'

The Ontario Teachers' Pension Plan (Ontario Teachers') invests and administers Canada's largest single-profession pension plan, with $189.5 billion in net assets at December 31, 2017. It holds a diverse global portfolio of assets, approximately 80% of which is managed in-house, and has earned an annualized total fund net return of 9.9% since the Plan's founding in 1990. Ontario Teachers' is an independent organization headquartered in Toronto. Its Asia-Pacific region office is located in Hong Kong and its Europe, Middle East & Africa region office is in London. The defined-benefit pension is fully funded. It serves the province of Ontario's 323,000 active and retired teachers. For more information, visit otpp.com and follow us on Twitter @OtppInfo.

Note to Editors: Please See Attachments:
Now, take the time to carefully read the full 2017 Annual Report which is available here. This annual report is very well written, one of the best I've read in years.

On page 2,  OTPP's Chair, Jean Turmel, notes the following in his report:
In 2017, the board implemented changes to the risk governance structure and investment strategy. The impact of these changes was to give management greater responsibility and improved agility for investment decisions.

Management’s integrated investment approach combines organization-wide risk management and portfolio construction with a continued focus on returns that add value above the plan’s benchmarks. This investment strategy also focuses on volatility management, with a clearly aligned focus on stability of contribution rates and benefit levels. We believe management’s ability to integrate these components will provide stability through a variety of different market conditions. The plan’s compensation scheme has been revised accordingly, with an increased weighting on the total-fund absolute return and risk, while keeping a focus on outstanding value creation, operations and service.
On page 3, Ron Mock echoed this focus on long-term sustainability and an integrated risk approach in his report:
Our employees deliver on the pension promise to our members. Our relationship with members is for life, and we want to make everything related to their pensions as easy and stress-free as possible. So we engage with them, and we try to anticipate their needs. We are making a serious commitment to new technology to enable this, which last year included ongoing replacement of legacy systems and upgrades to our contact centre capabilities including online chat.

The way we invest is also directly tied to the needs of our members. We want to stabilize contribution rates and benefit levels as much as possible. To do so, we have made a thoughtful and deliberate shift to our OneTeachers’ investment strategy. It is designed to succeed in a variety of market conditions over the long term while taking the appropriate amount of risk. In the future, this may mean we do not experience the double-digit returns of the past. Instead, we believe it will enable strong performance while also protecting us from the shocks and aftershocks of severe market events.
The message is clear, forget the old Teachers' which focused just on added value and beating a benchmark, the new Teachers' focuses a lot more on risk-adjusted returns to stabilize the contribution rates and benefit levels as much as possible.

You might be asking why, and I'll tell you exactly why. I've long told you, historic low rates are here to stay, which means Ontario Teachers' and other pensions need to prepare for lower returns and more volatility in public markets, and this requires a rethink of the strategic (long-term) focus.

Ron Mock and I had a pretty lengthy conversation but he was pressed for time so I let him speak as I tried to jot down everything I could:
  • He began by telling me he's proud of the plan's success. It's fully funded, contribution rates were lowered, inflation protection was fully restored and they still have a $10 billion cushion in case of a severe market event. "I'm proud of what the team has delivered" on total return, value-add, all within a tight focus on risk. However, Ron being Ron, he added this: "We're in a strong financial position but we'll never be complacent." 
  • He told me global diversification benefits really kicked in last year, with value-add coming from Teachers' Private Equity (18.8% vs 14.6% benchmark return) and Infrastructure (18.2% vs 8% benchmark return). He said that Teachers' has taken steps to reduce currency volatility as much as possible but given its size and its global investments and that it doesn't hedge everything, there will be some years where an appreciating Canadian dollar drags down returns.
  • He said asset returns are the best in years but going forward, he expects it will prove more difficult to deliver the recent high returns. Still, Teachers' upped the risk in Infrastructure and Private Equity but Ron stressed the focus remains on scrutinizing each and every deal very carefully.
  • In infrastructure, he said the airport portfolio continues to do well but Teachers' did take advantage of strong demand to realize gains on some infrastructure assets last year like the sale of High Speed 1 which they owned with OMERS. 
  • Interestingly, he told me that Teachers' is increasingly focused on greenfield, not brownfield, infrastructure using its platform of specialized companies around the world to evaluate greenfield projects. "Sort of like what Cadillac Fairview, our real estate subsidiary, did with the Deloitte building in Montreal which was built from scratch." Teachers' has experts in companies they own as part of their platform which evaluate projects which will determine whether it makes sense to move ahead with a greenfield project, which can be in renewable energy or an electric transmission lines in Chile (see an older comment of mine, OTPP's new infrastructure approach; Olivia Steedman is overseeing these greenfield projects).
  • In Private Equity, he told me they're doing very well, including in Europe, but they're being very selective with each and every deal.
  • Ron emphasized that while value-added came from Infrastructure and Private Equity in 2017, in 2016, Public Markets kicked in (see my analysis of 2016 results here).
  • He told there's "lots of liquidity around the world" looking for infrastructure and private equity assets and as long as rates don't rise significantly, this dry powder will remain in play, bidding up valuations.
  • Here is where the conversation got interesting for me. Ron personally doesn't think inflation is coming back, he read my comment on the US inflation disconnect and doesn't see rates normalizing to previous historic levels. In fact, he doesn't believe the Fed will hike rates four times this year and told me that escalating trade tensions are a concern because they "act as a tax, lowering global GDP." He added: "Central banks are monitoring the situation and if global growth starts waning, they will respond." I told him that I see a slowdown in the second half of the year which is why I'm defensive in public equities and recommending US long bonds (TLT). He told me "the economy is fine for now but there is a repricing of risk, mostly in public equities." However, he added: "It's not Armageddon as there's still plenty of liquidity out there" (true, but there is a shift to stability going on as quant/ momentum strategies get hit). 
  • On OTPP's success in terms of being fully funded, Ron told me the plan has intergenerational equity because when there is a deficit, active members see their contribution rates rise and retired members see a partial removal of full inflation protection. "Conditional inflation protection has worked well and made the plan young again". What Ron means is that 25 years ago, there were ten active members for every one retiree and now there are 1.5 for every retiree, and teachers live longer than the rest of the population. So by incorporating conditional inflation protection, the retired members which will grow in numbers will bear more of the burden but because a removal of full inflation protection isn't onerous on their benefits (over three or four years), they can withstand the minor adjustments to their benefit levels until the plan gets fully funded again and full inflation protection is restored (see this great clip which explains why conditional inflation is instrumental in the plan's success). By 2040, there will be ten people sharing the risk for every active member, which will make the plan a lot more sustainable and fairer in terms of generational burden. Ron added: "Conditional inflation gives us a $70 billion cushion in case the plan experiences a serious deficit."
  • It should be noted that Ontario Teachers' uses a 4.8% nominal discount rate (2.75% real) which is among the lowest fifth percentile from plans around the world. It's a mature plan with an aging demographics but as stated above, conditional inflation has made it young again.
Ron and I ended our conversation going over HR issues and I didn't hold back, stating that I didn't agree with certain departures which happened under Bjarne Graven Larsen's watch.

In particular, I was shocked to see Wayne Kozun, OTPP's former SVP Public Equities, leave the organization and more recently, Andrew Claerhout, who was in charge of Infrastructure and Natural Resources, leave the organization.

I hold both these individuals in high esteem and think Teachers' is a much weaker organization without them. In fact, I'm on record stating that Andrew Claerhout should have been named OTPP's next President and CEO as he would have made an outstanding CEO (and Wayne would have been a great CIO). I will openly state that I question why these two senior investment officers are no longer with Teachers' (yes, there are ten sides to every story but I still question why they were pushed out).

I also told Ron that a few sources told me there is chatter that morale is low at Teachers' because there have been way too many changes in the last couple of years and certain people are being promoted who don't really deserve it, and that Bjarne Graven Larsen was an outsider who didn't understand Teachers' unique culture.

Ron addressed my concerns head-on:
  • He said, "Bjarne is a brilliant man" who worked at ATP and implemented a lot of important changes there. Importantly, he told me the long-term strategy Teachers' adopted was created by senior managers and "Bjarne was brought in to execute".
  • He said, "the strategy is working, the focus is on risk, but I won't deny there were major changes that took place here over the last three years but the changes took place everywhere including HR and with the creation of a new COO position". He said that some of this change was "substantial and needed" but the "level of disruption is well within Teachers' historic norm" (8 % annual turnover rate).
  • In terms of morale, he told me he was particularly impressed with new hires coming to Teachers' with "fresh and innovative ideas" which he said is important to "combat complacency and groupthink".  He added: "Whenever there are high profile departures or significant changes to the way things are being done, some people will not agree but it needed to be done and the strategy is working.”
With Andrew Claerhout and Bjarne Graven Larsen now gone, I suspect Barb Zvan, OTPP's Chief Risk & Strategy Officer, is going to be groomed to take over Ron‘s job. Jane Rowe, the head of private capital, has tremendous investment experience which Barb doesn't have but she's older and the board will likely opt for someone younger with more years ahead of them (Barb can work with her CIO and senior officers if she gets the nod to replace Ron).

As far as who will replace Bjarne Graven Larsen, Ron told me for now it's him but he is looking at internal and external candidates that will be the right fit. I suspect Michael Wissell who leads the Portfolio Construction group is high on the internal candidate list but there are a few excellent external candidates too (still, I doubt Ron wants to risk bringing an outsider again to be the CIO but who knows).

One thing Ron emphasized to me, he's very proud of his entire team and thinks there is a lot of bench strength at Teachers'.

I ended by telling him flat out, I loathe the functions of a CEO, yes you get paid the big bucks, but I love markets and investments and saw first-hand the duties of a CEO working closely with Gordon Fyfe at PSP Investments years ago. I much prefer looking at markets, talking markets than dealing with a lot of frustrating nonsense that goes with the responsibilities of being a CEO (that and I can't stand office politics, total waste of time and precious energy).

Then again, that's why Ron Mock and other Canadian pension CEOs get paid the big bucks (click on image):


If you're wondering why Bjarne Graven Larsen waited until yesterday to resign, it's probably because he waited to get his bonus which was paid out last week. Still, the timing of his announcement was strange and it detracts from Teachers' overall results which were excellent once again.

Hope you enjoyed this comment, please remember that it takes a lot of time to write these comments and cover a lot in a timely manner. I remind you that this blog is truly unique and would appreciate if you can support my efforts by subscribing or donating via PayPal on the top right-hand side, under my picture. I thank the few of you who take the time to contribute and hope more will join them.

Once again, I thank Ron Mock for taking the time to talk to me and covering a lot of material. There is a lot I couldn't cover here, but take the time to read OTPP's entire 2017 Annual Report here, it's one of the best reports I've read in a very long time. I mean it, it's really well written and concise.

Below, Ontario Teachers’ net assets reach $189.5 billion, up tenfold since the plan’s inception; the Plan was 105% funded as at Jan. 1, 2018. See some of the highlights from the 2017 Annual Report.

I also embedded a clip on the impact that adjusting inflation protection has on the sustainability of the plan. Watch it and learn about a key element behind Ontario Teachers' long-term success.


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