OTPP looks east

The CAD129.5bn (€96.4bn) Ontario Teachers’ Pension Plan (OTPP) believes it is one of the best managed pension funds in the world. To remain that way, it is looking east for growth and is adjusting to the new demographic trends, but not abandoning its defined benefit (DB) model.

At the same time, the Canadian fund is changing leadership. Last month, president and chief executive Jim Leech announced that he will retire at year-end after holding the top job since 2007. His successor is Ron Mock, who joined the pension fund in 2001. He is currently in charge of around half of its assets, supervising the CAD60bn fixed income portfolio and the CAD6bn alternative investments.

To draw attention to the challenges that a pension plan faces today, OTPP made a documentary, Pension Plan Evolution: A New Financial Reality, that can be viewed on its website. A case study in the movie is the pension system of New Brunswick, a Canadian province. It built up such a huge deficit that it decided to change the plan from a DB one to a ‘shared risk’ model with elements of a defined contribution (DC) plan.

“We gave the example of New Brunswick to show that there are options even for plans in deep trouble,” Deborah Allan, OTPP’s director of communications said. “We are not in a situation as dire as theirs, and we do not want to convert to a DC model. But we have to adjust to ensure our benefits’ affordability for our members and sponsors for years to come. So while we keep our principles, we have introduced flexibility into the cost of benefits. Our sponsors have created a task force to study further modifications.”

Flexibility means that inflation protection, or increasing cost of living, is withheld if the fund cannot afford to pay for it. So for 2010-13 only 50% of inflation protection was guaranteed, and in 2014 it will be 45%.

Another adjustment OTPP has made is lowering its general exposure to equities. “It’s because of our members’ risk profile,” Allan explains. “We are a mature plan with a decreasing number of contributing members and an increasing number of people receiving benefits, which means more risks for the former.”

The fund has 303,000 members: 179,000 teachers, principals, and school administrators, and 124,000 retirees, so there are 1.4 working teachers for every retiree. With high longevity rates, members are expected, on average, to be retired for five years longer than they worked.

The fund is currently 97% funded and to stay in a healthy position it could either raise contributions or decrease benefits for future retirees; reducing benefits for current retirees is prohibited by law. “We chose the alternative of decreasing exposure to equities to reduce volatility. They were 65% of our investments 15 years ago, now they are 47%, including 12% of private equities managed by our investment arm Teachers’ Private Capital,” Allan adds.

OTPP’s 10.1% annualised rate of return since inception in 1990 comes from long-term investments in real assets such as real estate (it owns shopping centres and office complexes in Toronto and California) and infrastructure (like Copenhagen airport and GCT Global Container Terminals), which last year returned 19.4% and 8.4%, respectively. Equities returned 14.2%, and fixed income, 5.1%. Only commodities (-1.9%) and timberland (3.4%) underperformed their benchmark. The fund’s total return was 13%, two percentage points above its benchmark. All investments are managed in-house, using funds where appropriate, by 350 professionals.

Looking for opportunities to grow, OTPP is opening an office in Hong Kong, the fund’s first regional presence in Asia. “It will focus on private and public equities,” Allan says, “and it will be managed by a staff of expats and locals…. We have been investing for years in Asia, but now we think it’s important to be on the ground in order to find the right partnerships.”

OTPP’s other office abroad, in London, was opened in 2007 by its Teachers’ Private Capital, and is focused on private equity. But Europe, as an investment market, has been “dead for a long time”, as Leech said during a press conference, nor can the US be expected to offer good growth. “So that really just leaves you with the emerging markets,” Leech added. And this is why the fund is increasing its exposure to Asia and other emerging markets from 15% to 20%.

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