The experience of the C$26.7 billion ($25 billion) Hospitals of Ontario Pension Plan (HOOPP) is testament to the success of asset-liability driven investing. Amanda White spoke with chief executive, John Crocker, about how matching assets with liabilities led to an underweighting in equities and a subsequent (relative) survival of the global economic crisis.
At the end of 2008 the Hospitals of Ontario Pension Plan (HOOPP) remained 97 per cent funded, a rare position when compared with its global contemporaries. Its 2010 contribution rates have been set at the same level as this year.
As other funds grapple with how to meet their funding deficit, the fund”s enviable position of being able to meet its “pension promise” can partly be attributed to a move to liability-driven investment.
This approach to portfolio construction and management that explicitly integrates the exposure and cash flows of pension liabilities, the benefits owed to members, in formulating investment policies, was introduced in 2007.
At the time, like most other funds in Canada, HOOPP had an asset allocation of about 60:40 to equities and fixed income. However according to chief executive of the fund, John Crocker, when this was measured against liabilities, it didn’t make sense to have that allocation.
“We are paying $1 billion for pensions per year now, and can forecast that out; it is growing rapidly. We saw that the risk was too high for the valuations of equities,” he says.
The result was a move in late October to December of 2007 of about $6 billion from equities to fixed income. The subsequent asset allocation then moved from 60:40 equities versus bonds, to about 44 per cent in equities and 56 per cent in fixed income.
“This had no impact in 2007, but dampened volatility significantly in 2008. In one sense for the first eight months of 2008 there was not much volatility, it was a normal year. But the real excitement started at the end of the year,” he says.
The fund now estimates this move saved about $2 billion on that year’s returns – with the compounded effect of that saving being quite significant.
The fund ended 2008 with a return of -11.96 per cent –well above the average Canadian pension plan of -18 or -19 per cent.
“We were pleased with this result, but we are not in the competition business – we are in competition with our liabilities,” Crocker says. “Asset class benchmarks are irrelevant, it doesn’t matter whether we beat the S&P500. We have to pay $80 million a month in pensions and that is growing. That is the reality I am concerned about.”
At the end of 2008 the fund had 22.3 per cent in North American equities and 10.6 per cent in international equities, and while the fund recognises equities are more reasonably valued it is moving slowly back into the market.
“We are monitoring markets all the time. Equities were overvalued in 2007/08, and then undervalued earlier this year; now they are more reasonably valued. We are looking at moving more money back in to equities at the margin but not big dollups of money.”
HOOPP has an investment staff of 36, of a total of 300 across the fund, led by chief investment officer Jim Keohane, and manages 96 per cent of the assets inhouse.
Crocker says about five years ago the fund was about 80 per cent managed inhouse and “slowly but surely” has been increasing it.
“It is more economical to manage inhouse and through the use of derivatives we can replicate strategies,” he says.
In addition, shifting asset allocations must be easier if the money is managed inhouse.
The teams are allocated along specialty lines: real estate; private equity and special situations; money market and currency; fixed income and derivatives; and public equities.
The fund makes significant use of derivatives to replicate asset classes, reduce transaction costs, manage liquidity and to manage and rebalance the asset mix.
HOOPP Capital Partners, which manages the private equity portfolio, has been involved in the sector since 1989. It invests in Canada, the US and the UK/Europe, and returned -5 per cent for 2008, but has produced an annualised return of 13.6 per cent over 10 years.
One of the best performing sectors for the fund has been the $4 billion real estate portfolio which returned 10.23 per cent for the year.
“The real estate portfolio has had a good run for the past five or six years, but we would say real estate is treading water right now. Most of our investments are in Canada – we have more than 100 properties in the portfolio with a small amount in Mexico and Europe/UK from last year. The Canadian market hasn’t seen the extremes of the US , but is tenuous,” he says.
The real estate portfolio has generated good cashflow for the fund – between 6 and 8 per cent, with the upside of capital on that as well.
Croker is not a “fan” of infrastructure and believes the asset class is a bit of a misnomer.
“I think of it as an equity or debt deal. Lots of people have talked it up with a halo but it is not something we have emphasised,” he says.
In addition the fixed income portfolio also contained a lot of positive returns, with the universe of Canadian bonds returning 7.3 per cent, Canadian long bonds returning 4.98 per cent, real return bonds returning 0.13 per cent, and corporate credit returning -2.57 per cent.
The assets of the fund at the end of December, 2008 were $26.7 billion while the liabilities stood at $31.2 billion. The fund is fortunate in that it is cashflow positive.
“We have about $300 to $400 million off the plan, in contributions, with investment earnings on top of that,” Crocker says.
HOOPP asset mix
US equities 13.2%
Canadian equities 10.7%
International equities 10.6%
Real estate 13.2%
Private equity and special situations 4.7%
Cash and fixed income 49.2%