Apples with apples: Teachers’ plan emphasises risk as much as return

“You almost don’t need to say the words, ‘risk management’,” says Barbara Zvan, head of risk and asset mix at the $84.9 billion (C$87.4 billion) Ontario Teachers’ Pension Plan (OTPP), when asked about how closely integrated the investment and risk management teams at the big defined benefit fund are. She talks to Simon Mumme about how the OTPP assessed risk during the financial crisis, and how it views markets now.

Before the financial crisis belted markets, the OTPP was cutting investments in listed equity and credit strategies. To meet its projected liabilities, the fund built larger allocations to inflation-linked investments, such as timberland, commodities and real estate. But it was also worried about the risks brought on by widespread leverage in equity and bond markets.  

If only it moved faster. In 2008, the fund lost $12.1 billion from its equities portfolio and 6.5 billion from fixed income investments. Meantime, it’s inflation-linked, or real asset, portfolio gained $194 million.

Barbera Zvan“We were removing positions, but just not fast enough,” Zvan says.

In the extreme uncertainty of late 2008 and early 2009, Zvan was frequently called upon by the OTPP board for updates on its investment positions and the various risks affecting them.
“If market conditions change, you’re in front of the board and you’re talking about it,” she says.

Such reporting of risk is a function of Teachers’ governance structure, which ensures that the risk department has a direct line to the board. This guaranteed access is demonstrated by Zvan’s promotion to the post of chief investment risk officer earlier this year, in addition to being head of risk and asset mix, which sees risk management receive as much airtime as investment management at board meetings.

“It’s about having a clear line to the board, and getting information to the board so they can ask good questions of the management.

“Risk management is about getting the right information to the right people at the right time.”

And the ‘right people’ are usually those at the top. Jim Leech, chief executive officer of Teachers’, proves his respect for risk by chairing the fund’s enterprise risk committee. Throughout the organisation, “people in risk management are integrated into the business, so they know what’s going on,” Zvan says.

“You want to build that culture of collaboration, so people know what’s going on in the different groups. This works very well at getting people all across the plan talking about risk.”

The OTPP is continuing to divest from equities and bonds and build its exposure to real assets. This shift is driven by a declining contribution rate from fund members. In 1990, Teachers’ had four active members for each retiree. Now it has 1.6 for each retiree.  

“Regardless of what was happening [in markets], we were reducing equities. The underlying demographics of the plan meant this shift was necessary.”

The real asset portfolio now constitutes for 45 per cent OTPP’s assets, while equity strategies account for 40 per cent and bonds 15 per cent.

Among the equity and credit strategies being sold down by Teachers’ are hedge funds.

The plan was invested in hedge funds before the investment strategies enjoyed a boom following the underperformance of many long-only equity managers as the dotcom bubble burst.

But the failure of many hedge funds to provide absolute returns during the financial crisis has entitled OTPP, like all pension funds, for clearer explanations of the return drivers within these traditionally opaque operations.  

“We’re a bit more critical, we ask more questions,” says Zvan.

Zvan says the fund’s sell-downs of equity and bond investments weren’t reflective of a panic to find liquidity to meet liabilities and investment commitments towards unlisted assets.
“We got liquidity right. We were able to manage our liquidity and make payments.”

The OTPP uses a proprietary system to project its liabilities as far as 40 years ahead, and performs scenario testing to determine how its funding ratio would be affected in the face of severe macro events, such as the financial crisis, and declining contributions.

“We’ve always done that, but now we really understand the importance of that.”

For fund’s annual investment plan, which is developed in October and November each year, the team’s investment outlooks are translated into an asset mix policy which incorporates risk budgets and reviews of performance benchmarks.

Even though markets have rallied steadily from their March nadir, and some form of economic recovery seems likely, Zvan and her 30-person team bypass the immediate relief to gauge identifiable risks.

“We still think there’s uncertainty,” Zvan says. “Things can still make the recovery unbalanced.”

When asked to specify which markets or sectors present major risks for the foreseeable future, she singles out to the ability of companies to refinance, then pauses.
“I’m worried about all parts of the market,” she concludes.