The C$60 billion ($48 billion) Investment Management Corporation of Ontario, Canada’s newest pension investment manager, is assessing its inherited asset allocations and making plans to revitalise.
The fund, which was created in July 2016 and launched a year later, will look to increase its allocation to private markets and make more direct investments. It will also introduce a global credit portfolio, consolidating the global credit allocations that are now scattered across the asset-class buckets.
“The new structure will have all credit within one diversified portfolio, and we would expect the credit exposure of clients to increase because of that,” IMCO CIO Jean Michel says. “It’s a great way to diversify.”
IMCO’s current asset allocation is public equities (39 per cent), fixed income and money market (23 per cent), real estate (14 per cent), diversified markets (7 per cent), infrastructure (7 per cent), absolute return (6 per cent), private equity (3 per cent) and private debt (1 per cent).
Compare this with Ontario Teachers’ Pension Plan, one of IMCO’s contemporaries, which has an allocation to private equity of about 17 per cent.
Two specific aims of IMCO’s strategy evolution are to increase its amount of private assets and to increase the amount of assets managed inhouse.
When IMCO’s two inaugural clients, the Ontario Pension Board and the Workplace Safety and Insurance Board, came into the fold, the fund inherited their existing strategic asset allocations.
One of IMCO’s core offerings is to provide asset allocation and portfolio construction advice; it is now going through that process with clients. IMCO clients will retain asset allocation decision-making, with input from the IMCO team, which will offer 15 strategies for clients. It offers only eight now.
Key to its approach is the belief that asset allocation is among the most important determinants of investment returns and risk. Another core belief is that understanding and managing risk is at the core of investing.
One of IMCO’s key initiatives, and one of the purposes of the pooled asset management concept, is to provide better access to investments than clients can get on their own; in particular, minimising the use of expensive structures and maximising scale and experience to pick strong strategic partners.
“We inherited asset allocations that were fully invested and were 75 per cent externally managed,” Michel says. “We also inherited a cost structure we think we can improve on, as the existing investments include lots of active management as well as fund of funds and manager of managers.
“We are working with clients to look at the type of portfolio we are offering and working with them on asset allocation 2.0.”
Internal management, manager relationships and fees
Michel was appointed CIO in June, coming from Caisse de dépôt et placement du Québec, where he was executive vice-president, depositors and total portfolio. Prior to that, he was the president of Air Canada Pension Investments. He says the plan is for IMCO to manage the majority of assets inhouse within five years.
“We will be cheaper than our clients [for] the same asset mix,” he says. “The savings we make by managing assets internally we are using to build out our risk and portfolio construction function. Then, overall, we will get a better asset management function.”
As with many pension fund managers, one of IMCO’s core beliefs is that costs matter. That’s something it lives day to day.
“When we look at results, we look at them on a fully net basis, not every asset management firm does that,” Michel says. “We make sure all our portfolio managers understand the full costs of what it takes to invest and know all the external management fees they have, explicitly and implicitly, even those that are not fully transparent, so they can make the best decisions on whether to invest.”
IMCO will internalise investment management where it makes sense and where costs work. About 40 of the firm’s 100 staff are in the investment team. The expectation is that, five years from now, the organisation will employ between 250 and 300 people.
Direct investments are expected to provide a big portion of this growth. But Michel is quick to point out that the evolving investment structure will include a total-portfolio team to look at the fund as a whole.
“The probability of achieving long-term value creation is increased by looking at the total portfolio view. This is critical for us,” he says.
IMCO has many external managers, with an average of 10-15 partners per asset class. This will be reduced and the number per asset class is expected to be closer to five or six.
“Using strategic partners will be very important to us and we will focus on a limited number of great partners,” Michel says.
As the investment decision-making process becomes internalised, with IMCO taking more direct investments, there will also be a shift in the way the firm uses managers.
“We will be making more direct, but also more complex, transactions,” Michel explains. “So we will still use partners but use them differently. The goal is to be closer and create true partnerships. We will also look to co-invest but on more equal footing.”
IMCO chief executive Bert Clark, who was formerly chief executive of Infrastructure Ontario and the recipient of the 2017 Champion Award from the Canadian Council for Public Private Partnerships, says good partners offer something the firm can’t provide itself.
“We think what makes a good partner is origination capability and asset management expertise we don’t think we can replicate,” Clark says. “One clue to what that might look like is the fact IMCO has a global portfolio but just one office, in Toronto. Private assets are becoming more difficult and complicated, as there is more demand and also expertise has risen. We need to be important to external managers, and I think we can, as we can move quickly but still look at complicated transactions.”
IMCO was created following extensive review by the Ontario Government into the best model for managing pension assets, resulting in a report by the pension investment adviser, William Morneau. The report outlines the key attributes of best practice – including appropriate scale and an approach to governance – that could be a guide for all organisations managing pension assets.
Morneau’s report shows the advantages of a pooled pension management organisation, including reduced duplication and costs, greater access to additional asset classes and enhanced risk-management practices. It also outlines potential cost savings between $75 million and $100 million a year, once fully implemented.
Clark says the organisation offers strong risk management and reporting, which also requires scale.
There are two key advantages to such a new investment organisation, Clark says.
“On the IT side, many organisations struggle with legacy systems and it is hard to move off those. Starting at this point means we don’t have those legacy problems and, for example, we can buy software as a service [not a product].
“We also get to step back and see what’s worked for other big public funds globally. Everyone is aware of the success of the Canadian model, but that is not the only successful model and we’ve looked to the Northern European pension funds and the US endowments,” he says. “Starting with C$60 billion means we have the critical mass to build right.”
Specifically, the fund has looked to the specialties of various players and can borrow from each of them. US endowments are good at strategic partnerships with managers and focusing on the origination of investments. Northern European funds are good at total portfolio management. The Canadians are good at internal investment management.
IMCO has now built up its risk and investment functions and is ready for action.
“We are very close to being ready to engage with potential clients and will look to do that in Q1 next year,” Clark says. “We have our CIO, CRO [chief risk officer], a risk system and a way of reporting to clients. We have a set of investment strategies for each asset class and can advise on portfolio construction.”