The London Business School’s emeritus professor of finance Paul Marsh admits that you have to be slightly mad to embark on the kind of research detailed in the latest edition of Global Investment Returns Yearbook. This year Marsh and colleagues Elroy Dimson and Mike Staunton – Marsh describes the three of them, pictured below, as “old men with an interest in financial history” – have pulled together over a century’s worth of historical data spanning 25 countries to forecast what investors can expect in the future from delving into the past. It’s a historical  perspective tracing returns in stocks, bonds, inflation and currencies that doesn’t bode particularly well for institutional investors in the coming 30-odd years. “The high equity returns of the second half of the twentieth century were not normal, neither were the high bond returns of the last 30 years, nor was the high real interest rate since 1980. While these periods may have conditioned our expectations, they were exceptional,” says Marsh.

Exuberance is over

Since the 1950s investors have enjoyed “pretty good” returns on bonds and high real equity returns of around 6 to 7 per cent. Since 1980, equities have done well apart from disappointment in Japan, but real bond returns have been “incredibly high” at close to 6 per cent. “World bonds actually beat world equities,” says Marsh. “Investors would have done marginally better in bonds over a period equities have also done very well. Even cash has been wonderful.”

But from a historical perspective, the high bond returns since 1980 were more a blip than anything normal. “Real returns will revert to 1 per cent, not the 3 per cent we have gotten used to over last 30 years of bonds,” Marsh forecasts. He puts real returns for long-term index-linked bonds at zero or marginally negative. Reflective of their riskier qualities, long-term conventional bondholders can expect a marginally positive return. The prospect for cash is marginally negative. “Don’t think of 2 to 3 per cent real interest rates on cash as something we are going to get back too.” Marsh, Dimson, Staunton

Similarly, equities offer little relief. “Equities won’t bail you out,” he warns. Colour-coded lines on Marsh et al’s historical charts indicate that low interest rates imply low prospective returns on all assets, including equities. “When real interest rates are low, real equity returns can also be expected to be low,” he says. “We have shown that there is a strong association between low real interest rates and low subsequent equity returns, and high real interest rates and high equity returns.” The trio estimate that the prospective real return on world equities has fallen to 3 to 3½ per cent per annum in the long term, disputing those asset managers promising 7-per-cent returns or higher still, as in the US where Marsh says forecasts are “plain crazy”. He isn’t swayed by the fantastic returns investors have enjoyed in equities in recent months or talk of a great rotation. “It doesn’t pull the rug from under us,” he says. “There is zero relationship between the first few months of a year and the rest of the year. Our prediction is that the rest of 2013, and the next generation, will find it tougher in terms of returns.”

Historical data shows that volatility damps down surprisingly quickly after shocks like the 1987 crash when stock markets around the world plummeted, or the recent financial crisis. “The world will not stop shocking us but the remarkable thing about volatility is that it reverts to its long-run average quickly after a shock.” He suggests that for “serious long-term investors” with horizons beyond 10 years strategies to manage volatility may not be worth the cost. Only for funds with a particular need for cash at distinct points in the future would strategies to manage volatility actually pay off.

Learning to live after the golden age of returns

Marsh qualifies their findings: “The projections we have made for asset returns over the next 20 to 30 years are simply our own best estimates. They will almost certainly be wrong, but we cannot predict in which direction. There will also be large year-to-year variations in return and they should be viewed strictly as long-run forecasts.” They aren’t compatible with short-term optimism or pessimism about particular asset classes, he says. However, as long-term forecasts for the next 20 to 30 years, he is convinced their estimates are realistic.

His advice to investors in a low-return world is diversity. He doesn’t recommend any smoothing of assets and says pension schemes should put away a lot more now than they did in the old days. He also warns funds to be wary of consultants peddling strategies that are more likely to increase costs rather than returns. Funds seeking yield are also said to be on the wrong track. High yielding equities or risky corporate bonds take investors into higher risk areas. “High returns need higher risk strategies, but these don’t guarantee higher returns,” he says. His message to investors is to “live with it”.

Part of the challenge is the fact institutional investors have grown used to a golden age of returns. But Marsh says the returns are still there to be had. “If we are right and investors get an equity risk premium of 3.5 per cent over the next 20 years, they will still double their money over any cash returns.” All figures are also in real terms, so add inflation and returns on equities look bigger. “Other academic figures agree with us. We might be gloomy in our predictions, but we are not alone.”

Pension funds or any investor holding a slug of long-term fixed income needs to factor in some capital losses soon, says Princeton academic and former vice president of the Federal Reserve, Alan Blinder.

“The timing is difficult to predict, but three or 15 months, it doesn’t matter. It is predictable,” he says. “The unpredictable part is the risk spreads. When interest rates increase what happens to spreads between US treasuries and AA bonds, or US and Brazilian bonds, you name it, it is not very predictable.”

What is obvious is there will be a pure capital loss on holding duration.

Blinder says interest rates have to go up but the timing of when that will start is uncertain.

“There is zero uncertainty around the fact that interest rates will go up substantially. That’s important because if you were running a pension fund, usually you can’t say that with certainty. The timing of when it starts and how fast they will rise is uncertain,” he says. “But they will start sooner and go up faster than central banks want it to go. Markets will get hyper-excited and overreact. There is no doubt Ben Bernanke would like to see a gradual normalisation. My worry is the markets’ reaction.”

More worried than confident

Blinder says it is a “close call” whether to invest in credit, but he probably wouldn’t. And part of the game changer is that central banks are now working on the long end.

“It used to be a simple story,” he says. “If the economic climate is getting better, then you wouldn’t expect risk spreads to widen, but if because central banks are generating it, then spreads would widen.”

In the US he says he is less confident about the economic outlook than market opinion.

“The market swings too whimsically in both directions. It is too euphoric about fickle indicators like confidence,” he says. “I’m more worried than confident about the US economy in the next two years. In the long term I’m confident about the US’ ability to supply goods, but in the short term we need buyers.”

More generally, he is bemused by the actions of governments and the way they are acting as dampeners of demand.

“It is unprecedented to see governments contracting in period of economic weakness. Greece can blame the IMF, but the US can’t, the government should be spending.”

A paradox of public opinion

Blinder says there is a paradox of public opinion with regard to fiscal rectitude.

“The voters love it at the level of lip service, but hate it at the level of implementation. Politicians need to craft the message – don’t come in talking Keynsian and say we want to raise the deficit, say our bridges are falling down or people are starving.”

Similarly, in Europe Blinder thinks it should be abundantly clear that fiscal austerity doesn’t work.

“This is an opportunity for investors to be suppliers of capital,” he says. “If I was a Belgian investment fund, I would think of sending money to the US.”

From a monetary point of view, Blinder was one of the economists who advocated that the European Central Bank was the only institution that could stand behind the euro.

It is astonishing to him now that president of the ECB, Mario Draghi, just had to pledge that “he’d do whatever it takes”, without actually doing anything and have an effect.

“It’s a great time to be teaching economics. Unconventional monetary policy; it’s a new field.”

Blinder, who was vice chairman of the board of governors of the Federal Reserve System from June 1994 until January 1996, is the Gordon S Rentschler Memorial Professor of Economics and Public Affairs at Princeton University. He was also a member of former president Clinton’s original council of economic advisers.

His latest book, After the Music Stopped, looks at the 2007 crisis, asking not who done it but why they did it.

In organisational terms there isn’t a stone unturned at University of Toronto Asset Management (UTAM). The organisation has a new board, new staff, new risk and reporting systems and has restructured its portfolios, including a new policy portfolio.

Where previously the assets were managed in a traditional method, with public market assets and alternatives allocated across a benchmark portfolio, now a low-cost passive reference portfolio is the starting point for investments. The portfolio is assessed in risk-driver terms including equities, interest rates, cash, inflation and currency.

The settings

This passive, low-cost easily implementable reference portfolio was set at Canadian equities 16 per cent, US equities 18 per cent, international developed market equities 16 per cent, emerging markets equities 10 per cent, credit 20 per cent and rates 20 per cent.

Of course the actual portfolio in 2012 was quite different to the reference portfolio, with UTAM “believing” in active management.

The actual allocations at the end of 2012 were Canadian equity 15.9 per cent, US equity 17.9 per cent, international developed market equity 16.4 per cent, emerging markets equity 10.2 per cent, credit 19.8 per cent, rates 10.9 per cent and absolute return 8.9 per cent.

“We have changed the place quite considerably in the past four years,” Bill Moriarty, the chief executive and president of UTAM, says.

“We have gone to a simple reference portfolio concept. It’s easy, implementable and passive. What drove the allocations was the risk tolerance and budget of the organisation. We also acknowledged that risk, in terms of volatility and other risks, is not static, so the risk budget should be reference portfolio plus an element of active management,” he says. “We looked at it as beta risk and active risk, then created a portfolio around that.”

Once the reference portfolio was approved, he says the team “looked inside each area and then found the best way to gaining exposure to the risk over time”.

“It gave us the basic beta portfolio, then we look at whether we can build a better beta portfolio with strategies and then we think of the best managers,” he says.

University of Toronto Asset Management manages three pools of money on behalf of the university. The endowment and pension portfolios have a target return of 4 per cent plus CPI, the target of the Expendable Fund Investment Pool, which is the university’s working capital pool, is the 365-day Canadian treasury bill plus 50 basis points.

Positioning risk

Over the past 12 months UTAM has also implemented a position-based risk system, which went live in December 2012.

“I have more grey hairs than I did a year ago,” Moriarty says. “This is easier to implement for traditional long-only strategies but is more complicated with hedge funds and privates.”

University of Toronto Asset Management has also been working with Morgan Creek Capital, which is an investment adviser, built specifically to advise clients on the endowment model.

It has used State Street’s web-based truView market risk-management tool, which feeds into other international fund services applications, and is specifically aimed at the needs of hedge funds and hedge funds of funds.

“The hedge fund strategy is an evolving area where we are working with the university,” he says.

“On the private side, we pulled apart the commingled funds to understand the investments, proxied them with public investments and everything was put into portfolios. It means we can now look at our allocations across, say, regional or industry concentrations.”

“This has taken a lot of time to implement. We’ve found it very useful, and it’s told us some things that weren’t obvious, like some of our currency risks weren’t quite as obvious from the top down as when you look at granular level.”

The foreign currency hedging policy has also been changed, and is now set between 5 and 25 per cent of each portfolio’s total value.

One of the results of the new risk allocation model is that the portfolio is very underweight interest rate risk.

“Our rates exposure is now half of the policy portfolio and we have no exposure to high yield,” he says.

Performance plus

Moriarty is proud of the team’s performance, which he says has been steadily improving relative to the benchmark over the years.

Tens of millions of dollars in costs have been taken out of the portfolio as it comes up with strategies to create a better beta portfolio. Despite that, UTAM still has a large number of service providers, with more than 50 managers under the growth/equity critiera, 22 in income/credit, two in rates and 11 in the other category.

One of the enabling factors for all of the change at UTAM has been a new governance structure.

A large board has been reduced to five directors, which deals only with operational risk, strategic vision and budgets. The university has an investment advisory committee, with investments delegated to and implemented by UTAM.

“This structure focuses the board on the critical elements of managing the portfolios, which is setting the long-term risk and return targets,” he says. “Before the board was much larger and there was perhaps some lack of understanding or explicit statement of responsibility.”

Geraldine Leegwater, ABN AMRO Pensioenfond’s director, talks about her fund’s investment strategy process with a matter-of-factness that possibly belies how far it has moved established ground. While Leegwater sees logic at every vantage point behind the changes that she helped to introduce at the Dutch banking giant’s €18-billion ($24-billion) fund in 2007, she skips from one of its remarkable features to the next.

The most innovative part in her view is the setting of the fund’s strategic asset policy. The ABN AMRO pension fund trustees theoretically wipe the slate clean and pick their favoured policy from a wide-ranging list of 10 options every 12 months or so.

To keep any subjective views on asset classes out of the equation, the options are presented to the board of trustees purely on the basis of figures representing the most relevant criteria for them, such as indexation potential and downside risk. The underlying asset mix is then only revealed after the most suitable option is chosen from the range of projections. Leegwater recounts how there were some shocked faces at times in the first few years when the underlying strategy was unveiled, but these would fade when the reasoning was discussed. Regular asset-liability management studies are conducted, after all, to inform the risk-return forecasts at these all-important strategy meetings.

The trustees are nonetheless given the chance to launch a radical break in strategy on an annual basis. “The goal of our trustees – to generate sufficient return to pay indexation to participants with the lowest risk – has remained the same over the years, but the amount of investment risk you need to achieve this goal can differ over time,” Leegwater explains.

Remarkably though, the risk return-focused process has led the fund to continually reselect a dynamic liability-driven investment (LDI)-based asset allocation strategy. This has been in place from the first decision meeting under the new structure in 2007 to the most recent in December 2012.

Dynamics, not tactics

The LDI component of the strategy has resulted in a familiar separation of assets into matching and return portfolios. The matching portfolio invests the majority of the funds’ assets in interest-rate swaps, government bonds and highly rated short-term paper.

The return portfolio is the smaller alpha-seeking segment. It is dominated by developed market equities (70 per cent) with smaller emerging market equity, corporate credit and real estate buckets taking 10 per cent each.

The weighting between the matching and the return portfolios is set at the strategy-selection meetings and, like the investment strategy itself, can be revised dramatically. An increase in the return portfolio from 14 per cent to 43 per cent throughout the course of 2009 is the best evidence of that. Leegwater explains that this leap was made as during the selection meeting it became clear that a higher allocation to the return portfolio was required in order to achieve the goal of the board of trustees for a high indexation potential against acceptable risk.

The current dynamic strategy is such that during the year the matching portfolio is fixed to a set level. However, the dynamic element sees the weighting of the return portfolio float in relation to the latest funding ratio at predetermined rebalancing moments during the year. The exact consequence of a given funding ratio for the return portfolio is determined by the annual strategic asset allocation decisions. All in all, this helps to ensure that the focus is on the primary goals of the fund at all times.

Leegwater explains that an intriguing consequence of the dynamic asset allocation approach is that the natural bias of the strategy is for pro-cyclical investing in between the usually counter-cyclical moves at the yearly strategy meetings. This approach seems to be working well for now, with Leegwater happy to let the structure run its successful course. However, she is fully aware that this is dependent on the behavior of financial markets, with high volatility presenting a risk between annual strategy-setting decisions.

Another consequence of the dynamic strategy is that Leegwater and other managers have no tactical asset allocation calls to make whatsoever, and can therefore focus on liability projections. Leegwater is content with that too. “We don’t have any illusion that we can beat the markets,” she says, conceding the approach is not dynamic enough to react to rapid changes in markets as the portfolio is assessed only a few times per year for deviation from the planned strategy. Nonetheless she argues that each strategy-setting meeting offers a chance to compensate from any unintentional surfeit or deficit of risk taken into the portfolio over the last year due to market biases.

The refusal to make tactical investment calls means that the weightings within the return portfolio are followed entirely without any under- or overweightings.  The strategic make-up of the return portfolio is currently under review “and if we find a portfolio with more efficient risk-return qualities, that will go under consideration”. Leegwater admits that this could see alternative asset classes make an appearance in the ABN AMRO fund’s portfolio.

Liberated leverage

When Leegwater says that the fund has around 80-per-cent exposure to the matching portfolio and another 40-per-cent exposure to the return portfolio, it is obvious that an added piece of financial wizardry is at play. The ABN AMRO fund leverages it assets, an action it first embarked on in 2009. Leegwater says the fund is not unique in leveraging its assets, but possibly unique in openly reporting it. “I think there are many pension funds that have, say, a 50-per-cent fixed income and 50-per-cent return portfolio and state they are hedging what they call 70-per-cent of the liabilities,” she says.

Leegwater explains that the leveraging can be gained by investing in interest-rate swaps that don’t require up-front funding. Interest-rate swaps are a necessity for a Dutch pension fund looking to hedge risk on long liabilities, she points out. Leveraging is a position that has its natural limits though, as it requires both sufficient liquidity (interest-rate swaps expose a fund to short-term interest rate movements) and collateral.

Flexible fund

Altogether the approach has led the ABN AMRO fund to a fairly serene position for the time being. The latest funding ratio is 119 per cent under new Dutch central bank criteria – ahead of the 114 per cent legislated solvency target – although the funding ratio is a more modest 111 per cent in the fund’s own calculations, based on market rates.

The healthy surplus has seen steadiness become the current flavour of the dynamic strategy, with only minor changes made to the size of the return portfolio in the past year. The surplus contributed to a decision for the risk appetite to be slightly lowered by reducing the return portfolio at the last strategy-setting meeting in December. “The better the coverage ratio, the less excess return you need,” Leegwater points out, despite conceding that the fund’s capacity to take risk has also increased.

Few could argue with Leegwater’s reasoning when the ABN AMRO fund boasts investment returns of 14.3 per cent for 2012 and 16.1 per cent in the difficult year of 2011. While Leegwater reckons much of the success of the new investment structure and dynamic strategy came from its flexibility to shed risk at the right time, the complex pension solution is fully answering its sponsor’s needs for now.

 

Mention any asset class to John Pearce, chief investment officer of Australian superannuation fund UniSuper, and he will doggedly set out the good and bad thinking around it. A common source of his ire is the sight of investors herding around a belief based on a lack of rigorous thinking. Good practice for him involves standing up to accepted thinking or at the very least, like a chess player, anticipating the permutations ahead.

It is the mindset one would want from someone responsible for 479,000 members and $36 billion, but it also comes with a dose of self-righteousness quite understandable in someone who has called a lot of good decisions since the global financial crisis.

The complexity of equities

One of his favourite topics is the right way to invest in equities.

They are too broad to be dismissed in a simple growth-versus-income argument he reckons, distinguishing this by comparing an equity in a small-cap mining company that has not yet made money with low-geared companies such as Telstra or a property trust, which, as he says, “spits out cash”.

“Around 12 to 18 months ago, we had a bunch of prominent people coming up and saying Australian superannuants were crazy for having so much of their exposure in equities, and that there should be much more bonds. [Since then] we have had a 20-per-cent rally in equities, so hopefully nobody took their advice.

“If they are saying that superannuants should not have a lot of their life savings in high risk mining stocks, I totally agree. But I would prefer to own these lower risk equities than government bonds at 3 per cent. Absolutely I would prefer to own the equities.”

While he recognises that bonds will occasionally outperform equities, in current markets no one is going to convince him that bonds will do better.

“Australia has a real problem keeping inflation below 2.5 per cent, so you have got real returns of 0.5 per cent or 1 per cent [on a bond yielding 3 per cent],” he explains.

This reasoned bet has worked well for UniSuper’s defined benefit scheme, which holds 40 per cent of his fund’s total assets. Its funding fell to as low as 82 per cent during the global financial crisis, but has now rebounded to 96 per cent.

“A lot of defined benefit funds around the world after the GFC went about neutralising their exposure, duration matching, etcetera. We bought equities – not a scatter-gun approach – we bought moderate-risk equities, REITs, Australian banks. We loaded up on those and we benefitted from this massive rally in the equities market.”

Asia calling

Sitting behind Pearce is one of the strongest investment committees in Australia. One of its specialties is Asian investment. Most recently Ian Martin, the former chief executive and chief investment officer of BT Financial Group, joined as independent director, and he combines this role with acting as vice chairman of Berkshire Capital Securities Asia Pacific. Another director, Professor Michael Skully from Monash University, is an expert on Asian finance.

Asia is another of Pearce’s favourite topics, and UniSuper’s bias and knowledge of the region makes it more bullish about global growth and the future than other institutional investors. Close to half of its equities are offshore and most of that is based in Asia, where the opportunities for growth make Pearce passionate.

“If you spend some time in Asia, you will find a different outlook,” he says. “In the West you have rich westerners worried about preserving their wealth rather than Asians, who are much more positive about the future and looking to increase their wealth. They have a different perspective on the world.”

It is as if Asia has the same take on the future as him. He cites the region’s positivity about the next 20 years as one of the reasons he is bullish on investment returns staying high, in contrast to doomsayers who believe global warming, conflict and a lack of resources will slow growth.

As with equities, though, this is no blanket approach and Pearce is quite particular about where he invests.

So, while the fund has emerging markets investments, it has no explicit mandate for emerging markets, it focuses on sector andregional approaches – particularly Asia, where its exposure is managed by T Rowe Price, Schroders and Platinum.

China is central to the Asian growth story, but peculiarly Pearce is not that keen on direct exposure.

Indirectly in China and Japan

“We don’t like investing directly, but we like the Chinese story, so we allocate money to funds and strategies that are going to leverage this great secular Chinese story, but we do not really want to buy Chinese companies.”

For him the company data cannot be relied upon.

“Having worked a few years in China, [I know] it is not a capital friendly place to invest. The main reason is that you have got factor pricing distorted by the government, so when you have got capital sloshing around the system, capital gets misdirected when your factor pricing is not right.”

He points out that while Chinese GDP has outstripped the United States several times over, the US stock market has outperformed the Chinese stock market. He concludes that companies in China are not managed for the benefit of their shareholders, and in particular he avoids Chinese banks.

“We would not override the decisions of those managers, but the one thing we have been strong on is limiting the exposure to Chinese banks,” he says.

In India he sees potential for a boom of the likes “never seen before”, but despairs of a governing system that stands in the way of development and growth.

The fund has recently reduced its “perennially short” position on Japan, but he is unsure if the current round of liberalisation and quantitative easing is a turning point or a “false dawn”. He believes Japan must open up its industry and agriculture to competition from abroad to succeed.

“Let’s see whether [Japanese prime minister] Abe has got the will to bring in reform that is against the interests of his constituency. There is a big question mark over that. But no one can deny that there is not a big sugar shock being injected into the economy right now.”

Better in house

One of the fund’s beliefs is that it can better manage these complex themes – and the external managers who invest in them – if it is running most of its Australian investments in house. Building up this area has been one of Pearce’s main tasks since he arrived three years ago and through a process of “logical incrementalism”, as he puts it, he has built up Australian large-cap equities, Australian fixed interest, cash and listed Australian property in house to a level where it represents 35 to 40 per cent of all assets.

“That is one of the reasons I took the job,” he says. “I came with a mandate to build that capability. We work on the plain vanilla strategies. We know our limitations. I have to be very confident that we can do at least as good a job as an external manager. It does not have to be better because I am doing it much more cost efficiently.”

He is content with what he has built and is not currently looking to expand this expertise externally.

“We are a large fund with steady inflow. We have already got economies of scale. We do not see the imperative to open to the public for the time being, but let’s see what the future holds.”

Even the most successful and well run pension plans are facing underfunding challenges. The $129-billion Ontario Teachers’ Pension Plan is the latest to investigate solutions to solve the mismatch between the pension promise and the funds required to meet that, says Jim Leech, chief executive of the organisation .

OTPP has appointed a taskforce – chaired by Dr Harry Arthurs, former dean of Osgoode Hall Law School in Toronto, president emeritus of York University and chair of Ontario’s pension commission – to investigate how to reduce the cost of the mismatch caused by the difference in the time members spend in work and retirement.

Among other generous benefits, OTPP has generous early retirement benefits and on average teachers work for 26 years and retire for 31.

“We can change benefits to deal with these things or change the rules around some of those promises, and this is what the taskforce is all about,” Leech says.

The task at hand

He says the taskforce will look at how to reduce the cost of the mismatch and is investigating about nine different options. This will be reduced to three and then discussed with the membership.

“For example, we have generous re-employment rules, and we fund the mismatch between a member getting the Canadian pension and retirement. Why? It is just encouraging people to retire early,” Leech says. “All of these things impact the demographic of the workforce. It shouldn’t be the pension plan driving this; the employer should be driving it.”

The taskforce will also look at intergenerational risk, which now falls on the shoulders of younger and needs to be resolved, he says.

OTPP brought in inflation protection, now 100-per-cent conditional, which Leech says has gone a long way to building in flexibility into the fund.

“We are about 75 per cent to solving these problems, and now the taskforce is completing on that,” he says. “Every year a decision is made whether pensions are increased on the rate of inflation depending on the condition of the plan’s funding status. This is the perfect toggle to use in managing the plan. It is now dialled back to 45 per cent, but it can go as low as zero. If times are good, then it can go up.”

OTPP member benefits are calculated as two times the number of years worked multiplied by the best five-year average. Now there is no guaranteed inflation protection on that.

Leech says by introducing that initiative, the liability has been reduced by about $12 billion.

The fund is in a relatively good position, compared with its global peers, and is currently 97-per-cent funded.

Global context

OTPP is globally regarded as a leader in governance among pension plans, and Leech says it is its governance structure allows the sponsors to address the funding shortfall.

“It is 50-50 shared between the employer and employee, so it is in both of their interests to solve this. With most US pension plans, it’s still part of collective bargaining.”

The fund has produced a documentary that highlights the underfunding issues facing pension funds around the world, educating the public on the effects of the financial crisis, low interest rates and demographic changes.

Part of the impetus of the video was to put OTPP’s problems in context, he says, that this is a global pension phenomenon.

“The fallout of the financial crisis, in particularly low interest rates, means the prognosis for growth is not good. Our plan is extremely interest-rate sensitive. If interest rates go down then our bond portfolio goes up, but our liabilities go up even faster. We are constantly trying to manage that. Our liability-driven investing has increased and in the past five years have pushed that way – real estate, commodities, infrastructure. We also have an enormous bond portfolio, about $60 billion, which is almost entirely in Canadian and US sovereign bonds.”

Meanwhile the fund continues to expand, and has just opened a Hong Kong office.

OTPP allocates about 15 per cent of the fund to emerging markets and will increase that to 20 per cent in the next couple of years.

“It is estimated that 80 per cent of the world’s trade will be intra Asia by 2025. If that is true, then we think you have to be there,” he says.

Leech will retire this year after 12 years at OTPP and a tenure as only the second chief executive of the fund. Head of fixed income and alternatives, Ron Mock, will take over the role.

Leech identifies four factors in OTPP’s success, with the governance structure at the top of the list. He also says the culture, which is very learning-based, and humility of its professionals plays a big part. The fund’s proprietary risk system, which is instrumental in the fund allocating according to risk, not asset classes, is its secret sauce, he says.

OTPP has 1000 employees, about 275 of whom are investment professionals.