Describe your role as OPB’s new Chief Investment Officer. What are your primary responsibilities?
With the transfer of day-to-day investment operations to IMCO, my role as CIO is quite different than when my predecessor, Jill Pepall, held the role. While OPB’s assets are now under IMCO’s management, OPB retains its fiduciary duties and responsibilities as the administrator of the PSPP, which means that it remains responsible for the supervision of OPB’s business and investment of the Fund.
As CIO, I’m responsible for monitoring IMCO’s investment performance and compliance with our strategies and policies. I’m responsible for overseeing the relationship between the two organizations, and supporting IMCO as it executes our strategy according to OPB’s Strategic Asset Allocation (SAA). With support from our new Vice-President of Finance, Armand deKemp, our job is to monitor, assess and report to the Board on IMCO’s performance and investment returns. This includes IMCO’s execution of our strategies and its compliance with the contractual obligations under our Investment Management Agreement and our Implementation and Support Agreement (the IMA and ISA), including financial reporting, audit and internal controls.
In 2017, IMCO was officially launched. What will stay the same and what will change now that IMCO is managing OPB’s investments?
Now that IMCO is operational, the roles and responsibilities of OPB and IMCO have been clearly defined, with OPB continuing to own its assets and to be responsible only for PSPP pension liabilities and OPB-issued debenture. We will still control our SAA as well as other policies as defined by our agreements. This means that we set our overall investment strategy and asset mix to ensure the Plan’s investments are well matched to our liabilities.
IMCO’s role is to invest in accordance with those strategies, including overseeing our external investment managers. IMCO’s responsibility is to execute the strategy by making the individual investment decisions within each of the asset classes that align to our SAA.
What short-term and long-term benefits should OPB expect?
As mentioned in previous annual reports, we expect to realize a number of benefits stemming from the creation of IMCO. The first of these is scale. For a $25 billion or even $30 billion asset manager, there’s only so many investment opportunities one can have direct access to, especially in a market as competitive as today’s. As part of IMCO’s larger $60 billion of assets under management, and with an expectation of growth in assets under management, IMCO provides us with economies of scale that will allow OPB, and other members of IMCO, access to more and higher-quality investments capable of generating higher incremental returns at a lower unit cost. As a larger investor, IMCO will be positioned to negotiate better deal terms and to gain access to a broader range of investment and partnership opportunities – both of which we expect to help boost our risk-adjusted net investment returns over the long term.
Additionally, since IMCO operates on a cost-recovery basis and spreads its cost among its members, we expect to realize some cost efficiencies over the long term, especially as IMCO takes on new members. Pooling assets under IMCO also allows for further internalization of some investment functions that will reduce our external management fees. Finally, through IMCO, OPB will also benefit from: (i) the incorporation of more robust risk management systems into its investment decisions and processes; (ii) being more able to invest in advanced investment and investment finance systems; and (iii) access to greater research capabilities.
What were some of our key successes in 2017?
In addition to IMCO’s launch, I was very pleased with our total return of 10.8% this year, which exceeded our benchmark by 0.4%. This was a result of very good returns in global equity markets, which were buoyed by global economic growth and relatively low interest rates, which provided a favourable climate for us to invest in. Across our various asset classes, our Private Markets return was 4.5%, and our Public Markets return was 13.3%.
We also had a number of exciting transactions in 2017 that contributed to our success, including starting construction on the 16 York Street property we co-own with our long-time partner Cadillac Fairview (CF) in downtown Toronto. With its prime location, access to transit and sustainability features, we are confident that 16 York will attract prime tenants and provide us with an excellent return on our investment. We are very proud that this 800,000-square-foot office building will be built to LEED Platinum specifications and will target WELL certification, the fast-evolving, occupant-centric standard for tenant well-being, comfort and efficient operation. We also partnered with the Workplace Safety and Insurance Board (WSIB) to purchase 50% of CF’s Vancouver portfolio, including the Pacific Centre, one of North America’s top-performing shopping centres, and 12 best-in-class office properties in the heart of downtown Vancouver.
What were your key investment challenges in 2017?
The competition for investments across all private markets asset classes has been steadily increasing over the years and 2017 was no exception. The immense competition for larger deals has driven down capitalization rates for real estate and investment returns from infrastructure, resulting in high prices for these assets. While private equity is experiencing some of the compression in returns, OPB’s target market is not seeing the same level of competition yet, so we were still able to increase our exposure in 2017.
We also experienced some challenges with our Real Estate portfolio as a result of the Sears Canada bankruptcy, which detracted from our real estate and overall Fund returns. Preliminary plans have been developed for all locations that are affected by the store closures.
Lastly, while our bonds outperformed their benchmarks due to our shorter duration bond strategy, increasing interest rates and rising inflation expectations in the latter part of 2017 lowered the returns from bonds.
Prior to the launch of IMCO, OPB revised its Strategic Asset Allocation (SAA). Why is the SAA so important to the long-term sustainability of the Plan?
The SAA defines what the optimal asset mix is for the PSPP so it can meet the current long-term funding and cash flow needs of the Plan. It is the most important investment decision OPB makes and is key to:
- protecting the long-term viability of the Plan; and
- having affordable benefits and contributions.
Our investment approach is carefully structured to ensure the long-term sustainability of the Plan through the alignment of our pension obligations and our assets. This is why we conduct an asset/liability (A/L) study every three to five years to determine if our assets will be able to cover our pension liabilities based on up-to-date actuarial and market data. We then assess whether changes to our actuarial data or market and economic conditions require us to adjust our SAA. We completed our last A/L study in early 2017, just before we launched IMCO, and we took that opportunity to adjust the SAA.
As part of our revised SAA, we moved our 2017 target allocation for public markets from 73% to 71% and for private markets from 27% to 29%. This shift from public markets to less volatile private markets will continue over the next several years, toward an eventual optimal mix of 59% for public markets and 41% for private markets.
Why do you think investment returns could be lower going forward when plans have been earning strong returns over the past few years?
Looking forward to the next five to 10 years, we believe it’s going to be difficult to generate the same level of investment returns we’ve generated over the last five to 10 years. The Great Recession of 2009/2010 led to the deepest global recession since the Great Depression of the 1930s. In response, global policy-makers from China, the U.S., Europe, the U.K., Japan and Canada implemented unprecedented fiscal and monetary stimulus to help create wealth by lifting asset prices everywhere.
The success of these policies led to abnormally inflated investment returns and historically high price levels for real estate, infrastructure, private equity, credit, nominal bonds and public equities. While we can’t speculate on whether the cyclical correction we’re starting to see will pull prices down in the near term, the reality is that prices remain very high today. As a result, we expect future rates of return of financial assets to be lower than the levels we have seen over the past 10 years.
What is your 2018 investment outlook?
Since the spring of 2016, global economic growth is the most robust it has been in the post–Global Financial Crisis period and has been the engine of corporate earnings gains, and the basis for the long-drawn-out advance in risk assets (equities and credit in particular). We believe this will peak in the first half of 2018. This is not viewed generally as negative; however, it could lead to more moderate earnings growth in 2018, which could, in turn, lead to a meaningful sell-off in risk assets.
More recently, the Bank of England joined the U.S. Federal Reserve (Fed), the Bank of China, and the Bank of Canada by tightening its policy rate for the first time in 10 years. Our tracking of global liquidity remains constructive; however, the tide of liquidity infusion by the central banks is receding. Net contributions to global liquidity remain positive overall, a function of China’s additions to foreign exchange reserves and the ongoing Quantitative Easing programs of the European Central Bank and the Bank of Japan. By way of contrast, the Fed has commenced Quantitative Tightening (effectively reducing liquidity available to markets by reducing the central banks’ asset holdings that were built up in response to the Global Financial Crisis).
At present, it is difficult to see the basis for a global recession in the near term. However, the policy risk of “too loose for too long” is a rising threat indicated by signals such as economies reaching full output levels, and tight labour markets in many countries. As inflation rates approach policy objectives, there is the risk that central banks will implement tightening more than the level that economic fundamentals can withstand.