Ontario's giant municipal pension fund manager earned a 6.5-per-cent return in 2013 despite introducing a new investment strategy that lost money last year.
The Ontario Municipal Employees Retirement System (OMERS) said it implemented a new investment approach last year to reduce its public market investments – notably stocks and plain-vanilla bonds – and shift the money into a lower-risk "beta" portfolio designed to reduce the long-term effects of major market events such as a stock market crash. The new portfolio relies heavily on holdings such as inflation-linked bonds and commodities.
OMERS said the new risk-based portfolio lost $407-million last year due to a "sudden and unexpected spike in interest rates" in the second quarter of last year, which hurt inflation-linked bonds and commodities. The fund offset further losses with a $120-million gain from currency hedging strategies.
OMERS chief executive Michael Nobrega said it "is difficult to pick a perfect time" for such a major restructuring, but said OMERS remains committed to the long-term strategy of lowering risk and volatility compared to its old-style portfolio with 60 per cent of assets in equities and 40 per cent in bonds.
"We expect that we shouldn't judge a strategy in one year," Mr. Nobrega told reporters Monday. "There will always be growing pains. Tweaks will happen."
He said he already sees signs of improved commodity prices and improvements in U.S. government 10-year bonds, so "things have begun to shift in the direction of a risk-based portfolio."
James Donegan, president of OMERS Capital Markets division, said the fund has been hedging its Canadian dollar investment exposure for the past six months, which has been a profitable strategy as the dollar has dropped.
"We have a view that the Canadian dollar is vulnerable … We think there's more downside. It wouldn't surprise me if I saw 85 cents on the dollar at some point."
OMERS manages $65.1-billion in pension assets for 440,000 employees and retirees of municipal governments across Ontario. The fund said its assets climbed by over $4-billion from $60.8-billion in 2012, and its funded ratio improved last year by three per cent to 88 per cent, which means the fund has assets equal to 88 per cent of its long-term obligation to fund members' pensions on a solvency basis.
The pension manager said the remaining $8.6-billion deficit will probably be erased at some point between 2021 and 2025 depending on investment returns. OMERS plan members have increased their pension contributions since 2011 to help improve plan funding, but the increases are expected to be removed when OMERS returns to a surplus.
Although the new beta portfolio posted losses, OMERS said its returns were strong in all of its other investment categories. Its public market equities earned more than 20 per cent last year, while private market investments earned 15.5 per cent returns last year. That includes 23.6 per cent returns on private equity holdings, 14.3 per cent returns from real estate group Oxford Properties, and 12.6 per cent returns from infrastructure holdings managed by Borealis Infrastructure.
OMERS needs to earn a long-term annualized return of 7 per cent on its investments to meet its pension obligations. The fund currently has a 10-year annualized return of 7.6 per cent and a five-year return of 8.4 per cent since the global financial crisis in 2008.
Mr. Nobrega, who is retiring on April 1, said the introduction of the new "risk-balanced" portfolio last year was the final step in a restructuring launched in 2004 to reduce volatility risk in the investment portfolio. The fund now has 57 per cent of its investments in public markets and 43 per cent in private markets, and is working toward a goal of 53 per cent public market holdings.
He said the "risk-balanced" approach has out-performed the traditional approach 75 per cent of the time using rolling 10-year periods since 1970.
"We have a high conviction that this public markets strategy is the right one for a prudent pension plan investor," he said.