OMERS Gains 10% in 2012

Tara Perkins of the Globe and Mail reports, OMERS posts 10 per cent return helped by private equity, real estate gains:

The Ontario Municipal Employees Retirement System has posted a 10-per-cent return for 2012, slightly above its benchmark, with private equity and real estate investments more than making up for losses in the oil and gas sector.

But, as with many pension funds, OMERS is still feeling the impact of the investment losses it racked up when the financial crisis hit. The estimate of all of the payments that its members will be entitled to is $10-billion higher than the actuarial measure of OMERS’ net assets.

“This deficit is based on a long-term projection going out several decades and in no way reflects our ability to pay pensions in the short term,” OMERS chief financial officer Patrick Crowley stated in a press release.

“Solid investment returns which have averaged 8.9 per cent per year in the four years since the financial crisis, and 8.24 per cent over the past 10 years, combined with contribution increases, are already having a positive impact on reducing the deficit,” he added. “Sustained returns at this level could bring the plan back to fully funded status earlier than anticipated.”

The fund collected $3.2-billion in contributions during 2012 and paid out $2.7-billion in benefits. Its net assets rose by $5.7-billion to $60.8-billion.

Its capital markets arm, which manages its publicly-traded investments such as stocks and bonds, posted a return of 7.5 per cent.

Its private market portfolio posted a 13.8 per cent return. Within that portfolio private equity investments returned 19.2 per cent, real estate (managed by its real estate business Oxford Properties) 16.9 per cent, and infrastructure 12.7 per cent. But its “strategic investments,” which are largely in the oil and gas sector, posted a return of negative 10.1 per cent because of falling oil and gas prices in 2012.

During a press conference OMERS CEO Michael Nobrega said the pension fund is now seeing a flood of opportunities to acquire oil and gas properties in Saskatchewan and Alberta, with junior oil and gas firms unable to finance.

“We’ve had more opportunities in the last two weeks than we’ve had in three years,” he said.

OMERS is in the midst of rebalancing its portfolio away from stocks and bonds towards more private market investments. Its goal is to ultimately have about 53 per cent of its assets in the public markets, and 47 per cent private. At the end of the year it had 60 per cent in public markets and 40 per cent in private, compared to 82 and 18 per cent, respectively, nine years ago.

About 88 per cent of the fund is now managed by OMERS employees, as opposed to external fund managers, up from 74 per cent five years ago, and OMERS is trying to take that figure to 95 per cent.

And Andrea Hopkins of Reuters reports that OMERS is eying global deals as assets rise again:

Canadian pension fund OMERS said on Friday it wants to diversify beyond its traditional strongholds in North America, Britain and Western Europe, but will remain focused on property, healthcare, infrastructure and energy assets as it seeks deals around the world.

OMERS, which manages the pension plan for Ontario's public-sector municipal workers and has become a global dealmaker by virtue of its deep pockets, said it is just looking for the right opportunities based on risk and reward.

"We'll be highly focused in terms of the sectors we're looking at. We have investments in energy, large infrastructure projects on a world-wide basis, in healthcare and in pipelines, and we'll continue to look for those kinds of opportunities around the world for the right risk-return," OMERS chief financial officer Patrick Crowley said in an interview.

"I don't think we want to restrict ourselves to any one particular jurisdiction -- we have a large fund and we're very active and we want to get the best return for our members."

OMERS has been a major buyer of private market assets for more than a decade, accelerating the pace of acquisitions after the onset of the global economic crisis of 2008-09.

It said Friday it notched a 10 percent return on investments in 2012 as its private equity, property and infrastructure portfolios made strong gains, offsetting losses on its investment in Alberta's oil and gas sector.

Net assets at the fund grew to C$60.8 billion last year from C$55.1 billion at the end of 2011.

"The C$5.7 billion increase in our net assets demonstrates the strength and robustness of OMERS business model with the capacity to generate growing investment cash yields and more than ample liquidity to withstand market shocks under stressed financial conditions," Michael Nobrega, OMERS president and chief executive, said in a statement.

The Toronto-based pension plan also said it rang up returns of 19.2 percent in OMERS Private Equity, 16.9 percent in Oxford Properties, 12.7 percent in Borealis Infrastructure and 7.5 percent in capital markets.

A negative 10.1 percent return in OMERS Strategic Investments, which represents less than 3 percent of OMERS net investments, was due to year-end valuations of its principal assets in Alberta's energy sector as oil and gas prices fell to their lowest levels in five years.

Crowley said he expects that investment to pay off down the road, as OMERS benefits from the patience and long investment horizon that competitors may not enjoy.

"This is an investment where the gas and the oil is still in the ground, we have the properties, we valued those properties based on forecasts of prices for next three to four years, but we believe longer-term this remains a very good investment, and it is something we're still committed to," Crowley said.

"Not only Alberta but also this sector, and we think this could be a big opportunity for us to take advantage of people who may not have liquidity to stay in the business."

The 2012 total investment return of 10 percent far outpaced the 3.2 percent return in 2011 and edged out the plan's benchmark return of 9.75 percent, the fund said.

OMERS said it was still working to overcome investment losses in 2008 stemming from the global financial crisis. Its five-year annualized rate of return is 3.56 percent, while its 10-year rate of return is 8.24 percent. In the last four years since the financial crisis, the plan has notched an 8.9 percent investment return.

Crowley said OMERS, which competes with sovereign wealth funds as well as other big pension funds for acquisitions and investment deals globally, would continue to rely on partnerships to minimize investment risks in equity deals that require "quite large" checks to be written.

"We've looked at bringing in people to co-invest along side with us, and that has worked out reasonably well," said Crowley, pointing to its move last year to team up with Japan's pension funds and some major conglomerates to form the world's largest infrastructure fund to invest in assets such as roads and airports with greater agility.

"If you have that in place you can take advantage of opportunities faster, more efficiently, and there is not as much negotiation among yourselves as to what you are going to bid, because all of that is settled up front. That is the advantage of this type of arrangement," said Crowley.

The partnership has been seen as an unprecedented effort to cut out asset managers as middle men in infrastructure investment and compete head-to-head with the handful of the world's biggest funds that have the capacity to lead their own investments in infrastructure assets.

No doubt about it, OMERS is leading the charge in terms of shifting into private markets and unlike most other public pension funds, they have developed the expertise to manage these assets internally, significantly lowering costs and being a lot more nimble so that their stakeholders enjoy the gains of direct investments.

But taking a primarily direct approach and ultimately splitting public and private assets almost in half carries its own set of risks. First, there are many who wonder whether pension funds are taking on too much illiquidity risk by shifting such a large portion of their assets into private markets.

Second, there is performance risk. While going direct and managing assets internally saves external costs and fees, you still need to post solid numbers. Over a 10-year period, OMERS has managed to deliver a decent return (8.24%) but their "strategic investments," which are largely a big bet on oil and gas sector, posted a return of negative 10.1% in 2012.

In their press release, OMERS downplayed the negative results of their strategic investments:

OMERS Strategic Investments, which represents less than two and a half per cent of OMERS net investments, has its principal assets in Alberta’s oil and gas sector. The year-end valuation of these assets was negatively impacted as oil and gas prices fell to their lowest levels in five years. 

All true but I still wonder how Canada's perfect storm will impact these investments over the next 5 to 10 years and how this could impact OMERS' overall results as these are long-term illiquid assets.

Still, despite these losses, private market investments led the charge in 2012. OMERS private market portfolio had a 13.8% investment return – with returns of 19.2% (OMERS Private Equity), 16.9% (Oxford Properties), 12.7% (Borealis Infrastructure) and negative 10.1% (OMERS Strategic Investments).

OMERS Capital Markets, which manages the public market portfolio including public equities, fixed income and debt investments, generated a 7.5% return in 2012. The performance in public markets is basically passive benchmark performance, underperforming the 8.8% median return (gross of management fees) of institutional balanced and severely underforming Canada's best performing balanced fund managers in 2012:

The numbers on the performance of the country’s balanced funds are preliminary, but clients of two firms — Connor Clark & Lunn and HughesLittle — have reason to be well pleased with their investment manager in 2012.

Based on data compiled by API Asset Performance Inc., the two managers posted returns of 16.6% and 16% respectively last year, making them the only two to post one year gains of at least 16%. (The Signature Enhanced Yield Fund, managed by CI was close: it was up by 15.7%.)

That performance by CC&L’s High Income Fund and by HughesLittle’s Balanced Fund – gave them a top quartile ranking in the 90-plus institutional balanced funds surveyed by API. To be ranked in the first quartile a return of at least 10.7% was required.

The two-star performing firms are no stranger to generating impressive results: over the past one, two and four years the two funds have been in the top quartile. Over two and four years, on an annual basis, CC&L is up by 11.5% and 19.0% respectively; over the same two time periods HughesLittle was up by 14.1% and 15.8% respectively.

For 2012, the preliminary results for the institutional balanced funds indicate that the median manager generated a return of 8.8% gross of management fees. In a note, API said that “the 8.8% median return generated for the year is welcome news for pension funds with typical liability discount rates between 4.5% and 6.5%”.

At 8.8%, the return for the media manager was 110 basis points higher than the 7.7% generated by the API Balanced Passive Index. According to API, its balanced passive index “weights asset class market indexes on the average asset mix of institutional managers, and can be viewed as a low cost alternative to active management.” The result is also an argument for active manager, API argues given that “the average fee for a $100-million balanced fund is below 0.5%.”

API’s numbers show that over the past one, two and four years, its balanced passive index generated a performance good enough for a fourth, third and third quartile ranking, which is presumably an argument for active management.

Over four years the five best performing balanced funds were: CC&L (19.0%); HughesLittle (15.8%); Barometer High Income Pool (15.7%); CI Signature Income & Growth Fund (13.2%) and Bissett Dividend Income Fund (13.2%.)

While CC&L and HughesLittle were the top performers last year, the balanced fund managed by Acuity, the Acuity Pooled Canadian balanced fund, was the worst performer: it was up by a mere 1.9%.

Now, I realize comparing the performance of Canadian balanced funds to the performance of large Canadian pension plans is not entirely appropriate because their portfolios are different but I bring up this point because in the end, stakeholders need to understand the opportunity cost of taking on illiquidity risk in private markets and  managing assets internally as opposed to going to top external managers.

A fairer comparison is with its peer group. And OMERS slightly outperformed its peers in 2012. An RBC Investor Services Ltd. survey of 200 Canadian pension plans with over $410-billion in assets under management showed investment returns averaged 9.4 per cent in 2012, a significant improvement over returns of 0.5 per cent in 2011 but slightly shy of 2010 returns of 10.4 per cent.

Nonetheless, the results are not stellar. If you look at the financial results fact sheet provided by OMERS, you'll see the gross returns by investment entity for 2011 and 2012 (click on image above) as well as the rate of return relative to benchmark over a one, five and ten year period (click on image below):


The added value over the benchmark portfolio was a mere 28, 52 and 51 basis points over a one, five and ten year period.  This is hardly what I call "shooting the lights out" in terms of delivering significant added value over their benchmark portfolio but at least OMERS publishes these results. What remains to be seen is whether they can execute on their new strategy and deliver better results in the years ahead.

As far as the plan's deficit, I agree with Patrick Crowley, OMERS' CFO, it's not something to worry about short-term. Moreover, OMERS is fully transparent and provides a fact sheet on the plan's funding status with details on a plan to return the plan to fully funded status.

OMERS is the first to report their results. They have yet to post their full annual report for 2012 on their website so I cannot look into these results in detail or provide readers with other information like compensation. 

In the weeks that follow, other large Canadian pension plans will also report their 2012 results. It will be interesting to see how their results stack up to their peer group including OMERS.

Below, Michael Nobrega, CEO of OMERS, talks with Bloomberg's Erik Schatzker and Margaret Brennan about the role of alternative investments in their pension-fund strategy. Nobrega also discussed a special review by CalPERS of fees investment managers paid to placement agents to win state business.They talked at The Economist's Buttonwood Conference at Pace University (March 2012).

And Gareth Neilson and Bill Tufts from Fair Pensions For All present to the City of London Finance Committee on OMERS pension funding shortfalls (November 5, 2012). They raise some excellent points on sharing the costs of the plan more fairly among all stakeholders but unfortunately they engage in classic scaremongering and misinformation so take this presentation with a grain of salt.