OMERS Capital Markets (OCM) manages our public market investments, which include Canadian and non-Canadian investments in bonds, other interest bearing assets and publicly traded equities. These investments are often made in combination with a variety of derivative financial instruments. Over the last three years, the rate of return on our public market investments has exceeded the benchmark each year.
In 2007, Canadian and non-Canadian equity returns declined sharply compared to 2006; however, the investment expertise of OCM’s investment professionals allowed the Fund to earn an overall return exceeding the benchmark for the year. The return on public market investments, excluding the impact of the Fund’s currency hedging, was 2.6 per cent compared with a benchmark of 1.5 per cent and a return of 16.2 per cent in 2006. In 2007, public market investments generated net investment income of $1,713 million compared with $4,870 million a year earlier. The decrease from the prior year is primarily attributable to significantly lower returns in Canadian and non-Canadian public equity markets. In 2007, our Canadian public equities returned 12.8 per cent compared with 21.3 per cent in 2006, while our non-Canadian public equities returned 0.5 per cent compared with 20.0 per cent in 2006 (including the impact of our currency hedging program).
Interest Bearing Investments
Interest bearing investments provide low-risk returns that offset the more volatile nature of publicly traded equities. As a result they are a natural fit for a pension plan.
Interest bearing investments, excluding real return bonds, produced income before investment management expenses of $580 million, an increase of $66 million or 12.8 per cent compared with 2006. The return for interest bearing investments, excluding real return bonds, was 4.7 per cent compared with 3.7 per cent for the benchmark and 4.7 per cent a year earlier. The return of 1.0 per cent over the benchmark is primarily due to favourable sector positioning, general underweighting of the corporate sector in the portfolio, and OCM’s successful anticipation of interest rate and yield curve changes in both Canada and U.S. Another direct result of OCM’s investment expertise is that the Fund had no exposure to third party asset-backed commercial paper. Real return bonds produced income of $33 million, an increase of $82 million over 2006 and had returns of 1.6 per cent, consistent with the benchmark of 1.6 per cent and an increase compared with the -2.9 per cent return in 2006.
Public Equities
At December 31, 2007, the Fund had $10,017 million invested in Canadian public equities and $11,767 million in non-Canadian public equities including both actively managed and non-derivative, quantitatively managed portfolios. Included in the non-Canadian public equities are $867 million of assets in absolute return and other long-short strategies. Exposure to public equities also includes $3,422 million representing the market value of non-equity assets backing equity derivatives and the net allocation of -$80 million of investment related liabilities less cash and short-term investments and investment related assets.
Actively Managed Equity Portfolios
Actively managed Canadian equity investments totaled $9,062 million in 2007 compared with $8,090 million in 2006.
OCM’s investment professionals are value investors who buy the securities of well-managed, profitable companies that can produce reliable long-term returns. They select, for example, companies that should gain value from synergistic acquisitions or that have a competitive advantage in their industry. Within approved asset allocation guidelines, our investment professionals can take advantage of short-term trading opportunities to generate added value.
U.S. equities can comprise up to 10 per cent of our actively managed core portfolio. This enables us to add companies in economic sectors that are underrepresented in Canada, such as pharmaceuticals, or regional U.S. banks that have different valuation multiples and performance profiles than Canadian banks.
As part of our actively managed Canadian equity investments, we manage smaller portfolios with more specific mandates than our other equity investments to enhance overall investment returns. The more concentrated nature of these portfolios results in increased risk; however, we believe this risk is balanced by our expectation for enhanced returns over the long term.
Quantitative Managed Equity Portfolios
Our investment professionals earn enhanced and less volatile returns from market indices by employing actively managed low-risk strategies that include index-based swaps, arbitrage and the anticipation of changes in index composition. Using technical analysis and computer modeling, these strategies, referred to as quantitative management, are applied to Canadian equities. The Fund has invested $955 million in managed portfolios that target the S&P/TSX Composite Index and other indices.