Toronto (February 24, 2014) – The OMERS Primary Pension Plan concluded 2013 with a $1.3 billion reduction in unfunded liability, an improvement in its funded ratio by 3% to 88%, $4 billion in total investment income, and a stronger balance sheet and cash flows to secure its long-term obligation to pay defined pension benefits to its 440,000 plan members.
In order to satisfy its obligations and secure the pension promise, OMERS has implemented prudent and evidence-based investment strategies in public and private markets that target positive absolute returns.
The total investment income of $4 billion reflected a 6.5% gross return, compared with a minimum target of 7% gross return to match assets with liabilities over the long term. Public market equity returns in excess of 20% were offset by a significant market valuation reduction in the fund’s holdings of inflation-linked bonds and commodities, resulting in a 0.5% gross return from public markets. Private market investments continued to record strong results with a 15.5% gross return.
The total fund has produced $34.4 billion of cumulative absolute dollar income over ten years for a 7.6% annualized gross return, and $21.7 billion over five years for an 8.4% annualized gross return since the 2008 global credit crisis and stock market meltdown, both substantially above the actuarial assumption for investment returns.
Public market investments, valued at $37.7 billion, or 57% of the total fund, earned $200 million as OMERS Capital Markets completed the transition to a more diversified risk-balanced portfolio designed to deliver more consistent investment returns than the traditional pension plan strategy of investing 60% in equities and 40% in bonds. The five-year annualized gross return of 5.8% produced cumulative investment income of $9.2 billion.
“The public markets portfolio put in place in 2013 is the last piece of our investment strategy to earn more predictable and stable long-term returns,” explained Michael Nobrega, president and chief executive officer of OMERS Administration Corporation. “We now have a long-term strategy that balances portfolio risks to the drivers of capital market returns, namely growth and inflation.”
The structure has a portfolio that tracks the performance of market returns across a wide range of global asset classes and geographies, balances risk to growth and inflation outcomes, uses prudent levels of economic leverage, and is projected to achieve a 6.5% annualized net return over the medium and long term. Commonly known as a beta portfolio, this approach does not predict the direction of public markets.
Our evidence-based research shows, over rolling ten-year periods since 1970, that a risk-balanced portfolio has outperformed a 60/40 portfolio 75% of the time. However, in any one year, the risk-balanced portfolio may underperform the 60/40 portfolio 41% of the time. In 2013, the total beta portfolio lost $407 million due to a sudden and unexpected spike in interest rates in the second quarter. As part of the prudent risk management of any beta strategy, portfolio hedges were used in 2013 that contributed $120 million of investment income.
“It is difficult to pick a perfect time to undertake such a major portfolio restructuring, but the timing of implementation is not critical to earning long-term returns from the beta portfolio. A balanced beta portfolio is designed to outperform a less diversified one over time but market shocks (such as the sudden and unexpected interest rate spike in 2013) will cause underperformance until markets return to underlying economic fundamentals that drive investment returns,” Mr. Nobrega said.
The new public markets strategy includes an absolute dollar return portfolio designed to generate cash returns, known as alpha. Separate investment teams use proprietary research and skill to exploit market opportunities by taking long and short positions in global stocks, bonds, specialized credit products, currencies, commodities and macroeconomic trends. The alpha portfolio contributed $487 million in cash returns to the Pension Plan. Building additional alpha portfolios is a priority in 2014.
“We have a high conviction that this public markets strategy is the right one for a prudent pension plan investor committed to paying retirement benefits to contributing plan members over the next six to seven decades,” Mr. Nobrega added.
The Pension Plan’s net assets are also diversified through the successful transition into private market investments that continued to deliver strong and consistent absolute dollar returns. Valued at $28.0 billion, or 43% of the total fund, private market investments earned $3.8 billion in 2013. The five-year private markets annualized gross return of 11.3% produced cumulative investment income of $12.5 billion.
Four investment teams manage private market assets realizing strong gross returns. Borealis Infrastructure, with $9.3 billion of net investment assets, earned $1.1 billion (12.4%); Oxford Properties, with $9.1 billion, earned $1.2 billion (14.3%); OMERS Private Equity, with $7.1 billion, earned $1.4 billion (23.6%); and OMERS Strategic Investments, with $2.5 billion, earned $181 million (9.1%).
OMERS has built a balance sheet, with an AAA credit rating, to withstand severe market shocks, preserve liquidity and generate increasing cash flows. Net assets grew from $60.8 billion in 2012 to $65.1 billion in 2013. OMERS collected $3.5 billion in contributions from employers and plan members and paid out $2.9 billion in benefits to a retired population that expanded by 5,370 to 130,000 pensioners. With accrued pension benefits of $73.0 billion, the funding deficit was reduced by $1.3 billion to $8.6 billion due to higher actuarial asset values, higher contribution rates and lower inflation.
Background Paper on OMERS Investment Strategies