HOOPP Gains 2.2% in 2018

James Comtois of Pensions & Investments reports, Healthcare of Ontario Pension Plan posts annual return of 2.17%:
Healthcare of Ontario Pension Plan, Toronto, returned a net 2.17% on its investments in 2018, with the pension fund's assets reaching C$79 billion ($57.9 billion) as of Dec. 31, according to an announcement Monday.

HOOPP's funding ratio was 121%, vs. 122% the previous year. The 2018 return was below the previous year's return of 10.88% but exceeded the 2018 custom benchmark return of 0.01%.

The pension fund's assets were up 1.5% from the end of 2017. Investment income for 2018 totaled C$1.7 billion, down from C$7.6 billion in 2017.

"To ensure we deliver on our pension promise to members, our investment strategy takes a very long-term view while anticipating and adapting to market changes," said Jim Keohane, HOOPP's president and CEO, in a news release announcing the annual results. "Our approach allows us to preserve value even during turbulent and challenging investment environments."

HOOPP's liability hedge portfolio — nominal bonds, real estate and real-return bonds — generated 0.43% of value added, with a significant contribution coming from short-term, nominal bonds and real estate. Meanwhile, HOOPP's return-seeking portfolio generated 1.73% of value added with large contributions from private equity, credit and absolute-return strategies, according to the pension fund's annual report.

For the 10 and 20 years ended Dec. 31, the pension fund returned an annualized net 11.19% and 8.52%, respectively.

An asset allocation as of Dec. 31 was not provided.
On Monday morning, HOOPP put out a press release, Funded status is 121% and net assets increased to $79B:
The Healthcare of Ontario Pension Plan (HOOPP) announced today that its net assets reached $79.0 billion at the end of 2018, up from $77.8 billion at the end of 2017. Funded status at the end of 2018 remained strong and stable at 121% compared to 122% the prior year.

Investment return for 2018 was 2.17% compared to 10.88% in 2017. Of the 2.17% return in 2018, 0.01% was benchmark return and 2.16% came from value-added from active management decisions. The investment environment was very challenging in 2018 so we are pleased to have been able to produce a positive return.

Investment income was $1.7 billion for the year compared to $7.6 billion in 2017. The liability hedge portfolio generated a return of $1.1 billion (real estate and fixed income strategies were the main contributors), while the return seeking portfolio generated a return of $0.6 billion (private equity and other alternative strategies were the main contributors).

The Fund’s 10-year annualized return is 11.19% and its 20-year annualized return is 8.52%.

“To ensure we deliver on our pension promise to members, our investment strategy takes a very long-term view while anticipating and adapting to market changes,” said HOOPP President and CEO Jim Keohane. “Our approach allows us to preserve value even during turbulent and challenging investment environments.”

“Looking ahead, HOOPP continues to explore new and effective investment opportunities and strategies,” he added.

Other Highlights
  • In November 2018, HOOPP released groundbreaking research that looked at the most efficient ways for individuals to save for retirement and what can be done to reduce the cost of retirement for more Canadians.
  • In 2019, HOOPP will welcome more than 14,000 new members following the merger of six healthcare pension plans into HOOPP, pending regulatory approval.
  • As a result of HOOPP’s strong funded status, we were able to provide the maximum increase in the cost of living adjustment (COLA) allowed under the Plan.
  • Contribution rates have remained unchanged since 2004.
For more information about HOOPP’s financial results please view the 2018 Annual Report.

About the Healthcare of Ontario Pension Plan

Created in 1960, HOOPP is a multi-employer contributory defined benefit plan for Ontario’s hospital and community-based healthcare sector with more than 570 participating employers. HOOPP’s membership includes nurses, medical technicians, food services staff and housekeeping staff, and many other people who work hard to provide valued Ontario healthcare services. In total, HOOPP has more than 350,000 active, deferred and retired members.

As a defined benefit plan, HOOPP provides eligible members with a retirement income based on a formula that takes into account a member's earnings history and length of service in the Plan. HOOPP is governed by a Board of Trustees with representation from the Ontario Hospital Association (OHA) and four unions: the Ontario Nurses' Association (ONA), the Canadian Union of Public Employees (CUPE), the Ontario Public Service Employees' Union (OPSEU), and the Service Employees International Union (SEIU). The unique governance model provides representation from both management and workers in support of the long-term interests of the Plan. 
This press release was made public at 11 a.m. sharp this morning. An hour earlier, I had a chance to talk to HOOPP's CEO Jim Keohane about the 2018 results.

Let me first thank Jim for taking the time to talk to me and also thank James Geuzebroek, HOOPP's Senior Manager, Public Relations & Corporate Communications, for arranging this call and for sending me an embargoed press release on Friday, effectively giving me time to prepare for my call with Jim.

As I stated, I've been covering HOOPP's annual results for years with Jim so by now I pretty much know what he's going to tell me before he says it but I always learn something new and today wasn't any different.

Jim began by telling me 2018 was "a very tough year." He said over 90% of the assets classes were down and they were very happy to eke out a positive return, especially after a brutal Q4.

They began last year by thinking equities were overvalued and that hurt them in the first half of the year as they hedged and went underweight.

Come Q4, however, this proved to be the right call and it really helped them weather the storm.

I was actually suprised and asked: "Isn't 50% of HOOPP"s portfolio basically in Fixed Income, so didn't nominal US Treasuries protect you and give you some positive returns?".

Surprisingly, Jim said US Treasury spreads widened last year whereas Canadian one narrowed (I'm pretty sure he was referring to the 30-year bonds but on page 17 of the 2018 Annual Report, they discuss both 10-year and 30-year bonds ).

I was surprised to hear this and referred him to a recent comment of mine, Are US Public Pensions Cooked?, where one of the best bond traders I know here in Montreal (should put him in touch with HOOPP) told me told me that right now his conviction trade is to go long the 5-year US bond and to short the 10-year Canadian bond.

That bond trader also told me "a big fund keeps buying Canadian long bonds, much to his amazement."

Jim too was a bit perplexed as to this outperformance of Canadian long bonds relative to US telling me: "The US Treasurys market is the most diversified and liquid market in the world, so we were surprised to see this discrepancy."

Anyway, what's interesting is how HOOPP does its strategic asset alocation. By the end of October, they were "significantly underweight equities" and they go overweight/ underweight using put-call spread strategies, hedging just in case they're wrong.

Remember, HOOPP is a derivatives powerhouse, they use derivatives extensively to leverage and to express tactical calls because they are always looking to mitigate downside risk if they're wrong.

Now, let me go into a bit more detail on the 2018 annual results from pages 17-25 of HOOPP's 2018 Annual Report.

First, the overall results from page 17 (click on image):

As you can see, HOOPP gained 2.2% in 2018, in line with what OMERS delivered last year, but the interesting thing is unlike OMERS, HOOPP doesn't have almost half its portfolio in Private Markets and it fully hedges foreign exchange risk.

More interesting, that 2.17% gain is all value-added return (2.16%) over HOOPP's benchmark which "isn't easy to beat" making these results very impressive during a year when US long bonds didn't do particularly well.

Keep in mind, HOOPP's value-added and overall results were better in 2017 but it was an easier year, but over a 10 and 20- year period the value-added over benchmark is very impressive, and all this while keeping expenses at the lowest level relative to its larger peers (click on image):

Digging deeper on active management, on page 20 of the Annual Report, we see HOOPP's Liability Hedge Portfolio generated 0.43% of value-added, with a significant contribution coming from Short-Term, Nominal Bonds and Real Estate, while the Return Seeking Portfolio generated 1.73% of value-added with large contributions from private equity, credit and absolute return strategies (click on image):

On page 23 of the Annual Report, we see that HOOPP Capital Partners had a great year (click on image):
HOOPP Capital Partners (HCP) selectively invests globally in three key areas: (i) privately held businesses that offer the potential for equity or near equity returns, (ii) private equity funds, and (iii) other private capital opportunities such as private debt. Through the work of skilled teams, private capital provides an opportunity for pension funds to earn attractive risk-adjusted returns.

At the end of 2018, HCP had $9.4 billion invested, with a further $6.1 billion committed to private investments. The portfolio generated a currency-hedged return of 13.7% for the year compared to 19.6% in 2017 (the return on an unhedged basis was 20.8% in 2018 compared to 18.2% in 2017), exceeding its benchmark by $651 million. HCP’s invested capital has increased by over $7 billion since 2012 and now includes a larger proportion of direct and co-investments as well as credit and structured investments with lower risk/return attributes.

The fair market value of the invested portfolio represents 12% of the total Fund.
Equally impressive was the "Other Return Seeking Strategy" and how it performed in 2018. From page 24 of Annual Report:
Asset Allocation Strategies

HOOPP engages in the strategic re-weighting of major asset class risks (equities, fixed income and corporate credit) in order to manage the risk and return of the Fund. In 2018, this program generated a profit of $285 million, compared to a loss of $28 million in 2017.

Absolute Return Strategies

Absolute return strategies are designed to earn positive returns with minimal sensitivities to interest rates, credit or equities. These strategies contributed $233 million in investment income in 2018, compared to $158 million in 2017.

As I mentioned above, HOOPP got its asset allocation strategy (tactical asset allocation) right and this was a significant contributor to value-added as were its absolute return strategies which it does internally, forgoing paying any fees to outside managers.

[Note: See my recent comment on IMCO and why the Canadian pension model must evolve, the optimal rebalancing strategy, as well as a recent Man-AHL study on Strategic Rebalancing which Cam Harvey co-authored. ]

Interestingly, I asked Jim Keohane about where HOOPP's valuation models stand now after the big bounce in US equities this quarter and he told me "they're back close to fair value whereas at the end of December they were at a 5-year low in terms of valuations."

Another interesting tidbit is HOOPP's Long-Term Option Strategy (from page 23 of the Annual Report):
The Long-Term Option Strategy combines equity index exposure with equity index options and was successfully positioned to reduce HOOPP’s aggregate equity exposure during 2018. This portfolio had a gain of $1.2 billion during the year, compared to a loss of $496 million in 2017.
We also discussed HOOPP's Real Estate portfolio but before getting to that, from page 21 of the Annual Report:
In 2018, the HOOPP Real Estate Portfolio produced a return of 8.88% on a currency hedged basis. This represents an outperformance of 135 basis points relative to the benchmark MSCI Canadian Real Estate Index.

At year-end, the portfolio was valued at $14.3 billion on a gross market value basis (versus $13.4 billion at the end of 2017). A total of more than $1.4 billion in investments or investment commitments were made during the year, offset by just under $0.5 billion of property sales.

Recent investments position the Real Estate Portfolio well for future positive returns and include the following:
  • the start of construction on office development projects in Toronto (a 460,000-square-foot building at 25 Ontario Street) and Vancouver (the 370,000-square-foot phase two of Vancouver Centre), and the substantial lease-up of Creechurch Place, a newly built 276,000-square-foot office tower in London, England;
  • the continued expansion of the Industrial Portfolio with the completion of major distribution facilities for Amazon in Germany and in Vancouver, and the commencement of construction for buildings in Doncaster, England (for Amazon) and in the Greater Toronto Area (for Mars Canada)
  • in the residential sector, the acquisition of an interest in a 1,209-unit residential project in Denver, Colorado, and completion of a 507-unit apartment complex in Hollywood, California; and
  • successfully gaining control of the former Sears premises in a number of Canadian shopping centres within the portfolio, and achieving good progress in implementing plans to backfill the vacant space.
Now, you'll notice HOOPP"s Real Estate Portfolio is benchmarked relative to MSCI Canadian Real Estate Index and that's because almost 70% of its real estate portfolio is within Canada (click on image):

Still, with 32% of the Real Estate invested in the US and Europe (15% and 17% respectively), you wonder how much of the 135 bps outperformance in that asset class came from these regions and the  overweight of industrial real estate and whether the benchmark needs to be a regional mix (maybe not yet as 70% is invested in Canada).

Anyway, more interesting was the conversation I had with Jim on HOOPP's Real Estate portfolio. He told me that HOOPP is underweight retail for some time and while this turned out to be the right strategic decision given the plight of malls, he said it was because "all peers own the best retail properties around the country."

He said "Amazon is their single biggest tenant" and they are working with the company in the UK and Canada on industrial warehouses where they sign 20-year leases at very attractive rents (rents are cheaper than class A office buildings but they have grown the most recently because of the rise in  e-commerce).

In Vancouver, things are moving along nicely with the Brentwood Town Center (click on image):

Jim told me they have high-end tenants making up restaurants and shops. It's in Burnaby, right outside Vancouver, but "you can see downtown Vancouver" and "the Skytrain passes through it and it takes four or five stops to get to downtown."

He said 5 of the 11 condo buildings have been built and they're selling within a week as they're reasonably priced so young professionals can afford them (probably, with a huge mortgage).

Our conversation then moved to Infrastructure. Unlike its peers, HOOPP hasn't invested in any infrastructure but as the plan grows, it needs to start thinking about scale and Jim told me they're preparing the infrastructure for infrastructure so they can capitalize as opportunities arise in the future.

Importantly, he still thinks Infrastructure is expensive, said some of his peers like OMERS "haven't done a major infrastructure deal in a long time" and he thinks it's because the multiples don't justify the investment. "It's hard to make money when you pay too much upfront."

True, but I told him there may be structural reasons to worry that high valuations are here to stay in all private markets and you need to focus on realizing on your value creation plan, ie. work the asset, to realize gains.

I took the opportunity to plug Andrew Claerhout, the former head of Infrastructure and Natural Resources at OTPP, and told Jim I think HOOPP should definitely be one of his anchor investors in his new infrastructure fund because in my opinion, Andrew is one of the best infrastructure investors in Canada, he really knows the asset class well and he's the person I trust the most when it comes to making money in this asset class when the going gets tough. He's also the reason why his former team at Ontario Teachers' (which he hired) was recently awarded 2018 Infrastructure and Transport Investor of the Year, North America.

Anyway, it's true HOOPP isn't as invested in private markets as its larger peers but as the Fund grows, it won't have a choice but to invest in infrastructure. And with just over 25% in Real Estate and Private Equity, HOOPP still has an important exposure to private markets.

But Jim told me "privates aren't cheap" and it's getting tougher to make money as valuations remain high. Again, I totally agree but I'm not so sure there will be a big unwind any time soon and even if there is, institutional investors will be buying up assets like crazy.

If there are structural reasons to believe valuations will remain high, competition ferocious, then you have no choice but to buy high, work the asset in order to  realize a gain (ie., stick to a solid value creation plan and have the right partners to guide you through it).

What else? Jim and I spoke about the funded status of the plan which remains unchanged at 121%. Remember, by law -- a very dumb law in my opinion -- HOOPP (and other Canadian pension plans) cannot be more than 125% funded so when it approaches this level, it has to give some back to its members, like the recent 2% increase in their pension to reflect the full cost of living adjustments.

Importantly, even though COLA increases are not guaranteed (HOOPP has a shared-risk model and adopted conditional inflation protection), its Board has been able to grant a rate of 100% of the CPI since 2014, thanks to the Plan’s strong performance.

That's a nice problem to have, a lot of US public pensions wish they had this problem.

Jim told me even though the Plan is fully funded, HOOPP lowered the discount rate from 5.5% to 5.3% to "have an extra cushion," which shows you they are being wise and cautious, preparing for lower returns ahead.

We also discussed how the Government of Ontario pads its books by using pension surpluses to make its public finances look better. Jim assured me "in the case of HOOPP, it's the opposite, they only account for deficits, not surpluses but I don't think the government should use pensions on its books." I couldn't agree more and hopefully the Ford Government will put a stop top this practice.

That brought our conversation to public policy on pensions. Last week, when I compared OTPP to PSPP, I stated this:
You'll recall, this is what Malcolm Hamilton and Philip Cross called the dirty secret behind Canada's pensions. That comment generated many more comments from my readers and ultimately led me to write a lengthy comment on retirement security in Canada.

After writing that last comment, Malcolm Hamilton came at me hard in an email exchange stating this:
So here's the problem with your position. You compare Target Benefit Plans to Defined Benefit Plans that cost twice as much. It's like comparing a Pontiac to a Porsche (I'm dating myself).

Properly priced, a public sector DB plan costs 40% of pay. By changing the guaranteed benefit to a target benefit that will be adjusted as circumstances require (by changing the level of the benefit or the indexing), we reduce the cost of the pension plan to 20% of pay. So yes, the DB pension is much more valuable. But it is much more valuable because it is much more expensive, not because it is a better plan design. I see no evidence that members will voluntarily pay the extra 20% of pay. I believe that most public sector employees would rather pay 20% of pay for the Target Benefit Plan than pay 40% of pay for the Defined Benefit Plan. In other words, the Target Benefit Plan is better value.

In support of my position, I draw your attention to the behavior of employees in DC plans that allow them to choose between safe investments (long term government bonds) and more risky ones. Virtually no retirement saver voluntarily invests all of their money, or even half of their money, in government bonds. When employees retire, few decide to buy annuities. They prefer to take investment risk and, by so doing, to strive for higher returns and, eventually, higher incomes. They could save twice as much and take less risk, but they choose not to do so.

I believe that the same will happen in Target Benefit Plans. The plans will invest in balanced portfolios that will typically deliver good returns and good pensions, but with no guarantees. The plans will take less risk than today's public sector DB plans because employees will no longer be able to pocket the reward for risks borne by the public - hence risk-taking will be less advantageous to plan members.

You may not understand this. You may not want to understand it. But this is how things work. If you feel differently, explain how the public is now rewarded for the investment risks it bears. Or perhaps you think that public employees deserve a free ride? As I wrote earlier, the federal government's DB plan is no different than telling federal employees that they can use 20% of their compensation to buy long term RRBs with 4% real interest rate while offering other Canadians a 1% real interest rate on the bonds they buy.
I have tremendous respect for Malcolm, think he's one of the best-retired actuaries in the country but I'm not in full agreement with his proposed Target Benefit Plan because it leaves retired members of a plan vulnerable to the vagaries of markets.

I shared his comment with HOOPP's CEO, Jim Keohane, who shared this with me:
This is a bit of a “glass half empty “ view. You could also view it that prudent risk-taking, scale, good governance and good management allow Canadian model plans to provide good pensions for 20% of pay which would otherwise cost 40% of pay thus saving taxpayers 20% of pay.

The Federal Public service plan is unique in Canada in that the employer assumes all of the downside risk. Virtually every other public sector plan is a shared risk plan with contingent benefits. In the case of HOOPP, neither the employers or the province guarantee the pension. The only obligation the employer has is to pay their share of the annual contributions as long as they remain members of the plan (which is voluntary). When you consider that COLA is not guaranteed and can be reduced or eliminated should plan funding be insufficient, employees accept most of the risk of underfunding. The notion that taxpayers are taking all the risk and that plan members are getting all the benefit is simply not true.

What we should be focusing on is the efficiency of the conversion of pension savings into pension payments. Our recent research paper “The Value of a Good Pension” shows the efficiency of moving from individual savings plans to collective plans. If more Canadians were fortunate enough to be members of Canada model plans there would be a much larger pool of savings to pay pensions which would benefit all of Canadian society and taxpayers.
I couldn't agree more with Jim on this last point. Jim was actually in Washington D.C. last week where he spoke at a conference held by the National Institute on Retirement Security. You can find details of that event here and download Jim's presentation here.

Below, I share the key findings (click on image):

You should all take the time to watch a replay of that conference by clicking here. Jim Keohane was the first speaker (fast forward to minute 12) and he did a wonderful job.

Along with OPTrust's Hugh O'Reilly, Jim has been an outspoken defender of well-governed defined-benefit plans and thinks we need to expand the Canadian model of pensions to all Canadians.

I asked him why he's so outspoken and he told me it's because "it's in the Plan members' best interests" and it simply makes sense to expand coverage to all Canadians in a cost-effective and collective way.

Lastly, we discussed some organizational changes. In 2018, HOOPP hired Michael Wissell to be Senior Vice President, Portfolio Construction and Risk doing a lot of the same work he was doing at Ontario Teachers'. You can view HOOPP's Executive Team here.

I commend all the employees at HOOPP for delivering decent returns in a very difficult year. Jim told me it was a very challenging year so he's happy they had a positive return and more importantly, remained fully-funded.

I look forward to meeting with Jim, Michael Wissell and others at HOOPP and other large Canadian pensions when I make it back to Toronto later this month (need to plan my trip).

Anyway, please take the time to read HOOPP's 2018 Year in Review and the 2018 Annual Report.

A couple of minor things I think are missing in the Annual Report are asset class weightings and a full and transparent discussion on compensation along with the total compensation of the top five officers. I realize HOOPP is a private, not a public plan, but I'm a stickler for transparency and it can provide more details in all areas, including compensation (according to Jim, it's in line with others but not as generous and they make it up to their employees by giving them more breadth and responsibilities, more engagement).

Below, HOOPP's President & CEO Jim Keohane discusses the Plan’s 2018 performance and explains how the Plan performed in 2018.

Earlier today, Jim joined Amanda Lang of BNN Bloomberg to discuss the Plan's 'home country bias'. While I understand the home bias, can't say I agree with him there, I'm still very concerned about the Canadian economy (our day of reckoning is approaching fast) and prefer US equities to all other stock markets on the planet, especially the S&P/ TSX which is primarily banks, energy/ mining and telecoms.

Lastly, Jim answers questions from HOOPP members. These members can rest assured they are more than lucky to be part of one of the best pension plans in the world no thanks to Jim Keohane and the rest of the professionals working at HOOPP.

I thank Jim for taking the time to cover HOOPP's 2018 results in detail, hope you all enjoyed reading this comment and thanks to James Geuzebroek for keeping me in the loop.

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