Ontario’s giant municipal pension fund manager said it earned a 6.5-percent return in 2013 despite seeing its bond portfolio hit hard by higher interest rates after the fund implemented a new investment strategy that lost money last year.

The Ontario Municipal Employees Retirement System (OMERS) said its underfunded status improved last year, but the pension manager still has a $8.6-billion deficit, which will probably not be erased until some point between 2021 and 2025 depending on investment returns.

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 last year 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 all members’ pensions on a solvency basis.

The fund implemented a new investment strategy last year, moving many of its public market investment assets into a lower-risk “beta” portfolio designed to reduce the long-term impact of major market events such as a stock market crash. The portfolio relies heavily on holdings such as inflation-linked bonds and commodities.

Unfortunately, however, the beta 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, OMERS said. The fund offset $120-million of losses using hedging tools.

“It is difficult to pick a perfect time to undertake such a major portfolio restructuring,” OMERS chief executive officer Michael Nobrega said in a statement. “But the timing of implementation is not critical to earning long-term returns from the beta portfolio.”

He said he is convinced the portfolio will outperform the old approach over the longer term. The new “risk-balanced” portfolio was the “last piece” in a plan to reduce long-term volatility and ensure more stable returns for the plan, Mr. Nobrega said.

The new investing approach replaces a tradition strategy of investing 60 per cent of the fund’s assets in equities and 40 per cent in bonds, which is a formula long used by many pension funds. OMERS said the old approach was unlikely to deliver high enough long-term returns in current market environments, however, and it was too exposed to market volatility.

OMERS says 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 committed to paying retirement benefits to contributing plan members over the next six to seven decades,” Mr. Nobrega said.

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.

Aside from problems with its beta portfolio bond holdings, OMERS said its returns were strong in all of its other investment categories. Its public market equities earned over 20 per cent last year, but were offset by declines in inflation-linked bonds and other holdings, resulting in just a 0.5 per cent return from public market investments.

Private market investments — including real estate and infrastructure holdings — earned 15.5 per cent returns last year, including 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.

Source: The Globe and Mail