How do you lose $3 billion in a booming market? A massive Ontario pension comes clean on what happened
Part 2 of the Star's Risky Business series
How do you lose $3 billion in a booming market?
That question began plaguing one of the province's largest pension managers last year, when the Ontario Municipal Employees Retirement System (OMERS) reported a multibillion-dollar loss for 2020, even as its public-sector peers posted healthy gains, many in the double digits.
It was, admittedly, an unusual year: In March 2020, stocks plunged, the Canadian dollar dropped and many of OMERS' prized assets - malls, office buildings, airports - were hammered by lockdowns and travel bans. But by year's end, market confidence was high and stocks were surging.
Ontario Teachers' Pension Plan reported an investment return of 8.6 per cent in 2020 while Healthcare of Ontario Pension Plan (HOOPP) was up 11.3 per cent.
OMERS, on the other hand, lost 2.7 per cent - leaving the fund down $3 billion at $105 billion in net assets - and its very bad 2020 left some who depend on the pension plan for their retirement savings with major questions about its strategy.
A few months after OMERS reported its 2020 results, the Canadian Union of Public Employees Ontario, which represents 125,000 active members of the plan, called for an external review of the fund's investing practices.
Then last July, the city of Toronto, which employs more than 26,000 active members of the pension plan, passed a motion calling for more disclosure of OMERS' investment performance.
The importance of good investment returns for our city workers can't be overstated," Coun. Paul Ainslie (Ward 24, Scarborough-Guildwood), who advanced the motion, told the Star in an email. But it's a black box for those who want to know more details about OMERS' operations."
The board that oversees OMERS' investing performance has steadfastly rejected calls for an outside review. Board chair George Cooke said last year that the board was confident in management's investing strategy and an outside review was not warranted. The board has maintained that position.
Yet, a close look at information the fund has been willing to disclose suggests that in a volatile year where lots could go wrong, many things did in fact go wrong for OMERS.
On top of the shuttered offices and empty malls and airports, the fund had the wrong mix of stocks in its portfolio, it had only limited money in long-term bonds and a scramble to free up cash in the early days of the pandemic turned into a currency-hedging disaster.
Blake Hutcheson, the fund's CEO, doesn't want to dwell on the past and cites a favourite expression of his to explain why: The rear-view mirror is smaller than the windshield for a reason."
Still, to help explain his confidence in where OMERS is headed, Hutcheson agreed to revisit the chaos of those early pandemic days in an interview with the Star.
Anybody with consumer-facing businesses - and we at OMERS have a fair number of them - felt the pain immediately as legislators shut down our office buildings, retail outlets, some of our infrastructure assets, including airports."
Hutcheson, the long-time head of the pension fund's real estate business, Oxford Properties, was asked to take the CEO job three months earlier than planned.
The board said, Listen, we can't wait until June. You're in."
As the loonie was plunging, OMERS took steps to reduce foreign currency hedging, which it uses to protect against volatility in exchange rates when it invests abroad.
That freed up much-needed cash in the immediate term by reducing the amount of collateral the fund had to post to maintain those hedges.
But later in the year, the Canadian dollar came roaring back, leading to currency losses in the newly unhedged positions. OMERS said foreign exchange gains of $800 million during the year were offset by hedging losses of $3.1 billion.
It was a trying time, no question," says Hutcheson.
In a personnel shakeup after he became CEO, he expanded the fund's leadership team to 15 people from six, and named new heads of the capital markets and infrastructure businesses.
That team worked 24/7 for the next year to get us to the right place," he says.
Other Ontario pension funds were hit hard in one or two areas that year but avoided major pain across the board.
HOOPP's real estate business was largely flat and Ontario Teachers' actually lost almost 14 per cent, or $3.5 billion, on real estate in 2020. But both saw big gains on stocks, and private-equity stakes in pandemic-friendly businesses paid off.
Teachers' had wins with wine companies and medical labs, while HOOPP saw a gain from its logistics investments as the importance of global supply chains became evident.
Meanwhile, OMERS' real estate business posted a loss of $1.9 billion and its private equity division lost $1.1 billion, in part because of its stake in European cinema operator Vue Entertainment.
On stocks, it had a heavy emphasis on dividend-paying financial services and energy companies, sectors that lost value in the year, but little exposure to technology or the new economy" stocks that drove huge market gains.
OMERS also doesn't hold many long-term bonds - historically long-term bonds haven't paid out enough to cover the pension fund's growing liabilities - and didn't benefit from dramatic bond price increases that year.
Following the wipeout on foreign currency hedging, the fund has re-evaluated its approach to this practice. The first months of the pandemic showed just how expensive it can be to maintain hedges in the face of massive demands for cash.
To dampen the highs and lows," Hutcheson says, the new strategy is to substantially not hedge." OMERS has said this will also help free up more capital for investing.
But a big part of what his new team did in 2020 was nothing. They didn't overreact or make major changes.
Stakes in certain equities, real estate assets and private equity businesses were hit in the short-term but proved in 2021 that in the long-term, they will see through cycles," Hutcheson says.
OMERS also didn't jump on the bandwagon" of technology stocks, preferring to stick with more reliable dividend-paying stocks. That hurt in 2020, but paid off in 2021.
Today, 80 per cent of those (technology) stocks are off 80 per cent in value and we just didn't go there."
We had high confidence in our strategy. Confidence that we would get through that year," Hutcheson says. A quarter is not three months, it's 25 years. Don't judge us by any three- or six-month period, judge us by our long-term track record."
Long-term investing comes with highs and lows, of course. Just one year later, OMERS reported an investment return of almost 16 per cent, an increase of $16.4 billion.
Its 10-year rate of return dipped to 6.7 per cent on an annualized basis in 2020. But by the end of 2021, it was back at eight per cent, about where it was before the pandemic.
Malcolm Hamilton, a senior fellow at the C.D. Howe Institute, retired pension actuary and former partner at Mercer Canada, says it's understandable that OMERS would face questions about its performance in 2020 when peers such as Ontario Teachers' fared much better.
But he notes that by the following year, OMERS handily outperformed Ontario Teachers', which reported a gain of only" 11.1 per cent.
Some of 2020's underperformers bounced back in 2021 and some of 2020s out-performers disappointed in 2021. Some of the decisions that were responsible for a bad result in 2020 might contribute to a good result in later years."
Ultimately, according to Hamilton, It is best not to read too much into good and bad years."
Still, even the banner 2021 results have not dampened calls for more transparency from OMERS. CUPE Ontario has continued its call for an outside review of its investments.
OMERS is governed by two separate boards: one with responsibility for determining pension contributions and benefits as well as board appointments, and a second in charge of the administration of pensions and the plan's investments.
The administration board has flatly and consistently rejected calls for an outside investment review.
The City of Toronto Administrative, Professional, Supervisory Association (COTAPSA), a group representing non-unionized city workers, supports CUPE Ontario's call for an investment review. It has also been critical of the governance structure at OMERS, calling it cumbersome and expensive.
Mike Major, executive director of COTAPSA, says the 2021 results were undoubtedly good news for members," but adds, What is striking with our long history of interactions with OMERS ... is how averse the boards are to any criticism or suggestions on improving transparency and disclosure for OMERS two-tier governance and financial management."
After all, the plan is still not fully funded, and while retirement benefits have not been cut, the risk is not just theoretical.
In 2020, OMERS gave itself the option to reduce pension indexing - increases tied to inflation - on benefits earned after the end of 2022. Nothing has changed yet and there are no current plans to roll back indexing, but OMERS has told members that's contingent on the financial health of the plan.
Asked about these calls for more outside scrutiny, Hutcheson says both the management team and administration board do turn to outside consultants for advice periodically, so it's not as if we object to the assistance of outside consultants."
There are a few people that criticize OMERS every year, anything we do, no matter what. And that's their prerogative," he says. We're focused on 540,000 people (plan members), not the opinion of a few individuals."
Hutcheson would rather focus on what the fund has achieved, noting that in recent years, OMERS has dramatically improved" its funded status (the ratio of its investment assets to its long-term obligations to pay pensions).
A decade ago, it was only 86 per cent funded and it stands at 97 per cent today, he says, a level that has remained steady for three years despite the ups and downs of the pandemic.
We've always found a way to pay pensions on time."
Saturday: The ethics of investing and the push for more accountability on how Canada's biggest funds spend pensioners' money.
Christine Dobby is a Toronto-based business reporter for the Star. Follow her on Twitter: @christinedobby