Healthcare of Ontario Pension Plan (HOOPP) profited from last year’s choppy bond markets and strong equity performance to the extent that its funded ratio reached 114% as of December 31, 2013, its highest value in over a decade.
“Our portfolio has a lot of bonds,” said HOOPP president and CEO Jim Keohane. “Last year, we had rising interest rates, so bonds didn’t do so well, but the offset is that our liabilities came down by more than the bonds, so it improved our funded ratio. Rising interest rates is good for us.”
HOOPP employs a liability driven investing (LDI) approach in order to ensure that it can deliver its promised pension benefits at a reasonable cost far into the future. The LDI approach is a risk management philosophy that considers both the plan’s liabilities and the fund’s assets.
Under HOOPP’s LDI approach two broad portfolios are constructed. The Liability Hedge Portfolio is designed to hedge the major risks of the liabilities – namely, inflation and interest rates – and utilizes assets which exhibit behavior similar to that of the plan's liabilities, mainly fixed income. The Return Seeking Portfolio engages in controlled risk-taking in investment assets and strategies which are expected to deliver incremental returns, and consists mainly of equities and absolute return strategies.
“Our funded ratio in 2013 went up as much as it did in 2012, when we had a 17% rate of return,” Keohane said. “That was largely driven by rising interest rates, which reduced the present value of our liabilities, so the liability side didn’t go up as much as expected, while the asset side went up reasonably well.”
The LDI strategy is designed to keep HOOPP’s funded status stable over a broad range of possible future conditions, and this was more than accomplished in 2013 as the plan’s funded ratio increased. While rising interest rates caused the Liability Hedge Portfolio to decline in 2013, they also caused a reduction in HOOPP’s liabilities.
Conversely, the Return Seeking Portfolio posted very strong results and all of the strategies within this portfolio generated positive results. HOOPP’s U.S. equity total return of 28.1% in 2013 performed in-line with its benchmark, the S&P 500, while the total return for HOOPP’s international equity portfolio was 25.8%.
“We try to focus on the funded ratio,” Keohane said. “Our view is we’re in the business of pension fund delivery. We tend to own more bonds because that matches our liabilities most effectively. In the scenario that just transpired, where equities did well and interest rates rose, we’ll probably have lower top line return but our bottom line is still very good.”
HOOPP hedges its FX exposure in Canadian dollars. “We view FX as a residual risk of the investments we make, so we try to neutralize that through portfolio structuring,” Keohane said. “Our U.S. equity exposure is achieved through maintaining Canadian fixed income investments and overlaying that with a U.S. index futures or swaps, so there’s no translation gain or loss.”