As bond yields drop, many Canadian pension plans are looking at new strategies to increase returns through alternative investments, according to a webinar hosted by the Portfolio Management Association of Canada on Tuesday.
“We’re looking for uncorrelated scalable risk, with low or no correlation to major markets like equity or credit,” said Jane Segal, portfolio manager at the Healthcare of Ontario Pension Plan. “We’re looking to use these strategies to diversify our return streams at the fund and if we have a high beta-to-equities market, we’re likely doubling down on exposure that already exists elsewhere at the fund.”
For the HOOPP, the use of alternatives isn’t considered a substitute for the bond portion of its portfolio approach. Segal said the fund expects to see a meaningful allocation to alternatives within the next three to five years, with a current focus on market mutual strategies.
As well, while the HOOPP aims to reduce its overall volatility, it encourages individually volatile components, as they can help with increased returns.
“You can definitely have a strategy that has a low correlation to markets but has a high volatility,” said Segal. “Commodity markets tend to be uncorrelated to traditional markets while being fairly volatile. Low correlation and low volatility are very different things and with volatility, we look at it in a number of ways — one is performance in normal market conditions versus a stressed market scenario and the more of these scenarios we have, the better equipped we are.”
Also speaking during the webinar, Paul Sabourin, chairman and chief investment officer at Polar Asset Management Partners, referred to other approaches pension funds can explore. One option is convertible arbitrage, which involves the purchase of the convertible debenture issued by a publicly traded company and the simultaneous shorting of the underlying stock.
“What we’re trying to harness there, by being long on the convertible debenture and short on the underlying stock, is to isolate the coupon that gets paid and reduce the risk in the portfolio. The convertible debenture should move up and down in some sort of correlation to the underlying stock.”
Another strategy involves investing in a special purpose acquisition company, otherwise known as a shell corporation, which can then take a private company into the public market without going through an initial public offering, said Sabourin, noting the strategy provides some key advantages for investors.
“When we give the [special purpose acquisition company] money, they put the money in treasury bills waiting for them to buy a company. It’s a relatively low-risk opportunity, so if they buy a company that we like and the stock goes up, we can sell the stock. If they buy a company we don’t like, we can take our money back through the treasury bills.”
David Picton, president and portfolio manager of Canadian equity strategies at Picton Mahoney Asset Management, said regardless of the approach, diversification remains key.
“What we’re trying to do is take this simple efficient frontier, the maximum return per unit of risk in stock and bond portfolios, for your particular risk tolerance and try and boost the return per unit of risk for that same risk tolerance by adding in these other things.
“The only way that works is if they have a positive return benefit and they’re uncorrelated. That’s where the real benefit of alternatives fits in.”