Institutional investors’ best laid plans sometimes go awry — especially following global pandemics.
During a presentation at the Canadian Investment Review‘s 2022 Risk Management Conference, Marc Gauthier, treasurer and chief investment officer at Concordia University, said the dramatic events shaping the world in the past two years have challenged the university’s carefully designed investment model.
“The last time I was here, it was the summer of 2019. I shared some of my experiences transforming the university’s pension plan — its culture, its governance, its administration and, most importantly, its investment strategy. It was a massive transformation.”
Before the 2008/09 financial crisis, the Concordia’s defined benefit plan was split 60/40 between equities and bonds, respectively. During the crisis, the plan’s funding ratio dropped from 101 per cent to 74 per cent.
Things needed to turn around, said Gauthier, noting he was dealing with a board of directors that wasn’t interested in making changes. To start shifting the culture to focus on sustainability instead of headline risk, he spent five years pushing for change, inviting more than 20 specialists to educate the board.
Eventually, this led to the adoption of a new investment policy entirely driven by absolute returns and aimed at limiting drawdown without sacrificing returns. “It’s what I call [liability-driven investment] 2.0,” said Gauthier. “It’s driven by our funding policy. And ultimately, what the funding policy seeks to accomplish is to have stable and sustainable funding costs. . . . Predictability is the key. Our costs are mostly fixed because we’re heavy as a unionized environment. The university can’t afford volatility and expenses.”
Instead of dividing the plan’s portfolio by asset classes, it’s categorized based on funding objectives. On the defensive side, it has a capital preservation strategy. And is also has a growth category that focuses on specialization, concentration and high conviction. “On a going-concern basis, the behaviour of liabilities is pretty much absolute driven; it’s pretty much stable. You do have actual gains and losses, but I’ve never seen a negative liability ever.”
The final part was the diversification strategy, which is aimed to be disconnected from capital markets. “I focus on capital preservation,” said Gauthier. “If you do the math right, when you have capital withdrawals or capital decreases, it gets back to equilibrium.”
The plan, which helped Concordia’s pension plan reach its return targets and remain solvent from 2013 to 2019, continued to perform well through the rest of 2019, 2020 and most of 2021. Only as the threat posed by the coronavirus pandemic began to fade did it face significant turbulence. Its solvency ratio, which had been above 100 per cent, slipped to 94.5 per cent by May, 2022.
“What didn’t work well? From a portfolio construction perspective, each bucket had a funding objective. . . . They didn’t move in the same direction. . . . In 2021 and 2022, when rates started increasing and the bond market didn’t do so well, we saw the same type of returns.”
Despite the hiccup, Gauthier said the plan remains effective, though he added it’s in need of tweaking. ”For the last five years, we’d be able to participate in the growth side of the markets, limiting downside and, on a risk-adjusted basis, doing so very effectively. We also were able that upside while taking a whole lot less risk than other plans.
“The question now is, do we lean into our return-seeking side? While there’s no cheap beta, we could take advantage of equities being devalued and increase our exposure. . . . The idea here is to emphasize more idiosyncratic risk. Because we have very little exposure to the public equity side, we want to do so in a tactical overlay way.”
The growth program, which has a North American and Asian side, has been knocking its targets out of the park. “The performance has been outstanding, but what’s also good is that we have a strong alternatives portfolio.”
While many investors with considerable allocations to real estate were surprised by the pandemic, which hit offices and retail real estate pretty hard, Concordia’s portfolio saw double-digit returns. “We have short [real estate investment trust investments],” said Gauthier. “The capital preservation did very well throughout the post-pandemic.”
One other part of the carefully crafted investment model that was exposed by the pandemic was the pension plan’s exposure to the U.S. dollar, in which 40 per cent of its assets are invested. “It’s a massive exposure — it’s really my only risk concentration I have to manage.”
Up until the pandemic, Concordia’s in-house dynamic hedging program performed well, protecting the plan’s assets from shocks. “It’s based off the risk strength indicator model’s seven indicators. All behaved in line with the model, but then, suddenly, currency risk offerings were gone. Simple as that.”
While the weakness might push other DB plan sponsors away from U.S. assets, Gauthier said he isn’t planning a radical departure from the land of the free. “I like the exposure to the volatility. . . . It, probably, needs to have an overlay with a lot longer-term view — that’s the way to capture the benefits.”