The Healthcare of Ontario Pension Plan (HOOPP) is like the ant in Aesop’s fable “The Ant and the Grasshopper.” While others were enjoying market returns, HOOPP was preparing for the future.
After years of strong financial markets, HOOPP’s investment team, led by CEO Jim Keohane, decided to pull $6 billion out of equities to prepare for a potential market downturn. When shortly after that move in 2007 the figurative winter hit, HOOPP was one of the few pension plans to report positive results for the two-year period of 2008/09.
The plan’s 15.2% return in 2009 more than offset the 12.0% loss of 2008. Many other plans were left out in the cold—much like Aesop’s grasshopper.
While the brunt of the downturn is now in the past, the consequences are not over. Large DB plans such as HOOPP have new challenges to face. In addition to nagging European market risks and the U.S. economy, the driving concern is continued low interest rates, which threaten investment returns and pension promises.
HOOPP has more than 270,000 members and pensioners, and more than $40 billion in assets. In 2011, the fund saw a return of 12.2%.
Keohane explains how HOOPP transformed its strategy. The conservative philosophy behind the changes began decades ago when he and the investment team were juggling with the foreign property rule (FPR) in the 1990s. “We were only allowed to put 30% in foreign markets. It made it difficult to diversify risk in the portfolio,” he recalls.
Motivated by a desire to remove this risk, Keohane developed the plan’s first derivatives program to diversify the portfolio without breaking any investment regulations. “It also increased our returns, because Canadian products were overpriced since everyone had to own them.”
When the FPR was lifted in 2005, Keohane began looking for other weak spots in the portfolio. It didn’t take long to notice the plan’s overexposure to Nortel stock. “Nortel represented 40% of the TSX index, and, because it was such a huge component of the index, it was hard not to own. It was a concentration risk,” he says, especially because, at the time, external managers did much of the portfolio management.
To compensate, his team created hedging positions around the stock for every manager. The plan would buy a put option, which would allow the plan to sell the stock when the price dropped by, say, 5%, while also selling a call option to sell the stock if it rose by 20%.
“Essentially, we could limit our downside risk by giving away the upside above a 20% return.” This strategy saved HOOPP from taking a major loss when Nortel fell from grace.
Leigh Doyle is a freelance writer in Toronto and the managing editor for smallbizadvisor.ca.