Sounding Board: How OPTrust builds long-term sustainability

We’ve been called Maple Revolutionaries and the new masters of the universe. For years now, it has been a heady thing to be one of Canada’s largest public sector defined benefit plans. The Canadian model, as it is known, is respected around the world. And the results speak for themselves.

Take my own plan, OPTrust. We’re fully-funded, have high member satisfaction ratings, and a sophisticated and diversified investment program. By pretty much any measure, we have been very successful. Many people would look at our track record and suggest that we should keep doing what we have been doing.

And therein lies one of the greatest pitfalls of success: the temptation to rest on your laurels. It can be easier to hold on to what’s always worked rather than face change, even as the world changes around us. But complacency is not an option for OPTrust or any pension plan. Doing things the way we’ve always done them is no longer an option.

Read: OPTrust names new chief investment officer

As an industry, pensions are facing some of the most challenging conditions we have ever witnessed. Market volatility has become the new normal. Interest rates have remained low for a prolonged period. And all indications point to the coming years as ones in which investment returns will also be consistently low.

These investment conditions would be challenging enough on their own. The pension industry also faces the demographic reality of an aging, longer-living population, which while fantastic introduces new challenges for pension plans.

Many plans, including OPTrust, are becoming increasingly mature. The ratio of active, contributing members to retirees is shrinking and our retirees are living and collecting their pensions longer. The confluence of these factors means that it is becoming harder to achieve investment returns without taking on additional risk. Plans have a smaller pool of active members over which to spread the risk we take, and we must fund our plans to pay pensions for longer.

Read: OPTrust reports double-digit returns

Our continued maturity, combined with volatile investment markets and persistent low interest rates, means that the strategies of the past are inadequate for the challenges of the future. We need to adapt to ensure that we continue to thrive.

I believe that the first step for a pension plan to thrive in the current environment is to ensure it is consistently focused on the right thing: the funded status of the plan. That may sound obvious, and yet many pension plans have been in the habit of thinking of themselves as asset managers rather than pension managers.

As an asset manager, you seek out excess return, even when it means adding risk. That approach is increasingly misaligned with the environment pension plans now operate in. More important, it is increasingly misaligned with the interests of our members.

Creating long-term sustainability as pension managers means our investment approach must be inextricably linked to the goal of keeping the plan fully-funded. It sounds simple, but it actually represents a significant shift in mindset.

Read: OPTrust supports ORPP

Of course, mindsets must eventually translate into concrete strategy, so at OPTrust we rethought our investment approach. In 2015, we introduced a member-driven investing strategy, which is designed to enhance the likelihood of pension certainty by balancing sustainability, or generating necessary returns, with stability, or effectively managing investment risks. We call it member-driven investing, or MDI, because our strategy seeks to consistently align our activities and outcomes with the interests of our members.

For members, the true value of a defined benefit pension plan is certainty at a stage of life when there is little runway to accumulate more. In the current environment, demographic maturity, prolonged low interest rates and the expectation of lower investment returns over the next decade present substantial roadblocks to creating that certainty for members.

Our MDI framework recognizes that our primary duty is to preserve the funded status of the plan. Under this framework, we seek to earn a return high enough to maintain plan sustainability while employing risk purposefully and efficiently so that benefit and contribution levels remain as stable as possible.

Read: Hugh O’Reilly to run OPTrust

By lowering funding risk, we increase the likelihood of pension certainty for members. Our change in approach is supported by a new set of performance metrics that will closely link portfolio construction and management with the plan’s funding risks. These metrics have been designed to create strong alignment between members’ interests and our activities.

Sustainability extends beyond the realm of working to explicitly integrate our funding needs and investment strategies. Our investments themselves must be sustainable. This is where our responsible investing program comes in. OPTrust has integrated the consideration of material environmental, social and governance (ESG) factors into our investment decision-making processes and ownership practices across all asset classes. We actively engage with companies we own to talk about ESG risks. We also participate in a variety of initiatives designed to promote stronger governance standards and encourage the development of effective public policy.

Given that we have a responsibility to beneficiaries who span multiple generations, we must work to ensure that our activities consider those risks and align with the long-term nature of our obligations. It is fundamental to sustainability.

Read: Institutional investors want action on climate change

As pension managers, thinking about our members has to be at the centre of everything we do. Each calculation, each deal and each phone call is in service to people who are counting on us for their future.

Working in the pension industry gives you an appreciation for the long view. Our long time horizons are an inherent advantage, because they promote long-term thinking. It’s not enough to be content with paying pensions today. We also have to preserve them for tomorrow. Adopting new approaches today will keep our plans strong and sustainable for the future.

The Maple Revolutionaries still have some innovation to offer the world, and in the decades to come, people will continue to look to the Canadian model.

Hugh O’Reilly is president and CEO of OPTrust. He will be speaking at Benefits Canada‘s 2016 Benefits and Pension Summit in a session titled The ORPP and what it means for your DC plan.