James Davis joined the C$27 billion ($19 billion) Canadian pension fund OPTrust as chief investment officer a decade ago, and since that day has been driving the fund on a path towards a total portfolio approach to managing money.
Davis told the Top1000funds.com Fiduciary Investors Symposium at Harvard University that OPTrust believes TPA is the best way to deliver the sustainability of pension payments that its members want.
It’s taken time to get there and to shift the mindset of the organisation from being an asset manager to being a pension manager, Davis said, but that is now starting to be seen in behaviour across the organisation.
“When I joined, the one thing I noticed about OPTrust was we had super-skilled, talented and successful people, good performance, deep teams, but [we were] very siloed and the mission was missing,” Davis said.
“We saw repercussions of that, like hoarding of capital, a misunderstanding of risk and so forth. My belief was that TPA could make us better. So notice I said the word ‘belief’.
“TPA is a belief system, and I think for us, it’s the most aligned to what our members want.”
Davis said members want sustainability of pensions and “to know that they can count on their benefits today and well into the future”.
“TPA recognises that while alpha is important, alpha alone does not pay pensions. Total returns pay pensions,” Davis said.
Davis said there is no single model or method for implementing TPA, so how OPTrust went about it worked for its requirements but may not be appropriate for all funds.
“For us, TPA is a journey. Every journey has a destination; for us that is plan sustainability… being fully funded, having a stable contribution rate and benefits, sustainability is best measured by the level and the drawdown potential of our funded status. So the metric that matters the most is the funded status.
“We’re not trying to improve the funded status. We just want to stay comfortably above 100 per cent and try to keep it as stable as possible.”
Davis said for OPTrust, that means maximising total returns at an acceptable level of risk, in a context where “risk-free returns are not enough for us to keep the plan sustainable”.
“We have to take risk, and it’s how we take that risk that’s really important,” he said.
“Risk is scarce – that one of our beliefs in our TPA philosophy – and has to be shared, and we must use it purposefully and efficiently,” he said.
Capital competition
Davis said that competition for capital is also critical to implementing TPA, and OPTrust begins that process by dividing its portfolio into two large pools: liquid and illiquid assets. Portfolio construction is driven by a belief that the best opportunities for value creation lie in illiquid assets, so an early decision is “how much illiquidity are we willing to accept?”
“And then we commit capital to that,” he said. But once the fund is committed to that, it uses its liquid asset holdings to achieve the overall total portfolio risk profile it wants, given the risk profile already dictated by its illiquid assets.
“At the end of the day, this liquid program acts as a completion portfolio, so it considers what’s happening in the plan; liabilities; what’s happening in the market today, in the economic environment; and what is our overall risk profile in our liquids portfolio,” Davis said.
“And then this completion portfolio, which is the true role of the liquid portfolio to complete the overall risk profile of the plan, that’s where everything begins, from there.”
Davis said the concept of total portfolio risk is critical.
“We think about it, again, in terms of funded status,” he said.
“So we use a value-at-risk measure, except it’s not value-at-risk around returns, it’s value-at-risk around funded status. What are the chances that our funded status is going to fall, and how much are we willing to accept?
Constructing a portfolio – the mathematical and actuarial aspects of it, at least – are one thing; there is also a significant cultural and human-behaviour barrier to overcome when shifting an investment organisation onto a TPA footing.
“So first of all, we’ve got a mission: sustainability of the plan,” Davis said.
“I need to set an investment objective that’s aligned with the overall mission; we’ve done that. I need to make sure my strategy is appropriate and aligned with the objective. And then I need to make sure my culture is supporting the overall strategy.”
Davis said that “culture stuff is really, really important, and that’s a huge chunk of the journey that we’re on now”.
“I need a collaborative culture,” he said. “I need a culture of continuous improvement; a total portfolio mindset. Stop thinking about your own little silo and start thinking about the big picture. We’re moving there – not 100 not there, but we’re moving there.”
Davis said a balanced scorecard is the right way to deal with the so-called “soft stuff”. “Not everything has a hard number,” he said. “A lot of things are squishy, and you don’t really know how to evaluate them. We’re taking a red, amber, green – a RAG approach, Thinking Ahead Institute, Roger Irwin, way of thinking about this.”
Investment teams typically want to be set clear objectives, and then to be assessed against those objectives.
“Do this, do that, do the other thing, and then we’ll evaluate you whether your meets or exceeds expectations,” he said. Unfortunately, Davis said, such an approach doesn’t help the fund do its job any better.
“We need the support of the entire organisation for us to be able to be able to deliver on this challenge of plan sustainability,” he said.
“They have to see themselves in this; they have to believe that at the end of the day, they’re making a contribution, and we have to be able to reward them too. So this is really, really important.
“And what I would say…in terms of challenges and where we are, at the heart of TPA is acting as a team, coming together with a common mission, collaborating, recognising we have to share resources. It really is about culture, it’s about a total portfolio mindset, and it’s about continuous improvement. So this never ends.”
