Ontario Teachers' Petroff: 'Active Management Outperforms'

(April 5, 2011) — The Ontario Teachers’ Pension Plan (Teachers’) chief investment officer Neil Petroff, riding a 14% annual return in 2010, claims the fund’s active strategy has added more than C$23 billion to the bottom line since its inception in 1990.

In a wide-ranging interview with Petroff, the CIO of Canada’s third-biggest retirement-fund manager claims: “If we were a passive fund, we’d be C$23.2 billion lower in value, with liabilities at the same level. That really speaks to the value of active management – you add value when you pay for active management.”

This seeming evidence of the effectiveness of active management also supports the fund’s mix of external vs. internal structures that come at a time of stellar growth for the fund. Regarding the value of internal vs. external management, Petroff replies that all departments of the fund outperformed last year due to their embrace of both processes of active management. “As long as the internal team earns appropriate risk-adjusted returns given the cost, I’m indifferent to which approach is utilized,” Petroff tells aiCIO. Furthermore, Teachers’ benefitted from a range of transactions and investments in 2010, such as the fund’s purchase of UK’s national lottery operator, Camelot, a UK high-speed rail, and interest in a Brazilian investment bank. “All those investment from 2010 have great potential to help pay our pensions going forward.” “This was the best year in the past 20 years in terms of dollar-value added,” Petroff states, noting that large increases in real estate and private capital fueled the superior returns. According to a statement released by the fund today, Teachers’ achieved its double-digit return in 2010 thanks to rising stock prices and gains in real estate. Net investment income totaled C$13.3 billion ($13.8 billion) last year, up from C$10.9 billion in 2009. The fund managed C$107.5 billion in assets as of December 31, compared with C$96.4 billion a year earlier.

Teachers’ revealed that real assets such as infrastructure and timberland returned 13.9% for the year, followed by stock and private-equity investments (10.4%), fixed-income (9.9%), and commodities (3.2%). At the end of 2010, Ontario Teachers’ equity portfolio holdings were C$47.5 billion, up from C$41.2 billion a year earlier. Fixed-income assets were C$45.9 billion, up from C$35.3 billion. Meanwhile, the fund’s allocation to commodities rose to 5% last year from 2% in 2009, and was valued at C$5.2 billion at year end, up from C$1.9 billion.

Still, Petroff knows such high returns can’t last forever. “This kind of return is something that’s tough to repeat,” he says. Despite the optimistic returns, the plan said it continues to face funding challenges due to factors such as member longevity, retirement periods that exceed working years, and low real interest rates, with an estimated funding shortfall that increased to C$17.2 billion from C$17.1 billion a year earlier.

Nevertheless, Petroff will try to repeat 2010’s strong results. In terms of asset allocation, Petroff asserts that emerging markets will continue to be an area of intense interest for the fund. “I’d say that from a global perspective, emerging markets will do better than North American markets, and North America will do better than Europe,” he claims, emphasizing his confidence in the long-term value of the sector. “We took most of our exposure in 2005 and 2006. Emerging markets are overheating now from an inflation perspective, but long-term, with their young populations and growing middle classes, the asset class is growing rapidly.” When questioned about the embrace of alternatives, which have enjoyed heightened popularity among institutional investors, Petroff voices his belief that the sector serves not as an asset class but more as an investment strategy. “We started our research in alternatives in 1995, and entered our first hedge fund in 1996. It’s been an area that adds diversification to the total fund and it will always have a place in our portfolio.”