The Canadian pension giant
With C$30 bn in assets and a requirement to invest C$3-5 mn a day, the Ontario Municipal Employees Retirement System (Omers) is Canada's third largest pension fund and an active player in Canada's capital markets. Yet the 35 year-old fund, set up to consolidate Ontario's various municipal employee pension funds, is a little different from many of its peers.
For starters, despite being a public sector plan, Omers has had the freedom since 1975 to make its own investment decisions in the absolute interest of beneficiaries based on Canada's 'prudent person' rule. (The fund was initially invested entirely in non-marketable Ontario debentures.) It is furthermore distinguished because it has always managed the plan to a surplus. The Omers plan is fully funded by the contributions of its almost 200,000 plan members and employers as well as the investment earnings of the fund.
Omers takes a highly hands-on approach to investing, relying less on index funds than most other Canadian plans - only 18 percent of assets are managed passively. With a staff of 300 (50 in the investment area), some 75 percent of the fund's assets are managed internally. Almost all international activities, however, are managed by a score of external managers.
Long-term value
Overall, Omers fund managers seek value stocks, striving to provide a good, steady rate of return while minimizing risk. The Omers board believes plan liabilities can best be met with a long-term approach, and the current investment horizon for the fund is 15 years. Market timing and other short-term trading practices play only a small role in Omers' investment strategy.
'Omers investments are definitely geared to the long term,' says Dale Richmond, president and CEO of the pension system. 'We buy and sell on value, a strategy that delivers excellent results while insulating the fund from adverse returns.'
Omers has a policy of diversifying as prudently as possible. It does so by investment type, style, geographic region, industry and length of time to maturity. The strategy appears to work. Over the years, investment performance has provided an ever-increasing proportion of the defined benefit plan's funding. Preliminary year-end figures for 1997 show the fund grew by C$3.8 bn. Omers achieved that result despite some wild market fluctuations late in 1997.
Unlike other Canadian funds such as Quebec's Caisse de d p t et placement, Omers has no mandate to further social or political objectives. Says Richmond, 'Our fiduciary responsibility prevents us from pursuing any investment opportunities that do not primarily benefit our participants. Our investment criteria are designed to help us invest in good companies. Period.'
Omers' evaluation process focuses on the future return potential of the company under review, usually beginning with the calculation of standardized financial tests or ratios. This first screening determines whether time and resources will be allocated to further research, including examination of the company's financial statements and a determination of its current position and capital requirements.
An evaluation of the company's strategic goals, the potential growth of the industry as a whole, prospects for expansion of market share and product or service innovation is then developed, using other sources of information such as brokerage research.
Other somewhat less quantifiable criteria are also considered, including corporate governance practices, regulatory compliance, outstanding litigation and compensation philosophy. The quality of the company's management is scrutinized too, with particular emphasis on assessing the track record and integrity of the individual managers and directors. In short, Omers looks for companies that are good corporate citizens, with good facilities, managed by individuals who Omers feels confident will perform.
Mix and match
Omers' 13-member board does a detailed asset mix study every four years and reviews it annually. The pension plan has just completed a major asset mix review that has led to a greater weighting of equities and international exposure. The move was prompted in part by the reduced availability of Canadian government bonds, brought about by a lower deficit and reduced government borrowing which has made it harder to invest in Canadian fixed-income securities. Equity holdings are to be 55-65 percent of the allocation - a 5 percent increase over the previous four-year period. International content, currently just over 20 percent, may now go as high as 30 percent. The asset allocation process sets objectives not only for the entire fund but also for the many investment portfolios within the fund.
While tax constraints limit Canadian pension funds from investing more than 20 percent of total assets overseas, Omers, like many other Canadian funds, gets around foreign content rules by using a variety of instruments such as derivatives. However, Richmond admits derivatives have drawbacks.
'We don't want to have to use synthetic investment vehicles,' says Richmond. 'We are exploring the idea of pooled trusts because they allow us to own the underlying stocks. We introduce further risk when we introduce derivatives. If our objective is to diversify the fund, we want to do it in a way that is least risky.'
For Richmond, the 20 percent foreign content limit is an annoyance. 'It is a deterrent to the natural flow of decision-making,' he comments. 'Pension funds in countries with unrestricted access to investment usually end up with about 30 percent of their fund exposure outside their home country. We are trying to increase our international exposure for the simple reason that the capitalized value of the Canadian market represents about 3 percent of the total world market, and we are taking a risk in providing pensions when we have that type of restriction on our investments.'
Governance stand
With a position in almost every company on the Toronto Stock Exchange 300 index, Omers takes a strong stand on corporate governance issues. Yet its low-key style, typical of Canadian capital markets, differs markedly from highly vocal funds south of the border such as Calpers or New York pensions.
'People don't think there is much shareholder activism in Canada,' notes Richmond. 'In fact, it goes on all the time. Our percentage ownership of TSE 300 companies is probably three times the percentage ownership that Calpers has of any US company. For those companies that have been a disappointment in terms of shareholder value, we are quite active on governance issues.'
Omers first published a set of proxy voting guidelines in 1993. The guidelines, now in the process of being revised, are intended to alert corporate Canada to Omers' corporate governance philosophy as well as to instruct money managers on how to vote proxies.
'You can count on us standing by our governance principles,' comments Richmond, who also points out that corporate governance issues are handled at the highest level at Omers: the task is shared between himself and the chief investment officer, Tom Gunn. 'We don't compromise a lot, but on the other hand, we do take a situational approach. If managements can convince us they are pursuing a reasonable policy to address our concerns, then we are willing to be patient. We won't vote out management or directors on that basis.'
Of particular interest to Omers is separating the functions of corporate board chairs and CEOs. It has called for reform of the Canada Business Corporations Act to mandate a legislated separation of the two jobs, believing that would allow the board to hold management accountable and to better direct the company in shareholders' interests.
Overall, Omers has a distinctive profile in the Canadian public pension pantheon: it's fully-funded, its risk profile is slightly more conservative than most institutions, and it's an uncommonly active manager. Meanwhile, unlike almost every other public fund in Canada, it has always managed the plan to a small surplus.
'In Canada, there is definitely some anxiety that pension money supplied by the pay-as-you-go systems such as the Canada Pension Plan will not be available when it is needed,' concludes Richmond. 'In our case, it is absolutely secure.'
Subsidiary conflict
US companies setting up shop in Canada traditionally established a local subsidiary. As a result of the North American Free Trade Agreement (Nafta) and because of the globalization of financial markets, the structure of the Canadian subsidiary as it was once known has been considerably changed. This has resulted in conflict with Canadian investors such as Omers, and produced a novel IR challenge for US companies. 'Often, the parent company will come in and put a valuation on the Canadian subsidiary and attempt to buy it out at that price,' notes Richmond. 'However, our analysis often shows a different price.'
'Before, we were helping US companies achieve their objectives of having a Canadian subsidiary,' adds Richmond. 'Now, we have been put in the position of an oppressed shareholder in dealing with some of the big companies until we get a resolution on the value of the company that is being taken over.' Omers is still in litigation with Ford Motor Company over this issue.