Transcript Corporate PowerPoint Template

The Investment Environment
and Pensions
Presentation to Financial Management Institute
Doug Pearce
Chief Executive Officer / Chief Investment Officer
February 13, 2007
British Columbia
Investment Management Corporation
Outline
Part 1
– Capital markets: yesterday and today
– How the pension landscape is changing
Part 2
– History of B.C. public sector pension funds
– What are we doing in the new environment to meet
our clients’ needs?
What’s Driving Capital Markets Today?
Long-term trends and issues:
– Demographic changes.
– Globalization, shifts in economic power and wealth
– Lower volatility of output and inflation have reduced
risk premia embedded in financial asset prices.
– Lower macroeconomic risk means lower returns
over the long run.
Short-term trends and market factors
– global trade imbalances
– liquidity
Demographics: The World in 2006
Source: UN Population Program
Demographics: The World in 2050
Source: UN Population Program
Globalization Signals Shift of
Economic Power and Wealth
% shares of global GDP based on purchasing-power parity
35
28
30
25
21
20
20
Latin America,
Africa, Middle East,
Rest of Asia
1980
2006
29 30
20
19
15
8
10
6
5
7
5
2 2
4
0
U.S.
Source: IMF
E.U.
Japan
China & Canada
FSU
Others
(Former
4
Soviet Union)
Tigers*
* HK, Taiwan, S. Korea, Singapore
Economic Growth to 2016
Average annual change in real GDP
North America: 3%
Former Soviet
Union: 5%
Europe:
2%
Mideast: 5%
Africa: 4.5%
Latin America: 4.5%
Source: IMF, bcIMC
Asia: 7.5%
Lower Growth Volatility
– “The Great Moderation”
Source: Bank for International Settlements, “The Recent Behaviour of
Financial Market Volatility”, BIS Paper No. 29 (August 2006)
Stable, Low Inflation
Year/year % change in Consumer Price Index
16%
14%
12%
Canada
U.S.
10%
8%
6%
4%
2%
0%
-2%
1975
1980
Source: Bloomberg
1985
1990
1995
2000
2005
…Means Lower Interest Rates
Yields on Gov’t of Canada securities; percent
18
16
3-month
10-year
14
12
10
8
6
4
2
0
1975
1980
1985
Source: Bank of Canada
1990
1995
2000
2005
…and Low Equity Market Volatility
VIX Index of expected volatility of S&P 100; monthly
50
45
40
35
30
25
20
15
10
5
0
1990
1995
2000
Source: Chicago Board Options Exchange, Bloomberg
2005
= Lower World Equity Risk Premium
Annualized percentage return above risk-free interest rate
6
5
4.9
0.6
1.2
4
3.0
3
2
1
0
Historical risk
premium*
Minus: Impact
of unexpected
cash flows
Minus: Impact
of fall in
required risk
premium
Equals:
Expected 21st
century risk
premium
* 16 major countries, 1900-2000
Source: Dimson, Marsh and Staunton, Triumph of the Optimists (2002)
Recent Returns Have Been Strong…
Benchmark returns on typical pension plan (%)
25
Years ending Sept 30
20
15
8.3
10
5
0
-5
-10
-15
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 10yr.
avg.
Source: bcIMC
…But Lower Long-Term Returns Are Likely
%
Risk-Return Tradeoffs
20
Private Placements
18
16
EAFE
Canadian
Stocks
14
Real Estate
US Stocks
12
1990
Private Placements
Mortgages
Bonds
10
Money Market
8
Real Estate
6
2006
EAFE
Canadian
Stocks
US Stocks
Mortgages
Return a typical
pension client
needs
Bonds
4
Money Market
2
0
2
4
6
8
10
12
Risk (standard deviation)
14
16
18
Global Challenges
Energy
Climate change
Aging
Global Challenges
Infrastructure
Water
Urbanization
What’s Driving Capital Markets Today?
Long-term trends and issues:
– Demographic changes.
– Globalization, shifts in economic power and wealth
– Lower volatility of output and inflation have reduced
risk premia embedded in financial asset prices.
Shorter-term trends and market factors
– Liquidity
– ”Global savings glut”
Money Has Been Plentiful…
Source: The Economist, January 4, 2007
Global Savings Exceed Borrowing…
Current account balances as a percent of global GDP
Sum exceeds U.S. current account deficit
Source: Department of Finance Canada, The Economic and
Fiscal Update (November 2006)
… and Risk Premium is Low
2.5
Canada 10-year corporate BBB bond yields minus
Government of Canada bond yields, in percentage points
2.0
1.5
1.0
0.5
0.0
2000
2001
2002
Source: Bloomberg
2003
2004
2005
2006
2007
…Fuelling Alternative Asset Markets
Commodity derivatives outstanding
Billions of U.S. $, June & December
$7,000
$1,000
$900
$6,000
$800
$5,000
< Notional
amount
Gross market
value >
$4,000
$3,000
$700
$600
$500
$400
$300
$2,000
$200
$1,000
$100
$0
$0
2000
2001
2002
2003
2004
Source: Bank for International Settlements
2005
2006
… and Private Equity Deals
$U.S. billions, including net debt of target
$12
$400
$350
$10
$300
< Canada
U.S. >
$8
$250
$6
$200
$150
$4
$100
$2
$50
$0
$0
1996
1998
2000
Source: Thomson Financial
2002
2004
2006
H1
What’s Changing in the Pension World?
Longevity and Retirement Expectations
Defined-benefit pension plans designed when
life expectancy was shorter.
Living longer and retiring earlier makes
pensions more expensive:
– Living 20 years past age 65 vs. 10 years just after
WWII doubled cost of pension.
– “Freedom 55” (working 30 years, being retired 30
years) is twice as expensive as working for 40 years
and retiring for 20.
Investment returns will not solve this problem.
Accounting is Driving Pension Decisions
“The Perfect Pension Storm”: Equity market meltdown
from 2000-02, falling long-term interest rates combine
to lower asset returns, boost PV of pension liabilities.
Post-Enron and accounting changes put pension
plans on company books, shifted towards mark-tomarket accounting and eliminated ‘smoothing’
mechanisms in pension accounting.
Results:
– Pension plan directly affects corporate bottom line, net worth.
– Pension plan financial risk may reduce company’s ability to
take financial risk in its main lines of business.
– Consultants and boards advocate freezing DB plans, shift to
DC or cash balance plans for new hires.
– “Liability-driven investing”.
Private Sector DB Plans Under Siege
Plan design changes in prior 2 years, and/or expected in next 2 years
Source: Mercer Human Resource Consulting
What is bcIMC doing in the new
environment to meet our clients’
needs?
B.C. Public Sector Pension Plans
Pension plans established as early as 1920s.
Lack of clarity in provincial law as to who was
legally responsible for funding pension plans.
Funds managed by government and invested
in provincial bonds.
Late 1980s – government considers
diversification into equities.
1989 – diversification proceeds.
B.C. Public Sector Pension Plans
‘Joint trusteeship’ arrangement implemented in
March 2000.
Creates shared responsibility for plans and
plan funding positions, unlike many
jurisdictions where government is solely
responsible.
Pension plans were fully funded when joint
trusteeship began.
Employees and employers represented on
boards.
Pension Fund Management Models
Two models used in Canada for
managing public sector pension assets.
Consolidated
Central agency provides
portfolio management and
operations for several
different pension plans
Economies of scale
mean lower costs for
clients
More diversification
reduces portfolio risk
Examples: bcIMC, Caisse
de depot et placement du
Quebec, New Brunswick
Investment Management
Corporation
Separate
Pension plans manage and
operate their investment
portfolios on an individual
basis
Examples: Ontario Teachers’,
Ontario Municipal Employee
Retirement System, Hospital
of Ontario Pension Plan
bcIMC Mandate
The British Columbia Investment Management
Corporation (bcIMC) is a professional investment
management organization located in Victoria.
Legal authority to provide funds management
services from Public Sector Pension Plan Act
Specific mandate determined by client/trustees
Legislatively clients restricted to:
British
Columbia public sector pension plans
 Publicly administered trust funds
British Columbia provincial government
British Columbia government bodies
bcIMC’s Clients
As at December 31, 2006
Sinking
Funds
5.2%
Trusts
2.3%
Pensions *
76.6%
Gov't
Bodies
15.5%
CRF
0.4%
* Includes:
BC Hydro Pension Plan
College Pension Plan
Municipal Pension Plan
Public Service Pension Plan
Teachers’ Pension Plan
WorkSafeBC Pension
Assets Under Administration
as at December 31, 2006
Bonds
$24.1
Short-Term Mortgages
$4.5
$2.7
Canadian
Equities
$13.0
Other
$0.6
Real Estate
$8.4
Private
Placements
$1.7
Int'l Equities
$14.5
* In Billions of Dollars
Total: $81.4 billion
Strategic
Infrastructure
$1.3
US Equities
$10.7
bcIMC’s Philosophy and Approach
Asset allocation is the primary determinant of
risk and return
Asset allocation strategies should be
customized to reflect the purpose of each
fund, investment time horizon, legal
constraints, liquidity requirements, and the risk
tolerance of governing fiduciaries
In terms of processes, bcIMC’s roles are to:
– help fiduciaries understand the implications of key
policy decisions such as asset allocation
– manage the funds relative to the board’s instructions
– report on results
bcIMC’s Investment Philosophy
Managing risks is as important as
generating rates of return
“Three D’s”:
– Diversification of investments
– Disciplined approach to asset management
– Due diligence of investment opportunities
bcIMC’s Investment Philosophy
Diversification - began in 1990.
Long-only investments (i.e., can’t sell
stocks short)
Almost no hedge funds.
Generate cash flow.
Protect principal.
Investing for the long term.
Responsible investor.
bcIMC: Recent Directions
Recent challenge in markets is excess
liquidity.
“Hunt” further afield for returns, rather than just
“gather”.
Diversify across more markets/financial
instruments, and real assets such as real
estate and infrastructure.
Private placements – opportunity to directly
influence business direction to the benefit of
equity owners.
Looking at growth vs. developed markets.
Increased Exposure to Private Markets
US Companies with Revenues >$100M US
75%
25%
Source: Dun & Bradstreet, January 2002
Privately owned companies account for over US$9.7 trillion* of
the equity capitalization of global markets.
* bcIMC research estimate.
Overtaking the G6
When BRICs’* US$ GDP would exceed the G6
*BRICs: Brazil, Russia, India and China
Source: Goldman Sachs, Dreaming with BRICs: the Path to 2050
Global Economics Paper No. 99
BRICs’ 5-Year Average Annual Returns
Percent; in C$ terms
35
30.85
30
25.8
25
21.9
20
17.8
15
10
5
0
Brazil
Source: MSCI
Russia
India
China
Responsible Investing
What is responsible investing?
The consideration of environmental, social and
governance (ESG) issues in our investment decisions
and processes.
– environmental & social issues
– corporate governance issues
bcIMC has a responsibility to ensure that investments
are managed in the best financial interests of the
client.
bcIMC understands that by improving a company’s
corporate governance and its management of
environmental and social risks, is a means of
enhancing the long-term value of client equity
holdings.
Conclusions
Recent years – strong capital market returns,
lots of liquidity, perceived risk low.
Many new financial products/assets – hedge
funds, infrastructure, exotic derivatives.
Challenge is to find assets that will generate
required returns, without undue risk.
Pension world is changing, particularly for
private DB plans.
Institutional investors increasingly active on
environmental, social and governance issues.