Getting closer to Asian markets

Neil Petroff has been with Toronto-based Ontario Teachers’ Pension Plan (OTPP) for 20 years, and became chief investment officer in 2009.

He has been responsible for several portfolios, including international equity indices, fixed income, foreign exchange, commodities, tactical asset allocation and alternative investments. Petroff set up the hedge fund programme in 1996.

He began his investing career at Bank of Nova Scotia and continued at Guaranty Trust and Royal Trustco.

OTPP opened an office in Hong Kong, its first in the region, in September. Of the fund’s C$127.3 billion ($128 billion) in assets, over C$10 billion is invested in Asia and that number is set to rise.

Petroff spoke to AsianInvestor during a recent trip to Hong Kong.

Q Can you detail your portfolio asset mix?

A Including the C$40 billion we have in money markets that we count as negative net investment and which funds other asset classes, the total portfolio is C$167.3 billion.

Of that total, we have 47% in equities, of which public equity represents around two-thirds and private equity one-third (as of December 31).

The remainder is around 48% in fixed income, 23% in real assets such as property and natural resources, 9% in absolute return strategies and 5% in commodities. These are all constantly moving; they’re not set targets.

Since the start of this year we’ve combined commodities and timber in a natural resources group. We did that because we thought by having a broader description it would create greater opportunities in terms of looking at investments.

Q How much can you diverge from the portfolio asset mix?

A We can vary from those amounts by plus or minus 5%, but we try to stick close to them. I spend most of my time on an active allocation, which tries to add value above the policy benchmark. 

Q Please briefly outline the investment process.

A Our asset allocation is in risk terms, not dollar terms. I allocate risk to each department, and as long as they stay within that limit, they can buy what they want.

For every dollar of active risk we take – that is, not based on the policy portfolio – we allocate 1.6 times the risk based on the actual diversification. So if every department earns 10% return on their active risk, the total would be a 16% return on risk.

Q Can you tell me a bit more about how you decide on allocations?

A All the departments that report to me come together every two weeks, and we go through all investments that are in the pipeline, those that are getting close, those that are actively pursued and those that are on their way out.

We are one of the few organisations that allow fixed income to take a view on a public equity, and private capital to take a view on real estate. When you look at many other funds, the fixed income and equity staff don’t even talk to each other.

This a cultural shift that started when I became CIO, and I think it leads to better decision-making.

Q Last year you produced 13% return, above the policy portfolio target return of 11%, and you’ve consistently outperformed your benchmark. How have you done it?

A Yes, we have returned $2.2 billion over the benchmark last year and $26.9 billion over benchmark since inception in 1990. Part of that success comes from the fact that a lot of our transactions are done direct, so we don’t pay 2% and 20% [management and performance fees, respectively].

So instead of paying, say, 5% or 6% to a manager, we keep that.

Q What sort of assets do you own in Asia?

A We probably have more infrastructure assets in developed countries than we do in Asia. But our relationship investing and private capital assets [within the equities group] are probably a bigger proportion of the portfolio in this region.

Our public equities team uses a global benchmark, so they are also active in Asia. But the real estate team is not so active in the region, and we don’t buy Asian fixed income so much either.

All our commodity investments are done via derivatives on the Goldman Sachs Commodities Index. We have timber in countries like Australia, New Zealand, Brazil and the US, but not necessarily Asia.

Q What are your ambitions for the new Hong Kong office?

A We set up an office in Hong Kong because we believe there’s a critical mass here. My team travelled over 12 million miles last year, so it’s very stressful. There’s a point when it’s time to be closer to the markets. We also have a London office – to monitor investments in the Emea [Europe, the Middle East and Africa] region.

Doing deals in Asia used to be a lot tougher, but now people here are more receptive as the population ages and all these very wealthy families owning major conglomerates are looking at succession and simplifying their corporate structures.

Q Can you give more colour on your approach to these investments?

A From a private equity point of view, we have a three-legged approach: direct private deals; co-investments alongside some funds we invest in; and in certain locations, where we have no-one on the ground, we invest in external funds. Investments are split about a third in each.

We are opportunistic in our approach. We don’t necessarily decide we need exposure to China or Japan; we just want to buy great businesses at a good price.

Q How about your fixed income strategy?

A We invest in fixed income through credit, hedge funds and through yield curve and volatility strategies. We don’t make calls on interest rates going up or down, but investments that hopefully add value whether rates rise or fall – ie, market-neutral strategies.

Q Do you buy emerging-market debt?

A We do, but on a risk-adjusted basis they don’t really attain the return we are required to achieve on EM debt, which is 4.5%. That’s a tough number to reach if the market’s flat or Canadian government bond yields are at 3% or less.

Q I believe you invest in hedge funds – what’s your approach?

A We allocate to hedge funds globally including Asia-based strategies. We have two separate hedge fund platforms – one is totally internal, where we do all trading and strategies in-house. The other’s externally based – it’s a managed account; all the trading is done on our books, so we have full transparency for the strategies. We don’t do any funds of funds.

Q Can you explain how you manage risk? Do you use derivatives?

A We use derivatives extensively, across commodities, foreign exchange, equities etcetera. I’d say we trade $2 trillion a year in derivatives. Some are for value-add, some for managing our liabilities, and some for risk management.

The risk management team looks at the tail risk of a 1% tail event on the downside.

Each department has green, yellow and red limits. Green means they can do whatever they want within that limit; yellow means they have to come to me to explain why it’s yellow and whether they’re comfortable keeping it there. And when they’re in the red, they have to give me a plan for how they’ll get out of the red. I see that information on a daily basis.