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We invest with a long-term focus because the pension plan will be paying benefits to today’s young teachers 70 years from now. We look at the size of the plan’s liabilities and how long they will be paid, and carefully match the cost of future pensions to the best set of assets to meet the plan’s long-term needs, within appropriate risk limits.
The plan relies heavily on the investment program to generate the returns required to pay pensions. Due to the importance of investment income, we have continually looked for the best new investment opportunities and techniques to maximize returns and add value to the fund without adding to the fund’s risk exposure.
We manage risk carefully and have built the investment expertise to increase the chance of outperforming market benchmarks. Paying close attention to the job of maximizing returns at an appropriate level of risk helps to offset challenges presented by a maturing plan membership and attempts to minimize contribution rate volatility and other plan changes.
Stable contributions can best be achieved by minimizing the difference between asset values and liability costs. The intent is to generate strong enough investment performance so that, together, plan assets and contributions equal the cost of promised benefits over the long term at an affordable contribution rate.
Long-term, value investor
We have developed an innovative investment strategy to maximize returns using active management, including absolute return strategies, to add value above market benchmarks.
While our investment approach as a long-term, value investor remains constant, we continually refine our strategy as our assumptions, market conditions and plan’s funding status changes.
| There are three main components to our investment strategy: |
| 1. |
We set an appropriate asset mix policy, reflecting the plan's maturity and risk tolerance. |
| 2. |
We actively manage approximately half the fund with a focus on total fund returns. Our goal is to add value above market benchmarks. |
| 3. |
We also seek additional value above market benchmarks using innovative investment techniques and continually searching for new markets and investment opportunities. |
Setting the asset-mix policy
Teachers’ investment program faces a formidable two-fold challenge in managing plan assets in relation to the liabilities. The portfolio must generate the returns required to support the inflation-indexed pensions that have been promised. The desire for stable contribution rates and the low ratio of working teachers to pensioners (1.6 teachers per retiree) means the plan’s managers cannot justify increasing the fund’s risk exposure. If financial markets were to fall significantly, it would be difficult, if not impossible, to make up any investment loss that might arise through higher contributions from plan members.
Teachers’ investment managers address these competing concerns by operating within an asset mix that is more conservative than other large pension funds while skillfully exploiting opportunities and using innovation to maximize returns within mix.
We review the plan’s asset-mix policy annually (or more often as required) using an asset-liability model to determine an optimal investment strategy that reflects the plan’s lower risk tolerance. Using the model, we establish a weighting for each asset class that reflects the long-term risk and return trade-offs in relation to other asset classes. We set our currency hedging policy based on the asset mix chosen.
Seeking additional value
Our key investment objective is to beat the fund’s overall benchmark each year. We use several methods in the attempt to maximize returns by adding value greater than the performance of the market in which we invest. We also seek to identify new markets and opportunities.
First, we use a total fund management style that encourages the sharing of information and movement of capital among asset classes and portfolios to optimize risk-adjusted returns. We use a mix of active and passive strategies so that we can shift capital from index funds to active portfolios when we see opportunities to add value. We reward portfolio managers for maximizing value-added returns within the risk limit on total assets, not just their own portfolios.
Second, we actively manage approximately half of the fund’s investments and employ enhanced indexes for the fund’s remaining index weightings, providing the fund with broad market exposure and liquidity. Although indexed investing is often passive, using no discretion, we manage the indexed investments actively to generate enhanced returns.
Over the past decade, active management and tactical asset allocation improved the returns we would otherwise have received from passive index investing alone. While our asset mix and risk management processes are aimed at covering the impacts of inflation and portfolio volatility, the focus of the active management process is to earn returns above benchmarks. We strive to generate higher returns than those available from investing passively in a set of established, generally accepted benchmark indexes weighted to match our asset mix.
Active management means selecting securities we believe are undervalued, as well as under- or overweighting various asset classes relative to our asset-mix policy, as opposed to passive management, or simply “buying the index” at policy weights. Management is committed to this approach in the belief that passive investing through conventional public equity and fixed income market indexes cannot, with confidence, generate the risk-adjusted returns the plan requires.
Third, we allocate risk to asset classes that can generate superior returns. The fund’s largest active risk budgets are found in private equity, infrastructure and real estate. These assets consistently have earned significant returns above their benchmarks. We are able to allocate risk to these illiquid assets because of our long-term investment horizon.
Fourth, we may also over- or underweight individual index components, a strategy known as overlays, which aims to exploit medium-term investment opportunities. A senior member of the investment team leads an Investment Planning Committee that meets regularly to consider over- or underweighting asset classes, sectors and foreign currency positions during the year, based on fundamental and quantitative analysis.
Fifth, over the last decade we have added absolute return strategies to enhance returns. Their main advantage is that these returns have little or no correlation with those from public equity and fixed income markets. This additional form of diversification further cushions the fund from public market volatility, reducing the risk of a loss at the total portfolio level. The biggest risk to plan assets is a decline in equity markets. Absolute return strategies, however, are expected to generate positive investment returns regardless of upward or downward broad market movements. These strategies range from long-short programs to fixed income arbitrage strategies. Long-short strategies are primarily concentrated in the equity and fixed income markets, since they are largely self-financing -- the sale of securities on the short side finances the purchase on the long side.
Managing risk
At the same time, we manage risk carefully to understand our risk exposure and avoid undue losses. For more information, see Risk Management. |
