Ontario Municipal Employees' Retirement System chief executive Michael Nobrega clears the air about investing in government-shed assets and discusses his plans to expand OMERS' third-party asset management programme overseas, as Raquel Pichardo-Allison reports
Raquel Pichardo-Allison: You reported a drastic increase in your deficit. How do you plan to tackle that?
We’ve been very active in the markets in buying assets, but we bought them at a time when prices were reasonable
Michael Nobrega: First of all, let’s talk about the results. We made C$4.3bn (US$4.2bn) this year. But we have an actuarial deficit. This deficit is based on a predictive model with a lot of variables – mortality rate, wage increases, deflation. As the plan matures, you get a little more certainty, or these assumptions have to change. So we are working on that deficit, which is separate from us making money on the market side. This deficit is 10% of the fund, and is a direct result of two things. The first is that we made a loss in 2008, which is coming through, and the second one is that OMERS had a four or five year contribution holiday in the early 2000’s, which meant that we took a lot of money out of our system. We’ll adjust as we come down the line.
There are only three (adjustments) you can really make. The first is to have better investment returns, the second is that you can increase contribution rates, and the third one is to have some plan design changes. Some of these things might resolve themselves over time because we may have better investment returns. The other thing is on the inflation rate, I think we’re looking at inflation of less than one point, and the predictive model estimates long-term inflation rate at well over 2.25%, so this makes a big impact on the model.
We will have to do some sort of combination of the three items.
Raquel Pichardo-Allison: It’s been reported that you’ve been building up liquidity to take advantage of a fire-sale in government assets.
Michael Nobrega: People misquote me all the time. Someone asked me the question of why we have so much fixed income. We have twice the fixed income we would normally have. We are very concerned about the debt to GDP ratio of the countries we invest in, UK in particular, and in Canada. To the extent that there is a shake-up later on in the private markets and the public markets, then we would like to be positioned to take advantage of some of the value-added stocks and bonds in the private market assets. So that’s the context I said that in. We have the fixed income not because we think there’s a fire sale coming in investments, we’re just looking at the economic outlook we see in these countries and recognise that at some time, the rubber has to meet the road in how you pay for these deficits.
To the extent that governments borrow a lot more, that means interest rates will rise, so there will be more opportunity for fixed income. To the extent governments borrow and crowd the private markets out, then interest rates will have to rise in the private markets and that will decrease profits and reduce stock prices. To the extent governments have to partner with private sector and deal with some of their own assets, liquidate some of their assets, we’re positioned to take advantage of that. We’re a fund that is looking at a situation where government finances are fiscally unstable, and to the extent through monetary policy and fiscal policy that they will impact stock prices or assets prices, we obviously see that as an opportunity.
Raquel Pichardo-Allison: What kind of interest do you have in infrastructure projects? Partly because governments are having these problems, some of them are turning to pension funds to finance these projects.
Michael Nobrega: We’ve never bought assets because governments were in trouble. We’ve bought infrastructure assets in the UK; Associated British Ports, we have Scotia Gas pipelines, we just lost the Gatwick Airport to another bidder. We’ve been very active in the markets in buying assets, but we bought them at a time when prices were reasonable. We lost the British airport deal because we thought it was overpriced for the risk we take. So we will look at these assets if the government begins to bring these assets into the market.
Raquel Pichardo-Allison: Has the Canadian government asked you to invest in infrastructure?
Michael Nobrega: They have not. We have never had those discussions. I think they understand we’re independent. But to the extent that assets come up in your own backyard, we take a very serious look at them.
Raquel Pichardo-Allison: You seem to act as direct asset holders more so than other pension investors. Why is that?
Michael Nobrega: Do we have a direct drive asset management style? Yes, that’s true. We’ve been building that for a long period of time. We have Oxford (Properties Group, OMERS’ real estate arm) that has 25 years of experience building that platform. Borealis Infrastructure has another 12 years of expertise.
We find that there are a number of benefits. First of all we don’t pay the big fees. Number two is that we are closer to the assets and the management of those assets, so we find that we can provide guidance in the development of those assets. And number three, when you’re that close, you have real follow-on opportunities on the asset. Take Associated British Ports. We have 21 ports there. To the extent other ports become available, we have a team that can acquire additional ports.
And at the end of the day, we get better returns. We find that we get 100 to 200 basis points better returns by being a direct owner.
Raquel Pichardo-Allison: What’s the status of OMERS’ plan to manage the assets of other pension funds?
Michael Nobrega: The government has given us the authority to manage third party pension funds, other than direct members. We got that in June last year. It takes about a year to get all the regulatory things in place. We expect that by the third quarter this year, we will be in a position to offer products to third party pension funds. And that will be both here in Canada and outside of Canada. We will work as an investment manager of those funds.
Raquel Pichardo-Allison: What will some of the obstacles be once you get this going?
Michael Nobrega: It’s going to be, what I call, loss of control by management. I think that will be a big issue. Another issue will be comfort by the trustees that we can handle it. The third issue will be whether we can provide them with the asset mix that they like to have. And the fourth obstacle will be the size. We will not take a C$50m deal. We need to have critical mass. It’s no use setting up this programme with the resources that we have...to take the very small ones. We would love a minimum of C$500m.
Raquel Pichardo-Allison: Have you already been speaking to other pension funds?
Michael Nobrega: I speak to them regularly. There are a bunch of funds ready to actually look at the proposals. Because they have to do their due diligence and take this back to their trustees, we don’t plan to have a quick turn around; we don’t want to. We want to build this thing gradually over the next two to three years. With this third-party management programme, if we get to C$20bn to C$25bn in the next five years we’d be fine.
The UK market is a very good market for us, because they have very similar laws to ours. Not necessarily pension laws, but it’d be a good market for us to access as third-party managers. But we’re not there as yet. We have real estate in the UK, we have infrastructure in the UK. We have public bonds and public equities, so if we do start this programme, we would probably invest in the UK. We already have C$5bn to C$6bn invested in the UK, no one knows that.
Raquel Pichardo-Allison: What are the advantages of this programme?
Michael Nobrega: It gives us critical mass. OMERS is well positioned in terms of investment teams to access a lot of products that we need to find the money to actually secure these investments. So this gives us an opportunity to have clout. To (the third party), they get access to those products. We also get a fee income, but we don’t look at that as a major item. The main advantage to us is to get the size so we can access those products.
Raquel Pichardo-Allison: You already have a substantial portfolio (C$47.8bn). What are some assets you don’t think you have access to at your current size?
Michael Nobrega: The first one is on the follow-on investments I mentioned. We have some substantial investments that we maybe have 20% in, and we may want to buy the other 80%. But the other 80% will cost us billions of billions of dollars. We also have existing assets which we’d like to expand, and those also add up to a substantial amount. We have a pipeline that runs from Alberta to Chicago, the Express Pipeline, that we think we can double the size. We’re doing 300,000 barrels a day, and I think we can do 600,000 barrels a day. We have a transmission asset in Texas which we have 20% with another major player. The remaining 80% will have to be sold in the next three to four years. The 80% may cost us C$12b to C$15bn. We might want to acquire another 15%, but to do that, you have to deal with the other 80%.
We don’t have a lot of transportation assets right now. We’d certainly love to play in some of the motor ways, toll roads, airports.
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