Portfolio Diversification

To meet our funding obligation, OPTrust has built an investment portfolio valued at $14.7 billion at the end of 2012. The Plan's assets include Canadian and international equities, fixed income investments, growing real estate, infrastructure and private equity portfolios and an allocation to energy commodities.

Diversification is a key element of our long-term investment strategy. By selecting an appropriate mix of asset types and investing in a range of markets and sectors, we aim to achieve a number of objectives, including:

managing the Plan's exposure to investment risk
reducing the impact of poor returns from particular markets or asset classes in any given year, and
maximizing our ability to achieve the Plan's funding target return over time.

Diversification strategy
Our investment program is designed to ensure the sustainability of the Plan. This means constructing a diversified investment portfolio that is able to withstand negative market conditions while generating the returns needed to fund our pension obligations over the long term.

To help manage the Fund's investment risk, OPTrust regularly conducts asset/liability studies. These studies are used to help ensure that the portfolio is structured to maximize our ability to meet the funding target return over time, while keeping investment risk within limits established by OPTrust's Board of Trustees.

Between 2003 and 2012, OPTrust has implemented a series of measures to restructure the Plan's investment portfolio and enhance our asset mix. These changes have included:

the addition of three major alternative asset classes – real estate, private equity and infrastructure – to the portfolio to further broaden the potential return premiums and increase the overall diversification in the portfolio. Since 2004, these portfolios have grown to represent a combined net asset value of $4.6 billion, or 31.3% of the Total Fund at the end of 2012
a reduction in the allocation to Canadian real return bonds (RRBs). This reduction was offset by the growth in the Fund's alternative portfolios, which also provide a hedge against inflation but have much higher yields than RRBs
the addition of energy commodities to the portfolio, both as a diversifier and for their strong inflation hedging characteristics.

2012 asset/liability study
In 2012, OPTrust completed our most recent asset/liability study, which confirmed the match between our long-term diversification strategy and our goal of reducing the probability of a funding shortfall while maintaining the value of members' future pension benefits. The study also resulted in the following adjustments to the Plan's asset mix:

a reduction in the overall duration of the fixed income portfolio from long-term bonds to mid-term bonds. With expectations of yield levels normalizing over the next several years from the recent lows, a shorter duration in fixed income assets is expected to reduce interest rate risk in the portfolio
the integration of U.S. and EAFE equities into a developed market equities allocation. This change reflects the increased correlation between these markets and opportunity to benefit from geographic opportunities through active management
a temporary reduction in the Plan's private equity allocation to 10%. We believe a 15% long-term allocation to private equity is justified and continue our efforts to construct a portfolio based on that objective. However, over a three- to five-year horizon the 10% allocation is more feasible and recognizes the objective challenges in building a substantial private equity portfolio. In the meantime, public equities will be used as a substitute until the long-term allocation of 15% is achieved.

In 2012, OPTrust continued the multi-year implementation of the Plan's long-term asset mix. These changes are designed to reduce investment risk and volatility at the total fund level, while strengthening OPTrust's ability to meet the Plan's target return under a range of scenarios.

Through most of 2012, OPTrust maintained a tactical reduction in the weighting of public equities to limit the Fund's volatility. This strategy was wound down at the end of the year, returning our equity holdings to the Plan's short-term target weighting.