Like all major Canadian institutional investors, OPTrust faced extremely challenging conditions in 2008 as the worldwide financial crisis produced a steep drop in global equity and credit markets.

Against this negative backdrop, the Plan’s return for the year was -16.2%, compared to -16.8% for our weighted benchmark. [See below for the method used in calculating OPTrust’s investment returns.]

Over the longer term, OPTrust has outperformed our weighted composite benchmark for the past nine years. Since the Plan’s launch in 1995, the fund has produced an average annual return of 8.1%, versus 7.1% for our weighted benchmark.

OPTrust’s investment portfolio has outperformed the Plan’s market-based benchmark for the past nine years. Despite the Plan’s 16.2% loss in 2008, our 8.1% average annual return since the Plan’s inception in 1995 exceeds the average for both our funding target return and the benchmark.

2008 investment overview
The following provides an overview of OPTrust’s investment performance for each of the Plan’s major asset classes. For more information please see our 2008 Annual Report.

For Canadian equities, returns reflected the rise of commodity prices to record levels over the first half of the year followed by their even steeper drop in the face of growing concerns over the impact of a global recession. As a result, the resource-heavy S&P/TSX Composite Index fell dramatically in the third and fourth quarters of 2008, ending the year down by 33.0%.

In the United States, equity markets also experienced a sharp decline, with the S&P 500 Index falling 37.0% in U.S. dollar terms, compared to a 5.5% gain in 2007. In Canadian dollar terms, however, the S&P 500 Index saw a loss of only 21.2% as the weakness of the Canadian currency – driven largely by collapsing commodity prices – partly offset the poor returns from U.S. assets.

Returns from developed equity markets in Europe, Australasia and the Far East (EAFE) lost 29.2% in Canadian dollar terms, as measured by the MSCI EAFE Index.  Emerging market returns suffered the steepest collapse, with the benchmark Emerging Markets Free Index (MSCI EMF) losing 41.6% in Canadian dollar terms.

As equity markets deteriorated, investors fled to the relative safety of fixed-income securities, particularly government-guaranteed treasury bills and short-term debt. As a result, the Canadian bond market gained value, with the DEX Universe Bond Index returning 6.4%, compared to 3.7% in 2007.

Canadian equities – OPTrust’s Canadian equity portfolio fell by 30.1% in 2008. Despite this loss, the portfolio outperformed its weighted benchmark index, which dropped by 34.0% over the year. The difference is largely attributable to the investment strategies employed by the Plan’s active portfolio managers, who positioned their portfolios defensively in the face of the continuing market decline.

Since the Plan’s inception in 1995, our Canadian equity portfolio has generated an average annual return of 9.0%, outperforming our 7.4% average benchmark return for the same period.

Global equities – Our overall return on foreign equity investments was -37.4% in Canadian dollar terms, compared to -35.9% for our benchmark. This includes the impact of the Plan's passive and active currency hedging program. The performance of our equity managers investing outside of Canada was mixed in this very challenging environment. While some managers follow investment philosophies that do relatively well even in weak markets, the majority saw their portfolios more adversely affected by the sudden and dramatic shift in market sentiment in the latter half of the year.

Our foreign equity portfolio has generated an average annual return of 5.3% since 1995, outperforming our 4.8% average benchmark return.

Currency management – Because OPTrust’s foreign equity holdings represent almost one-third of our total assets, changes in the value of the Canadian dollar versus other currencies can have a significant impact on the Plan’s investment returns. We have therefore put in place a strategic currency hedging program aimed at reducing the volatility of our returns from foreign markets.

Up to December 31, 2008, our policy was to passively hedge 50% of the currency exposure from global equities in developed markets and 100% of the exposure from real estate and private market investments. Effective January 1, 2009, our hedging policy provides for the passive hedging of 50% of the Plan’s foreign currency exposure on a total fund basis. We also engage an active currency manager to supplement this program through short-term tactical allocations designed to take advantage of shifts in major currency exchange rates.

In 2008, the portfolio suffered a loss of approximately $380 million (CAD) resulting from our currency hedging program. This contrasts with our experience in 2007, when the currency hedging program produced a gain of $220 million.

Fixed income – OPTrust’s Canadian fixed income investments, which include government and corporate-issued bonds and interest rate derivatives, gained 7.5% in 2008, performing below their benchmark return of 7.8%. This underperformance occurred largely at the end of the year, when investors strongly favoured bonds issued by – and with the full guarantee of – the federal government, despite the relative creditworthiness of provincial governments and highly-rated corporations.

Since 1995, our fixed income portfolio has returned an average of 8.9% per year, compared with an average of 8.3% for the benchmark.

Real estate – In 2008, the real estate portfolio generated a return of 9.4% compared to 7.5% for its custom benchmark of CPI + 4%. In 2007, the annual return for the real estate portfolio was 21.3%, compared to a benchmark return of 6.5%. Our relatively strong return for 2008 reflects the resilience of real estate values through the third quarter of the year. It also reflects the impact of OPTrust’s policy of delaying the reporting of returns for our real estate, infrastructure and private equity portfolios by one calendar quarter, consistent with the external manager reporting cycle for these asset classes.

Since the creation of our internal real estate investment management team in 2004, the portfolio has returned 14.4% on an internal rate of return basis, outperforming our benchmark return of 6.5% for the same period.
 
Infrastructure and private equity – In 2008, our infrastructure portfolio generated a robust 12.1% return, versus 8.7% for our custom benchmark of CPI + 5%. Since the portfolio’s launch in December 2006, it has returned an average of 8.3% per year, compared to a benchmark of 8.4%.

The private equity portfolio lost 2.1% in 2008, compared to a return of 0.0% for the benchmark. Typically private equity returns follow a “J-curve” pattern. In the first several years of an investment, returns are expected to be negative. This reflects the fact that initial fees are paid on closing of the investment, while fund management fees are charged on committed capital that will typically be invested over a period of three to five years. After this "start-up" phase, this trend is expected to gradually reverse, as the portfolio becomes more fully invested, distributions increase and positive revaluations become significant. For this reason, we use a benchmark of 0.0% for the first four years of each private equity investment, to reflect the expected timing of returns.

OPTrust’s returns for 2008 include substantial losses for our Canadian and global equity portfolios. These were partly offset by strong positive returns for our fixed income, real estate and infrastructure portfolios.

Calculating investment returns
OPTrust uses a time-weighted methodology for calculating returns at the total fund level and for our Canadian and global equity portfolios, our fixed income investments and our real estate portfolio. Performance for our infrastructure and private equity portfolios is presented on an internal rate of return (IRR) basis, which provides the most relevant measure of performance for these asset classes and is consistent with industry practice.

Since-inception performance for real estate is reported on an IRR basis, which provides the most relevant measure of performance over periods greater than one year for this asset class and is consistent with industry practice. The portfolio’s inception date of April 2004 reflects the date on which OPTrust’s internal Real Estate Group began operation. Since-inception performance for infrastructure and private equity are based on portfolio start dates of December 2006 and April 2007, respectively.

In 2006, OPTrust adopted a policy of delaying the performance reporting for real estate, infrastructure and private equity by one calendar quarter to coincide with the reporting cycle of our external managers for these asset classes. Total fund returns for 2007 and 2008 include returns for these portfolios from October 1, 2006 to September 30, 2007 and October 1, 2007 to September 30, 2008, respectively.

OPTrust implemented a 100% currency hedging policy for real estate and private market investments on February 1, 2006. From that date onwards, return data for real estate, infrastructure and private equity investments reflects the impact of a proxy hedge.

All returns are calculated gross of investment management fees and operating costs.