Investment risk includes a wide range of factors that could affect our ability to meet the Plan’s funding target return over the long term. OPTrust manages investment risk on several levels.
First, from a total fund perspective, we determine the appropriate balance between the Plan’s overall long-term investment risk and the expected long-term rate of return needed to fund the Plan’s pension promise. We then analyse, allocate and manage investment risk at the level of each asset class, specific portfolios and individual investment manager mandates.
This approach is supported by robust internal systems for the regular monitoring of the performance of our portfolios. We also track results for each of our investment managers and their compliance with their mandates and OPTrust’s investment policies.
New investment risk system
To support our risk management program, OPTrust has developed an enterprise-wide investment risk system. By allowing us to track risk at the manager, portfolio and total fund levels, the system has strengthened our ongoing risk monitoring and reporting and enhanced our forward-looking analyses to support our investment decisions.
In addition to monitoring and managing the Fund’s absolute risk we also track our active risk resulting from the active management of the Fund’s assets relative to the policy benchmark for the Total Fund and each asset class. This in turn allows management to assign a set “risk budget” to individual portfolios as required, and to track portfolio-level decisions to ensure those budgets are not exceeded.
The system also allows us to monitor the impact of adverse market conditions and model how abnormal market events may affect the Fund. This capacity allows us both to project potential losses resulting from downside risks and to test the expected impact of a range of potential risk-mitigation strategies.
Credit risk
As part of our investment strategy, OPTrust invests in a range of public and private market debt securities and over-the-counter derivatives. To manage credit risk for our public markets portfolio, our investment policies require a credit rating of “A” or higher for fixed income investments and for all of our derivative counterparties.
We further mitigate credit risk through collateral and settlement requirements. In addition, we closely monitor our external investment managers to ensure their compliance with our high credit standards in executing their investment mandates.
Currency risk
OPTrust invests in a number of foreign markets. While this increases the Fund’s diversification, it also exposes the Plan to risks from changes in currency exchange rates. Over the long term, we expect these changes to have a neutral effect on the Plan’s returns. In the short term, however, changes in the value of the Canadian dollar versus other currencies can have a material impact on fund returns in any given year.
OPTrust therefore employs a “passive” currency hedging strategy to reduce the annual volatility of returns for our foreign investments. Under this strategy, we hedge 50% of the Plan’s exposure to developed market currencies at a total fund level.
