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.

With the market downturn in 2008, OPTrust increased the frequency of our monitoring to ensure that senior management and the Board of Trustees had access to the latest information on risks affecting the Fund’s performance.

Tactical risk reduction
As the market crisis deepened in the fall of 2008, our Investment Division modeled different options for reducing the Fund’s downside risk in the face of unprecedented volatility in the public equity and credit markets. This analysis resulted in a tactical decision to reduce the Plan’s public equity allocation by 10% of the Total Fund, converting nearly $1 billion in assets into short-term money-market investments.

This strategy, combined with falling equity values in 2008, reduced our public equity exposure to below the Plan’s long-term policy allocation, but the Fund’s risk remains at a historically high level due to ongoing market volatility. The three-year annualized volatility of the Fund at the end of 2008 was 9%, compared to 5.3% at the end of 2007, representing a 70% increase over the year.

Over the long term, our current lower public equity exposure will require us to rebalance public equities to our policy weights or make changes to the Fund's long-term asset mix.

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.

This conservative approach has helped OPTrust limit the Plan’s exposure to the credit crisis over the past two years. We did not own any of the “toxic” sub-prime mortgage assets that have featured so prominently in the current financial crisis. Similarly, our exposure to non-bank asset-backed commercial paper is negligible.

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 significant impact on fund returns in a given year.

We, therefore use a passive currency hedging strategy to reduce the volatility of the Plan’s returns, rather than to generate additional value. Up to December 31, 2008, our currency hedging policy involved passively hedging 50% of the currency exposure of our developed market foreign equity portfolios and 100% of our currency exposure from foreign real estate, infrastructure and private equity investments.

At the end of 2008, the Board of Trustees approved a change to the OPTrust currency hedging policy, which resulted in the implementation of a 50% currency hedge on a total portfolio basis, effective January 1, 2009.