Ontario teachers have the world’s best-performing retirement fund. Is it a model for the rest of us?
Retirement came as a surprise—a pleasant surprise,” muses Vic Genova as he moves around the kitchen of his rambling Toronto home one chilly evening, preparing chai. “I knew it was coming, but I didn’t think about it.” He was having lunch in his school’s staff room one day when a colleague mentioned, almost in passing, that he would soon be eligible to start collecting his retirement savings, which are invested, managed, and disbursed by the mighty Ontario Teachers’ Pension Plan (OTPP), currently ranked the world’s best-performing retirement fund.
“I wrote down the numbers,” says Vic with a chuckle, “and I remembered the line from The Godfather: it was too good to refuse.” As he and his wife, Linda, also a former teacher, set out the tea and a plate of almond biscotti on their dining-room table, they explain how, according to the terms of their contracts, they could start drawing pensions at fifty-five and fifty-six, respectively, when they attained the magic “eighty-five factor,” a formula based on age plus years of service.
In exchange for a mandatory contribution of 12 percent of each paycheque, the average retired teacher in Ontario receives an annuity of $48,000, based in part on an average of the best five earning years. Members of the profession are doubly fortunate because their pension plan has been famously profitable, averaging 10 percent annual returns over the past twenty-three years. Almost a decade after he left his career as a special ed teacher, Vic is both energetic and fit, blessed with knees that allow him to continue playing hockey and tennis. “We got lucky,” he says with a shrug.
The Genovas, and some 300,000 other current and former Ontario teachers, appear to exist in a parallel economic universe. The number of Canadian employees who belong to defined benefit pension plans, which provide recipients with a guaranteed annuity upon retirement, has plunged in the past fifteen years, and it now stands at just under 4.5 million people. Millions of Canadian baby boomers outside the teaching profession and not part of another defined benefit plan have not saved nearly enough in their RSPs to retire with an annual income of 60 percent of their working salaries, the minimum considered necessary for the middle class to maintain a pre-retirement standard of living. Incentives to save, such as tax shelters, have done little to mitigate this growing problem. As a result, this cohort faces the very real risk of an impoverished old age that will inflict extreme fiscal pressures on social programs and health care while starving other public services. Those without decent pensions will have little choice but to keep working if they want to avoid poverty.
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Linda sounds a little defensive about their good fortune, stressing that earlier generations of teachers, many of them single women, ended up as paupers. “The fact that I am part of a large group that has a well-managed pension, benefiting from economies of scale, is no reason to feel guilty,” she says. “I feel that I earned my pension.”
Not everyone agrees. If one common denominator exists in North American politics in the anxious post-2008 era, it may well be pension envy. In the private sector, employers have cut back on membership in defined benefit plans, in a bid to reduce labour costs and increase profit margins. Meanwhile, in jurisdiction after jurisdiction, right-of-centre politicians have taken aim at allegedly gold-plated government pensions that they consider unaffordable as well as unfair. With sentiment against public sector unions rising, many voters want to know why they must pay part of their earnings to furnish civil servants with retirement benefits they have no hope of securing in their own jobs. But the politics of pension envy overshadows another question: why can’t every Canadian have access to a pension that provides a measure of security after a long career?
Much of OTPP’s success since it was founded in 1990 can be attributed to smart management and financial acumen rather than government contributions, which have accounted for just 12 percent of its funding. Jim Leech, the rangy, plain-spoken former Bay Street deal maker who has run the sprawling $129.5-billion organization since 2007, points out that during the plan’s twenty-three-year history 77 percent of its asset growth—about $99.7 billion—has come from consistently impressive returns on its investments. “That’s phenomenal leverage you won’t get from your classic defined benefit plan,” he adds. (He retires at the end of this year.)
The OTPP’s immense portfolio dwarfs those of even the largest Canadian mutual funds. (By comparison, the Royal Bank’s well-regarded Canadian Equity Income Fund has just under $2.6 billion in assets.) Due to the combination of OTPP’s size and its investing prowess, its batting record is unrivalled worldwide, as The Economist has pointed out. “Over the past ten years,” the magazine reported in a March 3, 2012, article about the success of Canada’s large public sector pension plans, “Ontario Teachers’ has had the highest total returns of the biggest 330 public and private pension funds in the world.”
Those returns are also exceptionally robust because OTPP’s not-for-profit operation consumes just one-half of 1 percent (fifty basis points) of its assets per year, even with a staff of 900 headquartered in a nondescript office building in Toronto’s north end. Most large mutual fund companies—the ones that compete for Canadians’ RSP dollars—levy management fees that often average 2 percent, much of it for profit and bonuses. Such charges can swallow up half of an investment’s value over an employee’s career.
While OTPP is the most profitable Canadian public sector pension fund, it is not the only one attracting international attention. The Economist notes that four of the world’s top forty pension funds are now Canadian, and all have been structured according to the groundbreaking governance principles that underlie OTPP’s success. “It’s a made-in-Canada revolution being copied in many places outside Canada,” says Keith Ambachtsheer, a pension expert with the University of Toronto’s Rotman School of Management.
But what if OTPP’s model provided a solution to Canada’s looming savings crisis? What if we were all required to contribute to large non-profit pension funds with the size and savvy to deliver returns seldom offered by private mutual funds? The operative word is “required.” Unlike the rest of us, Ontario teachers can’t sell their stocks in a panic when the markets cough. They can’t raid their RSPs to finance an amazing sun holiday. And they don’t have to decide whether or not to believe the enticing sales pitch in the mutual fund brochure that comes in the mail. Rather, teachers outsource these tricky long-term investment choices to the OTPP’s pros, with the proviso that they may not touch the cash.
Although the prospect of a universal mandatory pension plan is anathema to the prevailing liberal ethic of individual freedom—and in particular to the Harper government, which has rejected the idea on philosophical grounds—a growing number of provincial officials, pension experts, and advocacy groups say it may well be the only way out of penury for a generation of Canadians.
“We don’t believe you’ll solve the problems of that group unless you do make contributing mandatory, because none of the other incentives have worked,” observes Leech, who believes that within a decade a federal election will be fought specifically over the issue of retirement security. In October, he will publish The Third Rail, co-written with the Globe and Mail’s Jacquie McNish, which lays out his vision for reforming a system that is, in his view, clearly broken: “What will happen in twenty-five years when millions of Canadians open the box and see there’s not much in there? ”
To trace the roots of Canada’s pension revolution, we must travel back to Detroit in the early ’40s, when a young Austrian-born academic named Peter F. Drucker was studying organizational practices at General Motors. From his experiences at GM and later as a corporate consultant, he created a humanistic philosophy of management and customer service. His work represented a sharp departure from the paleolithic pre-war capitalism of Henry Ford. Drucker was especially interested in the pension plan established by GM president Charles Wilson for his workers. (Ironically, the United Auto Workers opposed the proposal at first, fearing the company would misuse the workers’ contributions.) The prolific author later wrote a little-read volume, The Unseen Revolution: How Pension Fund Socialism Came to America, which laid the groundwork for pensions that answered to their sponsors, survived demographic shifts, and delivered long-term benefits.
The Unseen Revolution fell into Keith Ambachtsheer’s hands in 1977, a year after it was published. He now runs an international pension fund management think tank at U of T and heads a small but well-respected consulting firm. At seventy-one, he knows more about pension plans than almost anyone else in Canada. If you collect a public sector pension or CPP, you owe him big time. You also owe Drucker.
“I was one of the few people who read the book,” he recalls, eyes twinkling. Drucker, he adds, “asked all the important questions.” Over lunch at a Yorkville pub, the silver-haired, nattily dressed consultant recalls how he became an adviser to David Peterson’s Ontario Liberal government in 1987, soon after it won a general election. As the leader of the first non-Tory majority in over two generations, Peterson came into office taking aim at his predecessor’s budget deficit. He knew Bill Davis’s Tories had been using teachers’ pension contributions—which flowed into a sleepy provincial Crown agency that managed the Teachers’ Superannuation Fund—to fuel spending, by decreeing that those payroll deductions be invested in government bonds. “It was like catnip,” Peterson recounts in a phone interview. “There was no incentive to balance the budget.”
His treasurer, Robert Nixon, was charged with forming a task force to fix the situation, and the bureaucrats involved turned to Ambachtsheer to solve the problem. The next year, the task force released a blueprint, pointedly titled “In Whose Interest,” for reforming the teachers’ pension plan. Ambachtsheer made sure the recommendations reflected two of Drucker’s key insights: one, that the pension fund should answer to an independent and highly qualified board of directors with a fiduciary responsibility to the plans’ sponsors (the government and the teachers); and two, that the board should be allowed to recruit talented investment managers with competitive (i.e., Bay Street) pay packets rather than bureaucrats’ salaries. Last, the Liberals decided the new organization should be allowed to invest on the open market, a radical notion at the time.
The revamped organization, which inherited a $20-billion reserve of Ontario government bonds, would be overseen by an independent OTPP board that included the recently retired Bank of Canada governor, Gerald Bouey. He in turn recruited its first powerhouse executives: former MetLife Canada CEO Claude Lamoureux; and Bob Bertram, a long-time financial executive with the Alberta phone company that later became Telus. Lamoureux insisted that they set up offices in the north end of Toronto, where they could remain at a polite remove from the city’s financial hub, to avoid undue influence from Bay Street.
Luck played a part in the fund’s early successes: OTPP’s inception coincided with a devastating collapse in Canada’s commercial real estate market, and Lamoureux’s team began snapping up cash-strapped malls, office buildings, and a major real estate firm, Cadillac Fairview. The small crew then began buying up blocks of shares in publicly traded companies, using the Warren Buffett value investing model, says OTPP veteran Wayne Kozun, who oversees the plan’s equities investing team. From there, it diversified into international markets. “We realized that limiting our investments to Canada would make Teachers’ a very big fish in a very small pond,” he says.
After Leech joined in 2001, OTPP began playing aggressively in the so-called private equity field, meaning it would buy large stakes in large companies whose shares did not trade on any stock market. He orchestrated a handful of high-profile deals that saw Teachers’ pair up with American buyout giants such as Kohlberg Kravis Roberts to take multi-billion-dollar positions in companies like Shoppers Drug Mart and Yellow Pages; both investments paid off handsomely.
Over the past decade, as the average age of its members began to creep up, Leech and his executives started to play more cautiously, with more sedate revenue-generating holdings: toll roads, electrical utilities, and retirement homes—investments that generate predictable flows of income to support the looming wave of retirees who have been guaranteed pensions for the rest of their days.
Leech’s team, of course, is not infallible. In 2007, OTPP and two American firms made a bid to acquire BCE in a $35-billion blockbuster deal. By a stroke of cosmic luck, a Quebec court blocked the overpriced sale, a twist of fate that helped to blunt the savage impact of the 2008 credit collapse on Teachers’ holdings. “We were reminded that investments don’t just go up,” he says.
To help limit its exposure to companies with reckless executives, OTPP also became an activist shareholder, using its clout to push CEOs to manage their organizations more profitably. Lamoureux, and then later Leech, believed in urging such companies to address unsound governance practices, such as boards stacked with cronies who would not challenge the CEO. About a decade ago, Teachers’ further upped the ante by co-founding the Canadian Coalition for Good Governance, whose members include all of the big Canadian public pension plans as well as several large private sector fund companies. CCGG pressures directors and CEOs of publicly traded firms to improve their practices or face ouster, as happened recently when Teachers’ backed the overthrow of Canadian Pacific’s board in May 2012.
Despite its high-profile activism, OTPP has never allowed social or political considerations to infiltrate its investment choices. Unlike Quebec’s Caisse de dépôt, a public sector pension plan that has invested in many of the province’s massive infrastructure projects, Teachers’ has resisted government entreaties to become involved in such deals. It also turned a deaf ear on years of complaints from disaffected Leafs fans, who accused OTPP of being more interested in maximizing its profits than in fielding a winning team. (Teachers’ recently sold its stake in Maple Leaf Sports and Entertainment for an astonishing $1.32 billion.)
Nor have Leech and company paid much attention to more specific criticisms, for example those levelled by U of T’s Citizen Lab, which has publicly urged OTPP to use its stake in the American firm Blue Coat to press the organization to be more transparent about its human rights compliance record. Blue Coat makes communications equipment that has been used by repressive Middle Eastern regimes to suppress opposition groups. Earlier this year, OTPP endured another wave of controversy when Cadillac Fairview, its property arm, struck up a partnership with MGM Resorts International (a money-losing gaming giant with suspected ties to organized crime figures in Macau), in an ultimately unsuccessful bid to develop a casino in Toronto.
Teachers, an outspoken lot, can have strong views about these matters. Vic and Linda Genova sometimes hear about such investments, and they wish OTPP would avoid the ones with a taint. Because of Drucker, Ambachtsheer, and Lamoureux, the organization has long succeeded in politely ignoring its membership’s political views. So far, this studied disinterest has worked to the members’ benefit.