Investing 200: Behind the scenes on Western s two largest funds Martin Bélanger Director, Investments November 20, 2015 Human Resources Disclaimer This presentation material was created to educate and update members of the Western Retirement Plans. It is not intended to constitute legal, tax, pension, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. This presentation contains general information and should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. 2 1
Agenda Diversified Equity Fund Overview of the Fund Recent changes How it has worked Looking forward Diversified Bond Fund Overview of the Fund Recent changes How it has worked Looking forward Questions 3 Overview of Diversified Equity Fund Characteristics of the Fund Composition Foreign exposure and currency management Market capitalization Active VS passive management 4 2
Characteristics of the Fund $569 million in assets as of September 30, 2015 3643 members invested in the Fund Represents 48.9% of all plan assets Comprises 70% of the Balanced Growth Fund Comprises 30% of the Balanced Income Fund Balanced Growth Fund has been the default option since July 1, 2008 5 Composition Manager Weight Canadian Equity 30% Beutel Goodman 10% CC&L 10% Greystone 10% U.S. Equity 20% SSgA (U.S. Large Cap) 10% SSgA (Low Volatility Equity) 10% International Equity 16% AB Global 8% MFS 8% Global Equity 24% Harris 12% T. Rowe Price 12% Small Cap Equity 5% Franklin Templeton 5% Emerging Markets 5% William Blair 5% 6 3
Foreign Exposure and Currency Management 70% of the Fund is exposed to non Canadian equities Global equity mandates may also include Canadian stocks As of September 30, 2015: Harris Associates: None T. Rowe Price: 2.3% (Cdn Natural Resources, National Bank, TD Bank, Valeant Pharmaceuticals) Franklin Templeton: 9.4% (Fairfax Financial, Fairfax India, Major Drilling Group International, ClubLink Enterprises) MFS allowed to invest up to 10% in non EAFE stocks: 4.7% (Suncor Energy, Element Financial, Valeant Pharmaceuticals, Loblaw, CN Railway) 60% of the Fund is exposed to foreign currency fluctuations Half of the U.S. currency exposure is hedged 7 Market Capitalization One mandate fully dedicated to small and mid size companies: 5% of the Fund Other mandates may also be exposed to small cap equities (as of June 30, 2015): Canadian equities: 14% EAFE equities: 7.1% Emerging markets equities: generally no exposure Global equities: 1.8% U.S. low volatility equities: 26.3% U.S. large cap equities: no exposure Effective exposure: 13.4% Small cap stocks generally have larger expected returns, but more volatility 8 4
Active VS Passive Management 80% of the Fund is actively managed Theinvestment managers try to selectthethe securities that will perform the best, within a specific category 10% of the Fund is passively managed The investment managers purchase all or most of the securities within a specific category 10% of the Fund is managed based on a smart beta strategy Set of investment strategies that use alternative index construction rules instead of market capitalization based indices. Seek to capture specific factors or market inefficiencies. 9 Recent Changes Strategy Investment strategies considered New options 10 5
Strategy Capture additional sources of potential return Add assets that are expected to reduce the overall risk of the Fund 11 Investment Strategies Considered Four types of assets: Cash Liquidity and safety of principal Fixed income (or bonds) Debt instrument Equities (or stocks) Ownership in a company Alternative investments Everything else Focus on equities and alternative investments 12 6
Investment Strategies Considered Asset Class Product Details Equities Smaller companies Emerging markets equities Low volatility strategies Smaller companies are expected to outperform larger companies over the long term, albeit with higher volatility Emerging markets now represent approximately 10% of the world market capitalization are expected to be the engine of growth for the global economy This type of strategy typically has low sensitivity to market movements and thus provides stronger relative performance in down markets The strategy can either be constructed by focusing on companies with low leverage and that operate in stable businesses; or by focusing on shares that are less volatile 13 Investment Strategies Considered Asset Class Product Details Real estate Involves purchasing income producing properties Alternative Investments Infrastructure Private equity Active currency management Global tactical asset allocation Commodities Market neutral strategies Long/short strategies Involves taking ownership in roads, utilities, transport, water, ports, railroads, communication systems, etc. Involves investing in companies that are not listed on a stock exchange Involves trading a basket of currencies. Multi strategy approach that seeks to add value based on views about the economy. The strategy incorporates asset class, country, sector, and currency opportunities. Strategy that involves investing in a basket of commodity futures, such as oil, natural gas, gold, copper, zinc, coffee, livestock, wheat, etc. Strategies that involve taking both long and short positions in stocks to minimize the exposure to some of the stock market risks Strategies that combine a conventional portfolio with a market neutral strategy 14 7
Investment Strategies Considered Strategies Aiming to Capture Additional Sources of Return Strategies Retained Strategies Not Retained Smaller companies Emerging markets Private equity Active currency management Global tactical asset allocation Strategies Aiming to Lower the Risk of the Portfolio Strategies Retained Strategies Not Retained Low volatility equity Commodities Market neutral strategies Long/short strategies Real estate Infrastructure 15 Investment Strategies Considered Reasons for not retaining a strategy: Lack of liquidity Complexity J Curve Fees Risk Expected return 16 8
New Options Strategy Pros Cons Global Small Cap Higher expected return than large cap stocks Lower correlation with large cap stocks Greater potential for active management Emerging Markets Equities Low Volatility Equity Strategies Emerging markets are a source of growth for the global economy Market capitalization of emerging markets is growing Likely flow of investments may grow opportunity and liquidity Diversifier to developed markets Potential for higher returns Attractive investment opportunities for companies located therein Attractive demographics Emergence of middle class Enormous pool of cheap labour Stronger fiscal positions Historically lower volatility than traditional portfolios Low fees Research suggest that anomaly may persist Can be implemented in a passive way Higher volatility Less liquid Higher investment management fees Higher transaction costs Current valuation levels l Increases portfolio risk Lower liquidity Higher investment management fees Higher transaction costs Increasing correlations with developed markets Inconsistent legal and regulatory framework Transparency Stronger GDP growth does not necessarily translate into stronger stock market performance Large tracking error Outperformance may not re occur in the future Short history for products on the market May experience extended periods of underperformance 17 How Has it Worked? (Before) Annualized Returns as of August 31, 2011 (after fees) 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 10 Yr Diversified Equity Fund 6.05% 3.80% 3.44% 3 5.15% 5 1.67% 1 2.41% Benchmark 8.39% 5.76% 1.80% 3.13% 0.01% 3.09% Value Added 2.34% 1.96% 1.64% 2.02% 1.68% 0.68% Volatility as of August 31, 2011 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 10 Yr Diversified Equity Fund 11.50% 11.65% 17.73% 73% 16.22% 14.90% 13.46% Benchmark 10.74% 11.15% 17.36% 15.80% 14.51% 13.19% Difference 0.76% 0.50% 0.37% 0.42% 0.39% 0.27% Lower returns, higher volatility than the benchmark 18 9
How Has it Worked? (After) Annualized Returns (after fees) From Jan 1, 2013 to Sep 30, 2015 From Sep 1, 2014 to Sep 30, 2015 1 Yr 2 Yr Since Jan 1, 2013 Since Sep 1, 2014 Diversified Equity Fund 5.80% 11.63% 15.06% 3.54% Benchmark 3.63% 11.01% 13.98% 1.55% Value Added 2.17% 0.62% 1.08% 1.99% Volatility From Jan 1, 2013 to Sep 30, 2015 From Sep 1, 2014 to Sep 30, 2015 1 Yr 2 Yr Since Jan 1, 2013 Since Sep 1, 2014 Diversified Equity Fund 10.23% 8.63% 8.28% 10.06% Benchmark 9.85% 8.36% 7.90% 9.64% Value Added 0.38% 0.27% 0.38% 0.42% 19 New Mandates Annualized Returns from November 20, 2013 to September 30, 2015 (Before Fees) William Blair Emerging Markets Leaders 6.66% MSCI Emerging Markets 2.38% Value Added 4.28% Annualized Returns from February 1, 2014 to September 30, 2015 (Before Fees) SSgA U.S. Managed Volatility Equity 21.55% Russell 3000 18.26% Value Added 3.29% Annualized Returns from July 7, 2014 to September 30, 2015 (Before Fees) Franklin Small Mid Cap Equity 12.60% MSCI World All Country Small & Mid Cap 14.73% Value Added 2.13% 20 10
How Has it Worked? Decision to review the portfolio was made in September 2011 Final asset mix was approved at the December 3, 2012 meeting The implementation i of the new asset mix started in January 2013 and was completed in August 2014 with the implementation of the Global Small Cap Equity mandate Before: significant underperformance with higher volatility After: the Fund generally outperformed its benchmark, but with a little more volatility Although the U.S. low volatility equity mandate did outperform its benchmark with low volatility, the volatility of the strategy was not significantly lower than the benchmark, as we would expect in normal circumstances Two of the three new managers have significantly outperformed their benchmark The third one still managed strong absolute returns 21 Looking Forward Consider private equity and unlisted infrastructure Public equity returns are expected to be lower going forward Inefficiencies in private markets allow top managers to generate excess returns Premium for illiquidity It is possible to mitigate the J curve with secondaries Research and simulations suggest that it is possible to handle an illiquid component in the Diversified Equity Fund 22 11
Overview of Diversified Bond Fund Characteristics of the Fund Composition Foreign exposure and currency management Active VS passive management 23 Characteristics of the Fund $288 million in assets as of September 30, 2015 2738 members invested in the Fund Represents 24.7% of all plan assets Comprises 30% of the Balanced Growth Fund Comprises 70% of the Balanced Income Fund Balanced Growth Fund has been the default option since July 1, 2008 24 12
Composition Manager Weight Global Bonds AB Global 63.5% Canadian Bonds SSgA 26.5% Commercial lmortgages Romspen 10% 25 Foreign Exposure and Currency Management Component managed by AB Global can have a non Canadian exposure ranging from 30% to 70%. Normal stance is 50% Up to 25% of the component can be left unhedged The component managed by SSgA invests exclusively in Canadian bonds and as such does not have any foreign currency exposure The component managed by Romspen invests mainly in Canadian commercial mortgages Although there is no fixed limit on the non Canadian component, it is expected that the fund will remain predominantly Canadian More than 90% of the U.S. dollar exposure is hedged, either by having the borrower assume any currency losses, or by using forwards 26 13
Active VS Passive Management 73.5% of the Fund is actively managed The investment managers try to select the securities that will perform the best, within a specific category 26.5% of the Fund is passively managed The investment manager purchase most of the securities within a specific category to replicate the risk and return characteristics of an index 27 Recent Changes Strategy Investment strategies considered New options 28 14
Strategy Optimize the Diversified Bond Fund by increasing i its expected tdreturn and/or reducing its volatility. 29 Investment Strategies Considered Strategy Commercial mortgages Real return bonds Details Mortgage loan secured by a commercial property, such as an office building, shopping center, industrial warehouse, or apartment complex. Bonds that pay a rate of return that is adjusted for inflation 30 15
New Option Strategy Pros Cons Commercial Mortgages Higher yield than Higher investment traditional bonds management fees Lower volatility than traditional bonds Less liquid than traditional bonds Shorter duration Large component of the Low historical loss ratios Fund (10 15%) regularly in default Real return bonds were not pursued mainly because of their long duration, which made them less attractive in a rising interest rate environment. 31 How Has it Worked? (Before) Annualized Returns as of August 31, 2011 (after fees) 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 10 Yr Diversified Bond dfund 5.50% 50% 8.37% 7.25% 6.76% 6.18% 5.76% Benchmark 4.56% 6.12% 6.51% 6.53% 5.96% 5.79% Value Added 0.94% 2.25% 0.74% 0.23% 0.22% 0.03% Volatility as of August 31, 2011 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 10 Yr Diversified Bond Fund 2.80% 2.76% 5.00% 4.40% 40% 4.10% 3.93% Benchmark 2.78% 2.95% 3.55% 3.21% 3.14% 3.55% Difference 0.02% 0.19% 1.45% 1.19% 0.96% 0.38% Higher returns than the benchmark, but generally with higher volatility 32 16
How Has it Worked? (After) Annualized Returns from July 1, 2012 to September 30, 2015 (after fees) 1 Yr 2 Yr 3 Yr (Jul 1, 2012 Sep 30, 2015) Diversified Bond dfund 4.81% 5.96% 4.25% 4.50% Benchmark 5.04% 5.76% 3.97% 4.16% Value Added 0.23% 0.20% 0.28% 0.34% Volatility from July 1, 2012 to September 30, 2015 1 Yr 2 Yr 3 Yr (Jul 1, 2012 Sep 30, 2015) Diversified Bond Fund 3.92% 3.18% 3.16% 3.07% Benchmark 4.25% 3.40% 3.26% 3.15% Difference 0.33% 0.22% 0.10% 0.08% Generally higher returns than the benchmark, but with lower volatility 33 New Mandate Annualized Returns as of September 30, 2015 (before fees) 1 Yr 2 Yr 3 Yr Since Inception (July 13, 2012) Romspen 8.92% 8.04% 8.20% 8.31% Benchmark 7.11% 7.10% 6.54% Value Added 1.81% 0.94% 1.66% 34 17
How Has it Worked? Changes to the Diversified Bond Fund were triggered not so much by the poor relative performance of the Fund than by the challenging hll upcoming environment Low yields Increasing interest rate environment Fewer opportunities in corporate sector as credit spreads have significantly tightened The commercial mortgage mandate has significantly outperformed traditional fixed income Before: higher returns than the benchmark, but generally with higher volatility After: generally higher returns than the benchmark, but with lower volatility, in a much more difficult environment 35 Looking Forward Emerging markets debt High yield specialist Bank loans Private debt Real return bonds 36 18