Essay About Ontario Teachers’ Pension Plan Board And Asset Allocation Decisionfina

Ontario Teachers’ Pension Plan Board: The Asset Allocation Decision
Concordia UniversityJohn Molson School of BusinessOntario Teachers’ Pension Plan Board: The Asset Allocation DecisionFina 411 / Portfolio ManagementPresented to: E. Wong Written by:Lucas Rodrigues 40029800Enrico Donofrio 26462855Garlens Blemur 26645003Nicholas Baric 40005653To: William Booth, Management Committee, OTPPB From: JMSB InternsDate: January 1994Subject: Re-examination of diversification strategy  Dear Mr. Booth,As per your request, the following below contains a re-examination of the diversification strategies set in place by the Ontario Teachers’ Pension Plan Board. An analysis of the previous consultants’ recommendations was considered  as well as a comparison between asset only and liability driven investments.   Regards, JMSB Interns Part 1 – Asset Allocation Recommendations: In order to determine the most suitable asset allocation for the Ontario Teachers Pension Plan Board, it is important to first establish the main goals and constraints that are pertinent to the fund. The primary objective set in place by the OTPPB as specified by the previous independent consultants is to deliver expected benefits at the current or at a lower contribution rate. When allocating assets, the fund’s liabilities must also be taken into consideration in order to ensure that future obligations will be met. Thus, it is important to be able maximize the surplus of the fund which is achieved through a higher rate of return.  Seeking a higher return from the portfolio can result from having a higher asset allocation in equities. This will however increase the volatility of the returns and considering that over 200,000 individuals depend on the OTPPB for their retirement, excessive levels of volatility should be avoided. Increases in returns will also result in a lower contribution rate and thus a reduction in funding costs. A proper balance between risk and return is thus a critical factor to consider when determining the proper asset  allocation, and as such, the risk adjusted return will be the defining measure in weighing different asset classes.  The pension plan is vulnerable to many different forms of risk which affect both assets and liabilities. These risks should therefore be addressed when deciding on the asset allocation of the portfolio. The volatility of returns of the different asset classes is a major risk to consider, and with an increasing portion of the portfolio dedicated to equities, volatility will likely increase. Interest risk also affects the value of the bonds that are held and considering a substantial portion of bonds held are mid-to long term, the risk regarding interest rates are exacerbated. Interest rates are also used to determine the present value of the liabilities which are subsequently used to determine the surplus (deficit) of the fund. The contribution rate is adjusted according to the surplus therefore interest rate risk is an important factor to consider. Inflation rate also plays an important role because the benefits were indexed to inflation at 100% of the increase in the CPI. Thus, if inflation were to increase, so would the liabilities. The teacher’s themselves also pose some level of risk. The pension fund must provide an income stream for these individuals starting from their retirement up until estimated death. However, there is a current trend in which life expectancy is increasing while the retirement age and years of work stay consistently the same. This in and of itself provides a long-term risk for the fund.