Question:

Propose a sustainable strategic asset allocation for the entire direct investment portfolio of OHPIB by producing a report. The case is intentionally left open along many dimensions and you may need to source for needed information in order to conduct a robust analysis. Make assumptions, only if necessary, and state them clearly.

Case

OLDLOSTLAND AND HUSKADOR PENSION INVESTMENT BOARD (OHPIB) (fictional)

Oldlostland and Huskador1 (fictional)

Oldlostland and Huskador (OH) is the most easterly province in Canada and is made up of two large but disconnected land masses: Oldlostland and Huskador. It has an estimated population of 525,000, most of whom live on the island of Oldlostland. OH's economy is highly dependent on energy production and resource extraction, notably in industries such as oil & gas, logging, fishing, and mining, all of which contributed to 23% of its GDP last year.

As a result of its increasing economic dependence on oil & gas, the province is sensitive to fluctuations in oil price. Between 2007 to 2013, oil royalties on average accounted for more than 25% of total government revenue. Following the collapse of oil prices in recent years, this ratio has dropped closer to 13% (or around C$1billion2) of the 2018-2019 government budget. Following the price decrease, unemployment rate in OH rose from 11.6% in 2013 to 14.8% in 2017, the highest in Canada.

The OH Oil Spill

In 2018, the largest-ever oil spill in OH's history raised a fresh round of safety and environmental concerns related to the province's expanding offshore oil industry. Due to a flowline connector failure in Husky Energy's SeaRose oil platform off the coast of the Atlantic, an estimated 250,000 liters of oil were released into the surrounding waters. To worsen matters, the Canada Offshore Petroleum Board - the regulating authority dealing with the spill - has assessed that the oil has decomposed into the ocean to the point where a clean-up is no longer viable.

It is difficult to estimate the environmental and economic damage caused by the spill, such as the mortality of local wildlife and the impact on local fisheries and tourism. Following the incident, the SeaRose platform was forced to wind-down its operations. Critics and activists have also called for tighter regulation in the industry and the prioritisation of the environment and safety over revenue and profits, just as the province moves to expand the size and range of offshore drilling. In extreme cases, there have been demands for full divestment from the industry.

Oldlostland and Huskador Pension Investment Board

The province of OH historically had three separately managed pension funds covering public employees. Following a pension reform in 2000, the three funds were merged to form OHPIB, a crown corporation. OHPIB is the asset manager overseeing the pooled assets of these 3 largest public

pension plans and it is responsible for investing $15 billion of assets belonging to 82,500 members, ensuring that liquidity requirements are met.

The members include active members, who are currently working and contributing to the plan, inactive members, who are individuals who left the plan but haven't retired yet, and pensioners.However, the OHPIB is only an asset manager and, thus, is not responsible for administering the plans and paying out pension liabilities, although the liabilities are relatively well funded. The disbursement of funds to pensioners is administered by a separate government entity.

OHPIB has a legally binding dual mandate to both its pensioners and the citizens of OH. For one, it must achieve a minimum rate of return on its assets and there are consequences for missing this benchmark. Additionally, OHPIB's duties include making a sustained and durable contribution to the local provincial economy, which explains why 27% of its assets are directly invested in OH firms and infrastructure projects.

Fund Objectives and Strategy

The fund's primary objective is to generate returns above a given target set by OH's chief actuary. The fund's existing asset allocation meets its target. However, if the fund consistently misses the target, the board of directors would likely face public scrutiny and see significant turnover.

Additionally, OHPIB aims to:

Manage assets in the best interest of OHPIB contributors and beneficiaries;

Invest assets to achieve a maximum rate of return, without undue risk of loss, with regards to the factors that may affect the funding of OHPIB and the ability of OHPIB to meet its financial obligations;

Continue to invest in local initiatives to bolster the provincial economy.

In line with its dual mandate, OHPIB supports projects within the province jurisdiction to stimulate the local economy. In 2018, OHPIB's assets under management was equivalent to approximately half of OH's GDP. Given the Canadian economy's significant growth over the past ten years, management is confident that OHPIB's investments will generate sizeable returns over the long-term.

ESG Considerations

OHPIB encourages companies and organisations to adopt policies and practices that promote responsible corporate and organisational behavior with respect to environmental, social and governance (ESG) factors. OHPIB firmly believes in the consideration of ESG factors in the evaluation of both public and private investments.

With escalating tensions following the SeaRose oil spill, numerous activist groups have voiced their concern for the environment, with some pressuring OHPIB to implement investment strategies that are more sustainable and, in particular, divest away from its holdings in the oil & gas industry, which have traditionally been a large, revenue-generating component of the fund's assets and one of the largest sources of economic growth in the province.

Proponents of divestment have cited New York City's multi-billion-dollar divestment from fossil fuels and Norway's Government Pension Fund Global's ongoing disposal of oil and gas stocks as leading examples.

In fact, the arguments of some activist groups were found to be so compelling that members of OHPIB's investment board are now calling for a meeting to review its investment portfolio and consider divestment. In addition, following recent pressures to conform to ESG standards, OHPIB has begun to invest in two ETFs specifically focused on ESG investment strategies.

Asset Allocation

The fund currently allocates 27% of its portfolio to direct investments and the remaining 73% to indirect investments (i.e. managed funds). The Board believes that prudent diversification of the investment portfolio by asset class, underlying risk factor, geographic exposures, currencies and active management strategies, provides both substantial diminution of long-term portfolio risk and broad access to the worldwide range of investment opportunities for the generation of long-term returns.

Direct Investments

The fund's asset allocation strategy in recent years has been trending towards larger positions in fewer assets. The OHPIB invests mainly in three local industries: oil & gas, mining, and infrastructure. The breakdown of the directly managed portfolio is as follows:

Direct Investment

Value ($ Billions) % of Assets

North White Rose 1.6B 11%

Labrador Iron Ore 1.1B 7%

Muskrat Falls 0.5B 3%

Saint John's Airport 0.8B 6%

Total 4.00B 27%

North White Rose (Oil) (fictional)

Following the collapse of OH's cod-fishing industry and the subsequent discovery of new oil extraction sites in the province, OHPIB began to amass significant holdings in this sector. Discovered in 1984, the White Rose Oil Field is the province's third largest, estimated to contain over 230 million barrels of recoverable crude oil. OHPIB currently holds a $1.6B stake of North White Rose3, a 40-square kilometer subfield within the broader geography, making it the fund's largest local investment.

Labrador Iron Ore (Mining)

Mining is one of OH's oldest and most important economic activities. The sector provides over 6,000 jobs in the province, particularly in under-served rural areas. OHPIB has invested $1.1B of its direct portfolio in Labrador Iron Ore, a publicly traded iron ore mining company situated in a remote region of Huskador. Though this remains one of the fund's best performing assets, Labrador Iron Ore was adversely affected by a nine-week labor strike from March to May of 2018, halting all production during that time. As a result, the company faced a 17% drop in its 2018 revenues, as compared to 2017.

Muskrat Falls (Infrastructure)

OHPIB currently holds a $500M stake in the Muskrat Falls project, which is an 824 MW hydroelectric generating facility on the Lower Churchill River, for which construction began in late 2013. The project embodies OHPIB's commitment to sustainable investing. The facility intends to meet the province's long-term energy needs of providing clean and renewable energy for future generations, irrespective of oil production.

Upon sanctioning and approval from the OH government, the project was expected to cost around $6B. However, as of 2018, the project had incurred costs of over $12.7B and remains significantly behind schedule. Construction has also been slowed by organised protests on the part of the government comprising the indigenous peoples of OH, which fears that the project may cause methylmercury poisoning in the surrounding lake. Due to delay and cost overruns, the project has yet to generate returns.

Saint John's Airport (Infrastructure)

OHPIB holds an $800M stake in the St. John's airport, the largest in the province. In 2010, tourism in OH contributed $410M to the province's GDP, or 1.1% of economic output. This contribution was higher than logging and fish harvesting, showing the region's potential for further growth in the tourism sector. Supporting local infrastructure and tourism has the potential to generate economic wealth and prosperity in OH.