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9B01N008
“TIMBER!”: ONTARIO TEACHERS’ PENSION PLAN BOARD
CONSIDERS AN ALTERNATIVE INVESTMENT CLASS
Farzin Afshar prepared this case under the supervision of Professor Stephen R. Foerster solely to provide material for class
discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may
have disguised certain names and other identifying information to protect confidentiality.
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In September 2000, Ba
ara Zvan, director, research and economics department of the Ontario Teachers’
Pension Plan Board (OTPPB) was preparing an analysis for presentation to the board of directors
concerning the possible investment in a new “alternative” asset class: timberland. Timberland investments
were like investing in a “tree factory” and represented a unique opportunity to diversify the fund. However,
cu
ent North American institutional investment in timberland was only $12 billion, a tiny fraction of
institutional investment in other “traditional” asset classes such as equities and fixed income securities.
There were also numerous problems in attempting to measure the potential returns and risks associated
with such an investment. Zvan needed to present a complete picture of both the pros and cons associated
with timberland investments and ultimately recommend whether such an investment was worth
considering, if so, how it would be implemented, and, if not, what OTTPB should consider in order to
achieve the objectives set out in the fund’s investment policy statement.
PENSION PLANS IN NORTH AMERICA
In 1875, the American Express Company established the first private pension plan in the United States, and
shortly thereafter, utilities, banking and manufacturing companies also began to provide pension plans. By
2000, there were more than 44,000 private defined benefit pension plans in the United States, where the
top 100 (1,000) funds held around $3.1 trillion ($5 trillion). In Canada, by 1998, there were more than five
million employees that belonged to an employer-sponsored or union-sponsored pension plan. The total
assets of these plans exceeded $670 billion, much greater that those of the public Canada and Quebec
Pension Plans and individual registered savings plans combined (see Exhibit 1 for a list of the top 10
pension funds in the United States and Exhibit 2 for a list of the top 10 pension funds in Canada).
Pension funds were classified into two major groups: defined benefit plans and defined contribution (or
money purchase) plans. Under a defined benefit plan, the employee’s after-retirement benefit entitlements
were defined by a formula. The benefits were calculated as a percentage of the employee’s average
compensation over his or her entire service or a particular number of years, or both. The amount of
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enefits was either specified or could be calculated in accordance with a set formula based on various
factors such as age, earnings and service. The amount of annual contributions needed to provide the
specified benefits could be estimated actuarially. Since this type of pension was managed and maintained
as a group, no individual accounts were maintained. Fund managers were legally obliged to ensure benefits
for future retirees, thus, the asset mix and investment strategies were adopted in such a way that this
obligation would be met. Defined benefit plans were subject to government regulation and laws.
In a defined contribution plan, the benefit was based on the fund amount built up by plan members’ and
employers’ contributions and by the investment earnings of the assets in the fund. The plan specified the
contributions paid by and on behalf of each member, rather than a formula for the amount of pension. The
contributions were attributed to each individual and accumulated with interest or earnings. The pension
was based on the amount these contributions would provide at retirement, typically through an annuity.
Most of the early pension plans were defined benefit plans that paid workers specific monthly benefits at
etirement, funded entirely by employers. By 2000, in the United States 81 per cent of pension fund asset
were in defined benefit plans and 19 per cent were in defined contribution plans.
Over the years, the North American pension investment strategies had become more sophisticated and had
diversified into more return-enhancing asset classes. In 1999, on average, pension funds in North America
held about 60 per cent to 65 per cent in equity investments. Investments in emerging markets, venture
capital, private equity and derivatives were becoming mainstream in the pension industry. Exhibit 3
indicates the asset mix of the top 100 Canadian pension funds.
ONTARIO TEACHERS’ PENSION PLAN
A pension plan was first established for Ontario teachers in 1917. By 2000, the Ontario Teachers’ Pension
Plan Board was responsible for the retirement income of approximately 153,000 elementary and secondary
school teachers, 77,000 retired teachers and their survivors, and 92,000 former teachers with money in the
plan. The plan was sponsored by a partnership between the Ontario government and the plan members,
who were represented by the Ontario Teachers’ Federation.
Until 1990, the plan was restricted to investing in non-marketable Government of Ontario debentures. In
1989, however, an actuarial assessment of the fund determined that the funding of the plan was in
jeopardy. The report indicated that the value of the liabilities exceeded the value of assets (about $20
illion) by about $8 billion. In 1990, the Ontario government created the Ontario Teachers’ Pension Plan
Board with full authority to invest all assets, administer the pension plan, and pay members and their
survivors the benefits promised.
The pension board had the fiduciary duty to administer the plan and to manage the investment fund in the
est interests of present and future plan members and their survivors. A nine-member board of directors
had been appointed equally by the partners to govern the plan; further, the board delegated the day-to-day
management to a chief executive officer and his staff.1
By the end of 1999, the OTPPB merchant banking group had generated a 25.6 per cent annual
compounded rate of return since its inception in 1992. The merchant banking activities consisted of equity
and mezzanine capital investments in businesses of all sizes in a wide range of industries. More than $3.1
1See “Ontario Teachers’ Pension Plan Board: The Asset Allocation Decision,” Richard Ivey School of Business Case
9A97N003, for an examination of the initial asset allocation decisions.
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illion was invested in 83 corporations. The plan also launched a venture capital fund in 1997 to invest
equity in early-stage enterprises primarily in the technology and biotechnology sectors. More than $300
million was allocated to 24 North American early-stage companies directly or in partnership with other
venture capital firms.
As a result of a progressive investment strategy, the plan had a surplus of $8.9 billion as of December 31,
1999. However, the risk of surplus loss was the plan’s biggest fund concern. A steady surplus was needed
to avoid any future needs for an increase in contribution rates (cu
ently eight per cent for employees with
a matching amount contributed on behalf of Ontario district school boards). One major concern was that
pushing higher long-term surplus growth through active management could lead to short-term surplus
losses and a rise in contribution rates.
The surplus risk was managed using a value at risk (VaR) methodology.2 Value at risk was basically a
measure of the potential change in value of a portfolio of financial assets with a given probability over
some