cfa toronto annual pension conference 2013

2013 ANNUAL

PENSION

CONFERENCE

24 APRIL 2013

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2013 Pension Conference

Wednesday April 24, 2013, 8:00 AM – 5:00 PM Reception: 5:00 PM – 6:00 PM

Agenda

8:00 – 8:25 AM

Registration & Networking Breakfast

8:25 – 8:30 AM Opening Remarks

Peter S. Jarvis, CFA, CEO, CFA Society Toronto

8:30 – 9:30 AM The Biology of Risk Taking

Speaker: John Coates, Professor, University of Cambridge

The title says it all: the biology of risk taking. John Coates presents

research into the ways our body guides our risk taking, research

recently surveyed in his book The Hour between Dog and Wolf.

9:30 - 10:00 AM The Canadian Pension Model. Norway vs Yale vs Canada -

A Comparison of Investment Models.

Speaker: Keith Ambachtsheer, Executive Director, Rotman

International Centre for Pension Management

This discussion will consider a new formula for the “Canada

Pension Fund Model” (which is encapsulated in the Morneau

report) that studies the application of the Model by merging

all/most Ontario public sector funds smaller than OTPP, OMERS,

HOOPP.

10:00 – 10:15 AM Networking & Coffee Break

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10:15 – 11:00 AM Managing Extreme Risks in a Pension Plan

Speaker: Janet Rabovsky, Director, Investments, Towers Watson

Janet will explore the extreme risks that pension plans should

consider (even if they can’t always manage these unpredictable

and significant exposures). She will present a framework for

assessing the risks in a portfolio and examine how to diversify a

Plan by return drivers versus the more traditional asset and sector

categories.

11:00 - 12:15 PM LDI in a Low Interest Rate Environment

Speakers: James Davis, CFA, Vice-President, Investment

Planning & Economics, Ontario Teachers’ Pension Plan

Speakers: Malcolm Hamilton, former Partner of Mercer

Pension plans had fun in the 1990s. They earned high riskless

returns or even higher risky ones. Today’s pension plans have

much harder choices. Often they must choose between

unacceptably low returns and unacceptably high risks. LDI lets

them make the best of a bad situation; but it is still a bad situation!

Pension plans should stop using unrealistically high return

expectations to live in a past that is long gone. They must begin to

make tough decisions - about contribution rates, risk sharing and

benefit design – not just easy decisions about asset mix.

12:15 – 1:00 PM Networking Buffet Lunch

1:00 – 2:00 PM Pooling of Public Sector Asset Management

Speaker: Bill Morneau, Executive Chairman, Morneau Shepell

In May 2012, Bill Morneau was appointed by the Ontario Minister

of Finance as Pension Investment Advisor to lead in facilitating the

pooling of public sector pension fund assets. The report released

in October 2012 recommended that Ontario move to pooling the

pension assets of Ontario public sector organizations that are not

already in a jointly sponsored pension plan. This talk will review

the background of the project, and the merits and challenges of

moving to greater consolidation of pension assets in Ontario.

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2:00 - 3:00 PM The Price of Climate Risk

Speaker: Bob Litterman, Chairman, Risk Committee, Kepos

Capital

How does an investor or even more importantly society, rationally

price unknowable risks? This is the fundamental topic explored by

Bob Litterman one of the pre-eminent thinkers in the world on the

subject of risk.

Bob will explore the appropriate pricing of climate risk, its non-

diversifiable nature, societal risk aversion and implications for

portfolio construction. He will also identify that incentives matter,

inappropriate pricing of climate risk wastes scarce resources and

as a result will present a rational pricing model and method for

thinking about how to incorporate these types of risks into asset

management.

3:00 - 3:15 PM Networking & Coffee Break

3:15 - 4:15 PM Practical Application of Alternatives for Pension Plans

Speaker: Robert Cultraro, CFA, Executive Chief Investment and

Pension Officer, Hydro One

Speaker: Julie Cays Chief Investment Officer, Colleges of Applied

Arts and Technology (CAAT), Pension Plan

Listen in on an exclusive interview moderated by Marcus Turner,

CFA, Senior Investment Consultant at Towers Watson featuring a

panel of successful CIO's on investing in alternative investments.

4:15 - 5:00 PM Is Sluggish Growth Forever?

Speaker: Avery Shenfeld, Managing Director and Chief Economist,

CIBC

Avery’s presentation will focus on the economic outlook and its

implications for equity, fixed income and foreign exchange

markets.

5:00 - 6:00 PM Closing Remarks and Networking Reception – Rooms A/B/C/D

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2013 Pension Conference - Speakers Biographies John Coates Professor University of Cambridge John McBride Coates is a neuroscientist at the University of Cambridge and former Wall Street trader for Goldman Sachs, Merrill Lynch and Deutsche Bank. Coates' research focuses on the hormonal basis of financial decision making,[3] inspired by his own experiences trading. He describes how men trading "display what may be called [the] classical clinical symptoms of mania. They were delusional, they were euphoric, they were over confident, they had racing thoughts [and a] diminished need for sleep." In 2012, Coates published The Hour Between Dog and Wolf: Risk Taking, Gut Feelings and the Biology of Boom and Bust.

Keith Ambachtsheer Executive Director Rotman International Centre for Pension Management Keith Ambachtsheer is Director of the Rotman International Centre for Pension Management (ICPM), an Adjunct Professor of Finance, Academic Director of the Rotman-ICPM Board Effectiveness Program, and Publisher and Editor of the Rotman International Journal of Pension Management. His firm, KPA Advisory Services Ltd., has provided advice to governments, industry associations, pension-plan sponsors, foundations and other institutional investors since 1985. He is the co-founder of CEM Benchmarking Inc. which monitors the performance of 300 pensions worldwide. Keith has authored three books on pension management and has received numerous industry awards. Ambachtsheer is a four-time winner of the CFA Institute Financial Analysts Journal’s Graham and Dodd Scrolls (1979, 1985, 1987, and 1994). In 2003 he was named one of the 30 Most Influential People by Pensions and Investments, and in 2007 he was honored with the Outstanding Industry Contribution Award by Investments and Pensions Europe. In 2011, he received the CFA Institute’s Award for Professional Excellence. This award is presented periodically to a member of the investment profession whose exemplary achievement, excellence of practice, and true leadership have inspired and reflected honor upon the investment profession to the highest degree. Previous recipients include Martin Leibowitz, Jack Bogle, Charles D. Ellis, CFA, Warren Buffett, and Sir John Marks Templeton, CFA.

Bill Morneau Executive Chairman Morneau Shepell Bill Morneau is Executive Chairman of Morneau Shepell. Under his leadership, the firm has become the largest Canadian human resources services firm, with over 3000 employees. Bill is Chair of the Board of Directors at St. Michael’s Hospital in Toronto, and Chair of the Board of Directors at the C.D. Howe Institute. In May 2012, he was

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appointed by the Ontario Minister of Finance as Pension Investment Advisor, to lead in facilitating the pooling of public sector pension fund assets. Bill is also on the boards of AGF Management Ltd., the Canadian Merit Scholarship Foundation, The Learning Partnership, the London School of Economics North American Advisory Committee, the Canadian INSEAD Foundation, and Greenwood College. He is past Chair of the Board of Directors of Covenant House. In 2012, he co-authored a book, The Real Retirement, which is currently in bookstores across Canada. In 2002, he was named as one of Canada’s Top 40 Under 40. Bill holds a B.A. from Western University, an M.Sc. (Econ.) from the London School of Economics, and an M.B.A. from INSEAD.

James Davis, CFA Vice-President, Investment Planning & Economics Ontario Teachers’ Pension Plan James Davis is responsible for the fund's strategic investment planning, as well as recommending tactical risk management strategies and new asset classes for the fund. Mr. Davis joined Teachers' in 2006 and has more than 20 years’ experience in investment strategy and management. A CFA charterholder, Mr. Davis earned an MBA and B.Sc. from Dalhousie University.

Malcolm Hamilton Former Partner of Mercer Malcolm Hamilton is a former Partner of Mercer. He specializes in the design and funding of employee benefit plans in both the private and public sectors, with particular emphasis on registered pension and savings plans, unregistered pension plans, and retirement compensation arrangements. His clients include the Colleges of Applied Arts and Technology, the Ontario Teachers' Pension Plan, Ontario Power Generation, the Bank of Montreal and Manulife. Malcolm graduated from Queens University in 1972 as the Gold Medalist in Mathematics. He attended McGill as a National Research Council scholar, receiving his M.Sc. in 1975. He became a Fellow of the Canadian Institute of Actuaries and a Fellow of the Society of Actuaries in 1977. He is a frequent speaker at pension conferences

Janet Rabovsky Director, Investments Towers Watson Janet has been with Towers Watson since 2001 and regularly consults with clients on their DB and DC needs. In addition to working with clients, Janet is also part of the global private equity and infrastructure research teams. Prior to joining Towers Watson, Janet worked for the mutual fund company of a major chartered bank in Toronto where she was responsible for the development of a number of funds and portfolios, as well as manager selection and monitoring activities. Janet performed a similar function for a major public sector fund management corporation in Melbourne, Australia, though her focus was limited to Global equities at the time. Janet spent five years at an engineering firm and mining company performing various accounting, finance and pension related activities. Janet has a B.A. in English from the University of Toronto and an M.B.A. from the Schulich School of Business (York University).

Bob Litterman Chairman, Risk Committee

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Kepos Capital Bob Litterman is the Chairman of our Risk Committee and of our Academic Advisory Board. Prior to joining Kepos Capital in 2010, Bob enjoyed a 23-year career at Goldman, Sachs & Co., where he served in research, risk management, investments and thought leadership roles. He oversaw the Quantitative Investment Strategies Group, a portfolio management business formerly known as the Quantitative Equities and Quantitative Strategies groups, and Global Investment Strategies, an institutional investment research group. While at Goldman, Bob also spent six years as one of three external advisors to Singapore’s Government Investment Corporation (GIC). Bob was named a partner of Goldman Sachs in 1994 and became head of the firm-wide risk function; prior to that role, he was co-head of the Fixed Income Research and Model Development Group with Fischer Black. During his tenure at Goldman, Bob researched and published a number of groundbreaking papers in asset allocation and risk management. He is the co-developer of the Black-Litterman Global Asset Allocation Model, a key tool in investment management, and has co-authored books including The Practice of Risk Management and Modern Investment Management: An Equilibrium Approach (Wiley & Co.). Bob earned a Ph.D. in Economics from the University of Minnesota and a B.S. in Human Biology from Stanford University. He is also the inaugural recipient of the S. Donald Sussman Fellowship at MIT's Sloan School of Management and serves on a number of boards, including Commonfund, the Sloan Foundation and World Wildlife Fund.

Robert Cultraro, CFA Executive Chief Investment and Pension Officer Hydro One Robert has over twenty years of extensive experience in the investment industry, which includes investment research and fund management. Robert holds the Chartered Financial Analyst, Chartered Alternative Investment Analyst and the Certified Investment Manager designations. Robert is professionally affiliated with the CFA Institute, the CFA Society Toronto, the Chartered Alternative Investment Analyst Association, and is a Fellow of the Canadian Securities Institute. Robert is a member of the Investment Advisory Committee for the Office of the Public Guardian and Trustee and a member of the Investment Advisory Committee for the Pension Investment Association of Canada.

Julie Cays Chief Investment Officer Colleges of Applied Arts and Technology (CAAT) Pension Plan Julie Cays is the Chief Investment Officer at the Colleges of Applied Arts and Technology (CAAT) Pension Plan. She has extensive capital markets experience, having spent 16 years at CIBC. She was Vice President, External Managers at Healthcare of Ontario Pension Plan (HOOPP) until 2006 when she moved to CAAT to head the investment team in managing the $6.5 billion pension fund for the employees of the Ontario community colleges. Julie is the past Chair of the Board of the Pension Investment Association of Canada and is a member of the Investment Advisory Committee of the Financial Services Commission of Ontario. She received her degree in economics from the University of Waterloo and has her Chartered Financial Analyst designation.

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Avery Shenfeld Managing Director and Chief Economist CIBC Avery Shenfeld is Managing Director and Chief Economist of CIBC. He has been with CIBC since 1993 and is widely recognized as one of Canada’s leading economists for his perceptive analysis and insight on economic developments and their implications for financial markets. Mr. Shenfeld is a four-time winner of the Dow Jones Market Watch forecasting award and has received awards for forecast accuracy on the U.S. and Canadian economies by Bloomberg Markets. He has also been consistently ranked as one of the top Canadian economists by institutional investors. Mr. Shenfeld’s prior background includes experience in management consulting. He was on the economics faculty at the University of Toronto and in the summer program at Harvard’s John F. Kennedy School of Government. He has addressed numerous business groups and has been quoted in the media in the United States, Canada, Asia and Europe. Mr. Shenfeld holds a PhD in Economics from Harvard University.

Keith Ambachtsheer Director, Rotman International Centre for Pension Management

Rotman School of Management, University of Toronto April 24, 2013 - CFA Society Toronto Annual Pension Conference

Norway vs.Canada A Comparison of Investment Models

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Fiduciary mandate -> ‘for the sole benefit of...’

Strong governance and executive functions

Sensible investment beliefs

Right-scaled

Attract/retain top professional team

The Drucker Pension Organization

3

External Service Providers

NB Investment Management

Norges Bank

MPT Investment Model

Ministry of Finance

Norwegian Parliament

Norway Model – “Epistemic Proceduralism”

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Investment Results - OTPP vs. Norway Fund

OTPP Since 1990 OTPP Since 1998 Norway Fund Since 1998

Return of Fund* 9.95% 7.87% 4.23%

Return of Reference Portfolio 7.66% 6.01% 3.95%

EXCESS RETURN 2.29% 1.86% 0.28%

Average Management Cost 0.15% 0.20% 0.10%

NET EXCESS RETURN 2.14% 1.66% 0.18%

Tracking Error 3.01% 2.56% 0.80%

Information Ratio ** 0.70 0.63 0.23

* To Dec 31, 2010

** Net Excess Return / Tracking Error

Investment Results – OTPP vs. Norway Fund

5

“They own assets all over the world, including property in Manhattan,

utilities in Chile, international airports, and the high-speed rail line connecting

London to the Channel tunnel. They have taken part in six of the top 100

levered buyouts in history. They have won the attention of both Wall Street firms, who consider them rivals, and

institutional investors, who aspire to be like them.”

Excerpt from The Economist (“Maple Revolutionaries,” 3 March 2012)

© 2012 Towers Watson. All rights reserved.

Managing Pension Plans in Volatile Times

Janet Rabovsky Director

April 2013

© 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com 2

Plan sponsors have experienced three extreme market events in the

past decade

2001/2 – 95th percentile

2008 – 98th percentile

2011 – 95th percentile

Volatility has not been limited to equities – even bond markets have

been volatile since 2008!

Given the current environment and the prospect of continued market

volatility, what options do plan sponsors have?



60%

70%

80%

90%

100%

110%

120%

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

So

lven

cy F

un

ded

Rat

ioCanadian DB Pension Plans – Solvency Ratios

Strong stock markets in

Canada helped many

Canadian plans rebuild

their funded position

through the mid-2000s

Solvency was

approaching 95% to

100% for many

plans, before Euro

crisis of 2011

Partial recovery in 2004

Pension plans were

generally in healthy

shape in the late

1990’s in part due to

the tech bubble

Bursting of tech bubble

Financial/credit crisis

Solvency ratio

is 83% at

March 31,

2013

Solvency ratio

fell below 75%

in 2011


This presentation will review three main approaches that plan sponsors

can consider to help manage market volatility

Adopting a de-risking strategy

Managing extreme risks through thematic investing

Creating better diversity in the return seeking portfolio

The three approaches are NOT mutually exclusive and can be

combined


© 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. towerswatson.com

Journey planning

De-risking

5


Annuity

Purchase

Investment Strategy

Plan design

Many DB plan sponsors have already closed the plan to new entrants

Some have frozen DB accruals

Defined Benefit De-risking Is Not New

Over 50% of DB plan sponsors intend to further de-risk their investments in the next 12 months*

Few plan sponsors have opted to purchase annuities although a small fraction* are exploring this option

* 2012 Towers Watson DB Pension Risk Survey of 115 plan sponsors.


Initial asset-liability study usually forms the basis for developing short-

term and long-term goals and constraints

Preparedness — particularly for organizations with complex

governance requirements — and adaptability are key

Non-financial issues need

attention throughout the process

Developing a Journey Plan

Journey

Plan


60%

70%

80%

90%

100%

110%

120%

Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10

So

lven

cy F

un

ded

Rat

io

Developing a Journey Plan – Matching Desire With Ability

Bursting of tech bubble

Financial/credit crisis

When DESIRE to de-risk is highest, ABILITY to

de-risk is lowest, and vice-versa.

Often opportunities are lost before plan sponsor can react

Euro crisis continued


Journey Planning Many Paths to Plan Management

Frozen / Closed Plan Offer Bulk Lump

Sum to TV’s

Settle/transfer

Retiree Obligations

Current allocation

Reduce equity

risk

Reduce interest rate risk

Goal

Path B

Path C

As

se

t S

trate

gie

s

Benefit Strategies

Risk

Ris

k

Settle/Manage Remaining Obligations

There are many paths an organization can follow to reach the stated goal

Current

Path A

Alt.

Goal

Path D

Open Plan


Thematic responses

Extreme Risks

10


Macro Factors: Initial Framework 2008

Economic

imbalances

1. Rebalancing & deleveraging Consumption, savings and portfolio preferences alter

2. Financial repression & safety Misallocation of capital reduces returns, increases volatility

Adverse

demography

3. Population growth Strain on agricultural and water resources

4. Ageing Winners and losers at the stock and economic level

Degradation of

natural capital

5. Resource scarcity Resource price inflation and innovation

6. Climate change Externalities and mitigation equal winner and losers

Innovation and

technology

7. Globalization Inequality bad for political stability and potential growth

8. New technology Transformational new technologies will come on stream

Business

shake up

9. Sustainable business models Proper inclusion of ESG, adaption and capital efficiency

10.Labour and capital relations Create a workforce equipped for new environment

Government 11.Regulation Good or bad regulation will create winners and losers

12.Inter-generational equity Public finances will come under pressure to adapt

11


Extreme Risks 2011 – Ranking and Sample Hedges

12

* Our subjective measure based on the impact, the risk, and the degree of uncertainty in assessing the risk level

Risk ranking* as at 30 June 2011

Rank Risk Description Possible hedge

1 Depression Debt-deflation trap; falling growth and

incomes

Globally-diversified long-dated Sovereign nominal bonds

2 Sovereign default Default by a major developed country on its

debt

Country insurance (eg CDS)

3 Hyperinflation Extremely high inflation Real assets eg gold, globally-diversified inflation-linked bonds

4 Banking crisis Balance sheets can’t absorb another shock Nominal sovereign bonds (medium duration)

5 Currency crisis Extreme movement between floating rates Gold; foreign assets

6 Climate change Diversion of capital to mitigation uses No general hedge

7 Political crisis Rise in power of extremist groups No obvious hedge

8 Insurance crisis Insolvency within insurance sector Nominal sovereign bonds (medium duration) short insurance

equity

9 Protectionism Reversal of movement towards free trade No general hedge

10 Euro break-up At least one member leaves the Euro Long Germany (hedged)

11 Resource scarcity Peak “stuff” Depends on which resource

12 Major war A major global conflict Long neutral countries

13 End of fiat money Return to a gold standard Gold

14 Infrastructure

failure

(Temporary) interruption of grid / networks Tinned food, bottled water, guns & ammunition

15 Killer pandemic Contagious disease with very high mortality Long pharmaceutical equities, short airline equities


Transformational Changes - 2013

Transformation Economic imbalances

Adverse demography

Degradation of natural

capital

Innovation and

technology

Business shake up

Government

13


Portfolio Construction: Responding to Change

Bulk beta Alpha Smart beta

Equities

Sovereign bonds

Corporate bonds

Classic active management

Skill in alternatives

Thematic

Diversifying

Systematic Tactical

asset allocation

Portfolio construction skill

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Sample Smart Betas

Emerging wealth Sustainability

Value-weighted equity indices

Risk-weighted equity indices

Screened credit

Currency carry Volatility Trend

Demographics

Systematic

Thematic

Secure income alternatives

Core infrastructure

Enhanced commodities

Multi-strategy

alternative credit Reinsurance Agriculture

Diversifying

15


Portfolio Construction

Creating Diversity

16


Portfolio Construction: Return Driver Approach

Stage 1:

ALM/LDI

Stage 2:

Portfolio

Construction

Stage 3:

Implementation

Manager selection and monitoring

Liability-matching

Physical Bonds

Return-seeking

Equity

Asset Allocation Supporting Objectives

Illiquidity

Credit Duration

Insurance

Skill

Term

Credit

Currency

Inflation

Derivative

Instruments

Curve/ Convexity

Inflation

17


Return Drivers

18

Risk premium Investors are rewarded for bearing the risk of:

Equity Being lower down the capital structure in the event of

corporate default

Credit Corporate bond issuers defaulting on their bond obligations

Illiquidity Holding an asset that cannot be quickly or cheaply sold

Insurance Providing protection against extreme losses

Term The uncertain return and mark-to-market volatility of an index-

linked bond compared to holding cash

Inflation Inflation being higher than anticipated and therefore reducing

real returns on fixed-interest bonds

Currency The risk that the purchasing power of the currency falls due to

a currency crisis

Skill A manager, previously considered skilful, underperforming its

benchmark


Creating Diversity: Potential Risk and Return Drivers

.

Government bonds

Return Drivers

Cash Alternative

credit Corporate

bonds

Equities

Hedge funds

Private markets beta

Private markets alpha

Currency Commodities Insurance Volatility

Equity risk premium

Credit risk premium

Illiquidity risk premium

Insurance risk premium

Term risk premium

Inflation risk premium

Currency risk premium

Skill risk premium

Multiple Risk Premiums

Asset Classes

19


Adding Diversity……

Approaches that change the way risk and return

premiums are earned.

Exposure to different stages of a company’s life

cycle (private equity, high yield, emerging

markets, leveraged loans)

Change in ratio of skill to market exposure

Examples include:

Global Tactical Asset Allocation

Hedge Funds

“Alternative betas”, including non-market

capitalization weighted equity and beta

strategies that look to access certain market risk

factors.

Multi-strategy alternative credit

Multi-asset strategies

Assets that change the economic exposure of the

portfolio, as well as the mix of risk and return

premia

Examples include:

Real estate (direct and listed)

Infrastructure

Timberland

Agriculture

Commodities

Diversity: Strategic Asset Allocation Diversity: Implementation Approaches

There are two broad ways to access alternative forms of risk premia and / or add diversity to a traditional portfolio:

20


Diversifying Return Drivers

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Passive Global Equity Current Portfolio Long-Only DiversifiedPortfolio

Liquid, Diversified Portfolio Current Model Portfolio

Public Market Equities Credit Strategies Alternative Betas Hedge Funds Private Markets Investment Grade FI Cash

Passive Global

EquityCurrent Portfolio

Long-Only

Diversified

Portfolio

Liquid, Diversified

Portfolio

Current Model

Portfolio

Public Market Equities 100% 99% 70% 50% 34%

Non-US Developed 40.0% 22.2% 22.2% 18.3% 10.5%

US Large Cap 40.4% 47.7% 29.4% 18.3% 10.5%

US Small Cap 7.1% 20.7% 10.0% 5.0% 3.0%

Emerging Markets 12.5% 8.7% 8.7% 8.7% 10.0%

Credit Strategies 0% 0% 15% 15% 15%

Alternative Betas 0% 0% 4% 9% 9%

Hedge Funds 0% 0% 0% 15% 15%

Private Markets 0% 1% 11% 11% 24%

Investment Grade FI 0% 0% 0% 0% 0%

Cash 0% 0% 0% 0% 3%

21


Creating Diversity – Improving Outcomes

Passive Global

EquityCurrent Portfolio

Long-Only

Diversified

Portfolio

Liquid, Diversified

Portfolio

Current Model

Portfolio

7.0% 7.2% 6.9% 6.2% 6.5%

18.2% 19.0% 14.2% 11.1% 9.6%

7.5% 7.5% 7.5% 7.2% 7.5%

13.9% 14.5% 11.0% 8.7% 7.5%

6.7% 7.0% 7.1% 6.8% 7.1%

15.2% 15.9% 11.9% 9.4% 8.1%

(433.8) (452.3) (309.5) (225.0) (173.0)

4.2% 4.5% 4.7% 4.3% 4.7%

15.0% 15.7% 11.8% 9.3% 8.0%

0.28 0.29 0.39 0.47 0.58

* Downside Risk is measured as Conditional Value at Risk (CVaR95). CVaR95 is the average of the lowest 5% of results.

Absolute Return

Year 1 exp. return

Standard deviation

Year 10 exp. return

Standard deviation

Downside Risk*

Ten year exp. return - annualized

Standard deviation (%pa)

Return vs. Cash

Ten year exp. Return - annualized

Tracking error (%pa)

Information Ratio

-10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Equity Credit Illiquidity Insurance Term/Inflation Currency Skill

Passive Global Equity Long-Only Diversified Portfolio Liquid, Diversified Portfolio Current Model Portfolio

Attribution of Return

22


Monitoring Macro Risk Exposures

X = Has less exposure than the Benchmark

X = Has greater exposure than the Benchmark

Note: Shaded areas represent changes from last quarter. Grey represents less exposure, yellow represents more.

Man

ag

er

A

Man

ag

er

B

Man

ag

er

C

Man

ag

er

D

Man

ag

er

E

Man

ag

er

F

Man

ag

er

G

Man

ag

er

H

Man

ag

er

I

Man

ag

er

J

Man

ag

er

K

Man

ag

er

L

Long Bond Yields Decrease X

Corporate Spreads Widen X X

Consumer Spending Weakness X X X X X X X

Banking Sector Issues X X X X X X X X X

Global Inflation X X

Continued Japanese Deflation X X X

Euro Break-Up X X X X X X X

Base Metal Price Decreases X X X X X

Oil Price Decreases X X X X X X

Emerging Markets Slowdown X X X X X

Global Recession X X X X X X X X X

Poor Quality Rally (poor relative

performance during junk rally) X X X X X X X X


Bringing It Altogether

24


Bringing It Altogether

Portfolio Strategy Options

1. Risk identification

Defining financial framework within which plan needs to be run. Understanding fiduciary and sponsor constraints

Develop a Journey Plan to reduce the overall impact of the Pension Plan on the Plan Sponsor

2. Risk reduction

Sponsors have a non-uniform utility to risk and reward – more surplus has a diminishing value whereas more loss is increasingly painful

De-risk by increasing your allocation to liability matching assets, and/or

Purchase sufficient protection against severe outcomes (when it is cost-effective to do so)

Diversify the drivers of return

3. Risk mitigation

Ensuring that the sponsor doesn’t have too much exposure to things that can hurt them when they can least afford it

Building more diverse portfolios with better balance between exposures

Dynamic asset allocation (reserved for high governance organizations)

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Contact Details

Janet Rabovsky, MBA

Tel: 416.960.7089

Email: [email protected]

26


Disclaimer

This document was prepared for general information purposes only and should not be considered a substitute for specific professional advice. In particular, its contents are not intended by Towers Watson to be construed as the provision of investment, legal, accounting, tax or other professional advice or recommendations of any kind, or to form the basis of any decision to do or to refrain from doing anything. As such, this document should not be relied upon for investment or other financial decisions and no such decisions should be taken on the basis of its contents without seeking specific advice. This document is based on information available to Towers Watson at the date of issue, and takes no account of subsequent developments after that date. In addition, past performance is not indicative of future results. In producing this document Towers Watson has relied upon the accuracy and completeness of certain data and information obtained from third parties. This document may not be reproduced or distributed to any other party, whether in whole or in part, without Towers Watson’s prior written permission, except as may be required by law. In the absence of its express written permission to the contrary, Towers Watson and its affiliates and their respective directors, officers and employees accept no responsibility and will not be liable for any consequences howsoever arising from any use of or reliance on the contents of this document including any opinions expressed herein.

Copyright © 2012 Towers Watson. All rights reserved.

LDI in a Low Yield Environment

2013 Annual Pension Conference CFA Society Toronto – April 24, 2013

James Davis, CFA Vice-President, Strategy and Asset Mix & Chief Economist Asset Mix & Risk Department

2 What do we mean by LDI?

In a perfect world we would:

Fully hedge all the risks inherent in our liabilities

Construct the optimal Sharpe ratio portfolio

Employ leverage to earn the highest rate of return

LIABILITY HEDGE PORTFOLIO (LHP)

PROFIT SEEKING PORTFOLIO (PSP)

Manage risk of liabilities, e.g., real rate sensitivity, inflation

Earn the real rate of return required to meet liabilities

Assets Liabilities

3

But Teachers’ doesn’t live in a perfect world!

4 Fast Facts about Teachers’

Largest single-profession (DB) plan in Canada; membership of 372,000 current, former and retired teachers (and their survivors)

Jointly sponsored by the Ontario government and Ontario Teachers’ Federation

Plan benefits are indexed to inflation (Conditional inflation protection for benefits accrued post 2009)

Need to file a balanced funding valuation at least once every three years

Requires a real return of about 5% pa to have a fully funded plan in 20 years

C$129.5 billion in net assets (2012)

200 investment professionals; investments well diversified globally, across various asset classes

Strong performance-driven, incentive-based culture

10.1% average rate of return and annualized value added over benchmarks of 2.2% since 1990

5 Plan demographics are impacting our investment decisions

1. Teachers are living longer and collecting pension benefits longer

2. Teachers contribute for a shorter period than they collect benefits

3. The plan is mature and will mature further

1970 1990 2012

Expected Credit at Retirement (years) 27 29 26

Expected Years on Pension 20 25 31

Active Teachers

Per Retiree

Average Contribution Rate 5.2% 8.0% 11.0%

Increase in Contribution Rate for 10% Loss on

Assets 0.6% 1.9% 4.7%

10:1 4:1 1.5:1

6 Our plan maturity makes us sensitive to the path of returns

40

60

80

100

120

2011 2015 2019 2023 2027 2031

Funding Ratio

68%

100%

Shuffled path

Return Index

0

50

100

150

200

250

300

2011 2016 2021 2026 2031

Source: Cardano, OTPP

Two paths for asset returns providing the same geometric rate of return:

Blue: Assumes actual path of MSCI returns from 1990 – 2010 is repeated

Red: Assumes four annual MSCI returns are swapped to produce early losses

OTPP is sensitive to the pattern of returns

Our funding ratio is worse if the losses occur up-front

Same starting

point

Same ending point

Same starting

point

Different ending points

Actual path

7

Benefits

Contributions

Return

Our LDI objective is a sustainable balanced plan

What a balanced plan means for us?

Earning a return high enough to ensure plan sustainability; and

Maintaining stability of benefits and contribution rates at their target levels

8 LDI means balancing short- and long-term investment horizons

Source: Bloomberg, OTPP Asset Liability Model

Risk Contribution To Liabilities*

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1 5 9 13 17 21 25 29 33 37 41 45 49

Investment Horizon (years)

Change in real yield Level of real yield Inflation

* Assuming no longevity risk* Proxied by Canadian RRBs; does not consider Plan’s demographics.

9 We cannot fully hedge our real interest rate exposure

DRIVERS:

Correlation with Plan liabilities

Risk tolerance

Level of real yields

Best hedging asset is Canadian RRBs

CONSTRAINTS:

Insufficient supply

Counterparty risk if derivatives are used

Liquidity usage

Source: OTPP

Liability DV01

REAL RETURN BONDS

Asset DV01

NOMINAL BONDS

MISMATCH TO LIABILITY DV01

10 Nominal bonds are becoming less helpful for our Plan as yields move lower

3-Year Reward/Risk for

Long Canada Nominal Bonds

3-Year Correlation Between Canadian

Nominal and Real Return Bonds

Starting yield Starting yield Higher Lower Higher Lower

Source: OTPP Asset Liability Model

11 To meet our LDI objective, we must rely on the investment attributes of a broad spectrum of assets

Key desirable asset attributes: Provide potential as a source of diversified value add

Provide stable returns

Provide long-term inflation adjusted growth

Generate cash flow

Mitigate real rate sensitivity of liabilities

Mitigate inflation sensitivity of assets or allow inflation pass-through

Facilitate leveraging

Provide reliable source of liquidity when required

LHP PSP

0

Real Return Bonds

TIPS

Nominal Cdn Bonds

DM Sovereign

Bonds

Regulated Infrastructure

Core Real Estate

Timberlands

IG Corporate Bonds

GDP-Driven Infrastructure Equities

Commodities

Long-term Equities

Absolute Return

Strategies

Private Capital

EM Sovereign

Bonds

Dividend Equities

HY Corporate

Bonds

12 Asset classes behave differently in different economic environments; our asset allocation is dynamic

Economic Regime Map

High growth / Low inflation

High growth / High inflation

Low growth / High inflation

Low growth / Low inflation

GDP Growth

CPI Inflation

Equities

Corporate Bonds

EM Debt

Commodities

Inflation-Sensitive Equities

Real Estate

Growth Infrastructure

Nominal Bonds TIPS / RRBs

Gold / Precious Metals

Regulated Infrastructure

13 Our Asset-Liability Model allows us to do “what-if” scenarios …

18% 20% 22% 24% 26% 28% 30% 32% Increasing Worst Case Contribution Rate

Asset Mix #1 in normal environment (equilibrium)

Asset Mix #1 in low yield

environment

WORST: Higher Worst-Case Contribution Rate

Higher Average Contribution Rate

BEST: Lower Worst-Case Contribution Rate Lower Average Contribution Rate

Dec

linin

g A

vera

ge

Co

ntr

ibu

tio

n R

ate

RISK

REW

AR

D

A low yielding regime is detrimental to our goal of stability and sustainability

14 … and to identify better asset mixes to improve our reward-risk tradeoff


Asset Mix #1 in normal environment (equilibrium)

Asset Mix #1 in low yield

environment




Dec

linin

g A

vera

ge

Co

ntr

ibu

tio

n R

ate

RISK

REW

AR

D

Asset Mix #2, #3 and #4 in low yield

environment Our objective is to move

to the upper left by improving our asset mix

A low yielding regime is detrimental to our goal of stability and sustainability

15 Five reasons why the current low yield environment could be with us longer than we would like

1. Historical precedent

2. Low rates are necessary

3. Demographics

4. De-risking and risk management Risk parity / Bonds as insurance

LDI

5. Policy induced regime changes Deflation

Financial repression

#

#

#

#

#

16

Historical US 10-year Real Yields*

*Breakeven inflation is proxied by 10-year moving average of

realized inflation.

Source: OTPP, Global Financial Data

#1: There is a historical precedent for lower yields

Historical US 10-year Nominal Yields

+ s

Post WW II

Great

Depression

Post WW II

- s

+ s

- s

WW I

17 #2: Low yields are justified by current conditions

Source: Federal Reserve, Bloomberg, OTPP

US Monetary Aggregates

$ Billion

Money Supply: M2 to M0 (Ratio)

M0 (R)

Ratio of M2 to M0

18 #3: Demographic trends support lower yields

US Labor Force Participation Rate

US Real Yields and Demographics

(from 1981 to 2012)

%

%

Source: OTPP, BLS, Global Insight

19

Correlation Between US Stock and Bond Returns

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

87 89 91 93 95 97 99 01 03 05 07 09

Historical Correlation

3

4

5

6

7

8

9

Percent

Rolling 5-yr Correlation

10-yr Bond Yield (RHS)

#4: Nominal bonds are a good tail risk hedge even at low yields

ρ = -0.67

Source: Global Financial Database, Global Insight, Shiller, OTPP

Shiller P/E vs. 10-year Bond Yields

Less Diversification

More Diversification

0

5

10

15

20

25

30

35

40

45

50

2 4 6 8 10 12 14 16

US 10-Year Yield, percent

Shiller P/E

ρ = +0.82

20 #4: Many DB plans are waiting to de-risk

Source: Morgan Stanley

Funding Ratio Sensitivity Analysis

21 #5: Two different macro economic regimes can lead to yields remaining low or even heading lower

Economic Regime Map

GDP Growth

CPI Inflation

Nominal yield > Nominal GDP

Inflation < target

Arises from a policy mistake, e.g., austerity

Nominal yield < Nominal GDP

Inflation > target

Arises from a deliberate policy choice, e.g., inflate away debt

2. FINANCIAL REPRESSION

1. DEFLATION

22 Deflation: Two historical examples

Source: Global Financial Data, DataInsight

Yields too high relative to GDP

Very low inflation

Yields too high relative to GDP

Very low inflation

23 Deflation: Our simulated scenario reflects a sustained period of extremely low yields


Initial BE

In normalization, breakeven increases

In deflation, breakeven decreases

24 Deflation: Even with such low yields, bonds are the favored asset class


Simulated Asset Class Real Returns Policy Asset Mix Under Different Scenarios

25 Financial Repression: The US experienced financial repression post WWII

Source: Global Financial Data, CBO

Yields too low

relative to GDP

High inflation

%

%

US Debt-to-GDP

US Financial Repression

(1946-1952)

Due to financial repression, debt

declined by 3-4% of GDP per year.

26 Financial Repression: Our simulated scenario reflects a sustained period of extremely low yields


Initial BE

In normalization, breakeven increases

In financial repression, breakeven increases

even more

27 Financial Repression: Higher inflation and moderate growth favor commodities and real assets

Simulated Asset Class Real Returns


Policy Asset Mix Under Different Scenarios

28 In both low yield scenarios, our expected returns fall short of what we require to meet our liabilities


Real Yield

at t=10 -1.3% 0.5% 2.2%

Smaller Gap

Gap

29 Improving the asset mix will help but will not likely be sufficient if these scenarios come to pass


Asset Mix in normal

environment

Asset Mix in deflation




Dec

linin

g A

vera

ge

Co

ntr

ibu

tio

n R

ate

RISK

REW

AR

D

Improved Asset Mix in deflation

Asset Mix in financial repression

Improved Asset Mix in financial repression

30 Our base case assumptions favor normalization as the more likely scenario

Simulated Paths for US 10-Year Nominal Yield

Risk scenarios

Most likely

31 Some positive signs: De-leveraging is progressing and policy makers have made credible decisions … so far

Vows not to repeat the

mistakes of the 1930s Whatever it

takes Pace of austerity

must depend on

economic conditions

Committed to stop

deflation

32 Key takeaways

Plan demographics and market constraints pose significant challenges

Our liabilities are large and are very sensitive to real rates

Our plan maturity makes us increasingly less tolerant of volatility

Our LDI objectives of stability and sustainability become more difficult to achieve in a low yield environment

There are several reasons why yields could remain low

Different low yielding environments necessitate very different asset mix responses:

Deflation favors bonds or assets generating high quality cash flows

Financial repression favors real assets and commodities

Ultimately, an investment solution may not be adequate and plan design changes may be required

33

James Davis, CFA Vice President, Strategy & Asset Mix and Chief Economist Asset Mix & Risk, Ontario Teachers’ Pension Plan

Q & A

Bill Morneau, Executive Chairman, Morneau Shepell

Pooling of Public Sector Asset Management

CFA Pension Conference, April 24, 2013, 1:00 pm

Morneau Shepell 2

Agenda

• Defined benefit pension plans in context

• The government pension challenge

• The case for pooling BPS pension assets

• Project overview:

- Facilitating pooled asset management for Ontario’s public sector institutions

• Implementation challenges

Morneau Shepell 3

Defined benefits pension plans in context

• Canadian retirement income security is a success story

Morneau Shepell 4

Defined benefits pension plans in context

• Defined benefit pension plans are in secular decline

• Federal efforts in retirement emphasize personal responsibility

Morneau Shepell 5

The government pension challenge

• The private sector/public sector pension divide will widen

• Solvency deficits will likely persist in the medium term

• Healthcare costs will force continued government restraint efforts

• To facilitate negotiation, “No stone left unturned” will need to be the government mantra

Morneau Shepell 6

The case for pooling Broader Public Sector pension assets

• Government needs to better understand the pension situation

• There is clearly a case for cost-efficiency

• Alternative asset classes are difficult to cost-effectively source and manage

• Other cost-efficiency approaches, such as administration opportunities, or plan mergers, are more difficult

Morneau Shepell 7

Project overview: Facilitating pooled asset management for Ontario's public sector institutions

• “The government intends to introduce framework legislation in the fall of 2012 that would pool investment management functions of smaller public-sector pension plans in Ontario… The government will appoint an advisor to develop the framework, working with affected stakeholders and building on Ontario’s internationally-recognized model for pension plan management.”

– 2012 Ontario Budget, page 79. March 27, 2012

Morneau Shepell 8


• Process:

• More than 40 consultations and numerous written submissions were considered - Broader public-sector pension and investment

fund administrators - Representatives of broader public sector labour

groups - Current and former leaders of large pension and

investment funds - Representatives of Ontario’s investment

management community

Morneau Shepell 9


• Financial review:

• Pooling would support investment management savings for participating institutions - Once fully implemented, pooling could save

participating institutions $82 million to $130 million annually

- Pooling could also enhance returns by supporting greater diversification and improved risk management

- Government would provide start-up funding of $50 million over a three year period, to be recovered from the new entity

Morneau Shepell 10


• Key recommendation:

• A new, independent Corporate entity should be established to manage pooled investments on behalf of participating institutions

- Asset allocation decisions would remain the responsibility of participating institutions

- The Board of Directors would be self-regenerating, and feature six independent professional and five representative members

Morneau Shepell 11


• Key recommendation:

• Legislation would compel the participation of selected broader public sector pension plans

- Total assets under management of up to $100 billion

- Defined contribution and supplemental plans, as well as endowment funds could invest on a voluntary basis

- Participating institutions would be permitted to withdraw after a cooling-off period

Morneau Shepell 12

Implementation challenges

• Financial benefits from pooling will be unevenly distributed, at least initially

• Mandating participation presents legitimate concerns

• Time to fully establish the new entity is at least three years

Thank You

Bill Morneau Morneau Shepell

1

Bob Litterman Prepared for CFA Society Toronto

April 24, 2013

The Price of Climate Risk

2

Is Climate Change Real?

3

Is Uncertainty About Climate Change Real?

4

Is a Devastating Natural Disaster Outside the Realm of Possibility?

5

When…Where…or How?

6

Does it Matter How High we Fill this Reservoir?

7

Should Adding Emissions to the Atmosphere be Priced

Appropriately?

8

What is the Appropriate Price for Carbon Emissions?

9

The Reservoir – The Lake – The Flood

The Johnstown Flood

11

The Aftermath

13

Think about dynamic optimization

With Uncertainty, Tipping Points And Nonlinear Responses

14

Where should climate risk be priced?

There are 2 kinds of risk:

High risk aversion

Low risk aversion

Zero

The price of climate risk today

Non-diversifiable

Risk

Diversifiable risk Expected damage

risk

premium

The Equity Risk Premium US Historical Real Returns

Data are from http://www.econ.yale.edu/~shiller/data.htm

ERP = 4.75%

Stock real return = 6.4%

Bond real return = 1.6%

A consistent 475 basis points per year for the last 140 years

Equities pay off primarily in good states of nature

Consider a portfolio that pays off in bad states of nature

Data are from http://www.econ.yale.edu/~shiller/data.htm

16

An equally risky portfolio

long bonds and short equities earns

-310 basis points

17

What does the Equity Risk Premium have

to do with Pricing Climate Risk?

Pricing carbon emissions is a risk management

problem involving trade-offs between consumption

today and potential bad outcomes in the distant

future

This trade-off depends crucially on the degree

of societal risk aversion

Societal risk aversion can be calibrated to the

equity risk premium

18

Economic impacts depend on future

temperatures which are very uncertain

Science: 25 March 2012

Climate modelers generally use a low curvature in

the context of a standard CRRA utility function

Counter to intuition, in the standard utility function increasing the

risk aversion makes curbing emissions less urgent

Higher curvature has two impacts:

1) it increases the risk premium, but

2) it also increases the risk free discount rate

The second impact dominates and causes the price to decrease

Lord Nicholas Stern, for example, set a

degree of curvature that implies an

equity risk premium of around 12 basis

points,

more than 30 times too low relative to

observed risk premia

19

Estimates of the social cost of carbon

from Anthoff, Tol, and Yohe (2009)

emissions

prices

Increasing risk aversion Why???

Higher curvature across states of

nature is required to fit the very

significant equity risk premiums

that we observe in the market

While lower intertemporal curvature

is required to fit the relatively

low risk free rates

that we observe in the market

Risk aversion Intertemporal substitution

20

Epstein-Zin utility can be calibrated to both

high risk premia and low interest rates

consumption ( time, states of nature ) consumption ( time, states of nature )

u

t

i

l

i

t

y

u

t

i

l

i

t

y

The rigidity of standard utility functions explains

why in most climate models increased

risk aversion lowers the price of emissions

21

22

Higher societal risk aversion shifts the

appropriate emissions price path upward

Increasing risk aversion

23

One cost of delay is higher future emissions prices

Another is increased risk of catastrophic outcomes

24

Bad news

Good news

The resolution of uncertainty about risk will impact prices over time

as will surprises in the development of new mitigation technology

Emissions prices should be expected to fluctuate

Optimal climate policy should be sensitive

to the potential for bad outcomes in the lower tail

25

cost today

expected

bad draw

26

We implore you to support the European Union’s innovative efforts to place a price

on carbon.

Addressing emissions in this sector by negotiating a global pricing system through

the International Civil Aviation Organization (ICAO) would send an important signal

that carbon pricing is an effective way to correct a major market failure—the

growing concentration of greenhouse gases in the atmosphere.

…Because emissions are not priced, the world is wastefully using up a scarce

resource, the earth’s ability to safely absorb greenhouse gas emissions. We are

also failing to make appropriate investments in capital that would reduce future

greenhouse gas emissions. Our selfish inaction pushes increased costs onto

future generations, and dangerously increases the probability of extreme

events with major impacts on their welfare…

Economists Speak Out

On March 14, 2012 six Nobel laureates, and 20 other leading

economists wrote to President Obama as follows:

http://www.worldwildlife.org/who/media/press/2012/WWFPresitem27292.html

Kenneth Arrow, William Sharpe, Eric Maskin,

Thomas Sargent, Christopher Sims, Joe Stiglitz,…

27

“I think a global carbon tax is blindingly obvious and should have been

introduced 15 years ago, and that would have been completely fair.

Every single airline in the world would have been treated in the same

way.

As an airline owner, I’m sure I’ll get told off when I get home – but ideally

there should be a fair global tax with everybody taking a little bit of pain.

It’s not massive.

And if that happened, we would get on top of the problem.”

At least one airline executive agrees:

Sir Richard Branson, Chairman of Virgin Airlines, speaking at

a State Department Conference, April 26, 2012:

Waiting on the World to Change

By Avery Shenfeld, Chief Economist & Managing Director

April 2013

| 2

Canadian Household Savings Rate

Source: Statistics Canada, CIBC

0

5

10

15

20

25

81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11

%

| 3

Pensions: Fewer Covered, Less Certainty

Workers Covered by

Registered Pension Plans

31

32

33

34

35

36

37

38

92 94 96 98 00 02 04 06 08 10

% of workforce

Source: Statistics Canada, CIBC

0

5

10

15

20

25

30

35

92 02 11

Workers Covered by

Defined Benefit

Registered Pension Plans

% of workforce

| 4

Share of Canadians Facing 20% or More Drop in Living Standards on Retirement

0%

10%

20%

30%

40%

50%

60%

1940-1

944

1945-1

949

1950-1

954

1955-1

959

1960-1

964

1965-1

969

1970-1

974

1975-1

979

1980-1

984

1985-1

989

Birth Cohort

| 5

World GDP Growth: No Pick-up Until 2014

-2

0

2

4

6

8

10

12

2010A 2011A 2012E 2013E 2014E

Eurozone US China World

% chg

| 6

Fiscal Tightening Weighs on Global Growth (R) Little Room for Monetary Policy Offset (L)

0

1

2

3

4

5

6

Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12

%Global Monetary Policy Index

(Developed Economies)

Source: Central Bank News

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2009 2010 2011 2012 2013

Source: IMF, CIBC

Change in Cyclically Adj. Deficit

Advanced Economies (% of GDP)

| 7

Italy, Spain Fail to Boost Competitiveness

Source: Eurostat

-15%

-10%

-5%

0%

5%

10%

Ger Ita Spa Ire Por Gre

Chg (past year)

Chg (since 2008)

Labour costs per hour in euro

| 8

China: Not As Much Gain Where it Counts As Resource Imports Still Lackluster

-35

-30

-25

-20

-15

-10

-5

0

5

Lumber Crude Oil Unwrought

Copper &

Products

y/y % chg in China's import volumes from all countries

Note: two-month averages to smooth New Year's

distortions

Source: Markit, HSBC, Bloomberg, CIBC

-5

0

5

10

15

20

25

30

35

40

Jan-11Jun-11Nov-11Apr-12Sep-12Feb-13

46

47

48

49

50

51

52

53

54

55

China Imports (L)

China PMI (R )

Yr/Yr Index

| 9

Not the China of a Decade Ago

Source: CEIC

32

34

36

38

40

42

44

46

48

50

52

95:Q3 98:Q1 00:Q3 03:Q1 05:Q3 08:Q1 10:Q3 13:Q1

Industrial (L) Services (L )

% of GDP

Note: 4-qtr moving averages

| 10

Fiscal Drag Delays US Acceleration

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

No fiscal drag CIBC base case Full fiscal cliff

2013 US GDP growth forecasts

| 11

Low US Interest Rates Are Finally Seeing Results

Source: Fannie Mae, MBA, Bloomberg, CIBC

0

500

1000

1500

2000

2500

Q1-1

990

Q3-1

992

Q1-1

995

Q3-1

997

Q1-2

000

Q3-2

002

Q1-2

005

Q3-2

007

Q1-2

010

Q3-2

012

Housing Starts (thousands)

70

80

90

100

110

120

Jan-0

5

Apr-

06

Jul-

07

Oct-

08

Jan-1

0

Apr-

11

Jul-

12

Housing-related sales*

Other (ex-gasoline)

US Retail Spending (Nov'07 = 100)

*furnishing, appliances & building materials

| 12

Canada No Longer Outpacing US; Bank of Canada On Hold Until 2015

2013 2014

US 2.0% 3.2%

Canada 1.5% 2.4%

| 13

A Key Ingredient to the US Crash Missing Here

Non-Conforming

Mortgages as a Share of

Total Outstanding

0

5

10

15

20

25

Canada 2012 US 2006

%

0

20

40

60

80

100

120

Jun-0

6

Dec-0

6

Jun-0

7

Dec-0

7

Jun-0

8

Dec-0

8

Jun-0

9

Dec-0

9

Jun-1

0

Dec-1

0

Jun-1

1

Dec-1

1

Jun-1

2

C ities with above avg non-conformingexposure

Cities with below avg non-conformingexposure

Index June 2006=100

| 14

Credit Score Trend Not Threatening to Banks

Current

Good

Risky

Highly

risky

Very

GoodModerate

Source: Equifax, CIBC

2008

Good

Risky

Highly

risky

Very

Good

Moderate

| 15

Limited Fuel for Consumption

Stagnating Income

26,400

26,800

27,200

27,600

28,000

28,400

11Q

1

11Q

2

11Q

3

11Q

4

12Q

1

12Q

2

12Q

3

12Q

4

Real household

disposable income

per capita ($)

Consumer Credit

36

38

40

42

44

46

48

05 06 07 08 09 10 11 12

% of hdi

Source: Statistics Canada

| 16

Canada: Building Fewer Houses/Condos Swamps Energy Sector Rebound

-0.1%

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

0.7%

Energy Production Housing

2012 2013

Contribution to GDP (%-pts)

+0.2%

-0.5%

| 17

Canada’s Firms Less Eager to Invest (L) While US Firms Ramp Up (R)

-20%

-15%

-10%

-5%

0%

5%

10%

15%

2005

2007

2009

2011

2013

plan

Canada: growth in business capital

spending

40

50

60

70

80

Jan-

2006

May

-200

7

Sep

-200

8

Jan-

2010

May

-201

1

Sep

-201

2

US non-defense capital goods

ex-aircraft orders (US$ bns)

| 18 Source: Bloomberg, CIBC

Average

2012 2013 (f) 2014 (f)

Oil (WTI) $/bbl 94 93 98

Natural Gas $/Mn Btu 2.75 3.50 3.75

Gold $/troy oz 1657* 1400* 1200*

Copper $/lb 3.62 3.50 4.00

Lumber** $/'000 bd ft 287 410 435

Potash $/tonne 430 430 450

* end of period **1st Futures

Cyclical Commodities Await 2014

| 19

Cost of Bottlenecks to Remain High Even After Recent Spread Improvements

0

5

10

15

20

25

30

35

40

23-A

ug

11-S

ep

28-S

ep

17-O

ct

5-N

ov

22-N

ov

11-D

ec

28-D

ec

16-J

an

4-F

eb

21-F

eb

12-M

ar

29-M

ar

$Bn annualized, 30 day mov. avg

Note: Revenue loss based on

"normal" WTI premium of $2/bbl vs

Brent and $17/bbl discount of

Western Canada Select to WTI

$15.2 bn

$16.5 bn

2014 2015

Projected

Source: NEB, Bloomberg, CIBC

| 20 Source: US Department of Energy

Shale Oil Revolution Shifts the US Supply Curve (L); Import Share of US Market % (R)

0

1

2

3

4

5

6

7

8

1990 1995 2000 2005 2010 2015

Shale/Other Tight

Other Lower 48 onshore

Lower 48 offshore

Alaska

production, mn bbl/day

30

35

40

45

50

55

60

65

95 99 03 07 11 15 19 23

imports/US oil consumption (%)

| 21

Exports Stall on Volumes (L), Energy No Longer to Blame (R)

90

100

110

120

130

Jan-2

007

Nov-2

007

Sep-2

008

Jul-

2009

May-2

010

Mar-

2011

Jan-2

012

Nov-2

012

Export Volume Index

80

90

100

110

120

130

140

Aug-2

009

Jan-2

010

Jun-2

010

Nov-2

010

Apr-

2011

Sep-2

011

Feb-2

012

Jul-

2012

Dec-2

012

Export Index (2010=100)

Energy exports

Ex-energy

Exports

| 22

Capital Inflows Have Left Canadian Dollar Overvalued Relative to Trade Fundamentals

Source: IMF, BIS, CIBC

-15%

-10%

-5%

0%

5%

10%

15%

Indonesia

Japan

Germ

any

Chin

a

India

Thailand

S A

fric

a

Kore

a

Mexic

o

Euro

Are

a

Bra

zil

USA

Sw

itzerl.

UK

Canada

Austr

alia

Spain

Overvaluation/undervaluation (%)

*relative to each country's trading

partners; midpoint of estimated

range

| 23

Current Account Deficit (L) Leaves C$ Tied to Yield Spread (R)

-25

-20

-15

-10

-5

0

5

10

15

Q4-2

005

Q1-2

007

Q2-2

008

Q3-2

009

Q4-2

010

Q1-2

012

-6%

-4%

-2%

0%

2%

4%C$ bn

billionsShare of GDP

Canada: Current

Account Balance

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

Apr-

08

Aug-0

9

Dec-1

0

Apr-

12

Aug-1

3

Dec-1

4

0.80

0.85

0.90

0.95

1.00

1.05

1.10

Cdn - US 2 yr spread (L)

CADUSD (R)

Fcst

US$ per %

| 24

US Broad Money Still Below Trend: Inflation not a Threat

600

800

1,000

1,200

1,400

1,600

Jan-0

0

Jun-0

1

Nov-0

2

Apr-

04

Sep-0

5

Feb-0

7

Jul-

08

Dec-0

9

May-1

1

Oct-

12

US Divisia M4 Index (1967=100)

| 25

ETFs: The Elephant in the Room

Source: World Gold Council

0

500

1000

1500

2000

2500

3000

IMF ETFs Chinese

Government

Russian

Government

Holdings of gold, metric tonnes*

*China has not released official gold holdings since 2009. The

US is the largest holder at 8,100 tonnes, with Germany at

3,400.

| 26

6% Joblessness Was Consistent with Fed Funds Rate at 1%

0%

2%

4%

6%

8%

10%

12%

Sep-1996 Jun-2000 Mar-2004 Dec-2007 Sep-2011

Unemployment

Rate

Fed Funds

Target Rate

FF Rate @ 1%

with 6%

joblessness

Source: Haver Analytics, CIBC

| 27

Stimulus Goes Well Beyond Zero Funds Rate

-6%

-4%

-2%

0%

2%

4%

6%

2004 2008 2012

Fed Funds

Rate

Equivalent

stimulus

impact

(including

QE)

Source: Rudebusch (FRBSF Economic Letter, 2010), Haver Analytics, Federal Reserve, CIBC

| 28

Bond Yields Drift Modestly Higher in H2 2013 Anticipating End of QE

0

1

2

3

4

5

Feb-08 Dec-08 Oct-09 Aug-10 Jun-11 Apr-12 Feb-13 Dec-13

2-Yr Canadas 10-Yr Canadas 10-Yr US Treasuries

% 3.0% US10yr2.4% BE CPI

0.40% US2yr

1.7% US10yr2.5% BE CPI

0.23% US2yr

| 29

Why is the TSX Sucking Wind?

Q1 Appreciation (%)

-15

-10

-5

0

5

10

15

Total Energy Financials Materials

TSX S&P 500

| 30

Dividend Yield: Canada’s Comparative Advantage

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

Jan-

05

Jan-

06

Jan-

07

Jan-

08

Jan-

09

Jan-

10

Jan-

11

Jan-

12

Jan-

13

Dividend yield gap TSX Composite S&P 500

12-month trailing (%)

Historical average=57

Source: Haver Analytics, CIBC

| 31

Stocks Look Cheap vs. Historical or 2014 Earnings

Source: Bloomberg

0

10

20

30

40

50

60

Aug-6

5

Aug-7

0

Aug-7

5

Aug-8

0

Aug-8

5

Aug-9

0

Aug-9

5

Aug-0

0

Aug-0

5

Aug-1

0

Avg since 1965 = 20.2

17.9

Apr-13

Real stock prices/average

inflation-adj earnings, last 10 yrs 7.3%

1.7%

0%

1%

2%

3%

4%

5%

6%

7%

8%

TSX Yield on 2014

Earnngs

10-Year Canada

| 32

Waiting on the World to Change

Canada lagging US; No growth pick-up in 2013. But Bank of Canada wont ease rates.

US has more upside in retailing, housing

Housing corrects, but Canada is not the US

Canadian dollar softer ahead, rallies through parity in 2014

For now, favour less-cyclical, dividend paying equities

Anticipation of better 2014 drives “risk on” trade in late 2013, lifting commodities and bond yields

Exports and capital spending key to better growth and TSX in 2014

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