Building the Total Portfolio at Ontario Teachers – Stephen McLennan (EP.518)

Stephen McLennan is the Co-Chief Investment Officer of the Ontario Teachers' Pension Plan, where he oversees asset allocation for the $300 billion fund responsible for the retirement security of 346,000 teachers. Stephen joined OTPP in 2003 and worked across credit, natural resources, infrastructure, and Total Fund Management, before splitting the CIO seat with Gillian Brown in 2024 — a dual-CIO structure that is unique among Canada's largest pension funds. Our conversation traces that path and discusses OTPP's total portfolio strategy, including the balance of top-down asset allocation with bottom-up investing, role of active management, liquidity, leverage, and internal and external management. We cover where private equity, credit, infrastructure, hedge funds, and inflation-sensitive assets earn their place in the portfolio, how AI-driven concentration risk factors into portfolio resilience, and the evolution of the Canadian model, with both enduring edges and eroding competitive advantages. Register for TomorrowX using the Capital Allocators discount here https://tomorrowxsummit.com/partner-offer?token=WIVivSy7_so7XoVZGb2gLweZei3QtL8LZ_TdrCg-ocE. Learn more about Juniper Square here https://www.junipersquare.com/capitalallocators. Learn More Follow Ted on X at @tseides https://twitter.com/tseides?lang=en or LinkedIn https://www.linkedin.com/in/tedseides/ Subscribe to the mailing list https://capitalallocators.com/ Access Transcript with Premium Membership https://capitalallocators.com/signup Editing and post-production work for this episode was provided by The Podcast Consultant (⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠https://thepodcastconsultant.com⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠⁠ https://thepodcastconsultant.com/)

• 0:06Speaker 00

  I'm Ted Seides and this is Capital Allocators. My guest on today's show is Stephen McLennan, the co-chief investment officer of the Ontario Teachers Pension Plan, where he oversees asset allocation for the $300 billion fund responsible for the retirement security of 346,000 teachers. Stephen joined Ontario Teachers in 2003 and worked across credit, natural resources, infrastructure, and total fund management before splitting the CIO seat with Gillian Brown in 2024, a dual CIO structure that's unique among Canada's largest pension funds.

• 0:47Speaker 00

  Our conversation traces that path and discusses teachers' total portfolio strategy, including the balance of top-down asset allocation with bottom-up investing, role of active management, liquidity, leverage, and internal and external management. We cover where private equity, credit, infrastructure, hedge funds, and inflation-sensitive assets earn their place in the portfolio, how AI-driven concentration risk factors into portfolio resilience, and the evolution of the Canadian model with both enduring edges and eroding competitive advantages. Before we get going, I'm excited to tell you about an amazing conference and offer a discount to attend.

• 1:30Speaker 00

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• 3:00Speaker 00

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  That's alphacense.com with a hyphen in the middle slash capital. Capital Allocators is also brought to you by Morningstar. In a sea of data, you need to know what you can trust. Morningstar's data, analytics, and research helps bring clarity across public and private markets, connecting independent research and data into the tools and AI platforms you use every day, so insights are easier to spot and act on. Morningstar, nothing in your way. Visit morningstar.com/gameon to learn more. Capital Allocators is also brought to you by Juniper Square, the operations partner trusted by the leading private market GPs.

• 5:10Speaker 00

  One theme that keeps coming up on the show is GPs that build the strongest and most durable relationships with LPs are the ones that have both strong returns and strong operations. AI raises the stakes on operations, and having Juniper Square as your operations partner helps ensure your data is organized, accurate, and accessible, so you can unlock operational alpha. That's why thousands of GPs trust Juniper Square. Learn more at junipersquare.com/capitalallocators. Please enjoy my conversation with Stephen McLennan. Stephen, thanks so much for joining me.

• 5:50Speaker 01

  Thanks for having me, Ted. Big fan of the podcast.

• 5:53Speaker 00

  I'd love you to take me back to the early experiences that later you could look back and say influenced your investing.

• 6:01Speaker 01

  I'm not sure what it was. It was probably something related to the pop culture in the 80s, the movies and the TV shows of the time. My first foray into the investing world was in my last year of high school. I did a co-op session at one of the local brokerage firms. It coincided with the first Gulf War. As tragic as those circumstances were for the people on the ground, the connection between what was happening in the real world in terms of what was going on in CNN, how that transmitted immediately into what was going on in the markets, you could see that real-time reaction. That was the start of how I started to think about the investing world. I've done a number of different things career-wise.

• 6:43Speaker 01

  Each of those experiences has shaped me in terms of how I think about the world.

• 6:48Speaker 00

  What were some of those experiences and how did they shape your views?

• 6:51Speaker 01

  Coming out of high school, I did an undergraduate degree in business and economics and finance. My first job out of school was working for Archer Daniels Midland, which is the big US agribusiness company for their Canadian operations. It involved buying and selling grain, and involved logistics, and involved hedging on the Chicago Exchange. It was an interesting foray into the business world. It wasn't necessarily a pure investment-type of role. The plan was always to go back to school to do my MBA. After my MBA, I ended up joining Merrill Lynch in their Calgary office. Calgary's the energy hub of Canada, the Houston of Canada. It's a capital-intensive sector. There was a lot of capital raising required as part of that job, and Merrill was well positioned to do that.

• 7:36Speaker 01

  Combined with a lot of activity from US companies coming in, buying some of the Canadian E&P entities, I got exposure to that. For personal reasons, my now-wife wanted to move back to Toronto to go back to school and to be closer to family. I used that as an opportunity to think about what is the next stage in my career? How do I want to position myself to get closer to the investment process? So move away from that agent-type of role as an investment banker to more of a principal-type of role as an investor. Used that to go back to school, did a mathematical finance degree here in Toronto. Then I joined Teachers as a new entrant junior person. I joined the credit desk.

• 8:21Speaker 01

  Given my background, it was a wide mandate at the time. This would have been 2003. The credit business would have been your traditional corporate bonds, some private placements. Credit derivatives was a growing business. That was where I spent the bulk of my time, thinking about how best to use that product to implement whatever views we thought were appropriate at the time. The GFC was a credit derivative event. Lots of scars on my back from that particular experience. How do you deal with liquidity, counterparties, risk positioning, blocking and tackling, portfolio construction? Was eventually elevated to be leading the credit team. It was a fantastic team. In 2013, the head of our capital markets group had been tasked with building a new program

• 9:05Speaker 01

  called Natural Resources, which was a combination of our public commodity program, which we use for its inflation characteristics, combined with an aspiration to grow a private natural resource program to be a complement to those public commodities exposures. It was a great opportunity for me to work with a new set of colleagues, work for a new boss, build a business, and try to think through what should that portfolio look like based on my experience prior to Teachers in the energy space. We were successful in growing the private part of that program to a level on the back of some other organizational changes in terms of trying to streamline the number of programs

• 9:48Speaker 01

  or places where private investing was being undertaken. They moved myself and several colleagues into a renamed group called Infrastructure and Natural Resources. I had day-to-day responsibilities for natural resources, got familiarity with the infra team, those assets, and how those contribute to the overall portfolio. In 2018, when the previous head of capital markets had been promoted to become the CIO, he asked me to come over and help him set up a new team called Total Fund Management, which has become known as this TPA concept. The thoughts around that TFM group were to combine our asset allocation function with our treasury function. I always tried to explain asset allocation is what you want to buy, treasury is how

• 10:33Speaker 01

  do you pay for it. That was a great combination of my public market experience combined with my private market experience. One of the learnings that I've had over the course of my career is that public and private, notwithstanding that those two groups of market participants, from time to time are like different religions, don't like each other, or like to debate and throw rocks at each other. They're tools to implement an overall policy view or a portfolio view. Fast forward a couple of years, the CIO resigned. Organizationally, we took the time to think about what the right structure going forward was going to be. We arrived at a dual CIO or a co-CIO model. I'm one of the CIOs.

• 11:15Speaker 01

  We've divided the responsibilities between asset allocation and my colleague Gillian Brown, who is the CIO of public and private investing, is responsible for those active programs.

• 11:26Speaker 00

  Steve, why don't we take a step back and have you share the history of teachers?

• 11:30Speaker 01

  We were established in our current format in 1990. The origin story is that in the 1980s, the Teachers Union and the Province of Ontario are joint sponsors. We're getting worried about the long-term sustainability of the plan. There was a number of different commissions and studies undertaken. They arrived at creating an independent organization called the Ontario Teachers Pension Plan Board. A couple of key things that were important at the outset were independence, top-notch governance. The other requirement was to make sure that we were run as a business and had that mindset of running a world-class asset manager.

• 12:13Speaker 01

  The first thing that the board did was hired our founding CEO Claude Lamarrue. One of the first things Claude did was hire our founding CIO, Bob Bertram. Concurrent with that, the plan was seeded with a portfolio of non-marketable Province of Ontario debentures. One of the first things Bob and Claude did, which was pretty innovative at the time, was use financial engineering, a derivative program to transform those non-marketable debentures into a liquid portfolio of global public equities. That was the first step to this journey of diversification across a number of different asset classes. We're an early adopter of private equity, infrastructure, commodities, hedge funds.

• 12:59Speaker 01

  You fast forward to where we are now, 35 years later, we're a $300 billion plan. We cover the retirement security of the 346,000 active retired teachers in the province. We've got a global footprint with offices in North America, in Europe, and in Asia. We've got a real track record of direct internal deployment of asset management. That's resulted in a funding ratio of 111%, which goes to the long-term sustainability of the plan.

• 13:30Speaker 00

  Through that entire experience, public markets, private markets, TFM, now you sit today as co-CIO, how do you lay out the current strategy at OTPP?

• 13:43Speaker 01

  Ultimately, we're trying to build a diversified portfolio that's going to be resilient across a number of different economic environments to make sure that we're in a position to honor that pension promise. I would divide that investment strategy along a couple of different dimensions, one of which would be diversification. One would be, we are believers in active management. Where and how do you focus your activities to deliver on that excess return? Another one would be, we're focused on ensuring we've got the right risk management framework in place to deliver on that goal. The fourth one is, we do use a prudent amount of leverage to execute our investment plan. Those would be the four buckets.

• 14:26Speaker 00

  How do you think about the implementation of TPA or TFM?

• 14:30Speaker 01

  It's ultimately about delivering the best risk-adjusted portfolio with all the tools that you have at your disposal. I suppose our form of that, we probably started with a type of TPA back in 2015 or 2016 when we went down the path of a one-teacher strategy, where our board before that would say, okay, management, what is the desired asset mix? Management would present to the board. The board would say, okay, great, that's the right asset mix. Management would then go off, try to build a portfolio to beat that asset mix. That asset mix had some characteristics of that risk portfolio.

• 15:11Speaker 01

  One of the challenges with that is making sure there's alignment with what you're actually trying to do. Pensions are paid with total return, not with active return or just beta return. So how do you make sure that you're in a situation where everybody's aligned to deliver the best total return on a risk-adjusted basis? As we were going through that one-teacher strategy, the board said, hey, look, we're signing off on this asset mix, but it's what you folks are recommending to us. Why are we taking responsibility for that? Is there a way for you folks to be responsible for the asset mix as much as we are? So that moved us down this path of having much more flexible asset mix bands.

• 15:54Speaker 01

  The flip side to that is that that does not mean that you don't have a rigorous risk approach, which we do have. To me, a reference portfolio is more of a signal of risk appetite, not necessarily meant to give you a rigid portfolio construction exercise. I always say, if you're going to tell me what the right risk appetite is, tell me that directly. Then it's on management and the investment team to deliver the best risk-adjusted return. To achieve that, consistent with all the guardrails that you would have from a risk perspective. Some of the downsides of having a reference portfolio is that over time, investment teams will gravitate to what those weights are.

• 16:35Speaker 01

  You can end up in the circumstance where, if for instance, your reference portfolio is 60% equities, 40% fixed income, investment teams will be reluctant to deviate substantially away from those weights. You can be in the world where you have a lot of fixed income exposure, like we saw in 2020, 2021, where the reason for having that in the portfolio may not be as compelling as what it once was. You end up in a circumstance where investment teams are reluctant to deviate, even though they know that they should be deviating.

• 17:07Speaker 00

  How do you bring it all together?

• 17:09Speaker 01

  Total fund management is focused on that top-down asset allocation function. How do you then layer in some of that bottom-up thinking? That's where the real magic happens from an excess return perspective. The top-down is more my domain. My colleague Jillian would be responsible for that bottom-up piece. Top-down, some of the levers would be, what is your active versus passive mix? What is your leverage and liquidity formulation to implement that overall asset mix? The big thing that the team spends a lot of time on is where and how do you want to position the portfolio from a broader risk perspective? It can be complicated, and we have a lot of different systems that go into that.

• 17:51Speaker 01

  Our simple way to think about it is, do we want the portfolio to be positioned aggressively, neutral, or conservatively, depending on the market environment, overlaying what our risk-return bogeys are to satisfy our actuarial objectives? We're a pension plan. We have fairly good line of sight in terms of what our liability profile is, notwithstanding that that can be out 60, 70, 80 years.

• 18:16Speaker 00

  As you look today, that high level, do you want to be aggressive, neutral, or conservative? How do you go about making that assessment?

• 18:24Speaker 01

  We have a couple of different planning horizons and investment committees to do that. The first is our planning investment process, which is typical of the industry, but we do run an annual investment plan, where we try to think about where we want the portfolio to be over a one-year horizon. We also think about the planning process over a five-year horizon. Five years, there's nothing magic about that. It's far enough in the future where you don't have to do anything immediately today, but it's near enough that you have to start taking action today if you want to accomplish it. The five-year horizon is driven by the fact that we do have a portion of the portfolio that's in illiquid assets. We need to make sure that we've got the right buffer to be able to manage that,

• 19:08Speaker 01

  because you never want to be in a position where you're a forced seller of an asset. That's why we spend a lot of time on planning out, where do we think those allocations should go? We also overlay that with a rigorous liquidity and leverage system that's run by our risk team. That process of the one-year horizon, which is probably more relevant for risk positioning, is the beginnings of how we want to structure the portfolio. A one-year horizon is still an eternity in the investment business. Within our total fund management team, there is a function which looks at more dynamic type of opportunities, how the market might be evolving. How does that compare to our original assumptions? The point of TFM isn't to be day trading the portfolio. These are big decisions.

• 19:51Speaker 01

  We have a group that has a specific mandate within our capital markets team, which would be frequent in nature. The TFM team and this dynamic team is there to say, look, here's what we think the environment is. Here's what we think is currently priced in or not priced into the market. How should we think about a portfolio adjustment driven by a couple of things? One would be a risk mitigation type of approach. If there is a particular event on the horizon that if it were to happen would be unacceptable from a return or catastrophic loss perspective, we probably would want to be thinking about that. The prototypical example of that would be going into Brexit 10 years ago.

• 20:33Speaker 01

  If you have a large portfolio of UK or pound-based exposure, and you don't know what's going to happen, you might want to be thinking about aggressively trying to manage some of those risks. The other example would be, we have an allocation in the portfolio. Markets have moved. Is it still going to perform its role in the portfolio, given the repricing that's happened? An example of that would have been in 2022 with fixed income. We had an allocation of fixed income. We're adherents to that all-weather philosophy. When yields continued to go lower and lower, down to almost zero, we did a lot of analysis and our CIO at the time, working with our CEO and the board,

• 21:16Speaker 01

  said our expected return for fixed income is low because yields were close to zero. I totally understand that yields could go negative, as they had done and were doing in Europe. Our view is that is less likely to happen in North America, given some of the commentary from central banks and other authorities. Fixed income's role in the portfolio to be an offset or ballast to an equity shock is going to be more difficult. Why do we have this in the portfolio? There was a conscious decision to reduce our fixed income exposure. That would have been driven in combination and discussion and research from that TFM group.

• 21:55Speaker 00

  I'd love you to take us underneath the last time you went through your annual process.

• 22:02Speaker 00

  Where you came out on the five-year and the one-year thoughts?

• 22:07Speaker 01

  We've spent a lot of time thinking about where do we need to focus our active activities? A typical example of that would be what are the prospective returns for private equity? Some of our peers in the US, for instance, have been aggressive in reducing what they would view as the expected return for those assets. We would take the view that it has become more competitive for private equity in terms of prospective returns. If you used to be earning 500 or 600 basis points over whatever your comparator is, if it's less than that, then you probably want to think about what the implications are for the portfolio over that five-year time horizon. You'd never want to be in a position where you close a door.

• 22:49Speaker 01

  If market conditions change, there is a case to be made that those market conditions are changing, that you're not in a position to deploy, because we do use partners. We also have a team of internal investors that can also execute. Managing that aspect of things is a pretty important part of the puzzle.

• 23:05Speaker 00

  When you want to flex down a little bit, private equity in that scenario, how do you do it?

• 23:10Speaker 01

  You need to start thinking about where do you want it to be? How do you think about the team in place? Sometimes you need to have the forbearance to be able to not do something rash or erratic. We do have the benefit of being fully funded and having a flexible liquidity pool. So we're never in a position where we need to get a number to a certain level. We've taken the approach that we should be looking at opportunities to reduce that when we think that the market or the pricing for those assets is attractive and is still consistent with our long-term return assumptions, but not unduly force that allocation lower.

• 23:48Speaker 00

  In a scenario like this, that you did think over five years, you might want to reduce relative to where you were, how do you toggle the external relationships versus the internal capabilities?

• 24:00Speaker 01

  Part of this is reduction of the size of that program in dollar amounts is probably not as pronounced as what you would think, because the fund is going to continue to grow. The asset allocation function tries to allocate on a percent basis, because we're trying to scale up and down the overall portfolio. If you're a practitioner or a GP or an internal investor, you're also focused on how many dollars do I have? We actually haven't seen a substantial reduction in the dollar amount, because as we forecast out these things, that acts as a bit of an offset to this percent reduction.

• 24:35Speaker 00

  As you went from your five-year view to the one-year view, what were the things you were looking at changing?

• 24:42Speaker 01

  More recently, there's been a lot of discussion around our inflation-sensitive asset class, which is different than maybe some of our peers. We are an adherent to this all-weather, building a resilient portfolio. Our inflation-sensitive asset class, which we have about 20% of our portfolio in right now, is there for two purposes. One is to provide a reasonable return in most environments in an inflation spike or an inflationary environment, which has historically, in our estimation going forward, is going to have a pretty bad impact on equity and bond portfolios. In those types of instances, our inflation-sensitive asset class is there to provide offsets to what we expect to be happening in our equity market.

• 25:27Speaker 01

  We have a couple of levers within that basket. Our inflation-sensitive would be our public commodities, which would include gold. We have the private natural resource team, which I grew up in, in the organization. It also contains a bucket of public market inflation-related product to give us that protection. We've spent a lot of time, what is that inflation environment going to look like? How do we need to position that part of the portfolio in a world that we would expect inflation to be more volatile and likely to run at a higher weight? The other one is on the equity basket in terms of how do you think about your equity composition? We've got private equity, we've got a venture group, we've got our public or our passive completion part of the portfolio.

• 26:10Speaker 01

  Across each of those dimensions, there's positives and negatives. On the passive side, the US concentration is something that we're trying to be thoughtful around in terms of how do you manage that? The reality is, the US is still a pretty important market, and if you want to have exposure to that AI or that technology growth theme, it's difficult to find it in other markets. We spend a lot of time thinking about some of those issues below the surface.

• 26:38Speaker 00

  When you look at that one factor of AI and growth through a lens of risk, there's a lot of discussion of potential binary outcomes where this keeps going, or maybe something changes significantly. How do you incorporate that into your thinking about risk in the portfolio?

• 26:58Speaker 01

  AI is changing so quickly that having a high conviction view is difficult. We try to be humble. There's certain things that we don't know. You can debate whether other people know, but we want to be balanced and not be overconfident in our ability to predict what or how that AI theme is going to evolve. The other part of it is, we want to make sure that we're looking at the portfolio from this all-weather perspective and that we're not overbetting on a particular outcome as it relates to AI. It's even more important, given the range of outcomes associated with it, to be thinking about this portfolio resilience, recognizing that there's upside associated with that. There's also potential downside to what happens if AI tips over.

• 27:43Speaker 01

  To the extent that AI ends up being a positive productivity shock, it historically has benefited the equity part of the capital structure.

• 27:51Speaker 00

  What are some of the more recent dynamic shifts you made in that within-a-year bucket, presumably on the liquid side?

• 27:58Speaker 01

  I alluded to some of the work that we've been doing on the inflation-sensitive. There's been a lot of volatility in commodity markets. We've used that as an opportunity where appropriate, linked the impact on other asset classes. If there's an inflation shock, how much of that inflation shock have you already captured?

• 28:15Speaker 00

  How do you think about liquidity? You mentioned using some leverage, which those two things can go together.

• 28:22Speaker 01

  I would separate that into the triangle of leverage, liquidity, and funding. That's managed by our treasury team. Our risk team also helps us manage that part of the portfolio. Leverage and liquidity are important, because what's going to get any investor into trouble, and by trouble, I mean get pushed out of a conviction view around where they think the portfolio should be structured, would be, one, you have a liquidity event, you can't satisfy your near-term obligations. Two is, you lose a lot of money. The third is that you do things that your stakeholders aren't fans of. On the liquidity side, it's especially important, given that we do use derivatives to complete the portfolio.

• 29:05Speaker 01

  We do have a rigorous process around scenario analysis and downside circumstances to ensure that we always have substantial liquidity. That's a board limit for us. We do spend a lot of time monitoring that. There's been a number of instances, both in the US with some of the endowments going through the GFC, as well as even in the Canadian pension space, where some of this leverage items that didn't have a comprehensive liquidity management profile around it, got some institutions into trouble, where they were forced sellers of assets at very inopportune time. We certainly want to avoid that type of circumstance.

• 29:44Speaker 00

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• 31:02Speaker 00

  What type of metrics do you use to calibrate the appropriate amount of liquidity?

• 31:06Speaker 01

  We would use a LCR liquidity coverage ratio type of metric. It's not quite the same as what you would see with a bank or with a deposit-taking institution, because our liability structure is substantially different than a deposit-based one, would be akin to an LCR type of ratio customized for a pension plan.

• 31:27Speaker 00

  What's comfortable for you?

• 31:29Speaker 01

  Comfortable for me is to be able to absorb a pretty substantial shock and not get pushed out of a position. It depends on what the size of the portfolio is, has implications with currency hedging. A non-US-based investor has a slightly different challenge with currencies, where you're tending to hedge a illiquid, long-dated asset with a liquid security. You do have a maturity term mismatch. What tends to happen in a market shock is that the US dollar strengthens, in this case versus the Canadian dollar. If you've done any hedging, you tend to have to post collateral against that. That would be one of the liquidity draws that would be factored into our LCR framework.

• 32:12Speaker 00

  Have you thought about where to implement active management? Where to just gain passive exposure?

• 32:18Speaker 01

  It comes down to where do you think you have an edge? That can be done both internally and externally. It's broader than you should just do infrastructure with external managers or internal managers. It comes down to what are the necessary ingredients for a particular strategy to be able to deliver an excess return? What were the drivers historically? What do you think those drivers are going to be going forward? That active versus passive discussion, which is more of a top-down decision, paired with the bottom-up, where the bottom-up deal teams will then have to say, this is where we're going to focus our activities to achieve those types of outcomes.

• 32:56Speaker 00

  As you look across your asset classes, where have you decided to use active versus passive on one lens and then internal versus external on another, if you're filling in that two by two?

• 33:06Speaker 01

  In the equity space, passive equity versus an active public equity program has been much more challenging, at least for us. We have scaled back that program. We do have a team that still does some active stock picking. It's smaller than what it was a couple of years ago, given the fact that that's a difficult and competitive market. As we look at other asset classes, private equity, infrastructure and real estate being the big three, as well as venture. Venture introduces a different layer of complexity to the extent that those opportunities are successful, using a hybrid model of external and internal, depending on where the market is and where we think we have competitive advantage to be able to

• 33:47Speaker 01

  deliver on that excess return, trying to be thoughtful around where we focus our internal resources. Where do we need to recognize that it's an activity that we're best served by going with an external partner?

• 34:00Speaker 00

  How do you think about the use of hedge funds in your portfolio?

• 34:04Speaker 01

  Hedge funds, from a top-down perspective, would fall into what we call our absolute return strategies. The theoretical piece of that is have a high expected return with low correlation to some of the other major factors we have, the equity and bonds. Those are difficult to find. When you can find them, you need to be thoughtful around how are you considering the fee component of things. We do use hedge funds in that particular capacity to generate those non-correlated returns. In certain instances, if there's a certain skill set or a certain type of return stream that those individuals can deliver that we just won't be able to do internally, we are open to using that as a lever to complement our asset mix.

• 34:47Speaker 00

  How have you thought about the internal use of hedge funds?

• 34:50Speaker 01

  We have a capital markets team and they would be engaged in hedge fund-like strategies. One example is that we do have a quantitative systematic research team. They would be using some of the similar techniques that you would see with some of the big-name hedge funds, but they would be doing that internally.

• 35:08Speaker 00

  You mentioned the venture and growth. How do you go about implementing that?

• 35:12Speaker 01

  Our venture team, Teachers Venture Growth, was established in 2019. It had the role in the portfolio at the time of giving us exposure to innovative companies that were not necessarily available in the public market space. That team has done a fantastic job. One of the milestones for a venture company is when they go public, I would argue, a venture company going public is a feature, not a bug. From a portfolio perspective, it does introduce this tension between private and public investing. It's not to say that those instances didn't happen in the past with our private equity or our INR team. Wasn't as big an

• 35:54Speaker 01

  issue. We're trying to be practical between dealing with the mindset differences between a private and public investor, with the fact that the TBG team would have the most familiarity and knowledge of those particular entities. As those now IPO'd companies become more mature, you need to start thinking about how do you best position them. For the time being, we've made the determination that we want to keep the people with the best information closest to that asset, for those individuals to be the most accountable with it.

• 36:26Speaker 00

  How have you thought about the position size of something, as we get some of these large-scale IPOs, that you didn't have control over and now you do?

• 36:35Speaker 01

  These are world-class problems. When you have an asset that has become a 10, 20, 30, 40-bagger, it's a different form of problem in terms of having a concentration risk that you've grown into, as opposed to just having a large-size position. For some of these concentrated positions, we want to make sure that we're not overly concentrated, as the market circumstances allow, regardless of how attractive those entities might be or what the forward-looking view might be for those companies.

• 37:06Speaker 00

  Have you approached some of your historical areas, like credit, infrastructure and resources part of the portfolios?

• 37:12Speaker 01

  Credit is an interesting one. From a top-down perspective, I grew up in the credit business here, have a lot of affinity for the team there. It's got a great cash yield, can have a great sharp ratio or information ratio, has a form of risk premium from some volatility-related factor exposure. As I've transitioned to be more top-down, I recognize that it has a role for alpha generation. I'm always wrestling with the notion of credit, where from a portfolio construction perspective, when you want it to act like equity, it acts like fixed income. When it's a positive growth environment and equities are putting up big

• 37:55Speaker 01

  gains, by construction, you're capped. The other challenge with credit is that then, when you want it to act like fixed income, it acts like equity. It also has these other characteristics that depending on how extreme the overall macro environment is, you might be getting something that you don't want or need in the portfolio.

• 38:15Speaker 00

  What you described on credit is negative skew. How do you take that lens and decide how you want to implement that in the portfolio?

• 38:25Speaker 01

  We're fortunate that we have a wide scope of activities in the fund. Any one program is part of a bigger portfolio. How is it affected and how does it contribute to the overall portfolio? Another observation that I've had is diversification is a powerful portfolio tool. In any given period, it's likely to make you unhappy. Most investment committees will look at the line item of all the asset classes or all the securities, will then gravitate to the things that are above the line and say, these are really great. The things below the line, the natural reaction will be, why are we doing that? You need to put in the context of what was the expected contribution of those things

• 39:06Speaker 01

  above the line and below the line? How do they interact? That's another way to express that diversification. How do we think each of these components is going to contribute to our overall objective to deliver a risk-adjusted return?

• 39:19Speaker 00

  How do you layer that on to the risk reward in credit, where it doesn't act the way you would like in different environments?

• 39:27Speaker 01

  We use a pretty simple growth versus inflation type of metric. You can start thinking about what type of environment do you project to be out there? Credit does perform well in a low-vol environment. Other asset classes might not be performing quite as well. That's why I'm torn from a asset allocation perspective, because in a big set of outcomes, it's going to perform well. How do you think about those tail outcomes? What other parts of the portfolio do you need to be providing offsets to what might be going on for this particular asset class?

• 40:00Speaker 00

  One of those offsets would be infrastructure. I would love to hear how you've gone about implementing the infrastructure piece.

• 40:06Speaker 01

  We've been in infrastructure on the direct side since 2002, 2003. We were an early adopter of the asset class. Infrastructure has some interesting characteristics and it's loosely consistent with our overall risk profile. It's been a great contributor to the overall fund for the last 20 plus years. Our implementation has been to do that direct with the team. Those assets tend to be more scalable than what you might see in some other areas. We've had a team in place, not only here in North America, but in Europe, in Asia, that's been out there looking at those opportunities. And it does provide that stability of cash flows and that exposure to that real rate, which is quite attractive when we're thinking about the overall portfolio.

• 40:51Speaker 00

  As you look across the entire portfolio, where do you end up on the proportion of your assets that are internal versus externally managed?

• 41:00Speaker 01

  There's no preset number. We try to be thoughtful and pragmatic that in certain instances, partners, in this case, GPs, are we getting good value for fee? In many instances, we do. It depends on the market. It depends on how we feel our own internal capabilities are going to be able to execute on an appropriate risk return type of construct. There's no preset rules. We would want to be thoughtful and flexible and not be in a situation where it needs to be a specific number. That drives you to bucket filling, which can never be a good option.

• 41:33Speaker 00

  What's the range of the proportion of external managers that you've had over time?

• 41:39Speaker 01

  Each group will have a different allocation and it also depends on the maturity level. The ratio is anywhere from 10 to 30% on the external side.

• 41:49Speaker 00

  When you look for an external manager, what does that process look like?

• 41:53Speaker 01

  We have dedicated teams, both private equity and other groups that are focused on those fund relationships. They would be going through a more typical origination funnel around what or where are we trying to bulk up our expertise or exposures? They would go through a market screen, think about what the environment is in whatever sector or geography we're talking about. Then would go out, meet partners and then start thinking about the appropriate way to allocate capital.

• 42:22Speaker 00

  What are some of the common characteristics of partners that you gravitate to?

• 42:26Speaker 01

  First and foremost, it's having a partner that wants us to be a partner with them. That's important in terms of them being able to recognize that we can be more than just capital partners, but also be contributors to how they're thinking about their various businesses. We also want to make sure that we're getting the return that we need for the fees that are being paid.

• 42:48Speaker 00

  Love to talk about the structure of your team. Maybe start at the top, this dual CIO structure, which isn't something you hear a lot about. How do you come together to make decisions?

• 43:00Speaker 01

  We do have this co-CIO role and that was on the back of the resignation of the prior CIO. We took that as a chance to think about what would be best for the future. The fund's grown considerably over the last 35 years. The number of asset classes has grown. The number of investors that are within the investments group has grown substantially. The world's become a lot more complex. We made the decision to go with the dual CIO model, but we're clear that we each have our own domain accountabilities. I'm responsible for the asset allocation. My colleague, Gillian Brown, is responsible for the public and private investing function. We've worked together for quite some time, so we're very familiar personalities to one another.

• 43:44Speaker 01

  Where we have a more formal overlap, in addition to oversee the overall portfolio, is that the regional offices report into me. And one of the prime objectives of our regional offices is to deliver active returns. An easy example is that we have two major investment committees. We have a total fund investment committee, which would be those broader asset allocation functions, stocks, bonds, commodities. That is chaired by me. Jillian is a member of that committee and she will be able to provide context to me either in the meeting or outside of a meeting. We have another investment committee called the public and private investing committee. That is chaired by her. I'm a member of that. That's responsible for the oversight of our large public and private investments.

• 44:29Speaker 01

  Those are the more formal structural parts of the fund. Other things that we'd use to make sure that we're managing the portfolio effectively is we have weekly meetings with our CEO and CRO where any of those edge items or decisions that are closer to use the concept of economic indifference where there's not necessarily a right answer. There's some need for debate and discussion. The other part of this is making sure that we are constantly communicating with one another. Ultimately, it comes down to a level of trust and respect for each other's domain so that we don't end up with a major conflict when we're trying to make some of these key decisions. If there was a major issue, we would ultimately go to our CEO to help us arbitrate.

• 45:14Speaker 01

  But that hasn't been an issue to date.

• 45:16Speaker 00

  What's an example of some of the more interesting conversations you've had on one or both of those investment committees of late?

• 45:24Speaker 01

  There's been a number of transactions that we've looked at on the private side across a number of sectors where we're trying to be thoughtful around the disruption risk for these businesses. AI generally, it's difficult to have high conviction. We're in the investing business. That's part and parcel with making decisions under uncertainty, but there's been a lot of discussion and debate on that side. At the total fund level, recently, it's related to overall risk positioning.

• 45:53Speaker 00

  As you look at that today, on that lens of conservative, neutral, aggressive, how are you feeling about the world?

• 46:00Speaker 01

  It's a tricky world out there. We're probably of the view that we're best positioned to be a bit more in that neutral range. The challenge is that that can change. We try to be thoughtful and have a big debate about where, how we should be thinking about the overall portfolio positioning.

• 46:16Speaker 00

  As you look over the course of history, how often have you been in that neutral category compared to one of the ends?

• 46:22Speaker 01

  The bulk of the time, you probably are in the neutral category, given the fact that markets are pretty good at pricing. Things, my observation is that market efficiency is on average, they're efficient. And there's always pockets where things are overpriced and other areas where they're underpriced. Generally, the starting point is that they're probably fairly priced. Then you need to be quite selective.

• 46:46Speaker 00

  How do your internal and external investment teams share information and work together?

• 46:53Speaker 01

  That's something that we have spent a lot of time on over the last 10 or 15 years in terms of making sure we've got good information flow across those two groups. In some instances, they're more integrated. That is something that you need to focus on in terms of regular dialogue between those internal individuals. Also making sure that there's the right connectivity between the direct teams and those funds.

• 47:19Speaker 00

  What are the areas where you've found there to be more synergy between the internal and external teams?

• 47:24Speaker 01

  In some of the hedge fund spaces, we do have some large public market strategies that the partners in those spaces are true collaborators and have great dialogue with our internal teams in terms of challenges that we might have with how are we structuring a certain part of the portfolio? How do we think about liquidity? How do you use things like AI?

• 47:47Speaker 00

  You mentioned the regional offices reporting to you. I'm curious what those offices are tasked with.

• 47:53Speaker 01

  For background, we have a team in Europe. That would cover multiple sectors. It would include infrastructure. We have a venture group there. We have real estate investors there and we have private equity investors there. In Asia, we have a team in Singapore as well as a team in Mumbai. Those areas of focuses would be more infrastructure, private equity and venture. We don't have a forced allocation by geography. We want to be opportunistic and make sure that we're using that diversification lever. And so those teams are tasked with going out, finding, sourcing and asset managing, value add opportunities in those respective markets, in those respective asset classes.

• 48:34Speaker 00

  How did you think about the reporting lines of people on the ground looking at assets?

• 48:40Speaker 01

  We have been operating under a matrix model, which requires both the asset class as well as the regional head to be supportive of a transaction. To make sure that we're combining what is good for the overall portfolio with local knowledge that the deal teams in those regions are meant to bring.

• 48:59Speaker 00

  I'd love to ask you about the evolution of the Canadian model in the 20 something years you've been inside of teachers. What do you see as the remaining competitive advantages of the model?

• 49:12Speaker 01

  Independence of governance, diversification, varying degrees of internal management. 20 years ago, there was not a lot of folks that had those characteristics and had the pool of capital to be able to execute on those particular items. Fast forward to today, there is a lot more that would have a similar set of characteristics. The competition or the uniqueness of where we were 20 years ago is substantially different. Some of the advantages would be, we do have a long-term horizon. Now that might not be differentiable versus another pension plan, but it is a difference versus a GP or another entity that might have a fixed life and has to do certain things with their portfolio.

• 49:52Speaker 01

  We have a long track record of being a good partner and being in a position to be able to deliver on whatever we say we're going to deliver on. The third item that does position us quite well is that we do have that institutional memory. We have all the processes in place, board governance, back office, middle office, deal professionals that all can execute. Sometimes that gets taken for granted when I speak to some of the peers in the US, elsewhere in the world. That is something that they're like, oh my goodness, you gotta build out all this infrastructure. We have that already. Another advantage that we have is one single cohort of beneficiaries. That allows us to build one portfolio with that portfolio being fully aligned across that group.

• 50:38Speaker 01

  There's a real affinity for our mission. Most people in their life have had a positive experience with a teacher. That acts as a great way for us not only to attract the partners, but also to recruit and retain staff. The biggest one for the Canadian peer group is that we tend to be well-funded. In our case, we've got a funding ratio of 111%. People get into trouble or investors get into trouble when they're forced into a risk spot that they're not comfortable with. That's when mistakes get made. We can be the master of our own destiny. Pick where on the risk curve we want to play based on where we think the best market opportunities are.

• 51:17Speaker 00

  When you take into account that fully funded status, how do you think about the objectives of continuing to grow the pool compared to maintaining the fully funded status?

• 51:28Speaker 01

  It would be up to the sponsors. I don't want to overstep my role in this particular item, but we spent a lot of time thinking about where would you be optimally risked and how do you think about that as the funding ratio changes? That allows us to focus on what our actuarial return is, make sure that we're delivering on that to ensure pension solvency.

• 51:48Speaker 00

  Where does that shake out in terms of a number?

• 51:51Speaker 01

  Our stated objective on a risk-adjusted basis is to deliver 7% nominal on a consistent basis.

• 51:59Speaker 00

  What are some of the ways in which the early advantages of the Canadian model no longer exist?

• 52:07Speaker 01

  The ability to write a large check and get preferential deal terms with whoever the vendor of those, that is definitely eroded. There's been the broader increase in competition for many of these assets. More competition just means compressed expected returns. That's not necessarily unique to the Canadian model. That's a phenomenon that we've seen across all markets as more capital has flown in and the ability of that capital to kind of access private asset returns or alternative returns is compressed excess return premium.

• 52:40Speaker 00

  How do you think about the strengths, in some cases, the disadvantages of your size?

• 52:46Speaker 01

  The strength of our size gives us scope across a number of different opportunities. We're not forced into one particular set of activities. It also helps with attracting and retaining staff in terms of being able to offer, do you want to be a good investor and hone all your skills across the investment lifecycle? That would include origination, asset management, execution, also across asset classes. I'm the case in point. I've done a number of different things internally, public, private, putting it all together. The size of the business and the scope and scale of the business contributes to that aspect of things.

• 53:25Speaker 00

  What are some of the most top of mind investment topics that you're wrestling with?

• 53:30Speaker 01

  When you think of how the world's changed since COVID, let's use that as a delineation point, big themes, one would be heightened cost of capital, could be because of higher inflation, higher risk-free rates generally transmitting into higher required returns across a number of different asset classes. The second one would be related to geopolitics. That used to be predominantly focused on US-China in terms of how those two great powers we're going to think about and evolve through the next five, 10, 15, 20 years. That's evolved into being a bit broader of late.

• 54:12Speaker 01

  The third category would be technology, specifically AI. Those would be the three big things that we're trying to think about. How are those going to affect our overall portfolio? How are they going to affect the growth profile? How are they going to affect the inflation portfolio? How do we need to adjust now to make sure that we're still in a position to have a robust portfolio, recognizing that the range of outcomes have become significantly wider in our opinion over the last couple of years?

• 54:41Speaker 00

  If you look at your five-year projections, over each of those lens, cost of capital, geopolitics, technology, how are you trying to adjust the portfolio to best position for those changes?

• 54:55Speaker 01

  For each of them, we try to come at it with a degree of humility and say, what is the general direction of impact on growth and inflation? How is that going to interact with the various parts of the portfolio? I don't know if there's specific areas that I would want to comment on that, hey, look, we think that AI is going to lead to a giant productivity shock. That's going to be good for asset prices generally. I would hesitate to be overconfident in making those projections. We don't have high conviction on many of these items. Let's make sure that we're running a balanced portfolio and that we've got the right set of scenarios in place to ensure that we don't end up in a circumstance of having a big drawdown in our face.

• 55:38Speaker 00

  What are the most important initiatives from teachers over the next couple of years?

• 55:43Speaker 01

  The big one is ensuring that we've got the right handle on how do we use AI as a business in terms of making sure we've got the right tooling for people and ultimately are using that technology to get to better decisions. That's what the real prize is here. There's obviously productivity enhancements. To me, it's how do you make sure you're using the access to all this information and the way that AI can analyze and manipulate that information to get to better decisions?

• 56:15Speaker 00

  Stephen, I want to make sure I get a chance to ask you a couple of closing questions. What is the most rewarding thing you do outside of work?

• 56:24Speaker 01

  It's a pleasure to be the CIO of this institution, to be a steward of capital for the 346,000 teachers in Ontario. It is quite busy. Spending time with friends and family is pretty important. In the winter, I love snowboarding. In the summer, we're very fortunate to have a cottage, spending times outdoors and fishing.

• 56:44Speaker 00

  What was your first paid job and what did you learn from it?

• 56:47Speaker 01

  In high school, I had the typical jobs in retail, lifeguarding. My first paid job would have been as a newspaper delivery boy for the Ottawa Citizen. You had to show up every day, even though it probably only took 30 minutes or thereabouts. As I tie into my experiences in credit, the other aspect of being a paper boy was accounts receivable collection, because after you delivered the newspapers, you'd have to go back and collect every couple of weeks the $3. Surprisingly, there was always a couple of houses that nobody was home, even though you could see that the TV was on.

• 57:22Speaker 01

  That was a lot of fun and a real lesson.

• 57:25Speaker 00

  Which two people have had the biggest impact on your professional life?

• 57:28Speaker 01

  From my experience in Calgary as an investment banker, one of my bosses was Chris Burley. Chris was incredibly bright, incredibly hard worker. He had a real knack, which I still try to emulate to this day around preparation for whatever meeting or whatever session negotiation. Used a useful exercise of game theorizing out or wargaming out what the opposite side might be thinking about. The other piece would be, I've been fortunate, I've worked for all the CEOs, all the CIOs of teachers since inception. Each of them have sprinkled certain things and made impressions over time. Perhaps to coming to recency bias, which I know that you're not supposed to.

• 58:13Speaker 01

  I would want to give a shout out to Joe Taylor, our CEO, and Gillian Brown, my co-CIO, who have provided a support network, not only on the investment side, but also on some of the broader issues as it relates to people or other areas of the overall puzzle of running a business. Honorary mention would be to Ziad Hendo, who was the prior CIO, who was a great investor and had a great impact on me. One of the things that he always said and still sticks with me is that you need to do what you think is right for the portfolio, even if some people are going to disagree with you, you need to believe in what you're doing. That has stuck with me and is certainly something that I've tried to maintain as I think about the portfolio now.

• 58:59Speaker 00

  Stephen, last one. What life lesson have you learned that you wish you learned a lot earlier in life?

• 59:04Speaker 01

  Earlier in my career, I had a lot of fear of missing out in terms of, hey, look, why did that individual get that particular opportunity or that job or that promotion? One piece of advice that I have gotten, which I wish I had learned earlier, was related to be thoughtful and think about what you think the next stage of your career is or what the next role is that you want to have. That could be to get more technical knowledge, it could be to develop your leadership skills. As other opportunities come along, don't get too stressed out if that particular role doesn't fit that opportunity. If you look at it that way and you say, hey, look, my peer just got this particular role and you might feel, oh my goodness, I wish I had that. And then you reflect on and say, well, look, I don't even want to do that. Why am I getting all uppity about it?

• 59:48Speaker 00

  Stephen, thanks so much for sharing this great overview of teachers.

• 59:51Speaker 01

  Thank you for having me.

• 59:53Speaker 00

  Thanks for listening all the way to the end. If you made it this far, how about one ask for me? Tell one friend about the show. It's the best way to keep growing this incredible community. Thanks so much. And until the next one, stay curious and keep compounding knowledge, relationships, and capital a little bit at a time.

• 1:00:18Speaker 02

  All opinions expressed by TED and podcast guests are solely their own opinions and do not reflect the opinion of capital allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions and securities discussed on this podcast.