Otpp Case Study

Only available on StudyMode
  • Download(s) : 406
  • Published : October 3, 2011
Open Document
Text Preview
Case Study

Ontario Teachers’ Pension Plan
Patrick Jordan, John Schneider, David Mundorf, Alexandre Champavere, and Lezhi Huang

Table of Contents
Ontario Teachers’ Pension Plan............................... 2 Background .............................................................. 2 Risk Assessment ....................................................... 2 Portfolio Selection Analysis ...................................... 3 Optimal Asset Allocation.......................................... 4 Recommendations.................................................... 4 References ................................................................ 5 Exhibit 1.................................................................... 6 Exhibit 2 ................................................................... 7 Exhibit 3 ................................................................... 8 Exhibit 4 ................................................................... 9 Exhibit 5 .................................................................. 10 Exhibit 6 .................................................................. 11 Exhibit 7 .................................................................. 12 Appendix 1 ............................................................... 13

Ontario Teachers’ Pension Plan
Background
The Ontario Teachers’ Pension Plan Board (OTPPB) provides retirement benefits for nearly 200,000 employees. The primary goal for the OTPPB is to “secure and deliver expected benefits at current or lower levels of contribution within an acceptable range of costs.” Indeed, the primary goal seems quite intuitive, but the formalized problem is more complex. The OTPPB, like any institution, holds both assets and liabilities. Therefore, the primary objective can be defined as maximizing the surplus (assets – liabilities) given that contribution rates must remain in some predefined interval for a given level of confidence. Given this objective, it is natural to express the surplus as a function of the problem parameters, which may be either deterministic or random. These parameters include current assets, current liabilities, interest rates, inflation, wages, equity returns, the asset mix, and the contribution rate. The objective of the fund may now be formulated as a quantitative optimization problem, subject to certain [qualitative and quantitative] risk tolerance constraints. These risk tolerance constraints are the reason the OTPPB is reevaluating the diversification strategy. For instance, it is clear that the value at risk of the fund’s assets has grown large1 in recent years. This has raised concerns about the fund’s strategy and whether pursuing an asset mix similar to other pension funds is appropriate. Two questions arise: • What are the risks the OTPPB faces? • What is the ideal asset mix ratio?

Risk Assessment
The OTPPB faces a classic economic optimization problem: given the characteristics of the liabilities, find the asset mix that maximizes expected surplus, subject to the constraint that teacher contributions do not exceed a specific tolerance level. In finding the optimal asset mix, the OTPPB needs to consider several risk factors. These risk factors pertain to both the assets and liabilities of the OTPPB. More specifically, the OTPPB is exposed to market risk, interest rate risk, inflation risk, demographic risks, and currency risk. A summary of the major risk factors is given in the table below.

Risk
Market Risk

Description
Market risk can be defined as the risk related to the uncertainty of returns on a portfolio caused by changes in market conditions such as the price of assets, market volatility, and market liquidity. The volatility of stock and real estate returns has a great influence on the value of the OTPPB’s portfolio, especially since both asset classes comprise a large portion of their investments. Holding a well diversified portfolio bearing only systematic risk can...
tracking img