2023 Investments Review
HEPP Investment Returns*
The Healthcare Employees’ Pension Plan’s (HEPP) investments returned 10.8% in 2023, following a -7.1% return in 2022. We outperformed our benchmark return of 10.7% in 2023, after underperforming our 2022 benchmark return of -6.4%. Our five and ten year returns were 7.8% and 6.7% and were in excess of our benchmark returns of 7.1% and 6.6% respectively. Following the 2022 year where markets were challenged by rising interest rates, inflation and the Russian invasion of Ukraine, 2023 returns rebounded strongly. Our Canadian, International and US equity portfolios returned 11.0%, 16.1% and 20.1% respectively. Our other asset class returns were 0.5% in real estate, 8.0% in fixed income, and 10.2% in infrastructure. Since its inception, HEPP has had positive returns in 22 of 27 years.
As a result of stronger markets in 2023, the fund’s value rose to $10.551 billion, the highest level in the Plan’s history, from $9.565 billion at year-end 2022. Over the past 10 years, our investment returns have added $138 million of value when compared to the Plan’s benchmark returns.
Currently a return of 5.9% is required to fund the Plan’s obligations. The Plan’s exposure to equity-type investments has generated strong returns over the history of the fund. When HEPP was formed in 1997, 10 year Government of Canada bond yields were 6.4%. By the summer of 2020, these rates had fallen to 0.5%, and then closed at 3.1% at the end of 2023. When rates rise, the market value of our fixed income holdings fall.
*Total fund returns are after external management, custodial, and performance fees, transaction costs and operating expenses. Asset class returns are after transaction costs and performance fees but before external management and custodial fees, and operating expenses.
Major Market Returns
Returns in 2023 reversed from the overall negative market returns seen in 2022. For 2023, both public equity and fixed income markets produced positive returns, as the rate of inflation fell from an annual peak of over 8% in June 2022 to 3.4% at year-end 2023.
The Canadian equity market returned 11.8% in 2023 following a return of -5.8% in 2022. The US equity market was up 22.9% following a -12.2% return in 2022. International equity markets were up in 2023, returning 15.7% compared to -7.8% in 2022. Emerging markets returned 7.3% in 2023 after falling -13.9% in 2022. Canadian real estate returned 0.0% for the year following a 2.3% return in 2022. Returns for Canadian real estate sectors once again had a wide outcome: industrial properties rose 0.9%, Multi-Family Residential rose 3.1%, retail properties rose 2.8%, while office properties fell -4.5%. Infrastructure returns remained firm during 2023.
At year-end 2023, Government of Canada 10 year bond yields were at 3.1% down slightly from the 2022 year-end level of 3.3%. During the year, yields rose to just over 4.0% early in the 4th quarter before falling by year-end. This compares to levels at the height of the COVID-19 pandemic, in the summer of 2020, when rates were 0.5%. Government of Canada real return bonds, which have a rate of return adjusted for inflation, were yielding 1.5% at the end of 2023 vs. -0.1% in June 2020. Interest rates are now in the process of adjusting to inflation rates which are above the Bank of Canada’s long term target.
HEPP Asset Mix
Our overall public equity exposure at year-end 2023 rose by 1.7% to 57.3% as compared to 2022 levels. Public equity and fixed income returns were strong in 2023 following 2022’s returns where all major markets had negative returns. Within our private market asset classes, we had positive returns in infrastructure and real estate. Our private equity and private debt portfolios are in very early stages of investment, a point where returns are not meaningful. We actively monitor our exposure to equities and our regional allocations to Canadian, US and International equity markets as part of our risk management framework. These allocations will change over time, reflecting fluctuating return expectations and risk profiles. Changes to our regional equity allocations were driven by market returns and only changed by +/- 1% vs. 2022.
Our exposure to real estate and infrastructure were largely unchanged during the year. We currently hold 6.1% of the fund in infrastructure, with a target weight of 10%. We continue to commit funds for our global infrastructure investment program, which continues to perform as expected. Our real estate exposure at 12.4% is above our target at 10.0%. The real estate market remains in flux with higher interest rates having a negative impact as well as increased vacancy rates in office product as work from home remains a trend in place. We now have completed our second calendar year of investment in our private equity portfolio and made initial commitments to private debt. We have a 5% target allocation for each. All of our private market investments are invested over time, meaning that it will be several years before we reach our target allocation.
Detailed Investment Commentary
Public Equity
We have just over 57% invested in public equities. We diversify our equity holdings by geography, sector, company size, and investment style. At a strategic level, we run Canadian equity, US equity, International equity, and Global portfolios. International equity portfolios invest in developed and emerging markets outside of Canada and the US. Global portfolios invest in developed and emerging markets including Canada and the US. Within those portfolios, we further diversify by sector, company size and investment style.
Geographic exposure as % of total fund:
- International equity: 21%
- US equity: 21%
- Canadian equity: 15%
Sector exposure as % of total equites:
- Financials: 19%
- Information Technology: 17%
- Industrials: 16%
- Consumer Discretionary: 10%
- Health Care: 107%
- Energy 7%
- Consumer Staples: 6%
- Materials: 5%
- Communication Services: 4%
- Utilities: 3%
- Real Estate: 2%
Public Fixed Income
We have almost 23% of the fund invested in publically traded fixed income securities. At year-end 2023, our credit exposure as a % of total fixed income was as follows:
- Government: 35%
- Investment Grade: 41%
- High Yield: 24%
We hold Canadian government bonds primarily for liquidity purposes. When equity markets decline we are able to access ready cash to rebalance the overall portfolio.
We hold investment grade and high yield securities as their yield is higher than government bonds, and provides increased return opportunities. We hedge our currency exposure for our holdings in non-Canadian high yield markets to reduce return volatility.
Within our corporate bond holdings, our credit rating exposure is as follows:
- BBB and higher: 64%
- B/BB: 29%
- Below B/Not Rated: 7%
Real Estate
We have approximately 12% invested in direct real estate investments. These are private market transactions, which means that the assets are illiquid. In addition to our invested amounts, we have outstanding commitments of approximately 0.6% of total assets, which will be deployed over the next several years.
Geographic exposure as % of total real estate:
- Canada: 83%
- USA: 10%
- Europe: 3%
- Rest of World: 4%
Sector exposure as % of total real estate:
- Multi-Unit Residential: 34%
- Office: 23%
- Industrial: 21%
- Retail: 14%
- Other: 9%
Infrastructure
We have approximately 6% invested in infrastructure investments. These are private market transactions, which means that the assets are illiquid. Our long-term target for infrastructure is 10%. As we do with all private market investments, we will invest a certain portion of our allocation each year to minimize what is known as the “vintage year” risk. In addition to our invested amounts, we have outstanding commitments of approximately 3% of total assets, which will be deployed over the next several years.
Geographic exposure as % of total infrastructure:
- Europe: 50%
- North America: 32%
- Rest of World: 18%
Sector exposure as % of total infrastructure:
- Energy & Utilities: 48%
- Communications: 27%
- Transportation: 21%
- Other: 4%
Representative industry groups within each sector include:
- Energy & Utilities: renewables, midstream/storage, integrated/multi utility, gas transmission/distribution, water and wastewater
- Communications: telecom, fibre and data infrastructure
- Transportation: freight logistics, toll roads, parking, ports, aircraft leasing, EV charging, airports and airport services, cold storage
Private Debt and Private Equity
We have a 5% allocation to private debt and a 5% allocation to private equity, both of which are illiquid asset classes. We will manage the rollout of these programs over several years to manage our “vintage year” risk. We have almost 1% of total assets invested in private equity. In addition to this, we have outstanding commitments of almost 2% that will be deployed over the next several years. In 2023 we initiated our first investments in our private debt program. Inclusive of outstanding commitments, it represented less than 1% of total assets at year end.
Currency Management
Our largest currency exposure is in Canadian dollars, representing just over 42% of investments. Our second largest exposure is vs. the US dollar, representing almost 38%.
We generally do not hedge foreign currencies for our public equity investments.
Our non-Canadian publically traded fixed income portfolios are hedged as currency volatility adds unnecessary risk to our returns for an asset class which is generally defensive in nature.
At the present time we are not hedging our non-Canadian real estate holdings, infrastructure, private equity or private debt holdings. We anticipate establishing a hedging program for our private debt holdings in 2024.
Costs
Costs for managing investments are typically presented as a percentage of assets under management. For 2023, our costs were 0.51%, up from 0.50% in 2022. This includes external management fees (direct and indirect) and custodial costs as well as operating costs. Our five-year average cost is 0.50%. Generally, publically traded assets have lower fee structures than private market assets. As we increase our exposure to private assets over time, we expect our costs to drift upwards.
Like all large plans in Canada, we have a forward-looking strategy to deal with changes to our business model as our assets grow over time. As part of this strategy, we have adjusted our staffing levels accordingly and have transitioned two public equity portfolios and one public fixed income portfolio from being externally managed to internally managed.