OTPP: ‘We view agriculture as an area of growth’

Timber investments from the $139bn Ontario Teachers’ Pension Plan began in 2002, later complemented by an agricultural program launched in 2014. Portfolio manager Stephen McLennan tells Agri Investor about inflation, size requirements and the advantages of a direct investment approach.

What distinct roles do you look for agriculture and timber to play within the wider OTPP portfolio?

We view agriculture as an area of growth and are really looking to the asset class as a core building block of that natural resources strategy.

Natural resources is a key part of what we refer to as our inflation-sensitive assets, which are meant to provide three main things. First is stable returns across economic environments, or economic regimes. Second is diversification to other assets, such as stocks and bonds; your typical institutional asset classes. Third, which is perhaps the most important, is strong returns during inflation shocks, particularly when those are surprise-type shocks.

Where are your inflation expectations right now?

When we think about the portfolio, and in particular the natural resources portfolio, we’re really trying to build a blended portfolio that’s going to react to a variety of different sources of inflation. So, it’s a bit of a broader approach than ‘This is what we think inflation is going to be, so this is why we want this.’ It’s more about building that balanced portfolio that is going to weather a variety of different inflation environments.

Without predicting the future, one indicator that we do spend some time thinking about in a broader context is break-even inflation and some of the other financial metrics. We try to be building a portfolio that is going to respond if those variables that we are trying to protect the fund against react in a surprising manner. It’s not meant to say, ‘Hey, we’re forecasting inflation at five percent.’ It’s more about making sure that under the circumstances when inflation occurs, we’ve built a portfolio that’s going to provide the necessary protection.

How long are the average hold periods on your agricultural investments?

Well, the program is relatively new, so it’s tough to know going forward. When we are thinking about these opportunities, we are not a private investment fund or an infrastructure fund with a fixed holding period, so we do have a long-term horizon. Having said that, to the extent market circumstances and/or valuation levels get to a point that leads us to reconsider what the longer-term return profile is, we are open to monetizing assets.

Still, the going-in assumption is that these are going to be long-term holds, supported by the fact that we do not have a fixed unwind or a wind-down of a fund that you would see in some other instances. The assumption is that we are going to be holding this for a very long period of time.

Do you have size requirements for your agricultural investments?

Yes and no. The size requirements are more based on driving scale from the fund’s perspective, as it’s the same amount of work to do a $5 million or $10 million investment as it is to do a larger investment. Today we are seeing a sweet spot for size, for what we would refer to as a platform, in that $100 million to $400 million range. You can start constructing a story that’s sufficient in size and scale to really drive our results from a natural resource portfolio perspective.

What are your return expectations for agricultural investments?

They are really asset-dependent and consider the types of risks, diversification benefits and other attributes we are looking for. Having said that, we recognize that returns are not going to be in the private equity context, but given the risk profile, that they will be more consistent with the infrastructure space.

Would the pension ever consider a commitment to a dedicated ag fund? Why or why not?

Actually, we are open to deploying capital through a variety of different approaches. For instance, our row crop strategy is a bit more of a partnership approach, where we rely on partners to help us. It’s really dependent on the underlying opportunity and market structure. To the extent that the market structure is fragmented –  requiring boots on the ground to buy smaller-sized assets that then sum up to something that hits that size we mentioned earlier – we are open to doing that.

What advantages specific to agriculture does the direct investment approach provide OTPP?

It allows us to have better visibility on underlying market drivers and ensures that the objectives of the fund are being met in a full and consistent manner. Also, direct investments enable us to ensure that issues around health, safety and other considerations are being managed at the level that we think is required to sustain that business for the long term. There are some other considerations around appropriate leverage and some of those other things that we like to have line of sight on – and you do get better line of sight if you are in the direct role.