Item - 2023.EX5.4

The Executive Committee recommends that:

1. City Council receive the report (May 23, 2023) from the Chief Financial Officer and Treasurer for information.

The purpose of this report is to provide the following information:

1.  Performance of the Funds for the year 2022

2.  General Market Update and Benchmark Performance

3.  City of Toronto Investment Policy and Procedures

The City's General Group of Funds ("General Fund") hold the working capital and amounts designated for the City's reserves and reserve funds.  The General Fund is comprised of two pools of investments: (a) the Short Term Fund (liquidity funds managed internally), and (b) the Long Term Fund (funds not immediately required are managed by the Toronto Investment Board).  The General Fund had a book return of 0.9 percent and generated $92 million for the full year 2022. 

During the pandemic, the General Fund has held a larger position in the Short Term Fund to enhance the liquidity and to generally lower the overall risk (risk management).  On average, the Short Term Fund, including the short-term investments of the Long Term Fund, was about 65% of the overall General Fund in 2022 compared to 48% from the pre-pandemic level in 2019.  This higher weighting in the Short Term Fund provided significant protection, as well as increased returns as short-term rates moved higher.

The City's Sinking Fund portfolio, which holds the investment funds for future debt repayments, also had a return of 0.9% on the book return basis and generated $18 million for the 12 months ending December 31, 2022. 

Since January 1, 2018, the City's long-term investments (Long Term Fund and Sinking Fund) have been managed by the Toronto Investment Board ("Board") under a Council adopted Investment Policy which is based on the prudent investor standard. The investment portfolios have been progressively phased in to make use of the broader range of investments that have become available. Although the overall portfolio risk has been reduced through asset mix diversification, the potential for volatility in total returns over the short-term investment horizon still exist while the risk-adjusted total returns over the long-term investment horizon are expected to be higher.

The Board manages four external fixed income managers and four external global equity managers engaged in managing the long-term investments. Both fixed income and equity investment classes are fully funded in accordance with the target asset mix in the Investment Policy with 70 percent allocated to fixed income and 20 percent to global equities.  As at December 31, 2022, approximately 90 percent of both the Sinking Fund and the Long Term Fund were managed by external fund managers.  The remaining 10 percent will be allocated to real assets, which is currently at the contract negotiation phase with the Board selected investment managers.  Adding real assets to the current investment portfolios, which already compose of fixed income and global equity, will help to enhance the portfolios' risk-adjusted investment return and align with the Council-approved policy target asset mix. The Board continues to evaluate opportunities in the real asset category.

The Long Term Fund has an asset mix of both equity investments and fixed income investments. Due to the equity market downturn experienced in 2022 the total return results (which includes unrealized gains and losses) in both the Long Term Fund and the Sinking Fund were negatively impacted during 2022. In addition, due to global central banks implementing sharp increases to short-term interest rates it resulted in negative total returns for investors holding long-term assets like fixed income and global equities.  It has been more than a decade since the world has experienced such a dramatic change in these rates and the inflation rates experienced globally.  For example, the widely followed fixed income benchmark, called the FTSE Canada Universe Bond Index, had a 1-year return of -11.7 percent at December 31, 2022.  A negative return for this bond index is extremely rare (it has only experienced a negative 1-year return in three years since 1983), as well as the magnitude of this decline has never been experienced in the last 40 years (largest decline previously was -4.31 in 1994).

It is a legislative requirement that the Investment Policy be reviewed annually. Staff have reviewed the Investment Policy and are not currently recommending any changes given that the policies have only been in place since 2018 and in that time we have experienced three years of volatility triggered by COVID-19 impacts.  The City of Toronto Investment Policy can be reviewed in Attachment 1 of this report.

Although the prudent investor standard has only been in place for four years, and was carefully phased in, we have been monitoring whether this change was effective versus the previous prescribed list (prior to 2018).  The report also provides a comparison of returns between the previously used prescribed list versus the currently used prudent investor standard.  The review shows the current regulation has been beneficial to the Long Term Fund by approximately $200 million over the four years it has been in place.

For the year 2022, all funds managed are compliant with the Investment Policy. The City's auditor, KPMG LLP, will perform the Investment Policy audit during the second half of 2023.

The Board has hired a third-party data provider in order to monitor and report on the high-level Environmental, Social, and Governance (ESG) attributes of the City's investment portfolio.  This investment fund-level ESG reporting process will complement the existing corporate-level ESG performance report.  This service is relatively new and staff are working with the vendor to develop a report that will provide an overview of the City's portfolios from an ESG perspective.  It is expected this new report will be included in the next investment performance report in approximately six months.

The Russian invasion of the Ukraine occurred in February 2022 and all contracts with external investment managers include clauses prohibiting investment in sanctioned companies and countries.  These contracts also include clauses that focus on anti-terrorism and anti-money laundering policies and prohibit dealing with any sanctioned companies or countries in this regard. 

Subsequent to December 31, 2022, with a moderation of inflation and other related economic data, it would seem many central banks, such as the Bank of Canada, have now paused any further short-term interest rate increases.  Since it would appear the actions of central banks are near a terminal point, with the prospect of lower interest rates in the future, long-term assets have rebounded to provide significantly higher returns in the first three months of 2023 ending March 31, 2023.   

Other related events happening in the first few months of 2023 show the impact of higher interest rates.  More specifically, we have seen several regional bank failures in the U.S.  In addition, troubles with Swiss bank Credit Suisse resulted in them being purchased by Union Bank of Switzerland (UBS) in a move negotiated by Swiss regulators.  While the funds managed by the Board were largely insulated from these events, caution is being advised to external investment managers as other financial and corporate issues may emerge as we progress through 2023.