The Ontario Municipal Employees Retirement System today reported Monday a total fund return of 12.1% last year on net investment income of $3.7 billion.

However, OMERS warned of a funding shortfall that could hit $2.5 billion by the end of the year.

Fair market value of net assets grew by $3.6 billion, or 11%, to $35.7 billion and actuarial value grew to $36.8 billion, up from $36 billion in 2003. “A significant increase in the returns of our private market investments, combined with the continued strength of global equity markets, contributed to our strong performance,” said Paul Haggis, OMERS CEO, in a release.

“We are beginning to realize the benefits of our new investment strategy and we are well-positioned to improve returns for our members over the long term.”

OMERS did warn, however, of a $963 million deficit recorded at the end of last year as a result of market losses suffered by the plan in 2001 and 2002 but amortized over a five-year period. The plan reported a $509-million surplus at the end of 2003.

“According to the independent actuary, a funding deficiency of approximately $2.5 billion could emerge by the end of 2005 as investment losses, primarily due to the above-mentioned stock market downturn, are recognized in the actuarial smoothing process,” the OMERS said.

OMERS provides retirement benefits to about 350,000 active and retired members on behalf of 900 local government employers across the province.

Up to 40% of the pension fund will eventually be invested in private market assets such as real estate, infrastructure and private equity that the plan said it expects to “outperform traditional stocks and bonds over the long term.”

OMERS received $1.4 billion in contributions in 2004, an increase of $1 billion as contribution rates returned to full rates in January 2004. The pension payroll and other benefit payments totalled $1.5 billion, an increase from $1.4 billion in the previous year.

The plan’s public markets unit had a good year, exceeding its 9.5% benchmark with a return of 10.3%. In particular, the non-Canadian equities and fixed-income operations were strong performers.

Private equity investments, consolidated last year under the OMERS Capital Partners banner, recorded a 12.5% return last year, a significant recovery after the market value adjustments and foreign exchange losses of 2003.

OMERS infrastructure assets, consolidated under the Borealis Infrastructure banner, delivered a 31% return as a result of higher earnings and favourable market value adjustments on several investments. The fund’s real estate unit also delivered a strong 2004 with a return of 11%.