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Private & Confidential Redington : Manager Forum 12 February 2013
Red Manager Forum
The Eight Club, Bank
Robert Gardner
Pete Drewienkiewicz
1
Private & Confidential Redington : Manager Forum 12 February 2013
Our Mission:
To Design, Develop, and Deliver the best investment strategies for our clients
2
Private & Confidential Redington : Manager Forum 12 February 2013
Who Are We?
3
Private & Confidential Redington : Manager Forum 12 February 2013
Redington: Client Base
4
119.2
76.2
23.3
11.4
AUC by Client Type (£ bio)
Trustee
Sponsor Clients
Other Pensions
Related Clients
Non-Pensions
Work
25
11
3
8
Number of Clients
Trustee Clients
Sponsor Clients
Other Pensions
Related Clients
Non-Pensions Work
59.0
2.7
60.4
73.5
34.5
AUC by Relationship (£ bio)
Total AUC (Full
Consultant to Trustee)
Total AUC (Retained
Advisor to Sponsor)
Total AUC (Project-
Trustee)
Total AUC (Project-
Sponsor)
Total AUC (Project-Other)
Number of
Clients
47, including 10 of the UK’s
25 largest pension schemes
Assets under
Consulting
£230bn
Appointment
Type
• Advisor to Sponsor
• Advisor to Trustee
• Non-Pensions
• Project Basis
Private & Confidential Redington : Manager Forum 12 February 2013
Take Control – The 7
Steps to Full Funding
Robert Gardner
5
Private & Confidential Redington : Manager Forum 12 February 2013
Redington Philosophy
Our Philosophy:
 We believe there are multiple risk premia to be earned
 It is not possible to control return
 But it is possible to manage and control risk
Our 7 Steps Framework to Full FundingTM
puts our clients in control of their investment objectives and strategy.
6
Private & Confidential Redington : Manager Forum 12 February 2013
Redington Philosophy
7
IF A MAN KNOWS NOT
TO WHICH PORT HE
SAILS, NO WIND IS
FAVOURABLE
Lucius Annaeus Seneca
Private & Confidential Redington : Manager Forum 12 February 2013
The Seven Steps to Full Funding TM
8
Design an efficient investment
strategy
Destination for agile
implementation of LDI strategy
Transparency to make timely
decisions
Articulate clear objectives and
constraints
Mission Statement
To help our clients achieve full-funding with the minimum level of risk
Private & Confidential Redington : Manager Forum 12 February 2013
Our Mission:
To Design, Develop, and Deliver the best investment strategies for our clients
9
Dynamic
Continuous
Monitoring
Deliver
Develop
Design
Private & Confidential Redington : Manager Forum 12 February 2013
Step 1: Setting Clear Goals and Objectives
10
“The pessimist complains about the wind;
The optimist expects it to change;
The realist adjusts the sails.”
- William A. Ward
Private & Confidential Redington : Manager Forum 12 February 2013
Step 1: Setting Clear Goals and Objectives
11
Step 1. Description
1. Articulate clear funding objectives and risk constraints
2. Flight plan Analysis presents a projected path of the Scheme’s assets and liabilities and
derives the Required Rate of Return
3. Detailed 3 Lenses Risk Analysis of overall risk exposure and collateral requirements.
4. Incorporate the above into a Pensions Risk Management Framework which will be used
to monitor the Scheme’s progress towards its stated objectives.
Private & Confidential Redington : Manager Forum 12 February 2013
Application to Sample
Scheme
12
Private & Confidential Redington : Manager Forum 12 February 2013
The Pension Risk Management Framework
Objective Measurement Performance Indicators Performance RAG
Primary Funding
Objective
To reach 100% funded on a swaps
flat basis by 2026
Expected Returns (ER) > Required
Returns (RR)
RR: Libor + 300bps
ER: Libor + 200bps
Difference: -100bps
Investment
Strategy
Actual Returns should exceed
Expected Returns
Actual Returns (AR) > Expected
Returns (ER)
AR: Libor + 210bps
ER: Libor + 200bps
Difference: +10bps
Risk Budget
The investment strategy should not
risk the deficit worsening by
£600mm over a 1 year period
VaR95 < £600mm VaR95: £700mm
Hedging
Strategy
Nominal and inflation hedge ratio
should be maintained within +/- 5%
of the funding ratio
Funding Ratio (swaps flat) 70% n/a
Nominal Hedge Ratio (swaps flat) 50%
Inflation Hedge Ratio (swaps flat) 85%
Collateral
Maintain sufficient eligible for the
purposes of covering margin calls
that may arise from the Scheme’s
current derivative positions over a 1
year period.
Total available eligible collateral £900mm
Remaining collateral after VaR95 event £600mm
13
RAG Status Metric is at or above target Metric is within [10%] of target Metric is more than [10%] away
Private & Confidential Redington : Manager Forum 12 February 2013
Calls To Action
14
Summary
 The Scheme needs to simultaneously:
1. Increase Expected Returns to equal (at a minimum) the Minimum Required Returns, but should aim to target
the Required Returns; and
2. Reduce the risk it is exposed to (as measured by VaR95); while
3. Maintaining sufficient levels of eligible collateral to withstand a VaR95 event.
Objective RAG Comments Call to Action
Primary
Funding
Objective
Expected Returns are 100bps below the
Required Returns to reach 100% funded on
a swaps flat basis by 2026
 Amend/adjust the investment strategy to
increase Expected Returns
Investment
Strategy
Actual Returns are 10bps above the
Expected Returns
 No Action Required
Risk Budget
The current investment strategy risks the
deficit worsening by more than the £600mm
Risk Budget
 Reduce risk in the investment strategy
Hedging
Strategy
The nominal and inflation hedge ratios are
below and above the target hedge ratio (i.e.
the funding ratio), respectively
 Increase nominal hedge ratio
 Decrease inflation hedge ratio
Collateral
Maintains £600mm collateral in excess of
what might be required after a VaR95 event
 No Action Required
Private & Confidential Redington : Manager Forum 12 February 2013
Analysis and Recommendations
15
Recommendations
Recommendations
Recommendations
Recommendations
Recommendations
Private & Confidential Redington : Manager Forum 12 February 2013
Step 2: Access to LDI Hub
16
Step 2. Description Implementation-to-date
• Interest rate and inflation risk are typically one
of the largest “unrewarded risks” for a pension
scheme.
• Setting up an LDI hub which gives the Scheme
the ability to manage inflation and interest rate
risk efficiently and effectively.
• Appointment of XXX as LDI manager
Recommendations
1. Synthetic Equity Replication
• Consider replicating physical equity exposure with futures and use the proceeds to purchase Gilts
2. Target Hedge Ratio
• Consider increasing/decreasing the nominal and inflation hedge ratios to equal the funding ratio:
• Use full LDI toolkit including swaptions to increase nominal hedge ratio.
Private & Confidential Redington : Manager Forum 12 February 2013
Liquid Alpha & Beta Strategies
17
Step 3. Description Implementation-to-date
• To ensure that the scheme is receiving
adequate compensation for the risk
associated with its investments
• Instead of dividing assets into traditional
categories of growth and matching assets,
assets are assessed in terms of their liquidity.
• This includes allocations to liquid active and
passive strategies such as investment in
equities and certain hedge fund strategies:
• 10% to Liquid Alpha Strategies
• 15% to Liquid Beta Strategies
• Total exposure: 25%
Recommendations
1. Volatility-Controlled Equity Exposure
2. Risk Parity Strategies
3. CTA Allocation
Private & Confidential Redington : Manager Forum 12 February 2013
Liquid & Semi-Liquid Credit Strategies
18
Step 4. Description Implementation-to-date
• Credit consists of a range of sub-classes with
different risk-return characteristics.
• Includes Alpha oriented mandates where the
manager can operate in the entire fixed
income universe. This enables the manager to
take advantage of relative value between
different instruments, aiming to earn long run
risk premia throughout the credit and economic
cycle.
• 15% to Liquid Credit
• 3% to Semi-Liquid Credit Strategies
• Total exposure 18%
No Recommendations – current spreads for investment grade credit are not sufficiently attractive
Considerations:
• When credit spreads are wider (i.e. above the Required Returns), the 7 Steps to Full Funding TM
framework and
the PRMF will allow you to dynamically shift into credit from other asset classes.
Private & Confidential Redington : Manager Forum 12 February 2013
Illiquid Credit Strategies
19
Step 5. Description Implementation-to-date
• We believe there are a number of opportunities
available which can provide “long-dated,
inflation-linked” cash flows at a higher yield
than traditional matching assets (we call them
“Flight Plan Consistent Assets”).
• Typically, these assets tend to fit well with the
overall objectives of pension schemes when
assessed in the context of a scheme’s PRMF
• Total 0%
Recommendations
Make allocations to the below to increase credit diversification and Expected Returns.
• SME Lending
• Secondary UK PFI and core-infrastructure refinancing
• Social housing
• Secured Leases
• Ground rents
Private & Confidential Redington : Manager Forum 12 February 2013
Illiquid Alpha & Beta Strategies
20
fdStep 6. Description Implementation-to-date
• Assets under this category provide attractive
returns but are typically more complex and
illiquid e.g. private equity and PFI equity.
• 7% Private Equity
• 3% Property (EU and UK)
• Total 10%
Recommendations
Insurance-Linked Strategies (catastrophe risk)
• Make allocation to increase diversification and expected returns
Private & Confidential Redington : Manager Forum 12 February 2013
Ongoing Monitoring
21
Objective Measurement Performance Indicators Performance RAG
Primary Funding
Objective
To reach 100% funded on a swaps
flat basis by 2026
Expected Returns (ER) >
Required Returns (RR)
RR: Libor + 300bps
ER: Libor + 320bps
Difference: +20bps
Investment
Strategy
Actual Returns should exceed
Expected Returns
Actual Returns (AR) > Expected
Returns (ER)
AR: Libor + 210bps
ER: Libor + 200bps
Difference: +10bps
n/a
Risk Budget
The investment strategy should not
risk the deficit worsening by
£600mm over a 1 year period
VaR95 < £600mm VaR95: £450mm
Hedging
Strategy
Nominal and inflation hedge ratio
should be maintained within +/- 5%
of the funding ratio
Funding Ratio (swaps flat) 70% n/a
Nominal Hedge Ratio (swaps flat) 70%
Inflation Hedge Ratio (swaps flat) 70%
Collateral
Maintain sufficient eligible for the
purposes of covering margin calls
that may arise from the Scheme’s
current derivative positions over a 1
year period.
Total available eligible collateral £600mm
Remaining collateral after VaR95
event
£150mm
Private & Confidential Redington : Manager Forum 12 February 2013 22
Online iRIS to be launched in November. (blurb from Teresa)
*Technical Resources from Blackrock
The easiest way
to monitor your
pension scheme.
Watch our video to learn more about how iRIS
makes risk monitoring accessible.
Login
Track progress against clear goals and
objectives
Easy access.
Login anytime, anywhere
Monitor funding level
Monitoring: A Preview of Online iRIS
Private & Confidential Redington : Manager Forum 12 February 2013
Manager Research
Pete Drewienkiewicz
23
Private & Confidential Redington : Manager Forum 12 February 2013
Who Are We?
24
Pete
Drewienkiewicz,
Head of Manager
Research
Kenny Nicoll,
Director: LDI
Specialist
Huayin Liu,
Vice President
Tom McCartan,
Associate
Aniket Das,
Associate
Kate Mijakowska,
Analyst
Greg Fedorenko,
Analyst
Team Size
2011 3
2012 5
2013 7
Private & Confidential Redington : Manager Forum 12 February 2013
How Do We Look at the World?
25
Step
(2)
LDI
(3)
Liquid α & β
(4)
Semi-Liquid Credit
(5)
Illiquid Credit
(6)
Illiquid α & β
Collateral
Management
Equities Corporate Bonds Infrastructure Debt Insurance-Linked
Hedging Multi Asset
Asset Backed
Securities
Social Housing Debt Private Equity
Active LDI Sovereign Bonds High Yield Direct SME Lending
Infrastructure
Equity
Gilts Commodities / CTA Leveraged Loans Mezzanine Finance Unlisted Property
Currencies
Emerging Market
Debt
Distressed Debt
Hedge Funds with
Longer Lock-Ups
Liquid Hedge Funds
Commercial Real
Estate Debt
Long Leases /
Ground Rents
Private & Confidential Redington : Manager Forum 12 February 2013
Strategic Managers
26
Manager
Step
(2)
LDI
(3)
Liquid α & β
(4)
Semi-Liquid
Credit
(5)
Illiquid Credit
(6)
Illiquid α & β
ABC   
DEF   
GHI  
JKL  
Private & Confidential Redington : Manager Forum 12 February 2013
Team Responsibilities
   
  
  
   
   
  
27
Private & Confidential Redington : Manager Forum 12 February 2013
How Do We Divide Our Time?
Recommended level of interface for invested
strategies:
• Quarterly quantitative monitoring
• Annual formal review
• Constant contact in respect of specific queries:
• Impact based approach:
Increase contact for increasingly complex /
bespoke strategy (e.g. LDI portfolio), Larger AUM
/ VAR
Contact
–
+
Level of interface for non-invested strategies:
• Regular research meetings
• Tracking vs. 7 steps
28
Less contact e.g. Passive equities
Private & Confidential Redington : Manager Forum 12 February 2013
1. Do returns
contribute to overall
expected returns
being greater than
required returns to
reach full funding?
2. Do returns
compensate
investors for the
level of risk they
are being exposed
to?
29
3. Are better risk-
adjusted returns
available
elsewhere?
4. What are the
implementation
challenges?
Building on the 7 Steps to Full FundingTM, we outline below the Four Investment Filters:
The 4 Investment Filters provide clients with a framework in which to quickly assess and compare
different opportunities within and across different asset classes.
How Do We Prioritise Opportunities?
Expected
Returns
Risk
Assessment
ImplementationRelative
Value
Private & Confidential Redington : Manager Forum 12 February 2013
eVestment
30
• eVestment adopted June 2012
• Comprehensive database of
43,000 strategies across
traditional and hedge fund
providers
• Fund manager performance
• Peer group comparisons
• Database provides qualitative
data, including personnel
changes
• Growth / decline in firm AUM,
mandates won and lost
• Portfolio holdings information
• Fee schedules
Regular
Performance
Updates
Updated Docs
& Fund
Literature
Personnel
Changes
Hedged
Returns
Data Net of
Fees
What we
Need from
You:
Private & Confidential Redington : Manager Forum 12 February 2013
Implementing a New Allocation
31
a b c
Use of eVestment
for pooled strategies
N.B. Many clients
have bespoke
investments not
found on fund
databases.
Classify investment
according to relevant
part of 7 Step
Framework
Account teams decide
on appropriateness for
individual clients
Implement
Client
Bespoke
Industry
Net
Private & Confidential Redington : Manager Forum 12 February 2013
Breakdown of Recent Search Activity
32
Search Activity
Pooled LDI, Segregated LDI,
Segregated LDI (within a multi-manager
framework)
Equity Income, Diversified Growth Fund,
Emerging Market Equities, Risk Parity (2
searches)
Investment Grade Credit (2 searches),
Leveraged Loans & High-Yield Credit,
Absolute Return Bonds / Credit Multi-
Strategy (3 searches), Asset-Backed
Securities
Secured Leases (2 searches), Illiquid
Inflation-Linked Assets, Distressed Debt,
SME Lending
Insurance-Linked Securities
£365
£1,520
£565
£100
Assets Allocated in 2012 (ex-LDI) - £mio
Liquid Alpha & Beta
Liquid & Semi-Liquid
Credit
Illiquid Credit
Illiquid Alpha & Beta
3
5
7
5
1
Number of Searches in 2012
LDI Hub
Liquid Alpha &
Beta
Liquid & Semi-
Liquid Credit
Illiquid Credit
Illiquid Alpha &
Beta
Private & Confidential Redington : Manager Forum 12 February 2013
Steps 2-7:
Application
33
Private & Confidential Redington : Manager Forum 12 February 2013
Step 2: LDI Hub
34
Private & Confidential Redington : Manager Forum 12 February 2013
The LDI Manager as “Quarterback”
35
• Trust
• Technical Skills
• Transparency
Private & Confidential Redington : Manager Forum 12 February 2013
Step 3: Liquid Alpha and Beta Strategies
36
Private & Confidential Redington : Manager Forum 12 February 2013
Liquid Alpha & Beta
37
Key Features
• Built in risk diversification – equities,
commodities and rates
• Built in risk control through target volatility
• Built in nimbleness through daily
rebalancing
• Historically improved risk adjusted returns
• Low cost
• Easy to implement
• Highly liquid
• Efficient use of collateral
Trend Following Strategies
Risk Parity
Volatility-Controlled
Equity
Index-Linked Gilts
Swap Overlay
A One-Stop Liquid Alpha & Beta Portfolio:
Private & Confidential Redington : Manager Forum 12 February 2013
Liquid Alpha & Beta Strategy: Historical Performance Comparison
Cumulative Excess Returns of Liquid Alpha & Beta Strategies
Since 2001
38
Full Calendar Year Excess Returns of Liquid Alpha & Beta
Strategies Since 2001
Source: Bloomberg, MSCI, Redington
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
50
100
150
200
250
300
Liquid Alpha & Beta Portfolio
Passive Equity
Private & Confidential Redington : Manager Forum 12 February 2013
Step 4: Liquid & Semi-Liquid Credit, Step 5: Illiquid Credit
39
Private & Confidential Redington : Manager Forum 12 February 2013
Credit as a Core Building Block for Flight Planning
40
Corporate
Bonds
Direct
Lending
Absolute
Return
FPCA
FPCA
Gilts
Cash
Private & Confidential Redington : Manager Forum 12 February 2013
Equity Replacement Strategy
41
40%
20%
20%
20%
Sample Equity Replacement Portfolio
Risk Parity
Long / Short
Credit
Direct Lending
(SMEs)
Distressed Debt
Sources of Funding
Developed
Equity
EM Equity
Private Equity
50%
35%
15%
Current Allocation
25%
50%
25%
Replacement Portfolio
Portfolio Weightings: Whole Scheme
• Overall risk in the return-seeking
assets bucket reduced by a fifth
• Overall expected return on scheme
assets increased by more than 10%
Equities Credit Alternatives
Private & Confidential Redington : Manager Forum 12 February 2013
Step 6: Illiquid Alpha & Beta Strategies
42
Private & Confidential Redington : Manager Forum 12 February 2013
Insurance-Linked Securities
43
2.26%
2.28%
2.30%
2.32%
2.34%
2.36%
2.38%
Current Allocation Current +
Aggressive ILS
Allocation
Current +
Conservative ILS
Allocation
Sample Scheme: Impact on Portfolio Expected Returns
Probability
0%
Rtn
• Assets under this category provide
attractive returns but are typically more
complex, e.g. private equity, PFI equity.
• Inclusion of these assets depends on the
overall objectives and governance budget
of the scheme.
Exceedance Curve (Illustrative)
• Catastrophe risk offers chance to earn
uncorrelated returns with major asset
classes.
• Sample scheme – ca. £50m allocation
(of c. £3bn overall assets) increased
expected returns while decreasing overall
risk.
Private & Confidential Redington : Manager Forum 12 February 2013
Step 7: Ongoing Monitoring
44
Private & Confidential Redington : Manager Forum 12 February 2013
Manager Monitoring / Quarterly Reporting
45
Fund Allocation
as at
7/12/2012
Allocation
as at
17/9/2012
Manager
Monitoring*
Fund A 13% 14%
Fund B 14% 14%
Fund C 25% 24%
Fund D 23% 23%
Fund E 3% 3%
Cash 22% 30%
Equity
Futures
32% 33%
Synthetic
Gilts
60% 48%
• Managers reviewed as part of overall
scheme positioning
• Use of RAG ‘traffic lights’ in quarterly
quantitative reports echoes PRMF
Private & Confidential Redington : Manager Forum 12 February 2013
Performance Monitoring and Position-Based Reporting
46
USD
Credit
EUR
Credit
GBP
Credit
Total
Market
Value
(%)
26.3 9.6 64.1 100
Yield to
Worst
(%)
4 11.9 5 5.4
Duration
(yrs)
13.6 0.6 7.8 8.7
Spread
Duration
Contribu
tion (yrs)
3.4 0.5 5.4 9.3
Libor
Spread
(bps)
177.9 799.5 236 274.8
UK
France
Netherlands
Italy Switzerland
Jersey Chan Isle
Australia
Denmark
Finland
Germany
Japan
Norway
Spain
United States
0
100
200
300
400
500
600
700
800
LiborSpread(bps)
Market Value and Libor Spread by Country
Portfolio Benchmark
8.5%
10.4%
40.5%
33.0%
5.1%
1.4% 1.0%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
Aaa Aa A Baa Ba B Not Rated
MarketValue
Market Value by Average Rating
Private & Confidential Redington : Manager Forum 12 February 2013
Conclusion: Our Principles
47
• Identify managers who can
deliver return streams that
meet our strategic goals
Client Focus
• Consistent performance in
uncertain markets, downside
protection
Disciplined Process
• Transparency in investment
process, returns and reporting
Clarity
Priorities: How to Interact with Us:
Use
eVestment
Relate
Offerings to
Steps
Differentiate
Offering
Private & Confidential Redington : Manager Forum 12 February 2013
Red Manager Forum Survey
Asset Class Matrix
48
-5
-4
-3
-2
-1
0
1
2
3
4
5
-5 -4 -3 -2 -1 0 1 2 3 4 5
Developed
Equity
Gilts
SME Lending
Predictable
Unpredictable
LiquidIlliquid
Private Equity
Private & Confidential Redington : Manager Forum 12 February 2013
Link to Survey
49
http://svy.mk/XyuSCW
Private & Confidential Redington : Manager Forum 12 February 2013
13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk
Contacts
Robert Gardner
Founder & Co-CEO
Direct Line: 020 7250 3416
robert.gardner@redington.co.uk
50
Pete Drewienkiewicz
Director | Head of Manager Research
Direct Line: 020 3326 7138
pete.drewienkiewicz@redington.co.uk
Disclaimer text
For professional investors only. Not suitable for
private customers.
The information herein was obtained from various
sources. We do not guarantee every aspect of its
accuracy. The information is for your private
information and is for discussion purposes only. A
variety of market factors and assumptions may affect
this analysis, and this analysis does not reflect all
possible loss scenarios. There is no certainty that the
parameters and assumptions used in this analysis can
be duplicated with actual trades. Any historical
exchange rates, interest rates or other reference
rates or prices which appear above are not
necessarily indicative of future exchange rates,
interest rates, or other reference rates or prices.
Neither the information, recommendations or
opinions expressed herein constitutes an offer to buy
or sell any securities, futures, options, or investment
products on your behalf. Unless otherwise stated,
any pricing information in this document is indicative
only, is subject to change and is not an offer to
transact. Where relevant, the price quoted is
exclusive of tax and delivery costs. Any reference to
the terms of executed transactions should be treated
as preliminary and subject to further due diligence.
This presentation may not be copied, modified or
provided by you , the Recipient, to any other party
without Redington Limited’s prior written
permission. It may also not be disclosed by the
Recipient to any other party without Redington
Limited’s prior written permission except as may be
required by law. “7 Steps to Full Funding” is a trade
mark of Redington Limited.
Redington Limited is an investment consultant
company regulated by the Financial Services
Authority. The company does not advise on all
implications of the transactions described herein.
This information is for discussion purposes and prior
to undertaking any trade, you should also discuss
with your professional, tax, accounting and / or other
relevant advisers how such particular trade(s) affect
you. All analysis (whether in respect of tax,
accounting, law or of any other nature), should be
treated as illustrative only and not relied upon as
accurate.
Registered Office: 13-15 Mallow Street, London EC1Y
8RD. Redington Limited (reg no 6660006) is
registered in England and Wales.
©Redington Limited 2012. All rights reserved.
Private & Confidential Redington : Manager Forum 12 February 2013
13-15 Mallow Street London EC1Y 8RD
Telephone : +44 (0) 20 7250 3331
www.redington.co.ukThe Team
Pete Drewienkiewicz
Director | Head of Manager Research
Direct Line: 020 3326 7138
pete.drewienkiewicz@redington.co.uk
51
Kenny Nicoll
Director | Manager Research
Direct Line: 020 3326 7111
kenny.nicoll@redington.co.uk
Huayin Liu
Vice President | Manager Research
Direct Line: 020 3326 7105
huayin.liu@redington.co.uk
Tom McCartan
Associate | Manager Research
Direct Line: 020 3326 7139
tom.mccartan@redington.co.uk
Aniket Das
Associate | Manager Research
Direct Line: 020 3326 7153
aniket.das@redington.co.uk
Kate Mijakowska
Analyst | Manager Research
Direct Line: 020 3326 7106
kate.mijakowska@redington.co.uk
Greg Fedorenko
Analyst | Manager Research
Direct Line: 020 3326 7122
greg.fedorenko@redington.co.uk

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Red Manager Forum

  • 1. Private & Confidential Redington : Manager Forum 12 February 2013 Red Manager Forum The Eight Club, Bank Robert Gardner Pete Drewienkiewicz 1
  • 2. Private & Confidential Redington : Manager Forum 12 February 2013 Our Mission: To Design, Develop, and Deliver the best investment strategies for our clients 2
  • 3. Private & Confidential Redington : Manager Forum 12 February 2013 Who Are We? 3
  • 4. Private & Confidential Redington : Manager Forum 12 February 2013 Redington: Client Base 4 119.2 76.2 23.3 11.4 AUC by Client Type (£ bio) Trustee Sponsor Clients Other Pensions Related Clients Non-Pensions Work 25 11 3 8 Number of Clients Trustee Clients Sponsor Clients Other Pensions Related Clients Non-Pensions Work 59.0 2.7 60.4 73.5 34.5 AUC by Relationship (£ bio) Total AUC (Full Consultant to Trustee) Total AUC (Retained Advisor to Sponsor) Total AUC (Project- Trustee) Total AUC (Project- Sponsor) Total AUC (Project-Other) Number of Clients 47, including 10 of the UK’s 25 largest pension schemes Assets under Consulting £230bn Appointment Type • Advisor to Sponsor • Advisor to Trustee • Non-Pensions • Project Basis
  • 5. Private & Confidential Redington : Manager Forum 12 February 2013 Take Control – The 7 Steps to Full Funding Robert Gardner 5
  • 6. Private & Confidential Redington : Manager Forum 12 February 2013 Redington Philosophy Our Philosophy:  We believe there are multiple risk premia to be earned  It is not possible to control return  But it is possible to manage and control risk Our 7 Steps Framework to Full FundingTM puts our clients in control of their investment objectives and strategy. 6
  • 7. Private & Confidential Redington : Manager Forum 12 February 2013 Redington Philosophy 7 IF A MAN KNOWS NOT TO WHICH PORT HE SAILS, NO WIND IS FAVOURABLE Lucius Annaeus Seneca
  • 8. Private & Confidential Redington : Manager Forum 12 February 2013 The Seven Steps to Full Funding TM 8 Design an efficient investment strategy Destination for agile implementation of LDI strategy Transparency to make timely decisions Articulate clear objectives and constraints Mission Statement To help our clients achieve full-funding with the minimum level of risk
  • 9. Private & Confidential Redington : Manager Forum 12 February 2013 Our Mission: To Design, Develop, and Deliver the best investment strategies for our clients 9 Dynamic Continuous Monitoring Deliver Develop Design
  • 10. Private & Confidential Redington : Manager Forum 12 February 2013 Step 1: Setting Clear Goals and Objectives 10 “The pessimist complains about the wind; The optimist expects it to change; The realist adjusts the sails.” - William A. Ward
  • 11. Private & Confidential Redington : Manager Forum 12 February 2013 Step 1: Setting Clear Goals and Objectives 11 Step 1. Description 1. Articulate clear funding objectives and risk constraints 2. Flight plan Analysis presents a projected path of the Scheme’s assets and liabilities and derives the Required Rate of Return 3. Detailed 3 Lenses Risk Analysis of overall risk exposure and collateral requirements. 4. Incorporate the above into a Pensions Risk Management Framework which will be used to monitor the Scheme’s progress towards its stated objectives.
  • 12. Private & Confidential Redington : Manager Forum 12 February 2013 Application to Sample Scheme 12
  • 13. Private & Confidential Redington : Manager Forum 12 February 2013 The Pension Risk Management Framework Objective Measurement Performance Indicators Performance RAG Primary Funding Objective To reach 100% funded on a swaps flat basis by 2026 Expected Returns (ER) > Required Returns (RR) RR: Libor + 300bps ER: Libor + 200bps Difference: -100bps Investment Strategy Actual Returns should exceed Expected Returns Actual Returns (AR) > Expected Returns (ER) AR: Libor + 210bps ER: Libor + 200bps Difference: +10bps Risk Budget The investment strategy should not risk the deficit worsening by £600mm over a 1 year period VaR95 < £600mm VaR95: £700mm Hedging Strategy Nominal and inflation hedge ratio should be maintained within +/- 5% of the funding ratio Funding Ratio (swaps flat) 70% n/a Nominal Hedge Ratio (swaps flat) 50% Inflation Hedge Ratio (swaps flat) 85% Collateral Maintain sufficient eligible for the purposes of covering margin calls that may arise from the Scheme’s current derivative positions over a 1 year period. Total available eligible collateral £900mm Remaining collateral after VaR95 event £600mm 13 RAG Status Metric is at or above target Metric is within [10%] of target Metric is more than [10%] away
  • 14. Private & Confidential Redington : Manager Forum 12 February 2013 Calls To Action 14 Summary  The Scheme needs to simultaneously: 1. Increase Expected Returns to equal (at a minimum) the Minimum Required Returns, but should aim to target the Required Returns; and 2. Reduce the risk it is exposed to (as measured by VaR95); while 3. Maintaining sufficient levels of eligible collateral to withstand a VaR95 event. Objective RAG Comments Call to Action Primary Funding Objective Expected Returns are 100bps below the Required Returns to reach 100% funded on a swaps flat basis by 2026  Amend/adjust the investment strategy to increase Expected Returns Investment Strategy Actual Returns are 10bps above the Expected Returns  No Action Required Risk Budget The current investment strategy risks the deficit worsening by more than the £600mm Risk Budget  Reduce risk in the investment strategy Hedging Strategy The nominal and inflation hedge ratios are below and above the target hedge ratio (i.e. the funding ratio), respectively  Increase nominal hedge ratio  Decrease inflation hedge ratio Collateral Maintains £600mm collateral in excess of what might be required after a VaR95 event  No Action Required
  • 15. Private & Confidential Redington : Manager Forum 12 February 2013 Analysis and Recommendations 15 Recommendations Recommendations Recommendations Recommendations Recommendations
  • 16. Private & Confidential Redington : Manager Forum 12 February 2013 Step 2: Access to LDI Hub 16 Step 2. Description Implementation-to-date • Interest rate and inflation risk are typically one of the largest “unrewarded risks” for a pension scheme. • Setting up an LDI hub which gives the Scheme the ability to manage inflation and interest rate risk efficiently and effectively. • Appointment of XXX as LDI manager Recommendations 1. Synthetic Equity Replication • Consider replicating physical equity exposure with futures and use the proceeds to purchase Gilts 2. Target Hedge Ratio • Consider increasing/decreasing the nominal and inflation hedge ratios to equal the funding ratio: • Use full LDI toolkit including swaptions to increase nominal hedge ratio.
  • 17. Private & Confidential Redington : Manager Forum 12 February 2013 Liquid Alpha & Beta Strategies 17 Step 3. Description Implementation-to-date • To ensure that the scheme is receiving adequate compensation for the risk associated with its investments • Instead of dividing assets into traditional categories of growth and matching assets, assets are assessed in terms of their liquidity. • This includes allocations to liquid active and passive strategies such as investment in equities and certain hedge fund strategies: • 10% to Liquid Alpha Strategies • 15% to Liquid Beta Strategies • Total exposure: 25% Recommendations 1. Volatility-Controlled Equity Exposure 2. Risk Parity Strategies 3. CTA Allocation
  • 18. Private & Confidential Redington : Manager Forum 12 February 2013 Liquid & Semi-Liquid Credit Strategies 18 Step 4. Description Implementation-to-date • Credit consists of a range of sub-classes with different risk-return characteristics. • Includes Alpha oriented mandates where the manager can operate in the entire fixed income universe. This enables the manager to take advantage of relative value between different instruments, aiming to earn long run risk premia throughout the credit and economic cycle. • 15% to Liquid Credit • 3% to Semi-Liquid Credit Strategies • Total exposure 18% No Recommendations – current spreads for investment grade credit are not sufficiently attractive Considerations: • When credit spreads are wider (i.e. above the Required Returns), the 7 Steps to Full Funding TM framework and the PRMF will allow you to dynamically shift into credit from other asset classes.
  • 19. Private & Confidential Redington : Manager Forum 12 February 2013 Illiquid Credit Strategies 19 Step 5. Description Implementation-to-date • We believe there are a number of opportunities available which can provide “long-dated, inflation-linked” cash flows at a higher yield than traditional matching assets (we call them “Flight Plan Consistent Assets”). • Typically, these assets tend to fit well with the overall objectives of pension schemes when assessed in the context of a scheme’s PRMF • Total 0% Recommendations Make allocations to the below to increase credit diversification and Expected Returns. • SME Lending • Secondary UK PFI and core-infrastructure refinancing • Social housing • Secured Leases • Ground rents
  • 20. Private & Confidential Redington : Manager Forum 12 February 2013 Illiquid Alpha & Beta Strategies 20 fdStep 6. Description Implementation-to-date • Assets under this category provide attractive returns but are typically more complex and illiquid e.g. private equity and PFI equity. • 7% Private Equity • 3% Property (EU and UK) • Total 10% Recommendations Insurance-Linked Strategies (catastrophe risk) • Make allocation to increase diversification and expected returns
  • 21. Private & Confidential Redington : Manager Forum 12 February 2013 Ongoing Monitoring 21 Objective Measurement Performance Indicators Performance RAG Primary Funding Objective To reach 100% funded on a swaps flat basis by 2026 Expected Returns (ER) > Required Returns (RR) RR: Libor + 300bps ER: Libor + 320bps Difference: +20bps Investment Strategy Actual Returns should exceed Expected Returns Actual Returns (AR) > Expected Returns (ER) AR: Libor + 210bps ER: Libor + 200bps Difference: +10bps n/a Risk Budget The investment strategy should not risk the deficit worsening by £600mm over a 1 year period VaR95 < £600mm VaR95: £450mm Hedging Strategy Nominal and inflation hedge ratio should be maintained within +/- 5% of the funding ratio Funding Ratio (swaps flat) 70% n/a Nominal Hedge Ratio (swaps flat) 70% Inflation Hedge Ratio (swaps flat) 70% Collateral Maintain sufficient eligible for the purposes of covering margin calls that may arise from the Scheme’s current derivative positions over a 1 year period. Total available eligible collateral £600mm Remaining collateral after VaR95 event £150mm
  • 22. Private & Confidential Redington : Manager Forum 12 February 2013 22 Online iRIS to be launched in November. (blurb from Teresa) *Technical Resources from Blackrock The easiest way to monitor your pension scheme. Watch our video to learn more about how iRIS makes risk monitoring accessible. Login Track progress against clear goals and objectives Easy access. Login anytime, anywhere Monitor funding level Monitoring: A Preview of Online iRIS
  • 23. Private & Confidential Redington : Manager Forum 12 February 2013 Manager Research Pete Drewienkiewicz 23
  • 24. Private & Confidential Redington : Manager Forum 12 February 2013 Who Are We? 24 Pete Drewienkiewicz, Head of Manager Research Kenny Nicoll, Director: LDI Specialist Huayin Liu, Vice President Tom McCartan, Associate Aniket Das, Associate Kate Mijakowska, Analyst Greg Fedorenko, Analyst Team Size 2011 3 2012 5 2013 7
  • 25. Private & Confidential Redington : Manager Forum 12 February 2013 How Do We Look at the World? 25 Step (2) LDI (3) Liquid α & β (4) Semi-Liquid Credit (5) Illiquid Credit (6) Illiquid α & β Collateral Management Equities Corporate Bonds Infrastructure Debt Insurance-Linked Hedging Multi Asset Asset Backed Securities Social Housing Debt Private Equity Active LDI Sovereign Bonds High Yield Direct SME Lending Infrastructure Equity Gilts Commodities / CTA Leveraged Loans Mezzanine Finance Unlisted Property Currencies Emerging Market Debt Distressed Debt Hedge Funds with Longer Lock-Ups Liquid Hedge Funds Commercial Real Estate Debt Long Leases / Ground Rents
  • 26. Private & Confidential Redington : Manager Forum 12 February 2013 Strategic Managers 26 Manager Step (2) LDI (3) Liquid α & β (4) Semi-Liquid Credit (5) Illiquid Credit (6) Illiquid α & β ABC    DEF    GHI   JKL  
  • 27. Private & Confidential Redington : Manager Forum 12 February 2013 Team Responsibilities                      27
  • 28. Private & Confidential Redington : Manager Forum 12 February 2013 How Do We Divide Our Time? Recommended level of interface for invested strategies: • Quarterly quantitative monitoring • Annual formal review • Constant contact in respect of specific queries: • Impact based approach: Increase contact for increasingly complex / bespoke strategy (e.g. LDI portfolio), Larger AUM / VAR Contact – + Level of interface for non-invested strategies: • Regular research meetings • Tracking vs. 7 steps 28 Less contact e.g. Passive equities
  • 29. Private & Confidential Redington : Manager Forum 12 February 2013 1. Do returns contribute to overall expected returns being greater than required returns to reach full funding? 2. Do returns compensate investors for the level of risk they are being exposed to? 29 3. Are better risk- adjusted returns available elsewhere? 4. What are the implementation challenges? Building on the 7 Steps to Full FundingTM, we outline below the Four Investment Filters: The 4 Investment Filters provide clients with a framework in which to quickly assess and compare different opportunities within and across different asset classes. How Do We Prioritise Opportunities? Expected Returns Risk Assessment ImplementationRelative Value
  • 30. Private & Confidential Redington : Manager Forum 12 February 2013 eVestment 30 • eVestment adopted June 2012 • Comprehensive database of 43,000 strategies across traditional and hedge fund providers • Fund manager performance • Peer group comparisons • Database provides qualitative data, including personnel changes • Growth / decline in firm AUM, mandates won and lost • Portfolio holdings information • Fee schedules Regular Performance Updates Updated Docs & Fund Literature Personnel Changes Hedged Returns Data Net of Fees What we Need from You:
  • 31. Private & Confidential Redington : Manager Forum 12 February 2013 Implementing a New Allocation 31 a b c Use of eVestment for pooled strategies N.B. Many clients have bespoke investments not found on fund databases. Classify investment according to relevant part of 7 Step Framework Account teams decide on appropriateness for individual clients Implement Client Bespoke Industry Net
  • 32. Private & Confidential Redington : Manager Forum 12 February 2013 Breakdown of Recent Search Activity 32 Search Activity Pooled LDI, Segregated LDI, Segregated LDI (within a multi-manager framework) Equity Income, Diversified Growth Fund, Emerging Market Equities, Risk Parity (2 searches) Investment Grade Credit (2 searches), Leveraged Loans & High-Yield Credit, Absolute Return Bonds / Credit Multi- Strategy (3 searches), Asset-Backed Securities Secured Leases (2 searches), Illiquid Inflation-Linked Assets, Distressed Debt, SME Lending Insurance-Linked Securities £365 £1,520 £565 £100 Assets Allocated in 2012 (ex-LDI) - £mio Liquid Alpha & Beta Liquid & Semi-Liquid Credit Illiquid Credit Illiquid Alpha & Beta 3 5 7 5 1 Number of Searches in 2012 LDI Hub Liquid Alpha & Beta Liquid & Semi- Liquid Credit Illiquid Credit Illiquid Alpha & Beta
  • 33. Private & Confidential Redington : Manager Forum 12 February 2013 Steps 2-7: Application 33
  • 34. Private & Confidential Redington : Manager Forum 12 February 2013 Step 2: LDI Hub 34
  • 35. Private & Confidential Redington : Manager Forum 12 February 2013 The LDI Manager as “Quarterback” 35 • Trust • Technical Skills • Transparency
  • 36. Private & Confidential Redington : Manager Forum 12 February 2013 Step 3: Liquid Alpha and Beta Strategies 36
  • 37. Private & Confidential Redington : Manager Forum 12 February 2013 Liquid Alpha & Beta 37 Key Features • Built in risk diversification – equities, commodities and rates • Built in risk control through target volatility • Built in nimbleness through daily rebalancing • Historically improved risk adjusted returns • Low cost • Easy to implement • Highly liquid • Efficient use of collateral Trend Following Strategies Risk Parity Volatility-Controlled Equity Index-Linked Gilts Swap Overlay A One-Stop Liquid Alpha & Beta Portfolio:
  • 38. Private & Confidential Redington : Manager Forum 12 February 2013 Liquid Alpha & Beta Strategy: Historical Performance Comparison Cumulative Excess Returns of Liquid Alpha & Beta Strategies Since 2001 38 Full Calendar Year Excess Returns of Liquid Alpha & Beta Strategies Since 2001 Source: Bloomberg, MSCI, Redington -50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 0 50 100 150 200 250 300 Liquid Alpha & Beta Portfolio Passive Equity
  • 39. Private & Confidential Redington : Manager Forum 12 February 2013 Step 4: Liquid & Semi-Liquid Credit, Step 5: Illiquid Credit 39
  • 40. Private & Confidential Redington : Manager Forum 12 February 2013 Credit as a Core Building Block for Flight Planning 40 Corporate Bonds Direct Lending Absolute Return FPCA FPCA Gilts Cash
  • 41. Private & Confidential Redington : Manager Forum 12 February 2013 Equity Replacement Strategy 41 40% 20% 20% 20% Sample Equity Replacement Portfolio Risk Parity Long / Short Credit Direct Lending (SMEs) Distressed Debt Sources of Funding Developed Equity EM Equity Private Equity 50% 35% 15% Current Allocation 25% 50% 25% Replacement Portfolio Portfolio Weightings: Whole Scheme • Overall risk in the return-seeking assets bucket reduced by a fifth • Overall expected return on scheme assets increased by more than 10% Equities Credit Alternatives
  • 42. Private & Confidential Redington : Manager Forum 12 February 2013 Step 6: Illiquid Alpha & Beta Strategies 42
  • 43. Private & Confidential Redington : Manager Forum 12 February 2013 Insurance-Linked Securities 43 2.26% 2.28% 2.30% 2.32% 2.34% 2.36% 2.38% Current Allocation Current + Aggressive ILS Allocation Current + Conservative ILS Allocation Sample Scheme: Impact on Portfolio Expected Returns Probability 0% Rtn • Assets under this category provide attractive returns but are typically more complex, e.g. private equity, PFI equity. • Inclusion of these assets depends on the overall objectives and governance budget of the scheme. Exceedance Curve (Illustrative) • Catastrophe risk offers chance to earn uncorrelated returns with major asset classes. • Sample scheme – ca. £50m allocation (of c. £3bn overall assets) increased expected returns while decreasing overall risk.
  • 44. Private & Confidential Redington : Manager Forum 12 February 2013 Step 7: Ongoing Monitoring 44
  • 45. Private & Confidential Redington : Manager Forum 12 February 2013 Manager Monitoring / Quarterly Reporting 45 Fund Allocation as at 7/12/2012 Allocation as at 17/9/2012 Manager Monitoring* Fund A 13% 14% Fund B 14% 14% Fund C 25% 24% Fund D 23% 23% Fund E 3% 3% Cash 22% 30% Equity Futures 32% 33% Synthetic Gilts 60% 48% • Managers reviewed as part of overall scheme positioning • Use of RAG ‘traffic lights’ in quarterly quantitative reports echoes PRMF
  • 46. Private & Confidential Redington : Manager Forum 12 February 2013 Performance Monitoring and Position-Based Reporting 46 USD Credit EUR Credit GBP Credit Total Market Value (%) 26.3 9.6 64.1 100 Yield to Worst (%) 4 11.9 5 5.4 Duration (yrs) 13.6 0.6 7.8 8.7 Spread Duration Contribu tion (yrs) 3.4 0.5 5.4 9.3 Libor Spread (bps) 177.9 799.5 236 274.8 UK France Netherlands Italy Switzerland Jersey Chan Isle Australia Denmark Finland Germany Japan Norway Spain United States 0 100 200 300 400 500 600 700 800 LiborSpread(bps) Market Value and Libor Spread by Country Portfolio Benchmark 8.5% 10.4% 40.5% 33.0% 5.1% 1.4% 1.0% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% Aaa Aa A Baa Ba B Not Rated MarketValue Market Value by Average Rating
  • 47. Private & Confidential Redington : Manager Forum 12 February 2013 Conclusion: Our Principles 47 • Identify managers who can deliver return streams that meet our strategic goals Client Focus • Consistent performance in uncertain markets, downside protection Disciplined Process • Transparency in investment process, returns and reporting Clarity Priorities: How to Interact with Us: Use eVestment Relate Offerings to Steps Differentiate Offering
  • 48. Private & Confidential Redington : Manager Forum 12 February 2013 Red Manager Forum Survey Asset Class Matrix 48 -5 -4 -3 -2 -1 0 1 2 3 4 5 -5 -4 -3 -2 -1 0 1 2 3 4 5 Developed Equity Gilts SME Lending Predictable Unpredictable LiquidIlliquid Private Equity
  • 49. Private & Confidential Redington : Manager Forum 12 February 2013 Link to Survey 49 http://svy.mk/XyuSCW
  • 50. Private & Confidential Redington : Manager Forum 12 February 2013 13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk Contacts Robert Gardner Founder & Co-CEO Direct Line: 020 7250 3416 robert.gardner@redington.co.uk 50 Pete Drewienkiewicz Director | Head of Manager Research Direct Line: 020 3326 7138 pete.drewienkiewicz@redington.co.uk Disclaimer text For professional investors only. Not suitable for private customers. The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion purposes only. A variety of market factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can be duplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or other reference rates or prices. Neither the information, recommendations or opinions expressed herein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf. Unless otherwise stated, any pricing information in this document is indicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs. Any reference to the terms of executed transactions should be treated as preliminary and subject to further due diligence. This presentation may not be copied, modified or provided by you , the Recipient, to any other party without Redington Limited’s prior written permission. It may also not be disclosed by the Recipient to any other party without Redington Limited’s prior written permission except as may be required by law. “7 Steps to Full Funding” is a trade mark of Redington Limited. Redington Limited is an investment consultant company regulated by the Financial Services Authority. The company does not advise on all implications of the transactions described herein. This information is for discussion purposes and prior to undertaking any trade, you should also discuss with your professional, tax, accounting and / or other relevant advisers how such particular trade(s) affect you. All analysis (whether in respect of tax, accounting, law or of any other nature), should be treated as illustrative only and not relied upon as accurate. Registered Office: 13-15 Mallow Street, London EC1Y 8RD. Redington Limited (reg no 6660006) is registered in England and Wales. ©Redington Limited 2012. All rights reserved.
  • 51. Private & Confidential Redington : Manager Forum 12 February 2013 13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.ukThe Team Pete Drewienkiewicz Director | Head of Manager Research Direct Line: 020 3326 7138 pete.drewienkiewicz@redington.co.uk 51 Kenny Nicoll Director | Manager Research Direct Line: 020 3326 7111 kenny.nicoll@redington.co.uk Huayin Liu Vice President | Manager Research Direct Line: 020 3326 7105 huayin.liu@redington.co.uk Tom McCartan Associate | Manager Research Direct Line: 020 3326 7139 tom.mccartan@redington.co.uk Aniket Das Associate | Manager Research Direct Line: 020 3326 7153 aniket.das@redington.co.uk Kate Mijakowska Analyst | Manager Research Direct Line: 020 3326 7106 kate.mijakowska@redington.co.uk Greg Fedorenko Analyst | Manager Research Direct Line: 020 3326 7122 greg.fedorenko@redington.co.uk