Investment Strategy Webinar. December 18, 2013

Transcription

1 Investment Strategy Webinar December 18, 2013

2 Presenters John Thompson, Partner Institutional Advisory Solutions Phone: Eric Friedman, Associate Partner Investment Consulting Phone: Koray Yesildag, CFA Global Asset Allocation Phone: Mike Scotto, Partner Investment Consulting Phone: Leslie Smith, Partner Investment Consulting Phone: Matt Plaveczky, Senior Consultant Global Investment Management Phone:

3 Discussion Topics Opening Remarks Implications of PBGC Premium Increases in the Federal Budget Agreement Market Views: The U.S. Dollar DC Plan Costs: A Call to Action Opportunistic Funds Closing Remarks Q&A Session 3

4 Implications of PBGC Premium Increases in the Federal Budget Agreement Eric Friedman

5 Proposed PBGC Premium Increases for Private Sector Pension Plans On December 10, 2013, a House and Senate conference committee announced a budget agreement which includes significant increases in PBGC premiums Increases in flat-rate and variable-rate premium rates are in addition to those enacted in MAP-21 Per-participant cap on variable-rate premium would also increase Increases impact single employer plans but not multiemployer plans No risk adjustments based on plan sponsor financial strength, as have been proposed in previous budgets Projected to raise additional revenue of $7.9 billion 5

6 PBGC Premium Rate Increases Plan Year Flat-Rate (per participant per year) Variable-Rate (per $1,000 of unfunded vested benefits) 2012 $35 $ $42 $ $49 $ $49 (indexed) $57 $19 (indexed) $24 (indexed) 2016 $49 (indexed) $64 $19 (indexed) $29 (indexed) From 2012 to 2016, the flat premium rate would nearly double and the variable premium rate would more than triple The flat premium rate and variable premium rate for will be the 2016 values indexed to National Average Wages. 6

7 Potential Impacts on Pension Risk Management Strategies More liability settlement Lump sums Annuity purchase More contributions for underfunded plans More dynamic de-risking strategies More linkage between contribution strategy and investment strategy Addition of time dimension to dynamic investment policies, in addition to funded status 7

8 Market Views: The U.S. Dollar Is the U.S. Dollar Set for a Comeback? Koray Yesildag & Mike Scotto

9 The U.S. Dollar is Cheap in Both Nominal and Real-Terms Average Average Trade Weighted weighted U.S. US Dollar dollar Versus versus its Major major Trading trading Partners partners US U.S. Real Effective Exchange Rate Source: BIS 9

10 The U.S. Economic Recovery Supports the Dollar Manufacturing PMIs Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 U.S. UK Eurozone Japan China Source: Bloomberg 10

11 U.S. Interest Rates are Starting to Normalize, Which is Dollar Supportive 10 Year Inflation Adjusted Yields U.S. UK EMU Japan Source: DataStream 11

12 Government Debt Battles Threaten the Dollar U.S. Household Sector Liabilities % GDP U.S. Business Sector Liabilities % GDP U.S. Federal Government Liabilities % GDP Source: DataStream 12

13 Expect EM Currency Volatility Next Year, Especially for Deficit Countries Dollar appreciating Dec-10 Mar-11 Jun-11 Sep-11 Dec-11 Mar-12 Jun-12 Sep-12 Dec-12 Mar-13 Jun-13 Sep Indian Rupee to US$ Turkish Lira to US$ Brazilian Real to US$ US 10 Year Treasury Yield (RHS) Source: DataStream 13

14 U.S. Dollar Outlook Summary The U.S. dollar is well placed to gain in value against the majors, although country specific factors could play a role and the pace of dollar appreciation should be moderate Euro We expect some reversal of recent euro strength Sterling The recent strong run, based on growth, is likely to be at least partly reversed Yen Policy has weakened the yen sharply but further falls should be more moderate Emerging market currencies Be prepared for further volatility near term, especially for deficit countries. The longer term outlook is brighter, however Consensus expects the dollar to appreciate by 5% against euro and sterling by the end of 2014, and 10% against the yen. These look broadly reasonable. 14

15 Views on Currency Hedging Are Actions Required? For most clients, no actions suggested at this time The U.S. dollar valuation is not at extreme levels Our General Thoughts on Currency Hedging Programs Use depends on client circumstances Some considerations include: Views on future currency risk Materiality of potential currency risk relative to the organization Time horizon (shorter horizon may create greater need to hedge) Ability to handle program complexity (adverse cash flows, etc.) More details on our views on currency hedging are at 15

16 DC Plan Costs: A Call to Action Leslie Smith

17 DC Plan Expenses A Critical Topic Governmental Oversight The DOL and Congress are scrutinizing DC plan fees. Regulations have been issued regarding fee disclosure to plan sponsors and plan participants. Significant Media Attention Publications including USA Today, The Wall Street Journal, the New York Times, and Associated Press all continue to press on this topic. Plan Sponsor Litigation Continues Over two dozen 401(k) fee class action lawsuits have been filed. These assert excessive fund fees, use of retail fund share classes rather than institutional, and a failure to disclose revenue sharing. Intensifying Employee Focus Employees are becoming more educated consumers, and more attuned to the importance of their DC plan savings and structure. While a majority of employees are passive, vocal minority may continue to push for change. Increasing Employer Attention Employers recognize that there is no free lunch. Even if the out-of-pocket cost to the firm is zero, aggregate plan expenses might be onerous. Plan fiduciaries understand that they are on the hook to understand and manage costs appropriately. 17

18 DC Plan Expenses Employer Responsibilities Department of Labor 401(k) fees should be reasonable in light of the services provided Fiduciary responsibility Prudent expert standard Understanding fees and expenses is important in providing for the services necessary for your plan s operation. This responsibility is ongoing. After careful evaluation during the initial selection, the plan s fees and expenses should be monitored to determine whether they continue to be reasonable. 1 1 Source: A Look at 401(k) Plan Fees for Employers, U.S. Department of Labor 18

19 Defining Total Plan Cost Total Plan Cost = sum of fees associated with operating a defined contribution plan The major fee components are illustrated below: Investment Management (50%-80%) Administrative (15%-40%) Trustee (4%-6%) Other (2%-5%) 19

20 DC Plan Expense Framework Fee and Expense Type What is it Used For? What Does it Cover? Hard Dollar Fees Soft Dollar Fees Transaction Charges Transactions Transaction Cost Base Fees Plan Administration Per-Head Charges Add-on Charges for Specific Services Profit Wrap Fees Sub-TA Fees 12b-1 Fees Other Asset Charges Plan Administration Plan Administration Cost Investment Management Fees Investment Management Inv. Mgmt. Profit Investment Management Cost = participant paid fees = dollar based fees = asset based fees = part of fund expense ratio 20

21 Understanding Fees - Pricing Models for Administration Where We Have Been and Where We Are Going HEK s Recommended Pricing Structure Traditional Net Pricing Basis Point Method Gross Pricing Per Participant Method Summary Vendor receives all revenue sharing credit, PLUS Vendor receives quoted basis point fee Vendor receives quoted perparticipant fee Vendor may assess an additional per-participant or asset-based fee Revenue sharing can be used to offset fees, credited to a spending account, or rebated to participants Revenue sharing can be used to offset fees, credited to a spending account, or rebated to participants Pros If a $0 per participant fee is imposed, the Plan has perception of being free Fee transparency Low and high balance participants pay the same percentage for plan administration Fee transparency Vendor compensation stays LEVEL as assets grow This method is becoming the trend for administration fees Cons Vendor compensation GROWS as assets grow and may cause admin fees to exceed a reasonable amount Vendor compensation GROWS as assets grow and may cause admin fees to exceed a reasonable amount Charging participants a per head fee may be challenging to communicate to participants if they haven t been charged one before High balance participants pay a higher dollar amount than low balance participants Fees are not transparent High balance participants pay a higher dollar amount than low balance participants Low balance participants pay a higher percentage of their account balance than high balance participants 21

22 Current DC Fee Trends, Issues and Best Practices Current Trend Administration Fees Administration fees are declining (20%+ over past 2 years) More plan sponsors are negotiating reduced fees Vendor searches are resulting in reduced fees Current Issue Plan Cross-Subsidation Can occur with multiple plans, ex: Union / Non-union Qualified / NQ Plan sponsors can be unaware Important to look at fees for each plan Current Practice ERISA Spending Account Capture excess revenue Used to pay plan expenses, or allocate to participants Cannot be used to pay settlor expenses or offset company contribution Vendor capabilities and requirements vary greatly Emerging Practice Revenue Sharing Credit ISSUE - Cross-subsidization of participant-level fees Over time, it is likely that this practice will fall out of favor although it is fine right now Emerging trend allocate revenue sharing back to the participants at fund level 22

23 Revenue Credit Methodology as of July 2013 Vendor Setup ERISA Account? Minimum Assets? Allocate Pro-Rata? Allocate Per-Capita? Allocate at Fund Level? Frequency Vendor 1 Yes No Yes Yes No Quarterly Vendor 2 Yes No Yes Yes Yes Monthly Vendor 3 Yes Yes Yes In Progress Yes Quarterly Vendor 4 Yes No Yes Yes Yes Monthly Vendor 5 Yes No Yes Yes No Quarterly Vendor 6 Yes No Yes Yes No Quarterly Vendor 7 Yes Possibly Yes Yes Yes Quarterly Vendor 8 Yes No Yes Yes Yes Monthly Vendor 9 Yes No Direct Rebate Direct Rebate Yes Daily Credit Vendor 10 Yes Possibly Yes Yes Yes Quarterly Vendor 11 Yes No Direct Rebate Direct Rebate Yes Daily Accrued Vendor 12 Yes Possibly Yes Yes Manual Quarterly Vendor 13 Yes No Yes Yes Yes Quarterly Vendor 14 Yes Yes Yes Yes Yes Monthly Vendor 15 Yes Yes Yes Yes Yes Monthly 23

24 HEK s Total Plan Cost Database Benchmarking Your Fees The survey to collect this data was conducted in May defined contribution plans were included Investment management, administrative, and total plan costs were evaluated Investment management cost is based upon the expense ratio of the funds less any revenue sharing that is used towards administrative cost Administrative cost is the sum of recordkeeping fees and trustee fees Total plan cost is the sum of investment management cost and administrative cost Represents what other plans are currently paying Data distribution by plan asset size: Plan Assets Percent of Plans $50 million or less 16% $50.1 $150.0 million 14% $150.1 $500.0 million 18% Other Ways to Benchmark Fees Compare to current marketplace bids for similar sized-plans $500.1 $1 billion 18% More than $1 billion 34% Total Plan Assets $555 billion Median Plan Assets $539 million Average Plan Assets 1.46 billion Go to market to solicit bids for your plan Blind or named basis 24

25 Opportunistic Funds Matt Plaveczky 25

26 Discussion Outline Opportunistic Strategies: Overview and Characteristics Current Strategies Available Prospective Opportunities 26

27 Opportunistic Strategies Opportunistic strategies can provide various solutions to a diversified portfolio including return enhancement, diversification, risk reduction, income generation, interest rate risk mitigation and/or access to unique opportunities What does HEK define as Opportunistic? Non-traditional / niche strategies that border two or more asset classes Can take advantage of an aberration or extreme stress in marketplace Opportunity can be short-lived; may require quick investor action Strategies available in varying formats including single manager or multi-manager structures Recent focus has been on credit strategies for multiple reasons: Capital / lending void due to new banking regulations Return enhancement in low yield environment Need to diversify away from traditional long-only fixed income Income generation Interest rate hedge However, there can be strategies outside of opportunistic credit that HEK finds attractive 27

28 Long Only Credit Alternatives Strategy Description Invests in performing credit typically with a catalyst Tactical allocations across various sub asset classes driven by credit cycle Can hedge using index derivatives to reduce portfolio beta Return Potential: +200 bps over high yield Typical Structure / Terms Commingled hedge fund or separately managed account Redemption Frequency: Monthly or quarterly Lock Up: None or one year soft lock up Management Fee: 1% or lower Incentive Fee: None or Low Fee with a hurdle rate Key Advantages Less correlated to broader credit markets Interest rate hedge through portfolio duration adjustments and floating-rate securities Liquid focus providing investors allocation flexibility 28

29 Opportunistic / Multi-Asset Strategy Description Takes advantage of capital void left by banks, proprietary trading desks and hedge funds Can invest in performing / non-performing credit, equity and structured credit Buys distressed secondary assets or enters into privately negotiated lending transactions Long-term time investment horizon Return Potential: Low to High Teens Net IRR Typical Structure / Terms Drawdown structure with 7-10 year term and possible extensions Cash Flow Distributions: Variable Management Fee: Varies by manager; Based on committed and/or invested capital Incentive Fee: Typically 20% Clawback provision Key Advantages Flexible, opportunistic mandate investing across asset classes, industries and geographies Return enhancement / lower correlation due to nature of investments Strong sourcing capabilities and broad expertise through large asset managers 29

30 Middle Market Direct Lending Strategy Description Senior secured or uni-tranche loans to US middle market companies (<$75 million in EBITDA) Five year loan tenor on average that is held to maturity or refinanced sooner May use leverage up to 1.5x Return Potential: Unlevered 6-7% net; Levered 9-10% net Typical Structure / Terms Multiple Structures: Separately Managed Account, Commingled Fund or BDC Cash Flow Distributions: Quarterly Management Fee: 1% or lower on invested equity Incentive Fee: As low as 10% with preferred return Clawback provision Key Advantages Lower correlation to broader credit markets Historically low defaults with high recovery rates Embedded hedge against rising interest rates due to floating rate loans 30

31 Real Estate Recovery Focus Strategy Description Invests in residential and commercial real estate across U.S. and Europe Residential includes non-agency RMBS, non-performing loans, REO rental, Multi-family Commercial includes secondary structured credit, non-performing loans, equity investments May use leverage up to 2.5x Return Potential: Mid-to-High Teens IRR Typical Structure / Terms Drawdown structure with 5 year term and possible extensions Cash Flow Distributions: Variable Management Fee: 1.5% on invested capital Incentive Fee: 20% with preferred return Key Advantages Return enhancement with focus on continued housing / real estate recovery Strong sourcing capabilities and broad expertise through large asset managers Active exit approach to investments to realize value 31

32 Collateralized Loan Obligations (CLOs) Strategy Description Invests in externally and internally managed CLOs across managers High percentage (~75%) of equity investments with remainder in mezzanine Greater than 90% invested in US; Remainder in Europe Return Potential: Low-to-Mid Teens IRR Typical Structure / Terms Drawdown structure with 7-10 year term Cash Flow Distributions: Quarterly Management Fee: 1% on invested capital Incentive Fee: 20% with preferred return Key Advantages Experienced asset manager investing in multiple CLO tranches and performing credit research on collateral pool Embedded hedge against rising interest rates due to floating rate coupons Income generating with quarterly cash flows 32

33 Multi-Manager Manager (Fund of Hedge Funds) Strategy Description Invests in commingled funds or customized funds of underlying direct hedge funds Externally managed U.S. and European asset-backed securities, collateralized loan obligations, collateralized debt obligations, long/short credit, bank loans, distressed debt, secondary loans, whole mortgages Return Potential: High Single to Mid Double-Digit IRR Typical Structure / Terms Multiple Structures: Separately Managed Accounts or Commingled Funds Cash Flow Distributions: Throughout Life of Fund Management Fee: Varies and is based on invested capital Incentive Fee: Varies and includes preferred return Key Advantages Expertise in manager and strategy selection, customization of underlying funds, access to closed or emerging managers and fee negotiations Slightly shorter-term lock-up period Diversification across managers, investment instruments, geographies and sectors 33

34 Prospective Opportunities Types of investments include: Near Term Opportunities Long-Only Credit Alternatives Opportunistic / Multi-Asset Middle Market Direct Lending CLO Equity Medium Term Opportunities Stressed / Distressed debt Opportunistic / Multi-Asset: Secondary Offerings Multi-Manager Offerings Focused on European and Emerging market debt opportunities Broader investment mandates inclusive of credit and equity (activist) investment opportunities One-Off Opportunities Co-investment or side-car opportunities 34

35 Closing Remarks John Thompson

36 Q&A Thank you. 36

37 Our next investment strategy update call is scheduled for Wednesday, January 15 th, at 10 a.m. CST. 37