SCOTTISH WIDOWS PREMIER LIFESTYLING OPTIONS

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1 SCOTTISH WIDOWS PREMIER LIFESTYLING OPTIONS SCOTTISH WIDOWS PREMIER PENSION FUND RANGE (PREMIER RANGE) BUILDS ON OUR WELL-ESTABLISHED ORIGINAL RANGE OF PENSION INVESTMENT APPROACHES, GOVERNED INVESTMENT STRATEGIES AND PENSION PORTFOLIO FUNDS AIMING TO OFFER BETTER POTENTIAL RETURNS FOR BROADLY THE SAME LEVELS OF VOLATILITY. This information is for UK financial adviser use only and should not be distributed to, or relied upon by, any other person.

2 Premier Lifestyling Options INTRODUCTION launched the Pension Investment Approaches (PIA) lifestyling option for corporate pensions in This was followed by our equivalent Governed Investment Strategies (GIS) for individual pension customers in In both cases, our passively managed Pension Portfolio Funds have been effective underlying investment vehicles. We continue to believe in this robust and cost-effective approach to investing, and our passively managed lifestyling options for PIA and GIS continue to be available. However, as a result of Auto Enrolment and Pension Freedoms, we believe that customers are demanding more from their pensions, with the level of net returns becoming increasingly important. Our Investment Approaches (PPIA) and Premier Governed Investment Strategies (PGIS) are specifically designed to help meet this need, aiming to offer better potential returns for broadly the same levels of volatility as our original versions in each risk category.

3 Premier Lifestyling Options PAGE 2 WHAT ARE THE MAIN STRENGTHS OF THE PREMIER PIA AND PREMIER GIS LIFESTYLING OPTIONS? PAGE 4 HOW THE SCOTTISH WIDOWS PPIA AND PGIS LIFESTYLING OPTIONS WORK PAGE 7 HOW ARE THE PREMIER LIFESTYLING OPTIONS INVESTED? PAGE 8 THE PREMIER APPROACH TO ASSET ALLOCATION PAGE 9 THE UNDERLYING ASSETS AND STRATEGIES PAGE 16 HOW DOES THIS ALL FIT INTO THE PREMIER LIFESTYLING GLIDEPATHS? PAGE 18 WHY DO WE BELIEVE THE PREMIER VERSIONS OFFER POTENTIALLY BETTER RETURNS FOR BROADLY THE SAME LEVEL OF VOLATILITY? PAGE 20 FUNDS INFORMATION, AIMS AND RISKS 1

4 Premier Lifestyling Options WHAT ARE THE MAIN STRENGTHS OF THE PREMIER PIA AND PREMIER GIS LIFESTYLING OPTIONS? SCOTTISH WIDOWS PREMIER PENSION FUND RANGE 1. POTENTIALLY BETTER NET RETURNS* 2. TARGETING SIMILAR LEVELS OF VOLATILITY* 3. ROBUST DESIGN AND GOVERNANCE 4. COMPETITIVE PRICING *In comparison with the original Pension Portfolio Funds, Pension Investment Approaches and Governed Investment Strategies. The Investment Approaches (PPIA) and Premier Governed Investment Strategies (PGIS) are a key evolution of our corporate and individual pension investment propositions. By adding these investment packages to our existing lifestyling options, we are acknowledging changes in the market and anticipating developments we believe will happen. The three main drivers are: 1. Regulatory changes, including the Pension Freedoms introduced in April Increasing customer needs. We expect that customers are going to become increasingly concerned about whether they have enough to retire, and also how they can maximise the growth potential of their pension fund. 3. Investment developments. Since the launch of PIA in 2006, new investment strategies have become available, notably Smart Beta, which we will cover later. These offer the opportunity for potentially better risk-adjusted returns. The key difference in terms of the investment mix is that, in addition to investing in traditional equities and bonds, the Premier lifestyling options include specialised investment strategies, more asset classes and a degree of active management. Other than this, our PPIA and PGIS options have the same structure as our original PIA and GIS propositions: Three risk categories (Cautious, Balanced, Adventurous) and three retirement outcomes (Targeting Annuity, Targeting Encashment, Targeting Flexible Access). A glidepath design that gradually de-risks from 15 years to the customer s selected retirement date. A blend of underlying funds to achieve the selected asset mixes at different stages of lifestyling. To enable us to do this, we ve launched Premier versions of all our Pension Portfolio Funds, including those we use for lifestyling (Pension Portfolios 1 to 5). 2

5 Premier Lifestyling Options We see the following as the key benefits of PPIA and PGIS: 1. POTENTIALLY BETTER NET RETURNS We carried out extensive modelling when we designed PPIA and PGIS and the underlying funds using significant input from Moody s Analytics. Using certain assumptions*, the modelling projected annual returns that could be 0.75% higher (net of fees) than the equivalent portfolios within PIA or GIS over rolling three year time periods. Please note this isn t guaranteed. 2. TARGETING SIMILAR LEVELS OF VOLATILITY The Portfolio Funds are constructed so that they target broadly the same level of volatility as those within the original PIA and GIS. Because the Premier range uses a greater number of strategies than the passive equivalents, this allows for greater diversification. Different asset classes have the potential to help generate returns in a wide variety of market conditions. The Premier range uses some relatively lower risk strategies, such as Low Volatility Equities, which are not available to our original range. The broader combination of asset classes used led to modelling results which indicate a potentially improved efficient frontier, in terms of the potential return derived for broadly the same level of volatility. 3. ROBUST DESIGN AND GOVERNANCE The Asset Allocation Team assessed the suitable strategies available, and worked closely with quantitative modelling specialists Moody s Analytics to help us to refine the choice and to decide the strategic asset allocation within each Portfolio Fund. We carried out comprehensive testing of the portfolios under different market conditions to challenge and stress-test the proposals, with input from Moody s Analytics. There is a stringent and thorough governance framework in place for these funds, to monitor their ongoing performance and suitability, and ensure key decisions and reviews are communicated appropriately. 4. COMPETITIVE PRICING The PPIA and PGIS are priced at an additional 0.3% Total Annual Fund Charge per year compared to our original PIA and GIS options. This higher charge allows us to access a potentially better-performing blend of assets and advanced strategies. We believe this represents very good value for money. For corporate pensions, this means that some schemes could access our Premier PIA options as a default strategy and remain under the 0.75% total price cap. *The figure of 0.75% a year over rolling three year time periods was arrived at by running a large number of different scenarios that could affect the funds. These scenarios included the impact of varying economic and market conditions, and the probability of how this would affect the assets and strategies of the funds. We also allowed for the difference in fund charges between the Portfolio Funds and the Pension Portfolio Funds. As this is based on probabilities not certainties, relative performance between the Portfolio Funds and the Pension Portfolio Funds may be lower or higher than 0.75% a year over rolling three year time periods. Please note that the value of an investment is not guaranteed and can go up and down depending on investment performance (and currency exchange rates where a fund invests overseas), and you may get back less than you invested. This guide will explain in detail how our PPIA and PGIS lifestyling packages are invested, and why we believe their blend of carefully selected assets, complementary strategies and robust governance will appeal to many of your corporate and individual clients. 3

6 Premier Lifestyling Options HOW THE SCOTTISH WIDOWS PPIA AND PGIS LIFESTYLING OPTIONS WORK As we mentioned earlier, our PPIA and PGIS options are structured in the same way as our original PIA and GIS lifestyling investments, including the three risk categories. Our PPIA and PGIS lifestyling options are designed to help customers achieve what they need from their pension plan. Aiming for investment growth is vital, but we believe we also have a commitment to customers to: Make it easier for them to make an investment choice with confidence. Aim to ensure that the investment choice they make on day one remains equally relevant to the day they retire. Regularly test and re-test our understanding of investment risk and reward in light of market changes. Offer expert investment management at a competitive level of annual charge. Help our pension customers to prepare for the type of retirement income they ll want. To help customers make a suitable investment choice for their plan, we offer three risk categories, each with a different combination of risk and reward: ADVENTUROUS BALANCED CAUTIOUS Whichever one they choose, customers can be sure that we ll manage the investment of their plan with the aim that it always has a combination of investment risk and reward that both: matches their chosen risk category, and manages their investment to their selected retirement date. Our lifestyling risk categories all work in a similar way: the difference between them is how much investment risk they take in trying to help a customer s pension fund grow. We offer a smoothed approach to lifestyle switching, which ensures a reassuringly predictable transition between funds. In the earlier years, more money is invested in growth assets like equities to increase the potential for growth. We then begin to gradually reduce the exposure to risk once the customer is 15 years from their selected retirement date. Although this reduces the growth potential of the customer s plan, it also aims to help protect its value as they near their selected retirement date. Each of our three lifestyling risk categories are composed of multi-asset Portfolio Funds until five years from the customer s selected retirement date, and specialised funds for the final five-year pre-retirement phase. In the final five years leading up to the selected retirement date, our PPIA or PGIS customers will gradually move into one of three carefully selected packages of lower-risk investments. These are different for each of the three Retirement Outcomes we offer, which have been tailored to suit whichever retirement option the customer has identified: Targeting Annuity for those planning to buy an annuity. Targeting Encashment for those who plan to encash their fund. Targeting Flexible Access for customers who wish to remain invested as they plan to access their pension fund on a more flexible basis. 4

7 Premier Lifestyling Options Our full lifestyling structure is summarised as follows: PIA/GIS ADVENTUROUS RISK CATEGORY BALANCED RISK CATEGORY CAUTIOUS RISK CATEGORY Adventurous Targeting Annuity Balanced Targeting Annuity Cautious Targeting Annuity Adventurous Targeting Encashment Balanced Targeting Encashment Cautious Targeting Encashment Adventurous Targeting Flexible Access Balanced Targeting Flexible Access Cautious Targeting Flexible Access PPIA / PGIS ADVENTUROUS RISK CATEGORY BALANCED RISK CATEGORY CAUTIOUS RISK CATEGORY Premier Adventurous Targeting Annuity Premier Balanced Targeting Annuity Premier Cautious Targeting Annuity Premier Adventurous Targeting Encashment Premier Balanced Targeting Encashment Premier Cautious Targeting Encashment Premier Adventurous Targeting Flexible Access Premier Balanced Targeting Flexible Access Premier Cautious Targeting Flexible Access Customers therefore have three selections to make when they make their investment choice: The level of risk they are comfortable with Adventurous, Balanced or Cautious. The type of retirement outcome they are likely to want when they retire Targeting Annuity, Targeting Encashment or Targeting Flexible Access. The choice between our passive PIA and GIS options, or our Premier versions (PPIA and PGIS). The graphic overleaf is designed to demonstrate how a typical investment glidepath works, and applies to all our lifestyling options. Please note that this graphic indicates how the level of risk changes at different stages, not the likely performance of the investment. 5

8 Premier Lifestyling Options HOW AN INVESTMENT GLIDEPATH WORKS 5 years from retirement the glidepath diverges Level of Risk 15 years from retirement level of risk starts to fall Up to 5 years from retirement the glidepath is the same, regardless of which retirement outcome has been chosen Years to Retirement Retirement Targeting Flexible Access Targeting Annuity Targeting Encashment We realise that some customers may not be sure how they will want to provide for their retirement, especially those who are still some years from taking benefits from their pension pot. So we have made it easy for them to change towards a different Retirement Outcome, a different risk category or between a passively managed and Premier lifestyling option if their plans and objectives change. Since 2006, we have maintained and developed this structure for our PIA and GIS options, and this well-established approach has been replicated for PPIA and PGIS. We will now look at the Premier versions in more detail. 6

9 Premier Lifestyling Options HOW ARE THE PREMIER LIFESTYLING OPTIONS INVESTED? The overall structure of our PPIA and PGIS proposition is the same as our PIA and GIS. By this we mean that they invest in underlying funds to gain exposure to a selected asset mix. These different asset mixes reflect different levels of risk and how far customers are from their selected retirement date. We use multi-asset funds for the bulk of the lifestyling glidepath, and specialised funds for the five years leading up to retirement. The key difference for our Premier lifestyling versions is that we use our Portfolio Funds as the main underlying funds. These were primarily created for this purpose, and invest in assets and strategies other than traditional passively managed equities and bonds (i.e. those managed relative to marketcapitalisation-weighted indices). We added significantly more investment components to the Premier range. These include Smart Beta strategies (Fundamental Index Equities and Low Volatility Equities), Absolute Return, Property and a Tactical Asset Allocation overlay. This gives the Premier range greater investment scope, and means we are giving customers access to: A wider range of asset classes and strategies. The resulting diversification allows a higher proportion of the funds to be invested in asset classes which we believe could generate higher returns and less in those we expect to generate lower returns, such as fixed income and cash. Active management and specialist fund strategies that we feel have the potential to perform better than traditional passive investments. More options for strategic and medium-term asset allocation decisions, because there are more asset classes available. Tactical asset allocation, aiming to take advantage of short-term market opportunities. A more diversified blend of investments, which is intended to increase the benefits of non-correlated asset classes within the portfolios. We will now look at how PPIA and PGIS are constructed, focusing on the Premier range s asset allocation process, the strategies and assets that are used as the building blocks of the Portfolio Funds (the underlying funds), and how these funds fit into the lifestyling glidepaths. 7

10 Premier Lifestyling Options THE PREMIER APPROACH TO ASSET ALLOCATION The Premier range s approach to asset allocation is a fundamental strength. Effective asset allocation is a crucial influence on multi-asset performance, and compared with our passively-managed versions, the Portfolios offer greater diversification, an element of active management and specialised investment strategies that are not always available to individual investors. Greater diversification enables the Portfolios to potentially generate returns in a wider variety of market conditions, by reducing the impact of large falls in any one asset class on customers investments. A larger number of asset classes allows greater flexibility to make asset allocation decisions. Many multi-manager funds take an overly short-term view of asset allocation and frequently rotate fund managers. In contrast, the Premier range will take a much more long-term approach, because switching managers can be very expensive. By aiming to hold positions longer, we are also able to negotiate competitive deals with fund providers. The Premier range s asset-allocation framework takes place on three levels: 2 HOUSE VIEW MEDIUM-TERM ASSET ALLOCATION To help ensure that the Premier range s strategic asset allocation remains optimal as the attractiveness of asset classes changes over time, our Asset Allocation Team will recommend medium-term positioning in its favoured asset classes. Once the Insurance Investment Strategy Committee (IISC) has considered such recommendations they will form our house view. We will then apply them across our fund range, including Premier. 3 TACTICAL ASSET ALLOCATION Tactical asset allocation (TAA) involves adjusting the long-term asset allocation within a portfolio in order to capture shorter-term relative value opportunities in markets. We do not undertake TAA directly within Premier s portfolios but instead invest in GTAA 1, which is a TAA fund managed on our behalf by Aberdeen Asset Management. 1 STRATEGIC ASSET ALLOCATION The purpose of long-term strategic asset allocation is to determine the optimal mix of asset classes within a portfolio, based on the expected return of those asset classes over five years and longer, and their historic correlations, and taking into account the portfolio s performance objective and risk parameters. Asset Allocation Team worked closely with quantitative modelling specialists Moody s Analytics to determine the overall strategic asset allocation of each of the Portfolios. Stress-testing the portfolios for different market conditions supported these results. The Portfolios are less dependent on fixed income and cash than our passively-managed Pension Portfolios. To maintain the overall level of risk, they use diversified strategies, such as Absolute Return and Property, plus select exposure to equities, principally through Smart Beta strategies. 8

11 Premier Lifestyling Options THE UNDERLYING ASSETS AND STRATEGIES We use a wide selection of investment components within the Portfolio Funds (also referred to as Premier ). At any time, the assets and investment strategies that we may use are: Equities Passively Managed Equities Index Futures Low Risk Active Equities Fundamental Index Equities (Developed Market) Fundamental Index Equities (Emerging Market) Low Volatility Equities (Developed Market) Low Volatility Equities (Emerging Market) Bonds Corporate Bonds (Investment-Grade and High-Yield) Gilts (Fixed-Interest and Index-Linked) Absolute Return Strategies Multi-Asset Absolute Return Absolute Return Bonds Property Commodities Tactical Asset Allocation Short Dated Maturities PASSIVELY MANAGED EQUITIES Smart Beta strategies Passively managed funds aim to mirror the constituents and therefore returns of an index, such as the FTSE All-Share, and are also referred to as tracker funds. Passive equity management involves accepting the full level of market risk, or beta, and doesn t seek to outperform the market. Most equity indices weight their components according to market capitalisation. This means that stocks are included and ranked according to the total value of their shares. So a company that has recently enjoyed strong share price performance will be heavily weighted in a standard index, and this will be replicated by a passively managed fund. There are advantages to investing in tracker funds and we continue to believe that they are a cost-efficient way to benefit from the returns achieved by equity markets. In the context of our Portfolios, they allow us to express a view on specific regional markets. For example, if we held a positive view of the Japanese equity market then we would invest in it via a traditional market-capitalisation-weighted Japanese index fund. While we also believe in the advantages of Smart Beta, as explained below, we would be unable to express a positive view of the Japanese market using a Smart Beta strategy as Smart Beta indices are all global rather than regional. The means by which we would invest in traditional passively managed equities is via funds managed by State Street Global Advisors. For UK equities, we would invest via the SWUTM All Share Tracker Fund. INDEX FUTURES Futures contracts are an agreement to buy or sell an asset at a specified price at a particular point in the future. In the case of an equity index futures contract, the underlying asset is a stock market index, such as the FTSE 100. An investor will make a profit if the index is higher, at a particular point in time, than the price at which they had agreed to buy it, and vice versa. Futures are an important tool within Premier, which we may use for both efficient portfolio management purposes and to gain exposure to certain asset classes. For a number of the Portfolios, we use futures to gain exposure to UK equities. LOW RISK ACTIVE EQUITIES A low risk active equity fund takes a quantitative, systematic approach to investing and is designed to outperform a market-capitalisation-weighted index by a small amount on a consistent basis. We believe that this approach to investing is attractive relative to conventional active stock-picking. While a low risk active equity fund is designed to outperform by only a small amount each year, this amount should be relatively consistent (unlike the returns from active stock-picking) and therefore compounding over time should result in returns, we believe, that are comparable to those from a conventional active stock-picking approach. Meanwhile, the fee for investing in a low risk active equity fund is typically significantly lower than that for an active stock-picking one. 9

12 Premier Lifestyling Options The Portfolios invest in the Scottish Widows Emerging Markets Fund, which is managed on our behalf by Aberdeen Asset Management s Quantitative Investment Team. It is designed to outperform its market-capitalisation-weighted benchmark by 0.75% per annum. SMART BETA Smart Beta is an umbrella term for passive investment strategies that are designed to deliver higher returns than traditional market-capitalisation-weighted indices. Smart Beta strategies are usually based on indices that weight their components according to fundamental measures or low historical volatility. Other approaches simply weight their components equally. All of these approaches aim to sell stocks that appear fully valued and buy stocks that look undervalued. These transactions are triggered automatically when the Smart Beta indices are rebalanced. The two Smart Beta strategies that we employ in the Portfolios are Fundamental Indexing and Low Volatility. FUNDAMENTAL INDEXING Most passive investments track market-capitalisationweighted indices. This means that investors funds are concentrated in the largest and potentially most expensive companies, leaving them fully exposed to corrections in the prices of overvalued shares. Fundamental equity indexing aims to avoid this issue by weighting stocks according to real-world economic values for example, a company s sales, cashflow or dividends. A fundamental index can use one of these real-world values or a combination of several. So, when the fundamental index rebalances, it will give prominence to undervalued companies with good operating performance rather than those with good share price performance. Crucially, fundamental indices can avoid share price bubbles i.e. when a stock s market capitalisation rises to levels unjustified by its economic fundamentals. Rather than rebalancing into overvalued stocks, as traditional indices tend to do, fundamental indices rebalance out of overvalued stocks and into those that have fallen from favour. Research has indicated that fundamental indices tend to outperform market-capitalisation-weighted indices over the long term. By selling stocks when their share prices have overtaken their fundamentals, these indices take profits steadily and rationally. As this process is automatic, human biases and sentiment are avoided. LOW VOLATILITY Low volatility equity investing seeks to deliver strong returns from equity markets with a significant reduction in the associated risks. As with fundamental indexing, an important aspect of low volatility investing is that it is not dependent on companies market capitalisation. Whereas standard equity indices weight their components according to market capitalisation, low volatility indices weight their components according to their recorded levels of volatility, so that the index has a higher proportion of assets invested in stocks that have been the least volatile historically. Low volatility indices may also take into account fundamental factors such as book value, sales, cashflow and dividends. Extensive research has shown that low volatility stocks tend to outperform higher volatility ones over the long term. For both Fundamental Indexing and Low Volatility, the Portfolios invest via funds that use FTSE RAFI indices from Research Affiliates. These cover both developed and emerging markets. Research Affiliates is a specialist in Smart Beta and asset allocation. CORPORATE BONDS (INVESTMENT- GRADE AND HIGH-YIELD) Corporate bonds are issued by companies in order to raise cash. The purchaser of a corporate bond is effectively lending the company money in exchange for a regular interest payment (coupon) and the return of the original sum at the end of the term (if held to maturity). Rather than referring to this fixed rate of interest, investors in bonds tend to talk about the yield, which is calculated by dividing the interest payment by the price of the bond. If the price of a bond falls, the yield rises and vice versa. Two of the main drivers of bond prices are interest rates and inflation. As these fall, the fixed rate of income from a bond becomes more attractive. Investing in corporate bonds is generally more risky than investing in most government bonds, but the returns tend to be higher. However, investing in corporate bonds is generally less risky than investing in equities because the coupon payments should be paid unless the company defaults on the loan, whereas company dividends are subject to board approval on a year-to-year basis. As with equities, however, the market value of a bond can fluctuate. 10

13 Premier Lifestyling Options There are two main types of corporate bond: investment-grade and high-yield. Investment-grade bonds are considered to have a relatively low risk of default (failure to repay the loan or pay coupons when due). High-yield bonds have a greater risk of default than investment-grade bonds and because of this, lenders (i.e. the bond-holders) demand a higher rate of return on their loan, hence the name high-yield. This means that high-yield bonds can prove to be very attractive investments for those with sufficient appetite for risk. Most bonds, whether issued by companies or governments, receive credit ratings from agencies such as Moody s, Standard & Poor s and Fitch. These provide an assessment of the issuer s financial strength and, hence, an indication of its likelihood of default. We believe that corporate bonds can offer an attractive return for their given level of risk. The fact that equities and corporate bonds are not perfectly correlated can help to reduce risk in a portfolio. Beyond that, investment-grade corporate bonds generally offer lower levels of risk than many other asset classes, given the financial stability of their issuers and the ongoing scrutiny of the ratings agencies. The Portfolios can invest in investmentgrade corporate bonds via the Corporate Bond 1 Fund (Global) and the Corporate Bond Fund (UK)*. These funds are actively managed. Although it costs more to invest actively rather than passively, we believe that it is worthwhile to do so in the corporate bond market. This is because investing actively allows the fund managers to try to avoid those bonds that they think are at risk of default. It also allows them to try to avoid bonds that they think could be downgraded from investment-grade these bonds would incur transaction costs as they would have to be sold from an investment-grade fund. To access high-yield bonds, the Portfolios can invest in the High Income Bond Fund. This fund invests primarily in corporate and government bonds from the USA, UK and Europe, most of which will be higher risk, non-investment-grade securities: for example, as at 30th September 2017, about 77% of the fund was invested in bonds with credit ratings of B or BB. These three bond funds are all managed for by Aberdeen Asset Management s well established and respected fixed interest team. They are cost effective ways for the Premier funds to access corporate bonds, because they are all funds so the charges are very competitive. *Please note that the Corporate Bond 1 Fund is an institutional global bond fund and is not directly available to investors as a Life or Pension fund. Meanwhile, the Corporate Bond Fund is a UK bond fund and is available as a Life and Pension fund. GILTS (FIXED-INTEREST AND INDEX-LINKED) Gilts are bonds issued by the British government. The purchaser of a gilt is effectively lending the British government money in return for an interest payment. Conventional gilts offer a fixed rate of interest that is the holder of the bond receives a fixed amount of income, or coupon, each year. At the end of the gilt s term, the British government will repay the holder of the gilt the original amount that was loaned (the principal). Index-linked gilts are different in that they offer protection against inflation, with both the coupons and the principal being adjusted for inflation. Part of the attraction of gilts is that they are considered to be among the safest bonds in the world. This is due to the British government s high credit rating and its history of never having defaulted on its loans, which can make them an important defensive asset class. While historically gilts have returned less than other asset classes that may be used within Premier, they have also displayed a low level of correlation, particularly with equities. When equities are out of favour and equity markets are falling, gilts often do well because they are perceived as a safe haven. It is for this reason that they form part of the toolbox that we have at our disposal for use within the Portfolios. MULTI-ASSET ABSOLUTE RETURN Unlike many traditional investment funds, multi-asset absolute return funds are not constructed with reference to a benchmark. The fund manager therefore has freedom (within the terms of the fund) to invest simply in those assets that they think will perform the best. The aim is to produce a positive return in all market conditions indicatively over one year. In order to achieve this aim, the fund manager will undertake dynamic asset allocation across a range of asset classes, including more unusual assets that customers might not otherwise be able to invest in. Many absolute return funds also use derivatives in order to achieve additional returns and manage risks within the fund. 11

14 Premier Lifestyling Options Within the context of our Portfolio Funds, we believe that an allocation to multi-asset absolute return strategies has the potential to deliver strong risk-adjusted returns relative to the other asset classes in which they are invested. The Portfolio Funds invest in two specialist absolute return funds: the Insight Global Absolute Return Fund and the Nordea Diversified Return Fund. With different approaches and asset allocations, these two funds complement each other, and provide a blended overall approach. The Insight Global Absolute Return Fund invests in a diversified range of asset classes, with the principal ones being fixed income, equities, total return strategies and real assets. The use of a stop-loss facility, whereby investments are sold when their volatility reaches a certain threshold, is reassuring. Insight s managers have earned a strong reputation and are backed by a robust risk management process. We chose the Nordea Diversified Return Fund because the team s balance approach offers the prospect of steady positive returns through the market cycle, with a lower probability of loss than many other managers in this sector. ABSOLUTE RETURN BONDS The theory behind absolute return bond funds is the same as for multi-asset absolute return funds that is to use a variety of assets and strategies in order to achieve a positive return in all market conditions indicatively over one year. In order to do this, the fund manager will have flexibility to invest in a whole range of bonds and bond-related assets, including government and corporate bonds, currencies and money market instruments. The fund manager will also use an array of strategies in order to profit from their views of underlying markets and to mitigate risk; as part of this they are likely to use derivative instruments. For example, the fund manager may wish to express a view that interest rates will rise and they could use derivative instruments in order to do this. Equally, they may use derivatives to reduce the risk to the portfolio of a particular currency falling. The Portfolios can invest in two specialist Absolute Return Bond funds: the Payden Absolute Return Bond Fund and the PIMCO GIS Global LIBOR plus Bond Fund. The Payden Absolute Return Bond Fund was selected because it is well-diversified and conservative, with around 200 mostly investment-grade positions spread across approximately 30 countries, but with a bias towards the US. The managers use both conventional and investment-grade asset-backed securities for additional diversification from interest-rate risk. The result is a fund with lower volatility than many of its peers, run to a disciplined risk budget. PIMCO is a large, well-resourced bond manager. The GIS Global LIBOR plus Bond Fund was chosen because it is designed to capture PIMCO s highest conviction views across global bond markets (including Europe) in a diversified and risk-prudent manner. It reflects a combination of PIMCO s top-down macroeconomic views and sector selections, with bottom-up security research and relative value opportunities. By using these two experienced and well respected specialists, we can access country and currency diversification across global markets, within well controlled portfolio allocations. PROPERTY Direct property funds invest in physical property such as shops, offices and warehouses. They aim to make a profit from rental yield and capital appreciation. Indirect property funds invest in the shares of property companies quoted on a stock exchange. They aim to make a profit from an increase in the value of the shares of these companies. Property as an asset class offers attractive long-term growth and also helps to increase diversification within a multi-asset portfolio. The Portfolios may invest in two specialist property funds: the Pooled Property ACS Fund 1 and the BlackRock Global Property Securities Equity Tracker Fund. We chose the Pooled Property ACS Fund 1 because it is actively managed and we believe that active management experience can add value when investing in UK property. We chose the BlackRock Global Property Securities Equity Tracker Fund to achieve low-cost and liquid exposure to a wide range of global property markets. These two funds provide the Portfolios with complementary return-seeking profiles and significant diversification within the property market. 12

15 Premier Lifestyling Options COMMODITIES Commodities cover a wide range of physical goods, from oil and gas, to industrial and precious metals, to agricultural produce such as grain and livestock. The supply of commodities is controlled by the producers i.e. the oil companies, miners and farmers although for some commodities external factors can also affect the supply, for example adverse weather. Meanwhile, demand is determined by the consumers of the commodity i.e. companies and households. An investment in commodities can be made in various ways, including buying the physical good, buying contracts based on the physical good (e.g. a futures contract), buying Exchange Traded Products (ETPs) that track a physical commodity index, and buying shares in commodity companies such as mining companies. Commodities are actively traded on a wide variety of exchanges and for the most part they are traded via futures contracts. The futures price is therefore often the quoted price of a commodity, and while to an extent the futures price is determined by supply and demand, speculation by traders also plays a part. It is for this reason that commodities prices can move quickly and sharply in response to global events. Commodities can offer diversification from other asset classes and provide some protection against inflation. The Portfolios can invest in the Alternatives Pension Fund, which in turn currently invests in the Vontobel Harcourt Commodity Fund. The Vontobel Harcourt Commodity Fund is one of the few actively managed commodity funds within the market. The team behind it has a successful 19-year track record of managing commodity funds. Their competitive advantage centres on detailed research into the supply/ demand outlook for the 22 individual commodities that the fund can invest in. The aim of this research is to identify price inefficiencies that can successfully be exploited. A focus on downside mitigation has also contributed to the Fund having a compelling performance track record. TACTICAL ASSET ALLOCATION (TAA) Tactical asset allocation (TAA) involves adjusting the long-term asset allocation within a portfolio in order to capture shorter-term relative value opportunities in markets. We do not undertake TAA directly within Premier s portfolios but instead invest in GTAA 1, which is a TAA fund managed on our behalf by Aberdeen Asset Management. This fund invests in equities, bonds, currencies and commodities using derivative instruments such as futures and forward currency contracts. One of the main advantages of investing in a TAA fund rather than implementing TAA decisions directly is that it reduces transactions and transaction costs as the underlying assets within our Portfolios are not being bought and sold. This in turn reduces the need for cash to fund transactions, which can be a drag on portfolio performance. Finally, it ensures consistency of execution across portfolios. SHORT DATED MATURITIES We invest in short dated maturities through Premier Pension Portfolio 5, which is one of the specialised pre-retirement funds within Premier. No other Premier Pension Portfolio Fund invests in short dated maturities. Short dated maturities offer an alternative to money market or cash investments, and Portfolio 5 contains a blend of short dated fixed deposits, certificates of deposit, Floating Rate Notes (FRNs), Asset-Backed Securities (ABS) and short dated corporate notes. Some of these offer specific benefits not available from more traditional assets, such as exposure to floating interest rates (through FRNs), and physical collateral such as commercial and residential property, provided as security for thousands of underlying loans within ABS. 13

16 Premier Lifestyling Options Portfolio 5 invests in a range of underlying funds and is designed to target an annual return of Libor +0.75%, with a relatively low probability of loss and a low magnitude of loss. The allocation to the underlying funds will be reviewed and tactically adjusted depending on market conditions and investment outlook. The underlying funds currently are: Insight LIBOR Plus Fund Insight are a subsidiary of BNY Mellon, with a reputation for excellence in active fixed income. We chose their well-established Libor Plus Fund because it has a strong track record of exceeding its target of Libor + 2%, and all its holdings are FRNs. Aberdeen Liquidity Fund (Lux) Ultra Short Duration Sterling Fund This fund is managed by Aberdeen Asset Management s specialist Money Markets Team. Its aim is to achieve a consistent return in Sterling over the short to medium term through investment in bonds and money market instruments denominated in Sterling, including but not limited to commercial paper, floating rate notes, certificates of deposit and asset backed securities. SPECIALISED PRE-RETIREMENT FUND FOR PPIA AND PGIS TARGETING ANNUITY RETIREMENT OUTCOMES We use the Pension Protector Fund as a specialised fund during the last five years of our PPIA and PGIS Targeting Annuity retirement outcome. In combination with Portfolio 5, it s designed to prepare our Targeting Annuity customers pension pots for annuity purchase at retirement. The Pension Protector Fund invests mainly in long-dated UK bonds. PREMIER PENSION PORTFOLIO FUNDS 1 TO 5 The Portfolio Funds 1, 2, 3, 4 and 5 are the Premier equivalents to the Pension Portfolio Funds 1 to 5 used in our original PIA and GIS versions. The table overleaf illustrates how the assets and strategies outlined earlier are currently being used as building blocks to form the Portfolio Funds used within PPIA and PGIS. 14

17 Premier Lifestyling Options Here is the asset split for each Portfolio Fund, showing the percentages in each asset type as at 30th September ASSET SPLIT BY PREMIER PENSION PORTFOLIO FUND (%) Asset allocation and funds selected GLOBAL DEVELOPED EQUITY Fundamental Index Global Equity Fund Fundamental Low Volatility Index Global Equity Fund EMERGING MARKET EQUITY Emerging Markets Fund Fundamental Low Volatility Index Emerging Markets Equity Fund Fundamental Index Emerging Markets Equity Fund UK EQUITY All Share Tracker Fund FTSE 100 Index Futures * HIGH-YIELD BONDS High Income Bond Fund PROPERTY Pooled Property ACS Fund 1 BlackRock Global Property Securities Equity Tracker Fund GLOBAL INVESTMENT-GRADE CORPORATE BONDS Corporate Bond 1 Fund ABSOLUTE RETURN STRATEGY Insight Global Absolute Return Nordea 1 - GBP Diversified Return Fund COMMODITY SW Alternatives Pension Fund SHORT DATED MATURITIES Insight LIBOR Plus Fund Aberdeen Liquidity Fund (Lux) Ultra Short Duration Sterling Fund Premier Pension Portfolio Fund 1 Premier Pension Portfolio Fund 2 Premier Pension Portfolio Fund 3 Premier Pension Portfolio Fund 4 Premier Pension Portfolio Fund TOTAL Source:. Figures correct as at 30th September *The UK equity component represents the funds exposure to UK equities. Most of the funds UK equity exposure is gained predominantly through investments in FTSE 100 Index Futures. Please note that the table above excludes cash and Global Tactical Asset Allocation (GTAA) 1 fund, which is a TAA fund managed on our behalf by Aberdeen Asset Management. Tactical asset allocation (TAA) involves adjusting the long-term strategic asset allocation within a portfolio in order to capture shorter-term relative value opportunities in markets. We do not undertake TAA directly within Premier s funds, but instead most of the funds gain exposure to Aberdeen s TAA decisions by investing in GTAA 1. This investment is possible because we use futures to gain most of the exposure to UK equities. Using futures rather than buying UK equities directly frees up capital. This is then used for TAA purposes, with the aim of improving overall returns. For full details of the Portfolio Funds, including fund aims and the risks associated with each fund, please see the section on Funds information, aims and risks starting on page 20 of this guide. 15

18 Premier Lifestyling Options HOW DOES THIS ALL FIT INTO THE PREMIER LIFESTYLING GLIDEPATHS? As we have mentioned, the Portfolio Funds play the same role within PPIA and PGIS as the Pension Portfolio Funds do for PIA and GIS. Here s how they are used within the risk categories for Premier Adventurous, Premier Balanced and Premier Cautious: Adventurous risk category 15 years+ at 10 years at 5 years at 0 years Premier Adventurous Targeting Annuity Portfolio 1 100% Portfolio 2 100% Portfolio 3 100% Pension Protector 75% Premier Pension Portfolio 5 25% Premier Adventurous Targeting Encashment Portfolio 1 100% Portfolio 2 100% Portfolio 3 100% Premier Pension Portfolio 5 100% Premier Adventurous Targeting Flexible Access Portfolio 1 100% Portfolio 2 100% Portfolio 3 100% Premier Pension Portfolio 4 75% Premier Pension Portfolio 5 25% Balanced risk category 15 years+ at 10 years at 5 years at 0 years Premier Balanced Targeting Annuity Portfolio 2 100% Portfolio 3 100% Portfolio 4 100% Pension Protector 75% Premier Pension Portfolio 5 25% Premier Balanced Targeting Encashment Portfolio 2 100% Portfolio 3 100% Portfolio 4 100% Premier Pension Portfolio 5 100% Premier Balanced Targeting Flexible Access Portfolio 2 100% Portfolio 3 100% Portfolio 4 100% Premier Pension Portfolio 4 75% Premier Pension Portfolio 5 25% Cautious risk category 15 years+ at 10 years at 5 years at 0 years Premier Cautious Targeting Annuity Portfolio 3 100% Portfolio 4 100% Portfolio 4 100% Pension Protector 75% Premier Pension Portfolio 5 25% Premier Cautious Targeting Encashment Portfolio 3 100% Portfolio 4 100% Portfolio 4 100% Premier Pension Portfolio 5 100% Premier Cautious Targeting Flexible Access Portfolio 3 100% Portfolio 4 100% Portfolio 4 100% Premier Pension Portfolio 4 75% Premier Pension Portfolio 5 25% For details of the fund aims and risks for all the funds covered above, please see page 20 of this guide. 16

19 Premier Lifestyling Options The Portfolios provide the asset and strategy splits for each of our PPIA and PGIS risk categories through the bulk of the lifestyling glidepath. Using the Targeting Flexible Access retirement outcome as an example, here is how these asset splits change through the life of a customer s investment for each risk category: Adventurous (Targeting Flexible Access retirement outcome) Target % split of investments used Years to retirement 15 years+ 10 years 5 years 0 years Global Developed Equity Emerging Market Equity UK Equity High-Yield Bond Property Global Investment-Grade Corporate Bonds Absolute Return Strategy Commodity Short Dated Maturities Balanced (Targeting Flexible Access retirement outcome) Target % split of investments used Years to retirement 15 years+ 10 years 5 years 0 years Global Developed Equity Emerging Market Equity UK Equity High-Yield Bond Property Global Investment-Grade Corporate Bonds Absolute Return Strategy Commodity Short Dated Maturities Cautious (Targeting Flexible Access retirement outcome) Target % split of investments used Years to retirement 15 years+ 10 years 5 years 0 years Global Developed Equity Emerging Market Equity UK Equity High-Yield Bond Property Global Investment-Grade Corporate Bonds Absolute Return Strategy Commodity Short Dated Maturities Source:. Figures correct as at 30th September Please note that the table above excludes cash and Global Tactical Asset Allocation (GTAA) 1 fund, which is a TAA fund managed on our behalf by Aberdeen Asset Management. Tactical asset allocation (TAA) involves adjusting the long-term strategic asset allocation within a portfolio in order to capture shorter-term relative value opportunities in markets. We do not undertake TAA directly within Premier s funds, but instead most of the funds gain exposure to Aberdeen s TAA decisions by investing in GTAA 1. This investment is possible because we use futures to gain most of the exposure to UK equities. Using futures rather than buying UK equities directly frees up capital. This is then used for TAA purposes, with the aim of improving overall returns. 17

20 Premier Lifestyling Options WHY DO WE BELIEVE THE PREMIER VERSIONS OFFER POTENTIALLY BETTER RETURNS FOR BROADLY THE SAME LEVEL OF VOLATILITY? THE MAIN AIM OF THE PPIA AND PGIS IS TO DELIVER POTENTIALLY BETTER PERFORMANCE FOR VERY SIMILAR LEVELS OF RISK (MEASURED IN TERMS OF VOLATILITY) WHEN COMPARED TO OUR ORIGINAL, PASSIVELY MANAGED PIA AND GIS PROPOSITION. BETTER PERFORMANCE There are two factors that contribute to PPIA / PGIS offering potentially better performance than PIA / GIS: 1. The use of asset classes and strategies that we expect to deliver higher returns in the long term. In particular, the Smart Beta strategies employed with PPIA and PGIS have in the past delivered a higher returns than Standard Passively Managed Equities and we expect this to be the case in the future. PPIA and PGIS also invest more in higher-returning asset classes and strategies for example, in Emerging Markets equities. 2. The use of a greater number of asset classes and strategies which allows for better returns from strategic asset allocation. This is because there is more scope within PPIA and PGIS to alter the strategic asset allocation over time towards those underlying asset classes and strategies that we expect to perform best in future. Our Asset Allocation Team effectively has more freedom as to how best to invest, or allocate, the capital within a portfolio. A SIMILAR LEVEL OF RISK There are several different ways of measuring risk. In the context of PPIA and PGIS, we are referring to a measure of a portfolio s volatility. The riskier the portfolio, the sharper the potential moves in its value are likely to be. There are two factors that contribute to Premier portfolios presenting a similar level of risk to those within PIA and GIS, despite having larger allocations to higher-return-seeking assets: 1. The use of lower-risk strategies PPIA and PGIS use a mix of asset classes and strategies, including relatively low-risk ones, such as Absolute Return, that are not available within PIA and GIS due to their higher cost. They also use less of relatively high-risk strategies, such as traditional passively managed equities, which are used more within PIA and GIS due to their lower cost. 2. The benefits of diversification Diversification is achieved by constructing a portfolio with different types of assets. The correlation between these assets is important. The less correlated the assets are, the better, as the portfolio is more diversified and therefore less susceptible to any one investment risk. Diversification is key to reducing risk in a portfolio as it lessens the degree to which the portfolio value moves up and down - i.e. the volatility. PPIA and PGIS use a greater number of asset classes and strategies than PIA and GIS. Although some of the strategies are higher risk, for example Fundamental Index Equities, the overall risk within the PPIA and PGIS portfolios is similar to that within PIA and GIS, partly because of the greater diversification. 18