Successfully implementing absolute returns

Transcription

1 This document is intended for investment professionals only and must not be relied on by anyone else David Millar, FIA Investment Director Multi-asset investing A Standard Life presentation Successfully implementing absolute returns 26 October 2010

2 Agenda Introduction Pension fund risks A case study Absolute return investing 2

3 Introduction 3

4 Introduction an unusual recovery ahead The aftershocks of the financial crisis will last for some years Policy makers have achieved a moderate global economic recovery Despite the strength of corporate profitability, this business cycle remains unusual in some key respects A range of fiscal, monetary, political and regulatory issues impact on how investors view future returns Consequently, investors need to position for more than one outcome The way in which investors view risk needs to change Focus on Change 4

5 Pension fund risks 5

6 Understanding the fund objectives Funding level Generate excess returns to Meet your valuation interest rate Improve security Pay for discretionary benefits 100% New strategy Stabilise funding level Eliminate unrewarded risk A smoother route to a higher funding levels than a traditional approach Traditional Approach Improving funding and reducing volatility Time 6

7 Steps to de-risking a pension fund Risk Elimination Risk Management Comfort Zone Identify Hedge Exploit Action Identify and quantify the potential risks Implement hedging strategies using bonds & swaps Implementing diversified investment strategy Outcome Interest Rate/Duration risk Inflation risk Longevity/mortality risk Investment Risk Duration matched Inflation protection Longevity & investment risk remain Maximised return per unit of risk Only longevity risk remains 7

8 Holistic view of risk Risks in a traditional pension scheme 30.0% 25.0% 20.0% 3.7% 4.0% 1.0% 1.0% 16.3% 15.0% 7.5% 10.0% 5.0% 13.7% 14.6% 0.0% Interest Rates Equity Risk Inflation Mortality Credit Risk Active Management Diversification Total Major risks: Equity market risk Interest rate risk Inflation risk Interest rate / inflation risk are not rewarding risks 8

9 Holistic view of risk Introduction of interest rate/inflation swap overlay 30.0% 25.0% 20.0% 15.0% 1.2% 4.0% 1.0% 1.0% 10.8% 10.0% 7.5% 5.0% 5.4% 9.3% 0.0% Interest Rates Equity Risk Inflation Mortality Credit Risk Active Management Diversification Total Reduce interest rate and inflation risk Now equity risk is a significant barrier to further reductions in risk 9

10 Holistic view of risk Introduction of absolute return strategies 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 5.4% 2.5% 1.2% 4.0% 1.0% 1.0% 9.0% 6.1% 0.0% Interest Rates Equity Risk Inflation Mortality Credit Risk Active Management Diversification Total Reducing equity market risk has large impact on overall risk reduction 10

11 Valuation considerations trustees must consider... to what extent, account should be taken of a margin when choosing prudent economic and actuarial assumptions Expected return Absolute return The lower volatility means the absolute return approach is more likely to give a return near to its target Actuarial return assumptions used in valuations typically allow for the risk associated with equity investment Equities A prudent assumption of achieving the expected return will reduce the rate used. 3% margin for prudence For absolute return the assumption can be higher for the same level of certainty -10% 0% 10% 1% higher discount rate = 20% lower liabilities 20% 30% 11

12 Valuation considerations trustees must consider... to what extent, account should be taken of a margin when choosing prudent economic and actuarial assumptions Expected return Absolute return The lower volatility means the absolute return approach is more likely to give a return near to its target Actuarial return assumptions used in valuations typically allow for the risk associated with equity investment Equities A prudent assumption of achieving the expected return will reduce the rate used. 2% margin for prudence For absolute return the assumption can be higher for the same level of certainty -10% 0% 10% 1% higher discount rate = 20% lower liabilities 20% 30% 12

13 A case study The 48 FTSE100 companies reporting full-year results as at 31 December 2008 disclosed losses amounting to 42billion on their pension assets over the year, or 16.3% of assets held at the start of the financial year. source: Accounting For Pensions 2009, Lane Clark & Peacock Examples of companies that took such steps and therefore protected themselves from the worst effects of falling equity values include Standard Life (pension assets rose by 14% over 2008), Rolls-Royce Group (up by 8%) and Friends Provident (up by almost 3%). source: Accounting For Pensions 2009, Lane Clark & Peacock 13

14 Meeting the liabilities The trustee mandate hasn t changed Before: Longer time frames No accounting regimes Younger schemes Use of efficient frontiers to choose equities Strong employer covenants But, unmeasured liability risk Triggers for change Increasing challenges for trustees 14

15 The Standard Life pension fund experience Demutualisation of Standard Life was the trigger Investment manager played a key role Designed and built a liabilities-plus absolute return solution Liabilities + 2.2% Phased implementation Ongoing participation A new pension solution 15

16 Governance of liabilities-plus solutions Trustees Delegate macro-economic and asset allocation decisions to investment professionals Concentrate on liabilities, risk budget, who to trust it with Advisers Modelling of the assets and liabilities Provide advice on investment strategies Advise on investment concentration risk Investment managers Investment of assets to achieve stated objectives Modelling of the assets and liabilities Manage the investment risks Collaboration and communication to achieve pension fund goals 16

17 The Standard Life Pension fund experience Investment strategy based on GARS approach with Property and Private Equity + liability hedge 0.70 CAPS median fund Liability Benchmark Liabilities Plus fund Initially the CAPS median portfolio*, performed well Deficits fell as equities and yields increased Our liabilities-plus approach outperformed the liabilities For the next 18 months most pension portfolios suffered a double whammy Equities and yields suffered huge falls deficits ballooned Liabilities-plus held up well Recently the liabilities-plus approach has outperformed Source: Standard Life, 30 June 2010 * The average UK Institutional Pension Portfolio Liabilities plus approach avoided the volatility in funding position Q4 05 Q1 06 Q2 06 Q3 06 Q4 06 Q1 07 Q2 07 Q3 07 Q4 07 Q1 08 Q2 08 Q3 08 Q4 08 Q1 09 Q2 09 Q3 09 Q4 09 Q1 10 Q

18 Absolute return investing 18

19 GARS investment approach A broad range of return opportunities T R A D I T I O N A L Market returns Equities, Bonds and Property Good long term return expectations But can be negative returns over shorter periods Stock selection Active stock selection Added value through our approach A D V A N C E D Directional Specific directional investment ideas In markets with little or no long term risk premium With significant return potential on a 3 yr view Relative value Seek highly correlated markets or segments Where their relative valuation is strained We exploit their realignment Enduring diversity through a wider opportunity set 19

20 Strategies by type of approach Relative value HSCEI vs. FTSE Volatility UK vs. German Short-rates Swedish vs. German Short-rates Australian vs. US Short-rates Financial Sector vs. Broad Credit Alpha Stock Selection Global Equity European Equity High Yield Credit Market returns High Yield vs. Equity UK Corporate Bonds US Large vs. US Small Cap Equity Global Index Linked Bonds UK Equity Relative Variance Income * US Equity European Corporate Bonds Australian vs. Japanese Medium Term Duration FTSE 100 Dividends Long Sterling vs. South African Rand Other FX Long Polish Zloty vs. Czech Koruna Long Sterling vs. Euro Long US Dollar vs. Japanese Yen Long US Dollar vs. Euro Long Brazilian Real vs. Chilean Peso US Forward-Start Duration Directional Source: Standard Life UK GARS portfolio, 30 September 2010 * Please note that the strategy Relative Variance Income is an amalgamation of three strategies previously listed individually as Eurostoxx vs. S&P variance, Nikkei vs. S&P Variance, Nikkei vs. FTSE Variance and DAX vs. S&P Variance 20

21 Risk profile of multi-market return strategy Stand-alone investment risks Total stand-alone risk 25% Stock selection 21.1% 20% Relative value 15% Directional Diversification benefits 10% Market returns 5% Expected volatility 0% Global Equity position has stand-alone risk of 2.0 % 15.5% 5.5% The portfolio is exposed to multiple diversified market risks 21.1% is total stand-alone investment risk chasing returns Equivalent equity volatility is 20.2% Independent risk analysis shows the benefits of investment diversification Aggregate risks are comparable Source: Standard Life UK GARS portfolio, 30 September 2010 * Please note that the strategy Relative Variance Income is an amalgamation of three strategies previously listed individually as Eurostoxx vs. S&P variance, Nikkei vs. S&P Variance, Nikkei vs. FTSE Variance and DAX vs. S&P Variance Each investment strategy measured on a like for like basis 21

22 The best of both worlds Conventional asset funds - Index-relative style - Narrow investment universe - Tracking error to benchmark - Long only strategies - High correlation to equities Alternatives + Absolute return style + Large investment universe + Comprehensive risk analysis + Long/Short/RV strategies + Low correlation to equities + High regulation + Very accessible + Very liquid + Regular reporting + Competitive fees - Limited regulation - Limited size - Limited transparency - Limited liquidity -High fees Liabilities + investing Interest rate and inflation overlay 22

23 Conclusion Continued economic and market uncertainty requires a new approach to investment and risk Pension funds seek to eliminate unwanted risk and exploit manageable ones Some pension funds are structured to survive market turmoil Absolute return investing should be a key investment strategy for any pension fund 23

24 The information shown relates to the past. Past performance is not a guide to the future. The value of investment can go down as well as up. Standard Life Limited, tel , a company registered in Scotland (SC123321) Registered Office 1 George Street Edinburgh EH2 2LL. The Standard Life group includes Standard Life (Mutual Funds) Limited, SLTM Limited, Standard Life (Corporate Funds) Limited and SL Capital Partners LLP. Standard Life Limited acts as Investment Manager for Standard Life Assurance Limited and Standard Life Pension Funds Limited. Standard Life may record and monitor telephone calls in the UK to help improve customer service. All companies are authorised and regulated by the Financial Services Authority Standard Life 24