FOR PROFESSIONAL INVESTORS

Transcription

1 FOR PROFESSIONAL INVESTORS Liability Driven Investing Strategies: some practical issues Anton Wouters, Head of Customized & Fiduciary Solutions BNP Paribas Investment Partners EDHEC-Risk Days, London, 26 March 2014

2 March Lessons from the EDHEC research to implement in portfolios The application of the LDI paradigm could lead to a more optimal management of pension fund portfolio s Divide the portfolio in two sub-portfolios A LHP (Liability Hedging Portfolio) to match sensitivities of the liabilities and a PSP (Performance Seeking Portfolio) to earn excess return over liabilities Dynamic allocation between LHP and PSP to control the risk relative to liabilities Such a dynamic approach allows to reduce the conflicts of interest between the several stakeholders of a (corporate) pension plan. Dynamic asset allocation strategy can be improved Make the allocation of PSP a function of the available risk budget but also from potential of asset classes in both the PSP and LHP (mean reversion of asset class premia) The application of insurance strategies that could take care of short term constraints in a longer term asset allocation framework

3 March Some striking results from the survey The awareness of the LDI paradigm is high, but investors seem not to adopt to the LDI approach as a consequence Large majority of respondents measures risk against liabilities, but.. Do not always see the liability structure as the guiding benchmark for investing the asset portfolio Dynamic asset allocation is more used for fundamental/tactical reasons than for risk mitigation or funding ratio protection reasons No funding-ratio floor protection (conflict of interest with sponsor?) Lead also to more volatile funding ratio developments over time (conflict of interest with beneficiaries?) Respondents have an interest in using alternatives to the traditional asset approach in the Strategic Asset Allocation/Medium term Asset Allocation This could also change the traditional way of looking at an asset-based LDI- and PSP portfolio Difficulties are related to the mapping of asset classes, but question is also how to apply a more dynamic approach in this

4 March The practical challenges for investors at the moment The current environment is challenging while expected returns on asset classes are not always attractive and interest rates are low. Are investors able to use the LDI paradigm in practice? Taking more risk when you want is not always possible From a regulatory point not always an option Do you really increase risk when the opportunity set is not that attractive? How can you be more active in the current environment? Dynamic adjustment both within the PSP/LHP but also between PSP and LHP: not always possible How do you adjust? (fundamental-based on (superior) return expectations or more systematic) Can you (try to) squeeze more out of the existing portfolio with other asset classes? Invest (more) in illiquidity (has consequences for a dynamic approach) New asset classes (risk diversification, does it always work?) Manage your risks differently needs a change of thinking. Is that possible? Hedge of unintended and unrewarded risks (do you want to hedge your interest rate risk now?) Smart Beta, basket of well defined risk factors What about costs?

5 March Implementation of a Dynamic Asset Allocation process How to combine fundamental and systematic strategies in practice? 3 types of asset allocation: Strategic Asset Allocation Define long-term risk budget/objectives Medium term Asset Allocation Medium term asset allocation views Could be applied to LHP and PSP Tactical Asset Allocation Benefit from short-term opportunities Medium term asset allocation adjusts the long term SAA to: Exploit time varying risk premia Avoid pro-cyclical character of dynamic and risk controlled strategies Dynamic risk management to control the risk profile (can be daily process) Asset-only Dynamic risk management Short-term tactical asset allocation (3-12 months) Medium-term asset allocation Performance portfolio Investment horizon Liability-related Strategic asset allocation Long-term risk budget (10 years+) Matching portfolio Source: BNP Paribas Investment Partners

6 March Implementation of Risk Based strategies Dynamic risk management strategies in practice Example: Funding Ratio based strategy 55% of Equity / Return Seeking - of which 20% of Alternatives /illiquid assets 45% of Fixed Income Related / Cash Source: BNP Paribas Investment Partners, for illustration purposes only Several ways to implement Risk Based strategies based on Funding ratio Maximum Drawdown Maximum volatility/var Benefits Decreases volatility of funding ratio overtime (so you could increase risk in portfolio PSP) Avoid dramatic shortfalls (tail risk hedging) But.. opportunity costs mitigate all risks not always possible (for example the illiquid part of PSP) Further improvements Options Combination with fundamental views to mitigate pro-cyclical character

7 March Conclusion: Combining the Opportunities Smart portfolio construction is aimed on portfolios which manage assets relative to liabilities in a dynamic way and avoiding possible large drawdowns (tail hedges, holistic approach) By a truly dynamic approach Exploiting time varying asset premiums For risk control purposes By applying a broad set of investment strategies By state-of-the-art risk management that helps you to adjust the risk when necessary With liabilities as a starting point for construction

8 March Disclaimer This document is issued and has been prepared by BNP Paribas Investment Partners UK Limited ( BNPP IP UK ) a member of BNP Paribas Investment Partners (BNPP IP)**. This material is produced for information purposes only and does not constitute: - an offer to buy nor a solicitation to sell, nor shall it form the basis of or be relied upon in connection with any contract or commitment whatsoever or - any investment advice. Opinions included in this material constitute the judgment of BNPPIP UK at the time specified and may be subject to change without notice. BNPPIP UK is not obliged to update or alter the information or opinions contained within this document. Investors should consult their own legal and tax advisors in respect of legal, accounting, domicile and tax advice prior to investing in the Financial Instrument(s) in order to make an independent determination of the suitability and consequences of an investment therein, if permitted. Please note that different types of investments, if contained within this material, involve varying degrees of risk and there can be no assurance that any specific investment may either be suitable, appropriate or profitable for a client or prospective client s investment portfolio. Given the economic and market risks, there can be no assurance that the Financial Instrument(s) will achieve its/their investment objectives. Returns may be affected by, amongst other things, investment strategies or objectives of the Financial Instrument(s) and material market and economic conditions, including interest rates, market terms and general market conditions. The different strategies applied to the Financial Instruments may have a significant effect on the results portrayed in this material. Past performance is not a guide to future performance and the value of the investments in Financial Instrument(s) may go down as well as up. Changes in currency exchange rates may affect the value of your investment. Investors may not get back the amount they originally invested. The performance data, as applicable, reflected in this material, do not take into account the commissions, costs incurred on the issue and redemption and taxes. This document is directed only at person(s) who have professional experience in matters relating to investments ( relevant persons ). Any investment or investment activity to which this document relates is available only to and will be engaged in only with Professional Clients as defined in the rules of the Financial Conduct Authority. Any person who is not a relevant person should not act or rely on this document or any of its contents. * BNP Paribas Investment Partners UK Limited, is authorised and regulated by the Financial Conduct Authority. Registered in England No: , registered office: 5 Aldermanbury Square, London, England, EC2V 7BP, United Kingdom ** BNP Paribas Investment Partners is the global brand name of the BNP Paribas group s asset management services. The individual asset management entities within BNP Paribas Investment Partners if specified herein, are specified for information only and do not necessarily carry on business in your jurisdiction. For further information, please contact your locally licensed Investment Partner