Survival of the Fittest The Evolution of Investment Strategies Chris Wood Pensions Investment Manager Michelin Tyre plc 17 May 2011
Evolution of Investment Strategies What has changed since 1990? Where are we now? Where are we headed? Any views expressed in this presentation are my own and do not necessarily reflect the views of my employer
Pension Scheme Asset Allocation 1990 to 2010 100% 90% 80% 70% 60% 50% 40% Property Cash / Other Overseas Bonds Index Linked Gilts UK Fixed Interest Overseas Equities UK Equities 30% 20% 10% 0% 1990 1995 2000 2005 2010
Pension Scheme Asset Allocation UK Equities 1990 to 2010-32% +10% +18% Overseas Equities Gilts Fixed & Index Linked
The Decline of UK Equity Allocations Diversification of return seeking assets Overseas equities Global equities including emerging markets Alternatives Concentration risk Top 10 companies represent c. 40% of the All Share Index Gordon Brown removal of dividend tax relief in 1997 Increasing scheme maturity and risk awareness leading to increased allocations to bonds
Annualised Returns % per annum Investment Performance 1990 to 2010 10.00% 9.00% 8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% UK Equities Overseas Equities (in ) UK Fixed Interest Gilts Index Linked Gilts Cash Property
Mar-90 Sep-90 Mar-91 Sep-91 Mar-92 Sep-92 Mar-93 Sep-93 Mar-94 Sep-94 Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Yield % Gilt Yields 1990 to 2011 14 12 Fixed Interest Gilt Yield 10 year Index Linked Gilt Yield 10 8 6 4 2 0
% Gilt Yields and Inflation 1990 to 2011 14 12 Fixed Interest Gilt Yield 10 year Retail Price Inflation 10 8 6 4 2 0-2 Mar-90 Sep-90 Mar-91 Sep-91 Mar-92 Sep-92 Mar-93 Sep-93 Mar-94 Sep-94 Mar-95 Sep-95 Mar-96 Sep-96 Mar-97 Sep-97 Mar-98 Sep-98 Mar-99 Sep-99 Mar-00 Sep-00 Mar-01 Sep-01 Mar-02 Sep-02 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 Sep-09 Mar-10 Sep-10 Mar-11-4
Performance of Equities v Gilts 1990 to 2010 700 600 500 400 300 UK Equities Fixed Interest Gilts 200 100 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Effective Decision Making The investment world has become much more complex for trustees 1990 Balanced mandates; one or two investment managers; UK equities over 50% of assets; peer group benchmarks 2000 Specialist mandates; larger number of managers; peer group benchmarks 2011 Increased awareness of risk especially relative to liabilities; greater diversification; alternative asset classes; Liability Driven Investment, including use of derivatives; scheme specific benchmarks
Where are we now? Risk reducing assets Liability Driven Investment To implement or not to implement, that is the question? Fixed interest gilt yields lowest they have been since 1950s Real yields on index linked close to all time low Economic recovery and unwinding of Quantitative Easing may lead to higher yields and higher inflation Long dated swaps yielding less than gilts What are people doing? Setting triggers for implementation at higher yields Gilt repos or gilt total return swaps Switching swaps to gilts
Gross Redemption Yield % Yield Curve Fixed Interest Gilts 4.50% 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% Jul-11 Jul-13 Jul-15 Jul-17 Jul-19 Jul-21 Jul-23 Jul-25 Jul-27 Jul-29 Jul-31 Jul-33 Jul-35 Jul-37 Jul-39 Jul-41 Jul-43 Jul-45 Jul-47 Jul-49 Jul-51 Jul-53 Jul-55 Jul-57 Jul-59 Redemption Date
Where are we now? Equities Unconstrained equity portfolios Best ideas stock selection little or no attention paid to index weighting of stocks/sectors/region Global Emerging markets Passive management returning to favour? Have active managers earned their fees? Fundamental indices Based on economic fundamentals of companies (eg sales, balance sheet size) rather than market capitalisation Avoids overweighting overvalued stocks and underweighting undervalued stocks Outperformed market cap indices by 2% pa over 5 years and by 2-4% p.a. in back tests (Source: Research Affiliates)
Hedge funds Where are we now? Alternatives More correlated to equities than we thought? 120 100 80 60 40 20 0 01/31/2008 02/29/2008 03/31/2008 04/30/2008 05/31/2008 06/30/2008 07/31/2008 08/31/2008 09/30/2008 10/31/2008 11/30/2008 12/31/2008 01/31/2009 02/28/2009 03/31/2009 04/30/2009 05/31/2009 06/30/2009 07/31/2009 08/31/2009 09/30/2009 10/31/2009 11/30/2009 12/31/2009 01/31/2010 02/28/2010 03/31/2010 04/30/2010 05/31/2010 06/30/2010 07/31/2010 08/31/2010 09/30/2010 10/31/2010 11/30/2010 Hedge Fund Research Composite Index $ MSCI Developed World Index (local currency) 12/31/2010 01/31/2011 02/28/2011 03/31/2011 04/30/2011
Alternatives (continued) Private equity Shortage of credit for heavily geared deals Less reliance on financial engineering Property Going global Infrastructure Theoretically ideal for pension funds How to implement? Finding the right vehicle Gold Win/win? Some say it will do well in economic recovery as an inflation hedge OR in economic slump due to safe haven status
Alternatives (continued) Commodities Inflation hedge? Diversification Emerging market growth esp. China Emerging market local currency debt High yields; scope for lower spreads Currency appreciation Mezzanine debt Distressed debt Insurance linked products eg catastrophe insurance Uncorrelated to other markets
Where are we headed? Fiduciary Management aka Implemented Consulting, delegated consulting, delegated investment.. Difficulties for trustees Need to get back to full funding BUT Lack of time Lack of expertise Increasing cost and complexity of advice and implementation Don t meet often enough Need for more dynamic implementation Don t miss the boat
Fiduciary Management Consultant to help set strategic objective? Trustees: Set the strategic objective Set the risk budget Set the permitted asset classes Monitor Fiduciary Manager s performance Consultant to help monitor Fiduciary Manager? Investment Managers Fiduciary Manager: Implements the strategy Tactical asset allocation Risk management derivative overlays Selects & monitors investment managers Investment Managers
Where are we going? DC Target Date Funds National Employment Savings Trust (NEST) will have target date funds as default Similar to traditional Lifestyle structures but: Three phases compared to usual two Transition between the different phases will be dynamically managed on the basis of what is happening in financial markets and the economy. * * Quote from Developing and delivering NEST s investment approach published by NEST
NEST Target Date Funds 3 Phases - illustrative Foundation Growth Consolidation Income seeking assets Return seeking assets Annuity matching assets Age 22 30 38 46 52 60 65
NEST s Investment Beliefs Understanding member characteristics, circumstances and attitudes is essential to developing an appropriate investment strategy Incorporate Ethical Social and Governance (ESG) factors into investment process Taking investment risk is usually rewarded in the long term Diversification is key tool for managing risk and return Risk derived asset allocation is the biggest determinant of long term performance Analysis of economic conditions and market regimes should drive strategic decisions Passive management generally delivers better value for money than active security selection Paraphrased from Developing and delivering NEST s investment approach published by NEST
Survival of the Fittest Adapt and survive More diversification of assets Implementing LDI Is Fiduciary Management the answer? Are Target Date Funds the future for DC?