DGFs / Multi Asset Strategies Still a Solution? Oliver Kelly LCP Ireland
Newtonian mechanics Special and General relativity Quantum mechanics Solutions evolve I would rather have questions that can't be answered than answers that can't be questioned. Richard Feynman
The Five Ws of DGFs 1. What are they? 2. Who is using them? 3. Where did they come from? 4. Why are trustees concerned now? 5. When should we still consider using them?
1. What are DGFs?
Traditional multi asset DGF
Relative value DGF
2. Who is typically using DGFs? DC scheme members who may have a cautious attitude to investment risk or to decrease fund volatility DB schemes seeking to reduce equity risk or diversify, or those which are unwilling or unable to invest in matching bonds
3. Where did they come from? Balanced products popular until c2000 Interest was building in DGFs prior to the Global Financial Crisis ( GFC ). However the GFC galvanised interest. Many DGF s preserved or almost preserved capital through 2008 Many also re risked in 2009 to produce strong returns in the rebound Risk was well controlled at less than half of equity
4. Why are trustees concerned now? Recent returns have been below target Will the next market crisis resemble the last? Do DGF managers still have the tools to control risk? Are they too big and inflexible now? Can we achieve the same results with lower costs?
2006 2017 Merrill Lynch EMU 10+ Year Bond Index 6 5 4 3 2 It is better to be roughly right than precisely wrong. John Maynard Keynes 28 February: 1.62% 1 0 Jan 06 Jun 06 Nov 06 Apr 07 Sep 07 Feb 08 Jul 08 Dec 08 May 09 Oct 09 Mar 10 Aug 10 Jan 11 Jun 11 Nov 11 Apr 12 Sep 12 Feb 13 Jul 13 Dec 13 May 14 Oct 14 Mar 15 Aug 15 Jan 16 Jun 16 Nov 16
Fund returns vs best fit passive portfolio Multi asset Relative Value Performance of the fund compared to its best fit passive portfolio 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% Fund Passive Portfolio 5.0% 0.0% 5.0% 03 2011 07 2011 11 2011 03 2012 07 2012 11 2012 03 2013 07 2013 11 2013 03 2014 07 2014 11 2014 03 2015 07 2015 11 2015 03 2016 07 2016 11 2016 Fund returns (vertical) and passive portfolio returns (horizontal) 4.0% 3.0% 2.0% 1.0% 0.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 1.0% 2.0% 3.0% 4.0% 11
Attribution analysis Total Return = Passive portfolio + TAA portfolio (We assume that the correlation between the passive portfolio and the TAA portfolio is zero) LCP assumption (as at 31 December 2016). 12
Attribution analysis We use the passive portfolios weights to each asset class to calculate the expected returns and risk of each fund using LCP s long term asset class return assumptions. Asset class Multi asset Relative Value Expected return (pa) 3.6% 3.0% Risk (standard deviation) 6.8% 4.5% The expected returns fall short of the managers targets the shortfall must come from the TAA portfolio LCP assumption (as at 31 December 2016). 13
Attribution analysis Multi asset Relative Value Expected return of passive portfolio 3.6% 3.0% Return Target return (total return per annum) 5.3% 6.8% Return required from TAA 1.7% 3.8% Risk Risk of passive portfolio 6.8% 4.5% Target risk (volatility) 7.0% 6.0% LCP assumption (as at 31 December 2016). 14
Returns from TAA are required to supplement the passive portfolio returns in order to reach the target. We believe that the returns required from the TAA portfolio are not achievable within the volatility targets It is, therefore, unlikely the funds will achieve their stated return targets over the longterm 15
5. When should we still consider using DGFs? Should we be changing horses midstream? They may serve a role to protect capital values from a future market crash. How much risk can your scheme tolerate? Analyse and limit reliance on skill to achieve strategic targets across the performance portfolio. Are there other alternatives available to supplement DGFs?
Future solutions DC solutions to consider White labelling and blending of active DGF managers Multi asset and relative value managers Lower cost passive multi asset with explicit tactical overlay if preferred Market trend to add alternatives into DC portfolios in addition to DGF exposure
Future solutions DB solutions to consider Consider alternatives in conjunction with DGFs Infrastructure, private credit, long lease property etc. Blend of DGF managers and approaches Using scale or by using an investment platform Lower cost passive multi asset
If I have seen further than others, it is by standing upon the shoulders of giants. Isaac Newton
Scope This document is a visual aid to complement an oral presentation and does not constitute our written professional advice. Written advice about any matters discussed should always be sought in order to clarify the data relied upon, assumptions, conclusions and recommendations. While this document does not represent our advice, nevertheless it should not be passed to any third party without our formal written agreement. LCP is part of the Alexander Forbes Group, a leading independent provider of financial and risk services. Lane Clark & Peacock LLP is a limited liability partnership registered in England and Wales with registered number OC301436. LCP is a registered trademark in the UK (Regd. TM No 2315442) and in the EU (Regd. TM No 002935583). All partners are members of Lane Clark & Peacock LLP. A list of members names is available for inspection at 30 Old Burlington Street, London, W1S 3NN, the firm s principal place of business and registered office. The firm is regulated by the Institute and Faculty of Actuaries in respect of a range of investment business activities. Locations in London, Winchester, Belgium, Switzerland, the Netherlands, Ireland and the UAE. Lane Clark & Peacock Ireland Ltd (2017)