Redington press breakfast 29 august 2013

Private & Confidential Redington Ltd 29 August 2013

Press Breakfast

29 August 2013

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Volatility Controlled

Investing For DB and DC

2

Dan Mikulskis

Co-Head of ALM & Investment Strategy


0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

£mm

Assets Liabilities Assets realised

• Pension schemes manage a flight path to full funding, but are exposed to downside events

• Sponsors are concerned over pensions impact on wider business. Weaker funding positions have forced sponsors

to significantly increase deficit repair contributions.

Situation: Need to Earn the Required Return whilst Managing Risk

3

Unprotected against extreme downside event,

which would prevent scheme from meeting

Required Return objective


Commonly Heard Pension Problem – Downside Risk Concerns

• Trustee

“We have a low sponsor covenant that means we cannot rely on the company to plug the gap if our assets fall in value

... but we still need to generate returns to meet the scheme benefits”

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• Corporate sponsor “We want to tell the markets that we have the Pensions issue under control because we have

implemented an investment strategy whereby the deficit position cannot worsen by more than £X* m in any given

year.”

• DC scheme

• “I know default funds often invest in equities, but they can lose a lot of money in a market crash like 2008, is there

a way we can protect our members’ savings more, is there a better approach than traditional Lifestyling ?”


Drive To The Conditions

5


How Volatility Control Works

• Vary exposure to the equity market in response to market conditions

• As equity volatility rises, we reduce exposure from equity toward cash, depending on the volatility target

• Here we illustrate the dynamic exposure of a volatility control approach targeting 10% volatility

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Source: Bloomberg; Calculations: Redington


What Volatility Control is (and isn’t)

Volatility Control is ...

•An alternative approach to allocating capital;

•A technique for managing risk;

•A passive investment style;

• Implemented on a mandate level;

•Also known as Risk Control or Volatility Target.

7

Volatility Control is not ...

•A quantitative trading rule that tries to outperform

equities;

•A mechanism for trying to predict market crashes;

•A process for selecting low volatility stocks;

•A process for weighting individual stocks according to their

volatility;

•A guaranteed downside protection vehicle against

instantaneous crashes.


Case Study 1 : January 2008 – June 2009

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Source: Bloomberg; Calculations: Redington


Case Study 2 : January 2011 – December 2012

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• As the volatility of the FTSE 100 increased between August and September of 2011, the exposure of the volatility controlled

strategy decreased to around 40%.

-10%

10%

30%

50%

70%

90%

110%

130%

150%

0%

10%

20%

30%

40%

50%

60%

70%

An

nu

aliz

ed

Vo

lati

lity

(%)

of

FTSE

10

0

% A

lloca

tio

n o

f vo

lati

lity

con

tro

lled

ap

pro

ach

FTSE Allocation FTSE Rolling VolatilitySource: Bloomberg; Calculations: Redington


0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

£mm

Assets Liabilities Assets protected level (90%)

DB Pension Funds : Need

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Protected against extreme downside

events, more likely to meet Required

Return objective

Satisfies sponsor requirement for

market statement on downside

control

• Downside protection gives greater certainty that the scheme will be able to meet its flight plan


Volatility Control : Cost Effective Portfolio Downside Protection

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1 Year Protection level

Current cost of protection

on Global Equity Index (%)

over 1 year

Stressed market conditions

cost of protection on Global

Equity Index (%) over 1 year

Cost to protect 10%

Volatility Control portfolio

(%) over 1 year

90% 3.5% 6.5% 0.9%

85% 1.6% 4.8% 0.4%

80% 1.3% 3.5% 0.2%

Source: Bloomberg, Investment Banks

Calculations: Redington

• Cost of downside protection on a volatility control equity benchmark can be less than half the cost of equivalent

protection on a passive equity investment


0

50,000

100,000

150,000

200,000

250,000

300,000

Fund Value 100% Equity Floor Contributions Only DC Default Fund with Risk Control

• Delivering better risk and return outcomes for DC members than a passive equity fund

DC Pension Funds : Need

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Protected against extreme downside

events, more likely to meet Required

Return objective

Participation in equity markets with

reduced downside

Private & Confidential Redington Ltd 29 August 2013 13

DC Pension Funds : Need

• Two layers of risk protection:

• Volatility control

• Downside protection

-87,120

-57,454

-25,016

242,635

207,845

230,714

-150,000 -100,000 -50,000 - 50,000 100,000 150,000 200,000 250,000 300,000

100% Equity

Lifestyling

DC Default Fund with Risk Control

Terminal Fund Value (£) Largest Drawdown in Fund Value (£)


Volatility Control – Client FAQs

•Are you saying Volatility Control is a free lunch?

•What about transaction costs?

•Are there any investable Volatility Control futures?

•Does it employ excessive leverage and is this a problem?

• Is it an algorithm?

•Does future performance depend on volatility increasing prior to a market crash?

•Could it be implemented in conjunction with the low volatility stocks approach?

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Key Takeaways

• Risk control gives a smoother ride by driving to the conditions.

• Risk control allows scheme trustees and sponsors to lessen the impact of severe market crashed by implementing more

cost-effective downside protection.

• Analysis over long time periods and across markets shows that this approach can deliver better risk-adjusted return

outcomes than a fixed market exposure.

• Risk Control is easy and cost-effective to implement, being a semi-passive approach.

Further Reading -

The Actuary Magazine December 2012

http://www.theactuary.com/features/2012/12/volatility-control-taming-the-beast/

RedViews

http://redington.co.uk/getattachment/eea3dd74-37c8-446e-afa9-fd8d1973f295/Taming%20The%20Beast.aspx

RedBlogs

http://blog.redington.co.uk/Articles/Dan-Mikulskis/September-2012/VOLATILITY-CONTROL.aspx

http://blog.redington.co.uk/Articles/Dan-Mikulskis/December-2012/TAMING-THE-BEAST.aspx

The Journal of Indexes November / December 2012

http://www.indexuniverse.com/publications/journalofindexes/joi-articles/12932-optimal-design-of-risk-control-strategy-indexes.html

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http://redington.co.uk/getattachment/eea3dd74-37c8-446e-afa9-fd8d1973f295/Taming The Beast.aspx












































Volatility Control in the Media

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Illiquid Credit

Opportunities Pete Drewienkiewicz

Head of Manager Research

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The Seven Steps to Full Funding TM

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Design an efficient

investment strategy

Destination for agile

hedging strategy

Transparency to make

timely decisions

Articulate clear objectives

and constraints

Mission Statement

To help our clients achieve full-funding with the minimum level of risk

CLEAR GOALS &

OBJECTIVES

ACCESS TO LDI

HUB

LIQUID ACTIVE &

MARKET STRATEGIES

LIQUID & SEMI-LIQUID

CREDIT STRATEGIES

ILLIQUID CREDIT

STRATEGIES

ILLIQUID ACTIVE &

MARKET STRATEGIES

ONGOING

MONITORING


Spreads on Liquid Credit Have Compressed Across Market Sectors...

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0

100

200

300

400

500

600

Lib

or

Sp

rea

d (

bp

s)

Change in Libor Spread by Market Sector: GBP Liquid Credit

Cyclicals Non-Cyclicals Senior-Financials Telecoms-Utilities


...And Across The Ratings Spectrum

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0

500

1,000

1,500

2,000

Lib

or

Sp

rea

d (

Bp

s)

Change in Libor Spread by Rating: GBP Liquid Credit

AAA AA A BBB BB B


At the Same Time, Regulatory Change has Made Illiquid Asset Classes More Attractive

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I

Capital and

Liquidity

1. Basel 3

II III

Risk Mgt.

and

Supervision

Market

Discipline

Narrower range of eligible capital

Increased capital reqs.

Capital Ratio

Dur AAA AA A BBB BB <B Unrated

ABS

1 Yr 7.0% 16.0% 19.0% 20.0% 82.0% 100.0% 100.0%

5 Yrs 35.0% 80.0% 76.0% 80.0% 82.0% 100.0% 100.0%

10 Yrs 42.0% 80.0% 76.0% 80.0% 82.0% 100.0% 100.0%

Covered

Bonds

1 Yr 0.7% 0.9% 1.4% 2.5% 4.5% 7.5% 7.5%

5 Yrs 3.5% 4.5% 7.0% 12.5% 22.5% 37.5% 37.5%

10 Yrs 6.0% 7.0% 10.5% 20.0% 35.0% 58.5% 58.5%

Corp

bonds/

loans

1 Yr 0.9% 1.1% 1.4% 2.5% 4.5% 7.5% 7.5%

5 Yrs 4.5% 5.5% 7.0% 12.5% 22.5% 37.5% 37.5%

10 Yrs 7.2% 8.4% 10.5% 20.0% 35.0% 58.5% 58.5%

2. Proposed Capital Weightings under Solvency II:

Result:

• Declining ABS issuance

• Banks less active in loan origination

• Banks withdrawing from holding longer-dated assets on

balance sheets

• Uneconomical for insurance companies to hold longer-

dated, lower rated assets

• Opportunity for pension schemes to fill funding gap


As Pension Schemes in General have a Defined Liability Profile, They Can Often Tolerate Illiquidity Risk

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Corporate

Bonds

Direct

Lending

Corporate

Linkers

Infrastructure

Debt / Long

Leases

Ground Rents

Gilts

Cash


The Illiquid Investment Universe

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Higher-Rated

Lower-Rated

“Shorter-Dated” “Liability Matching”

Infrastructure

CRE Debt

Ground Rents

Long Leases

Aircraft Finance

Direct Lending

Distressed Debt


Infrastructure Debt

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Maturity Profile 15 years +

Liquid Alternative Publicly-Traded Debt of

Utility Companies

Expected Spread / Rate 225-300bps

Approx. Premium over

Liquid Alternative 125-200bps

What is it?

• Can refer to:

• Privately-negotiated deals with infrastructure-

rich corporates, secured on specific assets

• Project finance-style lending to individual

infrastructure assets or clusters of assets

• Infrastructure debt managers can finance projects

during the construction phase to diversify return

sources

Why is it Interesting?

• Secured lending

• Long-dated cashflows

• Possibility to structure index-linked returns

• Government support for sector via PFI

• Many projects are likelier to experience lower return

volatility due to the natural bias towards essential

service sectors

Indicative risk breakdown:

• Education

• Rail

• Water

• Pipelines

• Airports

• Satellites


Commercial Real Estate Debt

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What is it?

• Consists of loans made to owners of real estate assets

secured on underlying commercial property

• About 75% of property market finance in Europe

traditionally provided by banks, rest through covered

bonds and CMBS

• Risk / return profile can vary depending on level of

subordination: senior, ‘stretch senior’ & mezzanine

lending available

Why is it interesting?

• Bank deleveraging & drying up of CMBS market have

arguably created fundamental dislocation in asset

class

• Falls in LTVs provide a cushion to senior loan providers

from falling property values

• Security on underlying asset mitigates default risk

Maturity Profile 5-10 years (varies)

Liquid Alternative Sterling ABS

Expected Spread / Rate 225-350bps for Senior

Loans


Liquid Alternative 75-200bps

Sponsor

(Property

Owner)

Lender

Commercial

Property

Tenants

The lender has a lien

on the underlying

property

Principal + Interest

Loan Advance


Direct Mid-Market Lending

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Maturity Profile 24 – 72 Months

Liquid Alternative BB/B Non-Distressed US

High Yield

Expected Spread / Rate 650bps prior to defaults,

450bps after defaults


Liquid Alternative 250bps prior to defaults

What is it?

• Refers to asset managers taking the place of banks in

directly originating loans to primarily mid-market

borrowers

• Asset managers are not subject to the same

capital requirements as banks and can hence

lend money at more competitive levels

• Varying degrees of subordination can be targeted

Why is it interesting?

• Secured lending

• Attractive spreads available relative to other illiquid

opportunities

• Direct origination allows greater capture of loan

economics, as well as opportunity to tailor deals to suit

requirements (e.g. prepayment protection)

Corporate

(borrower)

Corporate

(borrower)

Bank

Asset

Manager

Bank

Asset Manager

Bank

Asset Manager

Bank

Typical syndication structure:

Typical direct lending structure:

Loan made Loan syndicated

Loan made Certain loans part-syndicated


Redington Has Seen Substantial Client Demand For Manager Searches in Illiquid Credit

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570

1,520

1,765

260

Liquid Non-Credit Liquid Credit Illiquid Credit Illiquid Non-Credit

Assets Allocated (ex-LDI), Jan 2012-Jun 2013, (£m)

0

2

4

6

8

10

12

Number of Searches Conducted, Jan 2012-Jun 2013

Asset Class Search Breakdown

LDI Pooled LDI, Segregated LDI, Segregated LDI

within a multi-manager structure

Liquid Non-Credit

Diversified Growth Funds, CTA/Managed

Futures, Risk Parity, Emerging Market Equity,

Equity Income

Liquid Credit ABS, Investment Grade Credit, Secured Loans,

Absolute Return Bond Funds

Illiquid Credit

CRE Debt, Distressed Debt, Infrastructure

Debt, Secured Leases, Direct Mid-Market

Lending

Illiquid Non-Credit Hedge Funds, Insurance-Linked Securities

Searches Conducted: Jan 2012-Jun 2013

• Since January 2012, Redington’s Manager Research Team

has conducted more searches for a higher value of assets in

illiquid credit than in any other asset class (for a full

breakdown, see the table below).

• Over the past six months we have conducted six manager

searches in illiquid credit for a combined value of assets of

c. £1.2bn.


13-15 Mallow Street London EC1Y 8RD

Telephone : +44 (0) 20 7250 3331

www.redington.co.uk Contacts

Dawid Konotey-Ahulu Co-Founder & Co-CEO

Direct Line: 020 3326 7101

[email protected]

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Pete Drewienkiewicz Head of Manager Research

Direct Line: 020 3326 7138

[email protected]

Disclaimer

For professional investors only. Not suitable for private

customers.

The information herein was obtained from various sources.

We do not guarantee every aspect of its accuracy. The

information is for your private information and is for

discussion purposes only. A variety of market factors and

assumptions may affect this analysis, and this analysis

does not reflect all possible loss scenarios. There is no

certainty that the parameters and assumptions used in this

analysis can be duplicated with actual trades. Any

historical exchange rates, interest rates or other reference

rates or prices which appear above are not necessarily

indicative of future exchange rates, interest rates, or other

reference rates or prices. Neither the information,

recommendations or opinions expressed herein constitutes

an offer to buy or sell any securities, futures, options, or

investment products on your behalf. Unless otherwise

stated, any pricing information in this message is indicative

only, is subject to change and is not an offer to transact.

Where relevant, the price quoted is exclusive of tax and

delivery costs. Any reference to the terms of executed

transactions should be treated as preliminary and subject

to further due diligence .

Please note, the accurate calculation of the liability profile

used as the basis for implementing any capital markets

transactions is the sole responsibility of the Trustees'

actuarial advisors. Redington Ltd will estimate the liabilities

if required but will not be held responsible for any loss or

damage howsoever sustained as a result of inaccuracies in

that estimation. Additionally, the client recognizes that

Redington Ltd does not owe any party a duty of care in this

respect.

Redington Ltd are investment consultants regulated by the

Financial Conduct Authority. We do not advise on all

implications of the transactions described herein. This

information is for discussion purposes and prior to

undertaking any trade, you should also discuss with your

professional tax, accounting and / or other relevant

advisers how such particular trade(s) affect you. All

analysis (whether in respect of tax, accounting, law or of

any other nature), should be treated as illustrative only and

not relied upon as accurate.

©Redington Limited 2013. All rights reserved. No

reproduction, copy, transmission or translation in whole or

in part of this presentation may be made without

permission. Application for permission should be made to

Redington Limited at the address below.

Redington Limited (6660006) is registered in England and

Wales. Registered office: 13-15 Mallow Street London

EC1Y 8RD

Dan Mikulskis Co-Head of ALM & Investment Strategy

Direct Line: 020 3326 7129

[email protected]

Redington press breakfast 29 august 2013

Economy & Finance

Transcript of Redington press breakfast 29 august 2013