Repositioning Assets for Buyouts & Buy-ins from Gilts to Infrastructure

Westminster and City 17 April 2013

Repositioning Assets for

Buyouts & Buy-ins from

Gilts to Infrastructure Robert Gardner, Co-CEO of Redington

Westminster and City

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Repositioning Assets for Buyouts and Buy-ins from Gilts to Infrastructure

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The Seven Steps to Full Funding


Step 1 Description

• A strategic Pension Risk Management Framework that sets out funding objectives, risk budget

and other constraints such as liquidity and collateral requirements

• A Flight Plan that charts each plan’s path to full funding and generates required returns used

to set investment strategy

Setting Clear Goals and Objectives

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Objective Measurement Performance Indicators Performance (31 Jan 13) RAG

Primary Funding

Objective

To reach full funding by [2026] (based

on discount rate of Gilts + 0.75%)

Expected Returns (ER) > Required

Returns (RR)

RR: Libor + 300bps

ER: Libor + 200bps

Difference: -100bps

Secondary

Funding Objective

To reach full funding on a buyout basis

by [2032] (based on a discount rate of

gilts flat)

Expected Returns (ER) > Required

Returns (RR)

RR: Libor + 250bps

ER: Libor + 200bps

Difference: -50bps

Investment

Strategy

Actual Returns should exceed

Expected Returns

Actual Returns (AR) > Expected Returns

(ER)

AR: Libor + xxxbps

ER: Libor + 200bps

Difference: xxbps

Risk Budget

The investment strategy should not risk

the deficit worsening by [20%] of

liabilities over a 1 year period

VaR95 < [20%] of liabilities VaR95: 28.0%

Hedging Strategy

Nominal/Inflation hedge ratio should be

maintained within +/- 5% of the funding

ratio.

Funding Ratio (gilts + 0.75%) 60%

Nominal Hedge Ratio (gilts + 0.75%) 20%

Inflation Hedge Ratio (gilts + 0.75%) 25%

Collateral

Maintain sufficient eligible for the

purposes of covering margin calls that

may arise from the Scheme’s current

derivative positions over a 1 year

period.

Total available eligible collateral xx mn

Remaining collateral after VaR95 event yy mn

The Pension Risk Management Framework

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RAG Status Metric is at or above target Metric is within [10%] of target Metric is more than [10%] away


1,000

1,500

2,000

2,500

3,000

3,500

4,000

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£m

m

Flight Plan

liability (swap flat) asset (swaps flat)

The Flight Plan

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100% - Swaps Flat by 2026

Required Returns Libor + 300bps

Expected Returns Libor + 200bps

Contributions & Asset Returns

Liability Basis

Time Horizon


Access to LDI Hub

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Step 2 Description

• Interest rate and inflation risk are typically two of the largest “unrewarded risks” for a

pension scheme

• Setting up an LDI hub which gives the scheme the ability to manage inflation and interest

rate risk efficiently and effectively


Steps 3 – 6: Designing an Efficient Investment Strategy

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Step

Liquid α & β Semi-Liquid Credit Illiquid Credit Illiquid α & β

Equities Corporate Bonds Infrastructure Debt Insurance-Linked

Multi Asset Asset Backed

Securities Social Housing Debt Private Equity

Commodities / CTA High Yield Direct SME Lending Infrastructure Equity

Currencies Leveraged Loans Mezzanine Finance Unlisted Property

Liquid Hedge Funds Emerging Market

Debt Distressed Debt

Hedge Funds with

Lock-Ups

Commercial Real

Estate Debt

Long Leases /

Ground Rents


Asset Class Universe: Results of Manager Survey

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Distressed Debt

Multi Asset

Long Leases

Ground Rents

High Yield

Private Equity

EM Debt

SME Lending Currencies

EM Equity

Social Housing

Infrastructure Equity

Mezz Debt

Lev Loans

ILS

CTA

ABS

Developed Equity

Corporate Bonds

Infra Debt

CRE Debt

Unlisted Property

-5

-4

-3

-2

-1

0

1

2

3

4

5

-5 -4 -3 -2 -1 0 1 2 3 4 5

Predictable

Illiquid Liquid

Unpredictable


Credit as a Core Building Block for Flight Planning

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Repositioning Assets: Steps 4, 5 and 6

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Liquid & Semi-Liquid Credit Strategies

Step 4 Description

• Credit consists of a range of sub-classes with different risk-return characteristics

• Bulk of excess returns are compensation for credit risk

Emerging Market Debt Investment Grade

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Liquid & Semi-Liquid Credit Strategies

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LL

HY

EMD

IG

SF

ABS

LLHY

EMD

IG

SF

ABS0

100

200

300

400

500

600

0 100 200 300 400 500 600

GB

P C

red

it S

pre

ad

over

Sw

ap

s (b

ps)

Credit Spread VaR 95 (bps)

Leveraged Loans High Yield Investment Grade Sub Financials ABS Emerging Market Debt

Q1 2007

Q4 2012

Equity expected

return: 300bps

over swaps

Sources: Babson Capital, Redington 25


Illiquid Credit Strategies

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Step 5 Description

• Long-dated, hold to maturity instruments that pay an illiquidity premium

• Usually for high-quality, inflation-linked cash flows

• Typically, these Flight Plan Consistent Assets (FPCAs) tend to fit well with the overall

objectives of pension schemes when assessed in the context of a scheme’s PRMF

• Careful consideration should be placed on ensuring the scheme invests in opportunities

providing the best risk-adjusted returns and offers better relative-value

Secured Leases Social Housing Infrastructure Ground Rents


Illiquid Alpha & Beta Strategies

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fd Step 6 Description

• Assets under this category provide attractive returns but are typically more complex and

illiquid e.g. private equity and PFI equity

• Inclusion of these asset classes in the scheme’s investments will depend on the overall

objectives and governance budget of the scheme as set out in its PRMF

• Examples: Private Equity, Property, Insurance Linked Securities

Insurance-Linked Securities


Step 7 Description

• Effective monitoring is key to measuring a scheme’s progress against its objectives

• Once you have set clear goals and objectives (step 1), the value of monitoring (step 7) is that

you can make better decisions by tracking where you are against your objectives.

• A scheme that regularly monitors understands the impact of its investment decisions and can

easily assess investment opportunities via-à-vis the liabilities

Ongoing Monitoring

Track scheme’s progress towards clear goals and objectives

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13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk

Contacts

Robert Gardner Founder & Co-CEO

Direct Line: 020 7250 3416

[email protected]

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Disclaimer text

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 document 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.

This presentation may not be copied, modified or provided by you , the Recipient, to any other party without Redington Limited’s prior written permission. It may also not be disclosed by the Recipient to any other party without Redington Limited’s prior written permission except as may be required by law. “7 Steps to Full Funding” is a trade mark of Redington Limited. Redington Limited is an investment consultant company regulated by the Financial Services Authority. The company does 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. Registered Office: 13-15 Mallow Street, London EC1Y 8RD. Redington Limited (reg no 6660006) is registered in England and Wales. ©Redington Limited 2012. All rights reserved.

Risk Management Firm

of the Year (2011, 2012) Pension Consultant of the

Year 2012

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Repositioning Assets for Buyouts & Buy-ins from Gilts to Infrastructure

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