The Bond Market Conference
Annuity Portfolio Management
By: Dr. Zoumana Kone, CFAFixed Income Strategist, Bifm
Agenda
1. Annuity Management
2. Market Trends
3. Regulatory Framework
4. Challenges
5. Capital Markets
6. Risks
7. Asset Liability Management
Annuity Management
Tittle Name Years with Bifm Total Experience
What are annuities?
o It is the conversion of retirement savings into a series of regular payments at
regular intervals
Salient property:
o It insures longevity: it guarantees the annuitant against outliving retirement
savings in the event of living long
It is the decumulation of retirement savings phase - final phase of
retirement savings
Annuity Management (continued)
Tittle Name Years with Bifm Total Experience
Ways of accessing retirement savings:
o In Botswana, the law prescribes that you buy annuities with 2/3 of
retirement funds.
Phased approach with limits on withdrawals amounts
Annuitisation (only option providing longevity insurance)
Obligations by the Issuer to pay when due
Market Trends
Tittle Name Years with Bifm Total Experience
Following the Global economic downturn starting in 2008:
o Annuitants age: increased incidences of early retirements
o Retirement ages decreased from 60 to 50 years
o Reduction in interest rates to historical low levels
Market Trends - Challenges
Tittle Name Years with Bifm Total Experience
Shortage of long term Government bonds
Reduction in annuity rates:
o resultant lower effective draw down rates due to declining interest rates
Eg: P1 million will purchase pension worth P7,400 per month for a male aged
65, compared to P10,000 per month, 10 years ago
Long end: supply and Potential demand
Tittle Name Years with Bifm Total Experience
400
200250
250
100
250
707
432
513
417
218
352
307232 263
167 118
102
0
100
200
300
400
500
600
700
800
Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16
Long end: Supply Vs Indicative Demand (P million)
Supply at Long end (BW011+BW012) Demand Potential Gap
Regulatory Framework
Tittle Name Years with Bifm Total Experience
Insurance companies, pension funds and asset management
companies are all regulated by NBFIRA
Capital Markets
Tittle Name Years with Bifm Total Experience
Assets availability: some route
Origination of assets:
o To find assets to match the liabilities issued
o This entails involvement in the capital market to lend to suitable companies,
which carries the least credit risk
Credit risk may erode the value of assets set aside to meet the
annuities
Capital Markets Development
Tittle Name Years with Bifm Total Experience
A side of our involvement: In the process: we lend to companies, to
fund their projects:
o Another way: companies issue bonds
We lend to companies, which are solid in terms of credit:
o Default undermines the capability of the funds to meet annuities payments
o Hence screening through the credit process
Using the Bond Market
Tittle Name Years with Bifm Total Experience
Assets are broadly of two categories:
o Unlisted mainly through Private Placement:
• The issues can be tailored made to be sold to the investors needs without
listing (unlisted).
o Listed bonds:
• The bonds will have to fulfil the listing requirements of the BSE
Using the Bond Market
Tittle Name Years with Bifm Total Experience
Unlisted bonds present opportunities:
o they can better suit the clients specific needs
They restrict tradeability:
o credit issues and specific agreements
They require credit monitoring, and may subject the buyers to credit
issues and greater information asymmetry
The Bond Market
Tittle Name Years with Bifm Total Experience
The bonds may be acquired through the following markets:
o Primary market: when the bonds first issued are bought
• Government is the large player in the primary market
o Secondary market: when the bonds already issued are traded in the local
market
Secondary market reinforces the primary market
Capital Markets - Fixed rate bonds
Tittle Name Years with Bifm Total Experience
Preference is for fixed rate bonds. The cash flows are known to a large
extent
o (ignoring default and market valuation impact)
Spreading along the yield curve
The yield curve allows the pricing of assets and facilitates asset liability
management
Capital Markets – Yield Curve
Tittle Name Years with Bifm Total Experience
The risk free yield curve represents a valuation tool for us for assets
and Liabilities
The current risk yield curve extends to BW012, which matures in June
2040
Yields have come down in Botswana on the back of low domestic
inflation, low and unstable worldwide growth environment, low
domestic growth environment
Capital Markets – Yield curve (Continued)
Tittle Name Years with Bifm Total Experience
Capital Markets – Yield Curve (Continued)
Tittle Name Years with Bifm Total Experience
-0.16
-0.22
-0.58 -0.57
-0.77
-0.40-0.38
-0.35 -0.36
-0.90
-0.80
-0.70
-0.60
-0.50
-0.40
-0.30
-0.20
-0.10
0.0014-day 91-Day T-BILL BW010 BW005 BW008 BW007 BW011 BW012
Risks of the Annuity Management
Tittle Name Years with Bifm Total Experience
Interest rate risk:
o Value will fluctuate with change in interest rate and mismatch losses can
occur
o The portfolio is exposed to the Botswana yield curve as the liabilities are
denominated in Pula
Credit risk:
o Default and deterioration in the credit quality
Asset Liability Management
Tittle Name Years with Bifm Total Experience
In order to match asset and Liability
Some key elements:
o Duration
o Convexity
o The total value of our assets and Liabilities
o The sensitivity or hedging position along the YC curve
Summary
Tittle Name Years with Bifm Total Experience
The important role of the capital market cannot be emphasized
enough
With a developed local bond market, trading can allow the funds to
align the portfolio to meet its objectives
The limited trading opportunities limits the portfolio flexibility: the
portfolio may sit in an unwanted position
Summary (Continued)
Tittle Name Years with Bifm Total Experience
We have seen some building blocks in the local market that facilitates
the management of the annuity funds
The building blocks of a risk free yield curve
The regular issuance of Government bonds
The availability of data on the markets in general through Bloomberg
and Reuters
THANK YOU
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