CFA Toronto Annual Pension Conference 2013


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CFA Toronto Annual Pension Conference 2013

  2. 2. 12013 Pension ConferenceWednesday April 24, 2013, 8:00 AM – 5:00 PMReception: 5:00 PM – 6:00 PMAgenda8:00 – 8:25 AMRegistration & Networking Breakfast8:25 – 8:30 AM Opening RemarksPeter S. Jarvis, CFA, CEO, CFA Society Toronto8:30 – 9:30 AM The Biology of Risk TakingSpeaker: John Coates, Professor, University of CambridgeThe title says it all: the biology of risk taking. John Coates presentsresearch into the ways our body guides our risk taking, researchrecently surveyed in his book The Hour between Dog and Wolf.9:30 - 10:00 AM The Canadian Pension Model. Norway vs Yale vs Canada -A Comparison of Investment Models.Speaker: Keith Ambachtsheer, Executive Director, RotmanInternational Centre for Pension ManagementThis discussion will consider a new formula for the “CanadaPension Fund Model” (which is encapsulated in the Morneaureport) that studies the application of the Model by mergingall/most Ontario public sector funds smaller than OTPP, OMERS,HOOPP.10:00 – 10:15 AM Networking & Coffee Break
  3. 3. 210:15 – 11:00 AM Managing Extreme Risks in a Pension PlanSpeaker: Janet Rabovsky, Director, Investments, Towers WatsonJanet will explore the extreme risks that pension plans shouldconsider (even if they can’t always manage these unpredictableand significant exposures). She will present a framework forassessing the risks in a portfolio and examine how to diversify aPlan by return drivers versus the more traditional asset and sectorcategories.11:00 - 12:15 PM LDI in a Low Interest Rate EnvironmentSpeakers: James Davis, CFA, Vice-President, InvestmentPlanning & Economics, Ontario Teachers’ Pension PlanSpeakers: Malcolm Hamilton, former Partner of MercerPension plans had fun in the 1990s. They earned high risklessreturns or even higher risky ones. Today’s pension plans havemuch harder choices. Often they must choose betweenunacceptably low returns and unacceptably high risks. LDI letsthem make the best of a bad situation; but it is still a bad situation!Pension plans should stop using unrealistically high returnexpectations to live in a past that is long gone. They must begin tomake tough decisions - about contribution rates, risk sharing andbenefit design – not just easy decisions about asset mix.12:15 – 1:00 PM Networking Buffet Lunch1:00 – 2:00 PM Pooling of Public Sector Asset ManagementSpeaker: Bill Morneau, Executive Chairman, Morneau ShepellIn May 2012, Bill Morneau was appointed by the Ontario Ministerof Finance as Pension Investment Advisor to lead in facilitating thepooling of public sector pension fund assets. The report releasedin October 2012 recommended that Ontario move to pooling thepension assets of Ontario public sector organizations that are notalready in a jointly sponsored pension plan. This talk will reviewthe background of the project, and the merits and challenges ofmoving to greater consolidation of pension assets in Ontario.
  4. 4. 32:00 - 3:00 PM The Price of Climate RiskSpeaker: Bob Litterman, Chairman, Risk Committee, KeposCapitalHow does an investor or even more importantly society, rationallyprice unknowable risks? This is the fundamental topic explored byBob Litterman one of the pre-eminent thinkers in the world on thesubject of risk.Bob will explore the appropriate pricing of climate risk, its non-diversifiable nature, societal risk aversion and implications forportfolio construction. He will also identify that incentives matter,inappropriate pricing of climate risk wastes scarce resources andas a result will present a rational pricing model and method forthinking about how to incorporate these types of risks into assetmanagement.3:00 - 3:15 PM Networking & Coffee Break3:15 - 4:15 PM Practical Application of Alternatives for Pension PlansSpeaker: Robert Cultraro, CFA, Executive Chief Investment andPension Officer, Hydro OneSpeaker: Julie Cays Chief Investment Officer, Colleges of AppliedArts and Technology (CAAT), Pension PlanListen in on an exclusive interview moderated by Marcus Turner,CFA, Senior Investment Consultant at Towers Watson featuring apanel of successful CIOs on investing in alternative investments.4:15 - 5:00 PM Is Sluggish Growth Forever?Speaker: Avery Shenfeld, Managing Director and Chief Economist,CIBCAvery’s presentation will focus on the economic outlook and itsimplications for equity, fixed income and foreign exchangemarkets.5:00 - 6:00 PM Closing Remarks and Networking Reception – Rooms A/B/C/D
  5. 5. 12013 Pension Conference - Speakers BiographiesJohn CoatesProfessorUniversity of CambridgeJohn McBride Coates is a neuroscientist at the University of Cambridge and former WallStreet trader for Goldman Sachs, Merrill Lynch and Deutsche Bank.Coates research focuses on the hormonal basis of financial decision making,[3] inspiredby his own experiences trading. He describes how men trading "display what may becalled [the] classical clinical symptoms of mania. They were delusional, they wereeuphoric, they were over confident, they had racing thoughts [and a] diminished need forsleep."In 2012, Coates published The Hour Between Dog and Wolf: Risk Taking, Gut Feelingsand the Biology of Boom and Bust.Keith AmbachtsheerExecutive DirectorRotman International Centre for Pension ManagementKeith Ambachtsheer is Director of the Rotman International Centre for PensionManagement (ICPM), an Adjunct Professor of Finance, Academic Director of theRotman-ICPM Board Effectiveness Program, and Publisher and Editor of the RotmanInternational Journal of Pension Management. His firm, KPA Advisory Services Ltd., hasprovided advice to governments, industry associations, pension-plan sponsors,foundations and other institutional investors since 1985. He is the co-founder of CEMBenchmarking Inc. which monitors the performance of 300 pensions worldwide. Keithhas authored three books on pension management and has received numerous industryawards.Ambachtsheer is a four-time winner of the CFA Institute Financial Analysts Journal’sGraham and Dodd Scrolls (1979, 1985, 1987, and 1994). In 2003 he was named one ofthe 30 Most Influential People by Pensions and Investments, and in 2007 he washonored with the Outstanding Industry Contribution Award by Investments and PensionsEurope.In 2011, he received the CFA Institute’s Award for Professional Excellence. This awardis presented periodically to a member of the investment profession whose exemplaryachievement, excellence of practice, and true leadership have inspired and reflectedhonor upon the investment profession to the highest degree. Previous recipients includeMartin Leibowitz, Jack Bogle, Charles D. Ellis, CFA, Warren Buffett, and Sir John MarksTempleton, CFA.Bill MorneauExecutive ChairmanMorneau ShepellBill Morneau is Executive Chairman of Morneau Shepell. Under his leadership, the firmhas become the largest Canadian human resources services firm, with over 3000employees. Bill is Chair of the Board of Directors at St. Michael’s Hospital in Toronto,and Chair of the Board of Directors at the C.D. Howe Institute. In May 2012, he was
  6. 6. 2appointed by the Ontario Minister of Finance as Pension Investment Advisor, to lead infacilitating the pooling of public sector pension fund assets. Bill is also on the boards ofAGF Management Ltd., the Canadian Merit Scholarship Foundation, The LearningPartnership, the London School of Economics North American Advisory Committee, theCanadian INSEAD Foundation, and Greenwood College. He is past Chair of the Boardof Directors of Covenant House. In 2012, he co-authored a book, The Real Retirement,which is currently in bookstores across Canada. In 2002, he was named as one ofCanada’s Top 40 Under 40. Bill holds a B.A. from Western University, an M.Sc. (Econ.)from the London School of Economics, and an M.B.A. from INSEAD.James Davis, CFAVice-President, Investment Planning & EconomicsOntario Teachers’ Pension PlanJames Davis is responsible for the funds strategic investment planning, as well asrecommending tactical risk management strategies and new asset classes for the fund.Mr. Davis joined Teachers in 2006 and has more than 20 years’ experience ininvestment strategy and management. A CFA charterholder, Mr. Davis earned an MBAand B.Sc. from Dalhousie University.Malcolm HamiltonFormer Partner of MercerMalcolm Hamilton is a former Partner of Mercer. He specializes in the design andfunding of employee benefit plans in both the private and public sectors, with particularemphasis on registered pension and savings plans, unregistered pension plans, andretirement compensation arrangements. His clients include the Colleges of Applied Artsand Technology, the Ontario Teachers Pension Plan, Ontario Power Generation, theBank of Montreal and Manulife.Malcolm graduated from Queens University in 1972 as the Gold Medalist inMathematics. He attended McGill as a National Research Council scholar, receiving hisM.Sc. in 1975. He became a Fellow of the Canadian Institute of Actuaries and a Fellowof the Society of Actuaries in 1977. He is a frequent speaker at pension conferencesJanet RabovskyDirector, InvestmentsTowers WatsonJanet has been with Towers Watson since 2001 and regularly consults with clients ontheir DB and DC needs. In addition to working with clients, Janet is also part of theglobal private equity and infrastructure research teams. Prior to joining Towers Watson,Janet worked for the mutual fund company of a major chartered bank in Toronto whereshe was responsible for the development of a number of funds and portfolios, as well asmanager selection and monitoring activities. Janet performed a similar function for amajor public sector fund management corporation in Melbourne, Australia, though herfocus was limited to Global equities at the time. Janet spent five years at an engineeringfirm and mining company performing various accounting, finance and pension relatedactivities. Janet has a B.A. in English from the University of Toronto and an M.B.A. fromthe Schulich School of Business (York University).Bob LittermanChairman, Risk Committee
  7. 7. 3Kepos CapitalBob Litterman is the Chairman of our Risk Committee and of our Academic AdvisoryBoard. Prior to joining Kepos Capital in 2010, Bob enjoyed a 23-year career at Goldman,Sachs & Co., where he served in research, risk management, investments and thoughtleadership roles. He oversaw the Quantitative Investment Strategies Group, a portfoliomanagement business formerly known as the Quantitative Equities and QuantitativeStrategies groups, and Global Investment Strategies, an institutional investmentresearch group. While at Goldman, Bob also spent six years as one of three externaladvisors to Singapore’s Government Investment Corporation (GIC). Bob was named apartner of Goldman Sachs in 1994 and became head of the firm-wide risk function; priorto that role, he was co-head of the Fixed Income Research and Model DevelopmentGroup with Fischer Black. During his tenure at Goldman, Bob researched and publisheda number of groundbreaking papers in asset allocation and risk management. He is theco-developer of the Black-Litterman Global Asset Allocation Model, a key tool ininvestment management, and has co-authored books including The Practice of RiskManagement and Modern Investment Management: An Equilibrium Approach (Wiley &Co.). Bob earned a Ph.D. in Economics from the University of Minnesota and a B.S. inHuman Biology from Stanford University. He is also the inaugural recipient of the S.Donald Sussman Fellowship at MITs Sloan School of Management and serves on anumber of boards, including Commonfund, the Sloan Foundation and World WildlifeFund.Robert Cultraro, CFAExecutive Chief Investment and Pension OfficerHydro OneRobert has over twenty years of extensive experience in the investment industry, whichincludes investment research and fund management. Robert holds the CharteredFinancial Analyst, Chartered Alternative Investment Analyst and the Certified InvestmentManager designations. Robert is professionally affiliated with the CFA Institute, the CFASociety Toronto, the Chartered Alternative Investment Analyst Association, and is aFellow of the Canadian Securities Institute. Robert is a member of the InvestmentAdvisory Committee for the Office of the Public Guardian and Trustee and a member ofthe Investment Advisory Committee for the Pension Investment Association of Canada.Julie CaysChief Investment OfficerColleges of Applied Arts and Technology (CAAT) Pension PlanJulie Cays is the Chief Investment Officer at the Colleges of Applied Arts andTechnology (CAAT) Pension Plan. She has extensive capital markets experience,having spent 16 years at CIBC. She was Vice President, External Managers atHealthcare of Ontario Pension Plan (HOOPP) until 2006 when she moved to CAAT tohead the investment team in managing the $6.5 billion pension fund for the employeesof the Ontario community colleges. Julie is the past Chair of the Board of the PensionInvestment Association of Canada and is a member of the Investment AdvisoryCommittee of the Financial Services Commission of Ontario. She received her degree ineconomics from the University of Waterloo and has her Chartered Financial Analystdesignation.
  8. 8. 4Avery ShenfeldManaging Director and Chief EconomistCIBCAvery Shenfeld is Managing Director and Chief Economist of CIBC. He has been withCIBC since 1993 and is widely recognized as one of Canada’s leading economists forhis perceptive analysis and insight on economic developments and their implications forfinancial markets. Mr. Shenfeld is a four-time winner of the Dow Jones Market Watchforecasting award and has received awards for forecast accuracy on the U.S. andCanadian economies by Bloomberg Markets. He has also been consistently ranked asone of the top Canadian economists by institutional investors. Mr. Shenfeld’s priorbackground includes experience in management consulting. He was on the economicsfaculty at the University of Toronto and in the summer program at Harvard’s John F.Kennedy School of Government. He has addressed numerous business groups and hasbeen quoted in the media in the United States, Canada, Asia and Europe. Mr. Shenfeldholds a PhD in Economics from Harvard University.
  9. 9. Keith AmbachtsheerDirector, Rotman International Centre for Pension ManagementRotman School of Management, University of TorontoApril 24, 2013 - CFA Society Toronto Annual Pension ConferenceNorway vs.CanadaA Comparison of Investment Models
  10. 10. 2Fiduciary mandate -> ‘for the sole benefit of...’Strong governance and executive functionsSensible investment beliefsRight-scaledAttract/retain top professional teamThe Drucker Pension Organization
  11. 11. 3External Service ProvidersNB Investment ManagementNorges BankMPT Investment ModelMinistry of FinanceNorwegian ParliamentNorway Model – “Epistemic Proceduralism”
  12. 12. 4Investment Results - OTPP vs. Norway FundOTPP Since 1990 OTPP Since 1998 Norway Fund Since 1998Return of Fund* 9.95% 7.87% 4.23%Return of Reference Portfolio 7.66% 6.01% 3.95%EXCESS RETURN 2.29% 1.86% 0.28%Average Management Cost 0.15% 0.20% 0.10%NET EXCESS RETURN 2.14% 1.66% 0.18%Tracking Error 3.01% 2.56% 0.80%Information Ratio ** 0.70 0.63 0.23* To Dec 31, 2010** Net Excess Return / Tracking ErrorInvestment Results – OTPP vs. NorwayFund
  13. 13. 5“They own assets all over the world,including property in Manhattan,utilities in Chile, international airports,and the high-speed rail line connectingLondon to the Channel tunnel. Theyhave taken part in six of the top 100levered buyouts in history. They havewon the attention of both Wall Streetfirms, who consider them rivals, andinstitutional investors, who aspire to belike them.”Excerpt from The Economist(“Maple Revolutionaries,” 3 March 2012)
  14. 14. © 2012 Towers Watson. All rights reserved.Managing Pension Plans in VolatileTimesJanet RabovskyDirectorApril 2013
  15. 15. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 2 Plan sponsors have experienced three extreme market events in thepast decade 2001/2 – 95th percentile 2008 – 98th percentile 2011 – 95th percentile Volatility has not been limited to equities – even bond markets havebeen volatile since 2008! Given the current environment and the prospect of continued marketvolatility, what options do plan sponsors have?Managing Pension Plans in Volatile Times
  16. 16. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 360%70%80%90%100%110%120%Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10SolvencyFundedRatioCanadian DB Pension Plans – Solvency RatiosStrong stock markets inCanada helped manyCanadian plans rebuildtheir funded positionthrough the mid-2000sSolvency wasapproaching 95% to100% for manyplans, before Eurocrisis of 2011Partial recovery in 2004Pension plans weregenerally in healthyshape in the late1990’s in part due tothe tech bubbleBursting oftech bubbleFinancial/creditcrisisSolvency ratiois 83% atMarch 31,2013Solvency ratiofell below 75%in 2011
  17. 17. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 4 This presentation will review three main approaches that plan sponsorscan consider to help manage market volatility Adopting a de-risking strategy Managing extreme risks through thematic investing Creating better diversity in the return seeking portfolio The three approaches are NOT mutually exclusive and can becombinedManaging Pension Plans in Volatile Times
  18. 18. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comJourney planningDe-risking5
  19. 19. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 6AnnuityPurchaseInvestment StrategyPlan designMany DB plan sponsors havealready closed the plan to newentrantsSome have frozen DB accrualsDefined Benefit De-risking Is Not NewOver 50% of DB plan sponsorsintend to further de-risk theirinvestments in the next 12months*Few plan sponsors have optedto purchase annuities althougha small fraction* are exploringthis option* 2012 Towers Watson DB Pension Risk Survey of 115 plan sponsors.
  20. 20. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 7 Initial asset-liability study usually forms the basis for developing short-term and long-term goals and constraints Preparedness — particularly for organizations with complexgovernance requirements — and adaptability are key Non-financial issues needattention throughout the processDeveloping a Journey PlanJourneyPlan
  21. 21. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 860%70%80%90%100%110%120%Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10SolvencyFundedRatioDeveloping a Journey Plan – Matching Desire With AbilityBursting oftech bubbleFinancial/creditcrisisWhen DESIRE to de-risk is highest, ABILITY tode-risk is lowest, and vice-versa.Often opportunities are lost before plansponsor can reactEuro crisiscontinued
  22. 22. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 9Journey PlanningMany Paths to Plan ManagementFrozen / Closed PlanOffer Bulk LumpSum to TV’sSettle/transferRetiree ObligationsCurrentallocationReduceequityriskReduceinterestrate riskGoalPath BPath CAssetStrategiesBenefit StrategiesRiskRiskSettle/ManageRemainingObligationsThere are many paths an organization can follow to reach the stated goalCurrentPath AAlt.GoalPath DOpen Plan
  23. 23. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comThematic responsesExtreme Risks10
  24. 24. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comMacro Factors: Initial Framework 2008Economicimbalances1. Rebalancing & deleveraging Consumption, savings and portfolio preferences alter2. Financial repression & safety Misallocation of capital reduces returns, increases volatilityAdversedemography3. Population growth Strain on agricultural and water resources4. Ageing Winners and losers at the stock and economic levelDegradation ofnatural capital5. Resource scarcity Resource price inflation and innovation6. Climate change Externalities and mitigation equal winner and losersInnovation andtechnology7. Globalization Inequality bad for political stability and potential growth8. New technology Transformational new technologies will come on streamBusinessshake up9. Sustainable business models Proper inclusion of ESG, adaption and capital efficiency10.Labour and capital relations Create a workforce equipped for new environmentGovernment 11.Regulation Good or bad regulation will create winners and losers12.Inter-generational equity Public finances will come under pressure to adapt11
  25. 25. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comExtreme Risks 2011 – Ranking and Sample Hedges12* Our subjective measure based on the impact, the risk, and the degree of uncertainty in assessing the risk levelRisk ranking* as at 30 June 2011Rank Risk Description Possible hedge1 Depression Debt-deflation trap; falling growth andincomesGlobally-diversified long-dated Sovereign nominal bonds2 Sovereign default Default by a major developed country on itsdebtCountry insurance (eg CDS)3 Hyperinflation Extremely high inflation Real assets eg gold, globally-diversified inflation-linked bonds4 Banking crisis Balance sheets can’t absorb another shock Nominal sovereign bonds (medium duration)5 Currency crisis Extreme movement between floating rates Gold; foreign assets6 Climate change Diversion of capital to mitigation uses No general hedge7 Political crisis Rise in power of extremist groups No obvious hedge8 Insurance crisis Insolvency within insurance sector Nominal sovereign bonds (medium duration) short insuranceequity9 Protectionism Reversal of movement towards free trade No general hedge10 Euro break-up At least one member leaves the Euro Long Germany (hedged)11 Resource scarcity Peak “stuff” Depends on which resource12 Major war A major global conflict Long neutral countries13 End of fiat money Return to a gold standard Gold14 Infrastructurefailure(Temporary) interruption of grid / networks Tinned food, bottled water, guns & ammunition15 Killer pandemic Contagious disease with very high mortality Long pharmaceutical equities, short airline equities
  26. 26. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comTransformational Changes - 2013TransformationEconomicimbalancesAdversedemographyDegradationof naturalcapitalInnovationandtechnologyBusinessshake upGovernment13
  27. 27. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comPortfolio Construction: Responding to ChangeBulk beta AlphaSmart betaEquitiesSovereignbondsCorporatebondsClassic activemanagementSkill inalternativesThematicDiversifyingSystematicTacticalasset allocationPortfolio construction skill14
  28. 28. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comSample Smart BetasEmerging wealth SustainabilityValue-weightedequity indicesRisk-weightedequity indicesScreenedcreditCurrency carry Volatility TrendDemographicsSystematicThematicSecure incomealternativesCoreinfrastructureEnhancedcommoditiesMulti-strategyalternative creditReinsurance AgricultureDiversifying15
  29. 29. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comPortfolio ConstructionCreating Diversity16
  30. 30. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comPortfolio Construction: Return Driver ApproachStage 1:ALM/LDIStage 2:PortfolioConstructionStage 3:ImplementationManager selection and monitoringLiability-matchingPhysical BondsReturn-seekingEquityAsset AllocationSupporting ObjectivesIlliquidityCreditDurationInsuranceSkillTermCreditCurrencyInflationDerivativeInstrumentsCurve/ConvexityInflation17
  31. 31. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comReturn Drivers18Risk premium Investors are rewarded for bearing the risk of:EquityBeing lower down the capital structure in the event ofcorporate defaultCredit Corporate bond issuers defaulting on their bond obligationsIlliquidity Holding an asset that cannot be quickly or cheaply soldInsurance Providing protection against extreme lossesTermThe uncertain return and mark-to-market volatility of an index-linked bond compared to holding cashInflationInflation being higher than anticipated and therefore reducingreal returns on fixed-interest bondsCurrencyThe risk that the purchasing power of the currency falls due toa currency crisisSkillA manager, previously considered skilful, underperforming itsbenchmark
  32. 32. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comCreating Diversity: Potential Risk and Return Drivers.GovernmentbondsReturn DriversCashAlternativecreditCorporatebondsEquitiesHedge fundsPrivatemarkets betaPrivatemarkets alphaCurrency CommoditiesInsurance VolatilityEquity risk premiumCredit risk premiumIlliquidity risk premiumInsurance risk premiumTerm risk premiumInflation risk premiumCurrency risk premiumSkill risk premiumMultiple Risk PremiumsAsset Classes19
  33. 33. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comAdding Diversity…… Approaches that change the way risk and returnpremiums are earned. Exposure to different stages of a company’s lifecycle (private equity, high yield, emergingmarkets, leveraged loans) Change in ratio of skill to market exposure Examples include: Global Tactical Asset Allocation Hedge Funds “Alternative betas”, including non-marketcapitalization weighted equity and betastrategies that look to access certain market riskfactors. Multi-strategy alternative credit Multi-asset strategies Assets that change the economic exposure of theportfolio, as well as the mix of risk and returnpremia Examples include: Real estate (direct and listed) Infrastructure Timberland Agriculture CommoditiesDiversity: Strategic Asset Allocation Diversity: Implementation Approaches There are two broad ways to access alternative forms of risk premia and / or add diversityto a traditional portfolio:20
  34. 34. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comDiversifying Return Drivers0%10%20%30%40%50%60%70%80%90%100%Passive Global Equity Current Portfolio Long-Only DiversifiedPortfolioLiquid, Diversified Portfolio Current Model PortfolioPublic Market Equities Credit Strategies Alternative Betas Hedge Funds Private Markets Investment Grade FI CashPassive GlobalEquityCurrent PortfolioLong-OnlyDiversifiedPortfolioLiquid, DiversifiedPortfolioCurrent ModelPortfolioPublic Market Equities 100% 99% 70% 50% 34%Non-US Developed 40.0% 22.2% 22.2% 18.3% 10.5%US Large Cap 40.4% 47.7% 29.4% 18.3% 10.5%US Small Cap 7.1% 20.7% 10.0% 5.0% 3.0%Emerging Markets 12.5% 8.7% 8.7% 8.7% 10.0%Credit Strategies 0% 0% 15% 15% 15%Alternative Betas 0% 0% 4% 9% 9%Hedge Funds 0% 0% 0% 15% 15%Private Markets 0% 1% 11% 11% 24%Investment Grade FI 0% 0% 0% 0% 0%Cash 0% 0% 0% 0% 3%21
  35. 35. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comCreating Diversity – Improving OutcomesPassive GlobalEquityCurrent PortfolioLong-OnlyDiversifiedPortfolioLiquid, DiversifiedPortfolioCurrent ModelPortfolio7.0% 7.2% 6.9% 6.2% 6.5%18.2% 19.0% 14.2% 11.1% 9.6%7.5% 7.5% 7.5% 7.2% 7.5%13.9% 14.5% 11.0% 8.7% 7.5%6.7% 7.0% 7.1% 6.8% 7.1%15.2% 15.9% 11.9% 9.4% 8.1%(433.8) (452.3) (309.5) (225.0) (173.0)4.2% 4.5% 4.7% 4.3% 4.7%15.0% 15.7% 11.8% 9.3% 8.0%0.28 0.29 0.39 0.47 0.58* Downside Risk is measured as Conditional Value at Risk (CVaR95). CVaR95 is the average of the lowest 5% of results.Absolute ReturnYear 1 exp. returnStandard deviationYear 10 exp. returnStandard deviationDownside Risk*Ten year exp. return - annualizedStandard deviation (%pa)Return vs. CashTen year exp. Return - annualizedTracking error (%pa)Information Ratio-10%0%10%20%30%40%50%60%70%80%90%100%Equity Credit Illiquidity Insurance Term/Inflation Currency SkillPassive Global Equity Long-Only Diversified Portfolio Liquid, Diversified Portfolio Current Model PortfolioAttribution of Return22
  36. 36. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 23Monitoring Macro Risk ExposuresX = Has less exposure than the BenchmarkX = Has greater exposure than the BenchmarkNote: Shaded areas represent changes from last quarter. Grey represents less exposure, yellow represents more.ManagerAManagerBManagerCManagerDManagerEManagerFManagerGManagerHManagerIManagerJManagerKManagerLLong Bond Yields Decrease XCorporate Spreads Widen X XConsumer Spending Weakness X X X X X X XBanking Sector Issues X X X X X X X X XGlobal Inflation X XContinued Japanese Deflation X X XEuro Break-Up X X X X X X XBase Metal Price Decreases X X X X XOil Price Decreases X X X X X XEmerging Markets Slowdown X X X X XGlobal Recession X X X X X X X X XPoor Quality Rally (poor relativeperformance during junk rally)X X X X X X X X
  37. 37. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comBringing It Altogether24
  38. 38. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.comBringing It AltogetherPortfolio Strategy Options1. Riskidentification Defining financial framework within which plan needs to be run.Understanding fiduciary and sponsor constraints Develop a Journey Plan to reduce the overall impact of the PensionPlan on the Plan Sponsor2. Riskreduction Sponsors have a non-uniform utility to risk and reward – more surplushas a diminishing value whereas more loss is increasingly painful De-risk by increasing your allocation to liability matching assets,and/or Purchase sufficient protection against severe outcomes (when it iscost-effective to do so) Diversify the drivers of return3. Riskmitigation Ensuring that the sponsor doesn’t have too much exposure to thingsthat can hurt them when they can least afford it Building more diverse portfolios with better balance betweenexposures Dynamic asset allocation (reserved for high governanceorganizations)25
  39. 39. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 26Contact Details Janet Rabovsky, MBA Tel: 416.960.7089 Email: janet.rabovsky@towerswatson.com26
  40. 40. © 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use 27DisclaimerThis document was prepared for general information purposes only and should not beconsidered a substitute for specific professional advice. In particular, its contents are notintended by Towers Watson to be construed as the provision of investment, legal,accounting, tax or other professional advice or recommendations of any kind, or to form thebasis of any decision to do or to refrain from doing anything. As such, this document shouldnot be relied upon for investment or other financial decisions and no such decisions shouldbe taken on the basis of its contents without seeking specific advice.This document is based on information available to Towers Watson at the date of issue, andtakes no account of subsequent developments after that date. In addition, past performanceis not indicative of future results. In producing this document Towers Watson has reliedupon the accuracy and completeness of certain data and information obtained from thirdparties. This document may not be reproduced or distributed to any other party, whether inwhole or in part, without Towers Watson’s prior written permission, except as may berequired by law. In the absence of its express written permission to the contrary, TowersWatson and its affiliates and their respective directors, officers and employees accept noresponsibility and will not be liable for any consequences howsoever arising from any use ofor reliance on the contents of this document including any opinions expressed herein.Copyright © 2012 Towers Watson. All rights reserved.
  41. 41. LDI in a Low Yield Environment2013 Annual Pension ConferenceCFA Society Toronto – April 24, 2013James Davis, CFAVice-President, Strategy and Asset Mix& Chief EconomistAsset Mix & Risk Department
  42. 42. 2 What do we mean by LDI?In a perfect world wewould: Fully hedge all therisks inherent inour liabilities Construct theoptimal Sharperatio portfolio Employ leverage toearn the highestrate of returnLIABILITY HEDGE PORTFOLIO(LHP)PROFIT SEEKING PORTFOLIO(PSP)Manage risk of liabilities,e.g., real rate sensitivity,inflationEarn the real rate of returnrequired to meet liabilitiesAssetsLiabilities
  43. 43. 3But Teachers’ doesn’t live in a perfect world!
  44. 44. 4 Fast Facts about Teachers’ Largest single-profession (DB) plan inCanada; membership of 372,000current, former and retired teachers(and their survivors) Jointly sponsored by the Ontariogovernment and Ontario Teachers’Federation Plan benefits are indexed to inflation(Conditional inflation protection forbenefits accrued post 2009) Need to file a balanced fundingvaluation at least once every threeyears Requires a real return of about 5% pato have a fully funded plan in 20 years C$129.5 billion in net assets (2012) 200 investment professionals;investments well diversified globally,across various asset classes Strong performance-driven, incentive-based culture 10.1% average rate of return andannualized value added overbenchmarks of 2.2% since 1990
  45. 45. 5Plan demographics are impacting our investmentdecisions1. Teachers are living longer and collecting pension benefits longer2. Teachers contribute for a shorter period than they collect benefits3. The plan is mature and will mature further1970 1990 2012Expected Credit atRetirement (years) 27 29 26Expected Years onPension 20 25 31Active TeachersPer RetireeAverage ContributionRate 5.2% 8.0% 11.0%Increase in ContributionRate for 10% Loss onAssets0.6% 1.9% 4.7%10:1 4:1 1.5:1
  46. 46. 6Our plan maturity makes us sensitive to the path ofreturns4060801001202011 2015 2019 2023 2027 2031FundingRatio68%100%ShuffledpathReturnIndex0501001502002503002011 2016 2021 2026 2031Source: Cardano, OTPP Two paths for asset returnsproviding the samegeometric rate of return:Blue: Assumes actual path ofMSCI returns from 1990 –2010 is repeatedRed: Assumes four annualMSCI returns areswapped to produce earlylosses OTPP is sensitive to thepattern of returns Our funding ratio is worse ifthe losses occur up-frontSamestartingpointSameendingpointSamestartingpointDifferentendingpointsActualpath
  47. 47. 7BenefitsContributionsReturnOur LDI objective is a sustainable balanced planWhat a balanced plan meansfor us? Earning a return high enoughto ensure plan sustainability;and Maintaining stability ofbenefits and contributionrates at their target levels
  48. 48. 8LDI means balancing short- and long-term investmenthorizonsSource: Bloomberg, OTPP Asset Liability ModelRisk Contribution To Liabilities*0%10%20%30%40%50%60%70%80%90%100%1 5 9 13 17 21 25 29 33 37 41 45 49Investment Horizon (years)Change in real yield Level of real yield Inflation* Assuming no longevity risk* Proxied by Canadian RRBs; does not consider Plan’s demographics.
  49. 49. 9 We cannot fully hedge our real interest rate exposureDRIVERS: Correlation with Planliabilities Risk tolerance Level of real yields Best hedging asset isCanadian RRBsCONSTRAINTS: Insufficient supply Counterparty risk ifderivatives are used Liquidity usageSource: OTPPLiabilityDV01REAL RETURN BONDSAssetDV01NOMINAL BONDSMISMATCH TO LIABILITYDV01
  50. 50. 10Nominal bonds are becoming less helpful forour Plan as yields move lower3-Year Reward/Risk forLong Canada Nominal Bonds3-Year Correlation Between CanadianNominal and Real Return BondsStarting yield Starting yieldHigher Lower Higher LowerSource: OTPP Asset Liability Model
  51. 51. 11To meet our LDI objective, we must rely on theinvestment attributes of a broad spectrum of assetsKey desirable asset attributes: Provide potential as a source of diversified value add Provide stable returns Provide long-term inflation adjusted growth Generate cash flow Mitigate real rate sensitivity of liabilities Mitigate inflation sensitivity of assets or allow inflation pass-through Facilitate leveraging Provide reliable source of liquidity when requiredLHP PSP0RealReturnBondsTIPSNominalCdn BondsDMSovereignBondsRegulatedInfrastructureCore RealEstateTimberlandsIG CorporateBondsGDP-DrivenInfrastructure EquitiesCommoditiesLong-termEquitiesAbsoluteReturnStrategiesPrivateCapitalEMSovereignBondsDividendEquitiesHYCorporateBonds
  52. 52. 12Asset classes behave differently in different economicenvironments; our asset allocation is dynamicEconomic Regime MapHigh growth /Low inflationHigh growth /High inflationLow growth /High inflationLow growth /Low inflationGDP GrowthCPI InflationEquitiesCorporate BondsEM DebtCommoditiesInflation-Sensitive EquitiesReal EstateGrowth InfrastructureNominal BondsTIPS / RRBsGold / Precious MetalsRegulated Infrastructure
  53. 53. 13Our Asset-Liability Model allows us to do “what-if”scenarios …18% 20% 22% 24% 26% 28% 30% 32%Increasing Worst Case Contribution RateAsset Mix #1 in normalenvironment(equilibrium)Asset Mix #1in low yieldenvironmentWORST:Higher Worst-Case Contribution RateHigher Average Contribution RateBEST:Lower Worst-Case Contribution RateLower Average Contribution RateDecliningAverageContributionRateRISKREWARDA low yielding regime isdetrimental to our goal ofstability and sustainability
  54. 54. 14… and to identify better asset mixes to improve ourreward-risk tradeoff18% 20% 22% 24% 26% 28% 30% 32%Increasing Worst Case Contribution RateAsset Mix #1 in normalenvironment(equilibrium)Asset Mix #1in low yieldenvironmentWORST:Higher Worst-Case Contribution RateHigher Average Contribution RateBEST:Lower Worst-Case Contribution RateLower Average Contribution RateDecliningAverageContributionRateRISKREWARDAsset Mix #2, #3and #4 in low yieldenvironmentOur objective is to moveto the upper left byimproving our asset mixA low yielding regime isdetrimental to our goal ofstability and sustainability
  55. 55. 15Five reasons why the current low yield environmentcould be with us longer than we would like1. Historical precedent2. Low rates are necessary3. Demographics4. De-risking and risk management Risk parity / Bonds as insurance LDI5. Policy induced regime changes Deflation Financial repression#####
  56. 56. 16Historical US 10-year Real Yields**Breakeven inflation is proxied by 10-year moving average ofrealized inflation.Source: OTPP, Global Financial Data#1: There is a historical precedent for lower yieldsHistorical US 10-year Nominal Yields+ sPost WW IIGreatDepressionPost WW II- s+ s- sWW I
  57. 57. 17 #2: Low yields are justified by current conditionsSource: Federal Reserve, Bloomberg, OTPPUS Monetary Aggregates$ BillionMoney Supply: M2 to M0 (Ratio)M0 (R)Ratio of M2 to M0
  58. 58. 18 #3: Demographic trends support lower yieldsUS Labor Force Participation Rate US Real Yields and Demographics(from 1981 to 2012)% %Source: OTPP, BLS, Global Insight
  59. 59. 19Correlation Between US Stock and Bond Returns-0.6-0.4- 89 91 93 95 97 99 01 03 05 07 09Historical Correlation3456789PercentRolling 5-yr Correlation10-yr Bond Yield (RHS)#4: Nominal bonds are a good tail risk hedge even atlow yieldsρ = -0.67Source: Global Financial Database, Global Insight, Shiller, OTPPShiller P/E vs. 10-year Bond YieldsLess DiversificationMore Diversification051015202530354045502 4 6 8 10 12 14 16US 10-Year Yield, percentShiller P/Eρ = +0.82
  60. 60. 20 #4: Many DB plans are waiting to de-riskSource: Morgan StanleyFunding Ratio Sensitivity Analysis
  61. 61. 21#5: Two different macro economic regimes can leadto yields remaining low or even heading lowerEconomic Regime MapGDP GrowthCPI Inflation Nominal yield > Nominal GDP Inflation < target Arises from a policy mistake, e.g.,austerity Nominal yield < Nominal GDP Inflation > target Arises from a deliberate policychoice, e.g., inflate away debt2. FINANCIAL REPRESSION1. DEFLATION
  62. 62. 22 Deflation: Two historical examplesSource: Global Financial Data, DataInsightYields too highrelative to GDPVery lowinflationYields too highrelative to GDPVery lowinflation
  63. 63. 23Deflation: Our simulated scenario reflects a sustainedperiod of extremely low yieldsSource: OTPP Asset Liability ModelInitialBEIn normalization,breakevenincreasesIn deflation,breakevendecreases
  64. 64. 24Deflation: Even with such low yields, bonds are thefavored asset classSource: OTPP Asset Liability ModelSimulated Asset Class Real Returns Policy Asset Mix Under Different Scenarios
  65. 65. 25Financial Repression: The US experienced financialrepression post WWIISource: Global Financial Data, CBOYields toolowrelative toGDPHighinflation%%US Debt-to-GDP US Financial Repression(1946-1952)Due to financialrepression, debtdeclined by 3-4% ofGDP per year.
  66. 66. 26Financial Repression: Our simulated scenario reflectsa sustained period of extremely low yieldsSource: OTPP Asset Liability ModelInitialBEIn normalization,breakevenincreasesIn financialrepression,breakevenincreaseseven more
  67. 67. 27Financial Repression: Higher inflation and moderategrowth favor commodities and real assetsSimulated Asset Class Real ReturnsSource: OTPP Asset Liability ModelPolicy Asset Mix Under Different Scenarios
  68. 68. 28In both low yield scenarios, our expected returns fallshort of what we require to meet our liabilitiesSource: OTPP Asset Liability ModelReal Yieldat t=10-1.3%0.5%2.2%SmallerGapGap
  69. 69. 29Improving the asset mix will help but will not likely besufficient if these scenarios come to pass18% 20% 22% 24% 26% 28% 30% 32%Increasing Worst Case Contribution RateAsset Mixin normalenvironmentAsset Mixin deflationWORST:Higher Worst-Case Contribution RateHigher Average Contribution RateBEST:Lower Worst-Case Contribution RateLower Average Contribution RateDecliningAverageContributionRateRISKREWARDImproved Asset Mixin deflationAsset Mixin financial repressionImproved Asset Mixin financial repression
  70. 70. 30Our base case assumptions favor normalization as themore likely scenarioSimulated Paths for US 10-Year Nominal YieldRisk scenariosMost likely
  71. 71. 31Some positive signs: De-leveraging is progressing andpolicy makers have made credible decisions … so farVows not to repeat themistakes of the 1930sWhatever ittakes Pace of austeritymust depend oneconomic conditionsCommitted to stopdeflation
  72. 72. 32 Key takeaways Plan demographics and market constraints pose significant challenges Our liabilities are large and are very sensitive to real rates Our plan maturity makes us increasingly less tolerant of volatility Our LDI objectives of stability and sustainability become more difficult toachieve in a low yield environment There are several reasons why yields could remain low Different low yielding environments necessitate very different asset mixresponses: Deflation favors bonds or assets generating high quality cash flows Financial repression favors real assets and commodities Ultimately, an investment solution may not be adequate and plan designchanges may be required
  73. 73. 33James Davis, CFAVice President, Strategy & Asset Mix and Chief EconomistAsset Mix & Risk, Ontario Teachers’ Pension PlanQ & A
  74. 74. Bill Morneau, Executive Chairman, Morneau ShepellPooling of Public Sector Asset ManagementCFA Pension Conference, April 24, 2013, 1:00 pm
  75. 75. Morneau Shepell2Agenda• Defined benefit pension plans in context• The government pension challenge• The case for pooling BPS pension assets• Project overview:- Facilitating pooled asset management forOntario’s public sector institutions• Implementation challenges
  76. 76. Morneau Shepell3Defined benefits pension plans in context• Canadian retirement income security is asuccess story
  77. 77. Morneau Shepell4Defined benefits pension plans in context• Defined benefit pension plans are in seculardecline• Federal efforts in retirement emphasizepersonal responsibility
  78. 78. Morneau Shepell5The government pension challenge• The private sector/public sector pensiondivide will widen• Solvency deficits will likely persist in themedium term• Healthcare costs will force continuedgovernment restraint efforts• To facilitate negotiation, “No stone leftunturned” will need to be the governmentmantra
  79. 79. Morneau Shepell6The case for pooling Broader Public Sectorpension assets• Government needs to better understand thepension situation• There is clearly a case for cost-efficiency• Alternative asset classes are difficult to cost-effectively source and manage• Other cost-efficiency approaches, such asadministration opportunities, or plan mergers,are more difficult
  80. 80. Morneau Shepell7Project overview: Facilitating pooled assetmanagement for Ontarios public sector institutions• “The government intends to introduce frameworklegislation in the fall of 2012 that would poolinvestment management functions of smaller public-sector pension plans in Ontario… The governmentwill appoint an advisor to develop the framework,working with affected stakeholders and building onOntario’s internationally-recognized model forpension plan management.”– 2012 Ontario Budget, page 79. March 27, 2012
  81. 81. Morneau Shepell8Project overview: Facilitating pooled assetmanagement for Ontarios public sector institutions• Process:• More than 40 consultations and numerous writtensubmissions were considered- Broader public-sector pension and investmentfund administrators- Representatives of broader public sector labourgroups- Current and former leaders of large pension andinvestment funds- Representatives of Ontario’s investmentmanagement community
  82. 82. Morneau Shepell9Project overview: Facilitating pooled assetmanagement for Ontarios public sector institutions• Financial review:• Pooling would support investment managementsavings for participating institutions- Once fully implemented, pooling could saveparticipating institutions $82 million to $130 millionannually- Pooling could also enhance returns by supportinggreater diversification and improved risk management- Government would provide start-up funding of $50million over a three year period, to be recovered fromthe new entity
  83. 83. Morneau Shepell10Project overview: Facilitating pooled assetmanagement for Ontarios public sector institutions• Key recommendation:• A new, independent Corporate entity should beestablished to manage pooled investments on behalfof participating institutions- Asset allocation decisions would remain theresponsibility of participating institutions- The Board of Directors would be self-regenerating,and feature six independent professional and fiverepresentative members
  84. 84. Morneau Shepell11Project overview: Facilitating pooled assetmanagement for Ontarios public sector institutions• Key recommendation:• Legislation would compel the participation ofselected broader public sector pension plans- Total assets under management of up to $100billion- Defined contribution and supplemental plans, aswell as endowment funds could invest on avoluntary basis- Participating institutions would be permitted towithdraw after a cooling-off period
  85. 85. Morneau Shepell12Implementation challenges• Financial benefits from pooling will beunevenly distributed, at least initially• Mandating participation presents legitimateconcerns• Time to fully establish the new entity is atleast three years
  86. 86. Thank YouBill MorneauMorneau Shepell
  87. 87. 1Bob LittermanPrepared for CFA Society TorontoApril 24, 2013The Price of Climate Risk
  88. 88. 2Is Climate Change Real?
  89. 89. 3Is Uncertainty AboutClimate Change Real?
  90. 90. 4Is a Devastating Natural DisasterOutside the Realm of Possibility?
  91. 91. 5When…Where…or How?
  92. 92. 6Does it Matter How High weFill this Reservoir?
  93. 93. 7Should Adding Emissions to theAtmosphere be PricedAppropriately?
  94. 94. 8What is the Appropriate Pricefor Carbon Emissions?
  95. 95. 9The Reservoir – The Lake – The FloodThe Johnstown Flood
  96. 96. 10
  97. 97. 11The Aftermath
  98. 98. 12
  99. 99. 13Think about dynamic optimizationWith Uncertainty, Tipping Points And Nonlinear Responses
  100. 100. 14Where should climate risk be priced?There are 2 kinds of risk:High risk aversionLow risk aversionZeroThe price of climate risk todayNon-diversifiableRiskDiversifiable risk Expected damageriskpremium
  101. 101. The Equity Risk PremiumUS Historical Real ReturnsData are from = 4.75%Stock real return = 6.4%Bond real return = 1.6%A consistent 475 basis points per year for the last 140 years
  102. 102. Equities pay off primarily in good states of natureConsider a portfolio that pays off in bad states of natureData are from equally risky portfoliolong bonds and short equities earns-310 basis points
  103. 103. 17What does the Equity Risk Premium haveto do with Pricing Climate Risk?Pricing carbon emissions is a risk managementproblem involving trade-offs between consumptiontoday and potential bad outcomes in the distantfutureThis trade-off depends crucially on the degreeof societal risk aversionSocietal risk aversion can be calibrated to theequity risk premium
  104. 104. 18Economic impacts depend on futuretemperatures which are very uncertainScience: 25 March 2012
  105. 105. Climate modelers generally use a low curvature inthe context of a standard CRRA utility functionCounter to intuition, in the standard utility function increasing therisk aversion makes curbing emissions less urgentHigher curvature has two impacts:1) it increases the risk premium, but2) it also increases the risk free discount rateThe second impact dominates and causes the price to decreaseLord Nicholas Stern, for example, set adegree of curvature that implies anequity risk premium of around 12 basispoints,more than 30 times too low relative toobserved risk premia19Estimates of the social cost of carbonfrom Anthoff, Tol, and Yohe (2009)emissionspricesIncreasing risk aversionWhy???
  106. 106. Higher curvature across states ofnature is required to fit the verysignificant equity risk premiumsthat we observe in the marketWhile lower intertemporal curvatureis required to fit the relativelylow risk free ratesthat we observe in the marketRisk aversion Intertemporal substitution20Epstein-Zin utility can be calibrated to bothhigh risk premia and low interest ratesconsumption ( time, states of nature ) consumption ( time, states of nature )utilityutility
  107. 107. The rigidity of standard utility functions explainswhy in most climate models increasedrisk aversion lowers the price of emissions21
  108. 108. 22Higher societal risk aversion shifts theappropriate emissions price path upwardIncreasing risk aversion
  109. 109. 23One cost of delay is higher future emissions pricesAnother is increased risk of catastrophic outcomes
  110. 110. 24Bad newsGood newsThe resolution of uncertainty about risk will impact prices over timeas will surprises in the development of new mitigation technologyEmissions prices should be expected to fluctuate
  111. 111. Optimal climate policy should be sensitiveto the potential for bad outcomes in the lower tail25cost todayexpectedbad draw
  112. 112. 26We implore you to support the European Union’s innovative efforts to place a priceon carbon.Addressing emissions in this sector by negotiating a global pricing system throughthe International Civil Aviation Organization (ICAO) would send an important signalthat carbon pricing is an effective way to correct a major market failure—thegrowing concentration of greenhouse gases in the atmosphere.…Because emissions are not priced, the world is wastefully using up a scarceresource, the earth’s ability to safely absorb greenhouse gas emissions. We arealso failing to make appropriate investments in capital that would reduce futuregreenhouse gas emissions. Our selfish inaction pushes increased costs ontofuture generations, and dangerously increases the probability of extremeevents with major impacts on their welfare…Economists Speak OutOn March 14, 2012 six Nobel laureates, and 20 other leadingeconomists wrote to President Obama as follows: Arrow, William Sharpe, Eric Maskin,Thomas Sargent, Christopher Sims, Joe Stiglitz,…
  113. 113. 27“I think a global carbon tax is blindingly obvious and should have beenintroduced 15 years ago, and that would have been completely fair.Every single airline in the world would have been treated in the sameway.As an airline owner, I’m sure I’ll get told off when I get home – but ideallythere should be a fair global tax with everybody taking a little bit of pain.It’s not massive.And if that happened, we would get on top of the problem.”At least one airline executive agrees:Sir Richard Branson, Chairman of Virgin Airlines, speaking ata State Department Conference, April 26, 2012:
  114. 114. Waiting on theWorld to ChangeBy Avery Shenfeld, Chief Economist & Managing DirectorApril 2013
  115. 115. | 2Canadian Household Savings RateSource: Statistics Canada, CIBC051015202581838587899193959799010305070911%
  116. 116. | 3Pensions: Fewer Covered, Less CertaintyWorkers Covered byRegistered Pension Plans313233343536373892 94 96 98 00 02 04 06 08 10% of workforceSource: Statistics Canada, CIBC0510152025303592 02 11Workers Covered byDefined BenefitRegistered Pension Plans% of workforce
  117. 117. | 4Share of Canadians Facing 20% or More Dropin Living Standards on Retirement0%10%20%30%40%50%60%1940-19441945-19491950-19541955-19591960-19641965-19691970-19741975-19791980-19841985-1989Birth Cohort
  118. 118. | 5World GDP Growth: No Pick-up Until 2014-20246810122010A 2011A 2012E 2013E 2014EEurozone US China World% chg
  119. 119. | 6Fiscal Tightening Weighs on Global Growth (R)Little Room for Monetary Policy Offset (L)0123456Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Jan-12%Global Monetary Policy Index(Developed Economies)Source: Central Bank News-1.5-1.0- 2010 2011 2012 2013Source: IMF, CIBCChange in Cyclically Adj. DeficitAdvanced Economies (% of GDP)
  120. 120. | 7Italy, Spain Fail to Boost CompetitivenessSource: Eurostat-15%-10%-5%0%5%10%Ger Ita Spa Ire Por GreChg (past year)Chg (since 2008)Labour costs per hour in euro
  121. 121. | 8China: Not As Much Gain Where it CountsAs Resource Imports Still Lackluster-35-30-25-20-15-10-505Lumber Crude Oil UnwroughtCopper &Productsy/y % chg in Chinas import volumesfrom all countriesNote: two-month averagesto smooth New YearsdistortionsSource: Markit, HSBC, Bloomberg, CIBC-50510152025303540Jan-11Jun-11Nov-11Apr-12Sep-12Feb-1346474849505152535455China Imports (L)China PMI (R )Yr/Yr Index
  122. 122. | 9Not the China of a Decade AgoSource: CEIC323436384042444648505295:Q3 98:Q1 00:Q3 03:Q1 05:Q3 08:Q1 10:Q3 13:Q1Industrial (L) Services (L )% of GDPNote: 4-qtr moving averages
  123. 123. | 10Fiscal Drag Delays US Acceleration- fiscal drag CIBC base case Full fiscal cliff2013 US GDP growth forecasts
  124. 124. | 11Low US Interest Rates Are Finally Seeing ResultsSource: Fannie Mae, MBA, Bloomberg, CIBC05001000150020002500Q1-1990Q3-1992Q1-1995Q3-1997Q1-2000Q3-2002Q1-2005Q3-2007Q1-2010Q3-2012Housing Starts (thousands)708090100110120Jan-05Apr-06Jul-07Oct-08Jan-10Apr-11Jul-12Housing-related sales*Other (ex-gasoline)US Retail Spending(Nov07 = 100)*furnishing, appliances& building materials
  125. 125. | 12Canada No Longer Outpacing US;Bank of Canada On Hold Until 20152013 2014US 2.0% 3.2%Canada 1.5% 2.4%
  126. 126. | 13A Key Ingredient to the US Crash Missing HereNon-ConformingMortgages as a Share ofTotal Outstanding0510152025Canada 2012 US 2006%020406080100120Jun-06Dec-06Jun-07Dec-07Jun-08Dec-08Jun-09Dec-09Jun-10Dec-10Jun-11Dec-11Jun-12Cities with above avg non-conformingexposureCities with below avg non-conformingexposureIndex June 2006=100
  127. 127. | 14Credit Score Trend Not Threatening to BanksCurrentGoodRiskyHighlyriskyVeryGoodModerateSource: Equifax, CIBC2008GoodRiskyHighlyriskyVeryGoodModerate
  128. 128. | 15Limited Fuel for ConsumptionStagnating Income26,40026,80027,20027,60028,00028,40011Q111Q211Q311Q412Q112Q212Q312Q4Real householddisposable incomeper capita ($)Consumer Credit3638404244464805 06 07 08 09 10 11 12% of hdiSource: Statistics Canada
  129. 129. | 16Canada: Building Fewer Houses/CondosSwamps Energy Sector Rebound-0.1%0.0%0.1%0.2%0.3%0.4%0.5%0.6%0.7%Energy Production Housing2012 2013Contribution to GDP (%-pts)+0.2%-0.5%
  130. 130. | 17Canada’s Firms Less Eager to Invest (L)While US Firms Ramp Up (R)-20%-15%-10%-5%0%5%10%15%20052007200920112013planCanada: growth in business capitalspending4050607080Jan-2006May-2007Sep-2008Jan-2010May-2011Sep-2012US non-defense capital goodsex-aircraft orders (US$ bns)
  131. 131. | 18Source: Bloomberg, CIBCAverage2012 2013 (f) 2014 (f)Oil (WTI) $/bbl 94 93 98Natural Gas $/Mn Btu 2.75 3.50 3.75Gold $/troy oz 1657* 1400* 1200*Copper $/lb 3.62 3.50 4.00Lumber** $/000 bd ft 287 410 435Potash $/tonne 430 430 450* end of period **1st FuturesCyclical Commodities Await 2014
  132. 132. | 19Cost of Bottlenecks to Remain High Even AfterRecent Spread Improvements051015202530354023-Aug11-Sep28-Sep17-Oct5-Nov22-Nov11-Dec28-Dec16-Jan4-Feb21-Feb12-Mar29-Mar$Bn annualized, 30 day mov. avgNote: Revenue loss based on"normal" WTI premium of $2/bbl vsBrent and $17/bbl discount ofWestern Canada Select to WTI$15.2 bn$16.5 bn2014 2015ProjectedSource: NEB, Bloomberg, CIBC
  133. 133. | 20Source: US Department of EnergyShale Oil Revolution Shifts the US Supply Curve(L); Import Share of US Market % (R)0123456781990 1995 2000 2005 2010 2015Shale/Other TightOther Lower 48 onshoreLower 48 offshoreAlaskaproduction, mn bbl/day303540455055606595 99 03 07 11 15 19 23imports/US oil consumption (%)
  134. 134. | 21Exports Stall on Volumes (L),Energy No Longer to Blame (R)90100110120130Jan-2007Nov-2007Sep-2008Jul-2009May-2010Mar-2011Jan-2012Nov-2012Export Volume Index8090100110120130140Aug-2009Jan-2010Jun-2010Nov-2010Apr-2011Sep-2011Feb-2012Jul-2012Dec-2012Export Index (2010=100)EnergyexportsEx-energyExports
  135. 135. | 22Capital Inflows Have Left Canadian DollarOvervalued Relative to Trade FundamentalsSource: IMF, BIS, CIBC-15%-10%-5%0%5%10%15%IndonesiaJapanGermanyChinaIndiaThailandSAfricaKoreaMexicoEuroAreaBrazilUSASwitzerl.UKCanadaAustraliaSpainOvervaluation/undervaluation (%)*relative to each countrys tradingpartners; midpoint of estimatedrange
  136. 136. | 23Current Account Deficit (L)Leaves C$ Tied to Yield Spread (R)-25-20-15-10-5051015Q4-2005Q1-2007Q2-2008Q3-2009Q4-2010Q1-2012-6%-4%-2%0%2%4%C$ bnbillionsShare of GDPCanada: CurrentAccount Balance0. - US 2 yr spread (L)CADUSD (R)FcstUS$ per%
  137. 137. | 24US Broad Money Still Below Trend:Inflation not a Threat6008001,0001,2001,4001,600Jan-00Jun-01Nov-02Apr-04Sep-05Feb-07Jul-08Dec-09May-11Oct-12US Divisia M4 Index (1967=100)
  138. 138. | 25ETFs: The Elephant in the RoomSource: World Gold Council050010001500200025003000IMF ETFs ChineseGovernmentRussianGovernmentHoldings of gold, metric tonnes**China has not released official gold holdings since 2009. TheUS is the largest holder at 8,100 tonnes, with Germany at3,400.
  139. 139. | 266% JoblessnessWas Consistent with Fed Funds Rate at 1%0%2%4%6%8%10%12%Sep-1996 Jun-2000 Mar-2004 Dec-2007 Sep-2011UnemploymentRateFed FundsTarget RateFF Rate @ 1%with 6%joblessnessSource: Haver Analytics, CIBC
  140. 140. | 27Stimulus Goes Well Beyond Zero Funds Rate-6%-4%-2%0%2%4%6%2004 2008 2012Fed FundsRateEquivalentstimulusimpact(includingQE)Source: Rudebusch (FRBSF Economic Letter, 2010), Haver Analytics, Federal Reserve, CIBC
  141. 141. | 28Bond Yields Drift Modestly Higher in H2 2013Anticipating End of QE012345Feb-08 Dec-08 Oct-09 Aug-10 Jun-11 Apr-12 Feb-13 Dec-132-Yr Canadas 10-Yr Canadas 10-Yr US Treasuries% 3.0% US10yr2.4% BE CPI0.40% US2yr1.7% US10yr2.5% BE CPI0.23% US2yr
  142. 142. | 29Why is the TSX Sucking Wind?Q1 Appreciation (%)-15-10-5051015Total Energy Financials MaterialsTSX S&P 500
  143. 143. | 30Dividend Yield:Canada’s Comparative Advantage- yield gap TSX Composite S&P 50012-month trailing (%)Historical average=57Source: Haver Analytics, CIBC
  144. 144. | 31Stocks Look Cheap vs. Historical or 2014 EarningsSource: Bloomberg0102030405060Aug-65Aug-70Aug-75Aug-80Aug-85Aug-90Aug-95Aug-00Aug-05Aug-10Avg since 1965 = 20.217.9Apr-13Real stock prices/averageinflation-adj earnings, last 10 yrs 7.3%1.7%0%1%2%3%4%5%6%7%8%TSX Yield on 2014Earnngs10-Year Canada
  145. 145. | 32Waiting on the World to Change Canada lagging US; No growth pick-up in2013. But Bank of Canada wont ease rates. US has more upside in retailing, housing Housing corrects, but Canada is not the US Canadian dollar softer ahead, rallies throughparity in 2014 For now, favour less-cyclical, dividend payingequities Anticipation of better 2014 drives “risk on”trade in late 2013, lifting commodities andbond yields Exports and capital spending key to bettergrowth and TSX in 2014