Dynamic Risk Management in Practice


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Dynamic Risk Management in Practice

  1. 1. Teach-in Pension Risk Management Framework in Practice 04 June 2013Pension Risk Management Framework in Practice:Dynamic De-risking Case Study04 June 20131
  2. 2. Teach-in Pension Risk Management Framework in Practice 04 June 2013ContentsIntroduction 3Strategy Design 5Implementation 10Summary & Conclusion 162
  3. 3. Teach-in Pension Risk Management Framework in Practice 04 June 2013Background: Challenging Economic Landscape (May 2008-May 2013)320-Year Nominal Gilt Yields 20-Year Breakeven InflationCredit Spreads Equity Markets2. 100 MSCI World MSCI Emerging Markets050100150200250300350400Bps
  4. 4. Teach-in Pension Risk Management Framework in Practice 04 June 2013Case Study: The JourneyBefore: May 2008• No clear funding objectives or risk budget in place• No monitoring in place• Strained relationship with the sponsor• Quarterly Trustee meeting• Over 70% allocation to equities, hedge ratios close to 0%4After: May 2013• A clear Pension Risk Management Framework (PRMF)• Daily monitoring of funding level; quarterly monitoring of PRMF• Improved relationship between Trustees and Sponsor• Flexible governance schedule• 0% allocation to equities, fully hedged against interest rates andinflation60%65%70%75%80%85%90%95%FundinglevelOriginal StrategyActual StrategyDe-Risking TriggersDe-Risking TriggersRe-Risking TriggerDe-Risking Trigger89.2%81.0%
  5. 5. Teach-in Pension Risk Management Framework in Practice 04 June 2013 5Strategy Design
  6. 6. Teach-in Pension Risk Management Framework in Practice 04 June 2013Process – 7 Steps Framework6To be fully funded at the minimum level of riskMission Statement
  7. 7. Teach-in Pension Risk Management Framework in Practice 04 June 2013Sample Pension Risk Management FrameworkStep 1: Setting clear goals and objectives7Putting clients in Control of the Decision-Making Process:We believe that the most effective way to ensure that the investment strategy remains relevant over time is the Pension Risk ManagementFramework – a clear, strategic and market-consistent approach for capturing market opportunities and identifying, monitoring and controlling risks.2013 2014 2015 2016 2017 2018 2019 2020GBPMillionsLiabilities Path Actual Liabilities Assets Path Actual AssetsContributions andasset returnsLiability BasisTime Horizon
  8. 8. Teach-in Pension Risk Management Framework in Practice 04 June 2013Strategic Asset Allocation15%10%13% 19%33%1% 1%13%11%4%1%0%10%20%30%40%50%60%70%1y VaR95 - Risk Attribution - New vs. Old StrategyStep 2-4: Design and implementation of an efficient investment strategy8Implementation via a single managerReduce unrewarded riskIncrease rewarded riskEquityFuturesActive Credit MandateBuy-and-Hold Index-Linked Gilts PortfolioClosely Matching the Liabilities’ ProfileMoney Market InstrumentsPooledSegregatedActive Credit MarketKey benefits• Low governance solution• Efficient collateral management for derivative positions• Fully integrated platform to deploy future strategies
  9. 9. Teach-in Pension Risk Management Framework in Practice 04 June 2013Step 7: Ongoing monitoringCalls to Action: Dynamic Risk Management Framework• Disciplined yet dynamic approach to manage risk• Triggers linked to “required return”• Pre-approved by the Scheme actuary9Daily funding level trigger monitoring• De-risking triggers implemented on a non-recourse basis• Re-risking trigger to initiate “discussion”• Quarterly monitoring of Pension Risk ManagementFramework75%80%85%90%95%100%105%2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Target flight planDynamicDe-riskingReach fullfundingfasterFunding Level Trigger Required Return Total Equity ExposureAs of 31 Dec 201087.0% 2.60% 50.0%90.0% 2.30% 40.0%92.0% 2.00% 30.0%93.5% 1.70% 20.0%95.5% 1.40% 10.0%96.5% 1.10% 5.0%97.0% 0.80% 0.0%
  10. 10. Teach-in Pension Risk Management Framework in Practice 04 June 2013 10Implementation
  11. 11. 11Portfolio StructureAn overview of the initial solutionSource: Schroders, Redington. For Illustration Purposes only.Liability coverage obtained by corporate bonds and index linkedgilts not to scaleLiabilitycoverageInvestmentLiabilities Liabilities £92mEquity Futures overlayCorporate bonds CashPortfolio StructureCorporateBondsIndex linked giltsIndex LinkedGiltsLiability Risk CoverageCorporate bonds and index-linked giltscover approximately half the liability risksCorporate BondsActively managed corporate bond fundsIndex-linked GiltsA bespoke portfolio, delivering stability,certainty and low cost liability coverageMinimal Cash holdingsSupporting the futures exposure, managedto maximise liability coverage.Bespoke equity exposuresA bespoke portfolio of equity futures that can be adjusted as the Plan’s requirements change
  12. 12. 12Equity Futures OverlayMaintaining a bespoke set of exposuresEquity region Future AllocationUK FTSE100 25%-50%Europe Eurostoxx50 16%-25%US S&P500 16%-25%Japan and AsiaTopix, Hang Seng, SPI20016%-25%Total 100%Example equity future exposuresSource: Schroders, Redington For Illustration purposes onlyMaintaining growth exposureTo back the equity overlay the Plan can place:– Index linked gilts for initial margin– Cash for the rest (~20%)– Profits can be passed into growth assets– Too little cash => potential sale of bondsassetsA bespoke exposure to equity futuresSchroders can deliver equity exposures specificto the Plan’s requirementsSchroders will manage this process, (lowgovernance) whilst also giving the flexibility tore-direct profits into other assetsPortfolio StructureEquity Futures overlayCorporate bonds CashIndex linked gilts
  13. 13. Schroder Matching PlusRisk controlled and effective liability matching with pooled fundsSource: Schroders, for illustration only. The liabilities above are an example Scheme.13Portfolio structure Scheme’s liabilities0500,0001,000,0001,500,0002,000,0002,500,0003,000,0003,500,0004,000,0004,500,0005,000,0002011202120312041205120612071LDI Interest rate coverage LDI Real Rate coverageFixed Pension Cashflows Index-Linked Pension CashflowsGilt-based coverage Launched range in 2007, added Gilt funds in 2011 Robust and effective processes unchanged sincelaunch and throughout the financial crisis for:– Liability coverage– Counterparty risk management– Cash management process Flexible use of Total Return Swaps and Repo togenerate coverage
  14. 14. Schroder Matching PlusMinimum capital requirement and robust solvency managementOther assetsDynamic AllocationKey :LiabilitiesPooled LiabilityMatching Fund PortfolioOther assetsLDI CoveragePortfolio StructurePortfolio ManagementCash Holdings20%Interest rates fall / Inflation risesInterest rates rise / Inflation fallsLDIPortfolioNote: Percentages shown above for illustration only. Actual amounts depend on the structure of the hedgeSource: Schroders, for illustration only14
  15. 15. Keeps the Trustees in control of the solutionClient serviceFunding level based monitoring and reportingSchroders are delegated to: Undertake daily monitoring of the fundinglevel, and Adjust asset allocation automaticallyAllows Trustees to focus on: How well the solution is working Which areas need attention15Source: Schroders. For illustration only.-50-250Start Accrual atdisc rateHedgeA vs LDifferentialperfUnhedgedliabilitiesExcessreturnA vs Lnet inflowEnd£m13 45 6Liabilities2Trigger Proxy FundingLevelDGF EquityFuturesEMEquityManager A Manager BCurrent <87.5% 13% 14% 24% 3%1 87.5% 13% 14% 20% 3%2 89.0% 13% 14% 11% 3%3 90.5% 13% 14% 6% 0%4 92.0% 11% 14% 0% 0%5 94.0% 7% 7% 0% 0%6 95.5% 0% 4% 0% 0%7 96.0% 0% 0% 0% 0%
  16. 16. 16Summary & Conclusion
  17. 17. Teach-in Pension Risk Management Framework in Practice 04 June 2013Integrityclaritysimplicity2008 2009 2010 20112012and... Scheme close to a full buyout;no robust monitoring framework Funding position significantlydeteriorated during financialcrisis 10 year recovery plan put inplace Time for a change Search for new investmentconsultant Redington selected after severalmeetings to get comfortable with“new concepts” New investment strategyimplemented Dynamic de-risking frameworkin September 2010 New governance arrangementsand efficient monitoringprocess Four triggers hit by Feb-2011and successfully captured Three “Pension Awards” forbest investment strategy Funding level deterioratedagain - governancearrangements meant we couldact quickly Funding level c8% highercompared to original strategy Risk (1y VaR95) reduced fromover 30% to under 10% Fully hedged against interestrates and inflation
  18. 18. Teach-in Pension Risk Management Framework in Practice 04 June 2013Integrityclaritysimplicity A clear, focussed and disciplined approach to managing investments A good and complementary skill set on the Board A flexible and robust governance structure Collaboration between all parties Nothing stands still – we have to keep learning all the timeKeys to success
  19. 19. Teach-in Pension Risk Management Framework in Practice 04 June 2013 19Questions?
  20. 20. Teach-in Pension Risk Management Framework in Practice 04 June 201313-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.ukNeha BhargavaSenior Vice President, Redington020 3326 7156neha.bhargava@redington.co.uk20Ian MayburyHead of Solutions Management, Schroders020 7658 2591ian.maybury@schroders.co.ukRita PowellManaging Director, Inside Pensions08454 377321rita.powell@insidepensions.comContactsDisclaimerFor professional investors only. Not suitable for privatecustomers.The information herein was obtained from various sources.We do not guarantee every aspect of its accuracy. Theinformation is for your private information and is fordiscussion purposes only. A variety of market factors andassumptions may affect this analysis, and this analysis doesnot reflect all possible loss scenarios. There is no certaintythat the parameters and assumptions used in this analysiscan be duplicated with actual trades. Any historical exchangerates, interest rates or other reference rates or prices whichappear above are not necessarily indicative of futureexchange rates, interest rates, or other reference rates orprices. Neither the information, recommendations oropinions expressed herein constitutes an offer to buy or sellany securities, futures, options, or investment products onyour behalf. Unless otherwise stated, any pricing informationin this message is indicative only, is subject to change and isnot an offer to transact. Where relevant, the price quoted isexclusive of tax and delivery costs. Any reference to theterms of executed transactions should be treated aspreliminary and subject to further due diligence .Please note, the accurate calculation of the liability profileused as the basis for implementing any capital marketstransactions is the sole responsibility of the Trusteesactuarial advisors. Redington Ltd will estimate the liabilities ifrequired but will not be held responsible for any loss ordamage howsoever sustained as a result of inaccuracies inthat estimation. Additionally, the client recognizes thatRedington Ltd does not owe any party a duty of care in thisrespect.Redington Ltd are investment consultants regulated by theFinancial Conduct Authority. We do not advise on allimplications of the transactions described herein. Thisinformation is for discussion purposes and prior toundertaking any trade, you should also discuss with yourprofessional tax, accounting and / or other relevant advisershow such particular trade(s) affect you. All analysis (whetherin respect of tax, accounting, law or of any other nature),should be treated as illustrative only and not relied upon asaccurate.©Redington Limited 2013. All rights reserved. Noreproduction, copy, transmission or translation in whole orin part of this presentation may be made withoutpermission. Application for permission should be made toRedington Limited at the address below.Redington Limited (6660006) is registered in England andWales. Registered office: 13-15 Mallow Street London EC1Y8RD
  21. 21. Teach-in Pension Risk Management Framework in Practice 04 June 201313-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.ukAbout Redington21Redington is an independent investment consultancy with a mission to design, develop and deliver the best investment strategies for its client to reachtheir funding goals with the minimum level of risk. We combine the practicality of an investment banking approach to investment consulting with the bestof actuarial analysis, which delivers clients clear, actionable advice. Our clients trust us with over £250 billion of assets, and we advise ten of the 25biggest pension funds in the UK.Recent Publications IRIS: Monitor Risk. Measure Progress. Stay on Track.Industry AwardsRisk Management Firmof the YearBest Consulting Firmof the YearPension Consultantof the YearInvestment Consultantof the YearSpecialist InvestmentConsultant of the Year