3Liability Driven Investments (LDI)Maximise your toolset
The PRMF Dashboard4
5Respond to changes: Set up to take decisions quickly as conditions change or falls away from roadmap to full fundingActive asset allocation Dynamic de-risking Efficient governanceMonitor regularly: Clear framework to measure progress against those objectivesFunding level Risk metricsLiquidity and collateralrequirementsSet objectives: Achieve a fuller understanding of objectives and constraintsIntermediate goals Longer term aspirations Risk toleranceKey stages in building a Pension Risk Management Framework
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020GBPMillionsLiabilities Path Actual Liabilities Assets Path Actual AssetsLiability BasisContributions & Asset ReturnsTime HorizonThe Flight Plan is an effective tool for making focussed asset allocation decisions andidentifying the best opportunities.It allows schemes to identify the assets which contribute most towards their progressto full funding – we call them Flight Plan Consistent Assets.Moving from “set and forget” to“anticipate and recalibrate”6
Funding LevelCase study: Dynamic De-RiskingPension Risk Management Framework in action27 Sep 2010 28 Oct 2010 15 Dec 2010 04 Feb 2011Funding Ratio 80% 86% 89% 91%Equity Allocation 85% 65% 50% 40%Value at Risk* 33% 29% 25% 23%
8Case study: Dynamic De-RiskingPension Risk Management Framework in actionOriginal1 New2 withoutde-riskingNew2 withde-riskingFunding level01 Oct 201078.4% 79.2% 79.2%Funding level 7Sep 201170.6% 71.8% 76.2%Volatility offunding level17.5% 15.9% 13.3%1Old strategy prior to Redington’s appointment2New strategy consisting of index-linked gilts, corporate bonds and cash overlaid withequity futures.
11-6-4-2024680 5 10 15 20 25 30GBPMillionsYearsInitial investmentAttractive realreturnsInflation-linkedcashflowsProviding a matchfor liabilitiesInflowsOutflowsSource: RedingtonFlight Plan Consistent Asset – Example Cashflow ProfileFlight Plan Consistent Assets – How?
• Take advantage of attractive yields on long-term secured propertyleases• Yields may be in excess of yields on corporate bonds issued bysame borrower• Long-dated index-linked cashflowsSecured Leases• Ground rent created when freehold land or building is sold on longlease• Typically “pepper-corn” rent for land only (not buildings)• Offers attractive returns, limited credit risk and high level ofsecurityGround Rents• Low-cost rental housing provided for disadvantaged people inneed of housing• Generally provided by local councils and housing associations• Offers long-dated, inflation-linked cashflows from securedborrowers (i.e. housing associations) with quasi-governmentguaranteeSocial Housing• Investing in public sector projects through, for example, PrivateFinance Initiatives (PFIs), bespoke investments structures or bypurchasing a suitable infrastructure asset• Wide range of possible assets, from roads to power generation• Long-term, potentially inflation-linked revenue streamsInfrastructureExamples of “Flight Plan Consistent Assets”
Social Housing: Risk profileFlight Plan Consistent Assets – How?• The diagram shows a typicalsocial housing portfolio for apension fund investor with ablended real return of ca. 3-4%p.a.• The portfolio consists of differenthousing types with specificrisk/return profiles.• By adapting the share of thedifferent housing types in theportfolio, an investor can tailorthe portfolio’s return and the riskcharacteristics so that they fitrequirements.Social Housing is typically a low-risk asset class but the returnsand the risk on a portfolio can be tailored (to some extent) tomeet pension funds’ requirements.13Source: Evolution Securities,Redington
Flight Plan Consistent Assets – How?Example: Tapping the illiquidity premium in waterThe UK water sector is an excellent example of a Flight PlanConsistent Asset, providing the security, returns and cashflowsthat pension funds need.• Economic environment has small impact on returns:water is a necessity and will therefore be demandedirrespective of economic growth.• Inflation-linked cashflows and returns: water companiescan increase prices in line with the agreed price reviewwhich in turn is based on a formula related to RPI.• Low regulatory risk: The regulator’s desire to increasecompetition in the area could have a negative impact onreturns but the Government is likely to block any suchmove.Water sector: key characteristics• Currently up for sale• Bought by HSBC in August 2011 (for warehousing) for £74m• Provides water for 300,000 people in Cambridgeshire• 2010/2011: Revenue of £20m with profits of £7m before tax withno external debt except for a revolving credit facility to coverworking capital• Attractive purchase opportunity for a large pension fund or aconsortium of funds.Case study: Cambridge Water14
The PRMF Dashboard16The Dashboard summarises provides a comprehensive, easy-to-understand overview of how well a scheme is performingagainst objectives.Risk Radar – What are your biggest riskfactors? What risks should you be focussingon?Scheme Gauge – What condition is yourscheme in judged on four fundamentalvariables?Risk Monitor – Putting numbers to yourexposure: How much risk is the schemetaking at the moment? (as measured by fourelemental risk metrics)Performance Monitor – Shows how the mostimportant markets have performed.Traffic light system – Where your scheme ismeeting targets (green), falling short by asmall margin (yellow) or underperformingsignificantly (red). Ideal for identifying areaswhere effective action is needed.PRMF checker – A summary of your scheme’sobjectives and whether they are being metDashboard – Key Features13465212123456