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Redington press breakfast 29 august 2013
 

Redington press breakfast 29 august 2013

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    Redington press breakfast 29 august 2013 Redington press breakfast 29 august 2013 Presentation Transcript

    • Private & Confidential Redington Ltd 29 August 2013 Press Breakfast 29 August 2013 1
    • Private & Confidential Redington Ltd 29 August 2013 Volatility Controlled Investing For DB and DC 2 Dan Mikulskis Co-Head of ALM & Investment Strategy
    • Private & Confidential Redington Ltd 29 August 2013 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000 £mm Assets Liabilities Assets realised • Pension schemes manage a flight path to full funding, but are exposed to downside events • Sponsors are concerned over pensions impact on wider business. Weaker funding positions have forced sponsors to significantly increase deficit repair contributions. Situation: Need to Earn the Required Return whilst Managing Risk 3 Unprotected against extreme downside event, which would prevent scheme from meeting Required Return objective
    • Private & Confidential Redington Ltd 29 August 2013 Commonly Heard Pension Problem – Downside Risk Concerns • Trustee “We have a low sponsor covenant that means we cannot rely on the company to plug the gap if our assets fall in value ... but we still need to generate returns to meet the scheme benefits” 4 • Corporate sponsor “We want to tell the markets that we have the Pensions issue under control because we have implemented an investment strategy whereby the deficit position cannot worsen by more than £X* m in any given year.” • DC scheme • “I know default funds often invest in equities, but they can lose a lot of money in a market crash like 2008, is there a way we can protect our members’ savings more, is there a better approach than traditional Lifestyling ?”
    • Private & Confidential Redington Ltd 29 August 2013 Drive To The Conditions 5
    • Private & Confidential Redington Ltd 29 August 2013 How Volatility Control Works • Vary exposure to the equity market in response to market conditions • As equity volatility rises, we reduce exposure from equity toward cash, depending on the volatility target • Here we illustrate the dynamic exposure of a volatility control approach targeting 10% volatility 6 Source: Bloomberg; Calculations: Redington
    • Private & Confidential Redington Ltd 29 August 2013 What Volatility Control is (and isn’t) Volatility Control is ... • An alternative approach to allocating capital; • A technique for managing risk; • A passive investment style; • Implemented on a mandate level; • Also known as Risk Control or Volatility Target. 7 Volatility Control is not ... • A quantitative trading rule that tries to outperform equities; • A mechanism for trying to predict market crashes; • A process for selecting low volatility stocks; • A process for weighting individual stocks according to their volatility; • A guaranteed downside protection vehicle against instantaneous crashes.
    • Private & Confidential Redington Ltd 29 August 2013 Case Study 1 : January 2008 – June 2009 8 Source: Bloomberg; Calculations: Redington
    • Private & Confidential Redington Ltd 29 August 2013 Case Study 2 : January 2011 – December 2012 9 • As the volatility of the FTSE 100 increased between August and September of 2011, the exposure of the volatility controlled strategy decreased to around 40%. -10% 10% 30% 50% 70% 90% 110% 130% 150% 0% 10% 20% 30% 40% 50% 60% 70% AnnualizedVolatility(%)ofFTSE100 %Allocationofvolatilitycontrolledapproach FTSE Allocation FTSE Rolling Volatility Source: Bloomberg; Calculations: Redington
    • Private & Confidential Redington Ltd 29 August 2013 0 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000 £mm Assets Liabilities Assets protected level (90%) DB Pension Funds : Need 10 Protected against extreme downside events, more likely to meet Required Return objective Satisfies sponsor requirement for market statement on downside control • Downside protection gives greater certainty that the scheme will be able to meet its flight plan
    • Private & Confidential Redington Ltd 29 August 2013 Volatility Control : Cost Effective Portfolio Downside Protection 11 1 Year Protection level Current cost of protection on Global Equity Index (%) over 1 year Stressed market conditions cost of protection on Global Equity Index (%) over 1 year Cost to protect 10% Volatility Control portfolio (%) over 1 year 90% 3.5% 6.5% 0.9% 85% 1.6% 4.8% 0.4% 80% 1.3% 3.5% 0.2% Source: Bloomberg, Investment Banks Calculations: Redington • Cost of downside protection on a volatility control equity benchmark can be less than half the cost of equivalent protection on a passive equity investment
    • Private & Confidential Redington Ltd 29 August 2013 0 50,000 100,000 150,000 200,000 250,000 300,000 Fund Value 100% Equity Floor Contributions Only DC Default Fund with Risk Control • Delivering better risk and return outcomes for DC members than a passive equity fund DC Pension Funds : Need 12 Protected against extreme downside events, more likely to meet Required Return objective Participation in equity markets with reduced downside
    • Private & Confidential Redington Ltd 29 August 2013 13 DC Pension Funds : Need • Two layers of risk protection: • Volatility control • Downside protection -87,120 -57,454 -25,016 242,635 207,845 230,714 -150,000 -100,000 -50,000 - 50,000 100,000 150,000 200,000 250,000 300,000 100% Equity Lifestyling DC Default Fund with Risk Control Terminal Fund Value (£) Largest Drawdown in Fund Value (£)
    • Private & Confidential Redington Ltd 29 August 2013 Volatility Control – Client FAQs • Are you saying Volatility Control is a free lunch? • What about transaction costs? • Are there any investable Volatility Control futures? • Does it employ excessive leverage and is this a problem? • Is it an algorithm? • Does future performance depend on volatility increasing prior to a market crash? • Could it be implemented in conjunction with the low volatility stocks approach? 14
    • Private & Confidential Redington Ltd 29 August 2013 Key Takeaways • Risk control gives a smoother ride by driving to the conditions. • Risk control allows scheme trustees and sponsors to lessen the impact of severe market crashed by implementing more cost-effective downside protection. • Analysis over long time periods and across markets shows that this approach can deliver better risk-adjusted return outcomes than a fixed market exposure. • Risk Control is easy and cost-effective to implement, being a semi-passive approach. Further Reading - The Actuary Magazine December 2012 http://www.theactuary.com/features/2012/12/volatility-control-taming-the-beast/ RedViews http://redington.co.uk/getattachment/eea3dd74-37c8-446e-afa9-fd8d1973f295/Taming%20The%20Beast.aspx RedBlogs http://blog.redington.co.uk/Articles/Dan-Mikulskis/September-2012/VOLATILITY-CONTROL.aspx http://blog.redington.co.uk/Articles/Dan-Mikulskis/December-2012/TAMING-THE-BEAST.aspx The Journal of Indexes November / December 2012 http://www.indexuniverse.com/publications/journalofindexes/joi-articles/12932-optimal-design-of-risk-control-strategy-indexes.html 15
    • Private & Confidential Redington Ltd 29 August 2013 Volatility Control in the Media 16
    • Private & Confidential Redington Ltd 29 August 2013 Illiquid Credit Opportunities Pete Drewienkiewicz Head of Manager Research 17
    • Private & Confidential Redington Ltd 29 August 2013 The Seven Steps to Full Funding TM 18 Design an efficient investment strategy Destination for agile hedging strategy Transparency to make timely decisions Articulate clear objectives and constraints Mission Statement To help our clients achieve full-funding with the minimum level of risk CLEAR GOALS & OBJECTIVES ACCESS TO LDI HUB LIQUID ACTIVE & MARKET STRATEGIES LIQUID & SEMI-LIQUID CREDIT STRATEGIES ILLIQUID CREDIT STRATEGIES ILLIQUID ACTIVE & MARKET STRATEGIES ONGOING MONITORING
    • Private & Confidential Redington Ltd 29 August 2013 Spreads on Liquid Credit Have Compressed Across Market Sectors... 19 0 100 200 300 400 500 600 LiborSpread(bps) Change in Libor Spread by Market Sector: GBP Liquid Credit Cyclicals Non-Cyclicals Senior-Financials Telecoms-Utilities
    • Private & Confidential Redington Ltd 29 August 2013 ...And Across The Ratings Spectrum 20 0 500 1,000 1,500 2,000 LiborSpread(Bps) Change in Libor Spread by Rating: GBP Liquid Credit AAA AA A BBB BB B
    • Private & Confidential Redington Ltd 29 August 2013 At the Same Time, Regulatory Change has Made Illiquid Asset Classes More Attractive 21 I Capital and Liquidity 1. Basel 3 II III Risk Mgt. and Supervision Market Discipline Narrower range of eligible capital Increased capital reqs. Capital Ratio Dur AAA AA A BBB BB <B Unrated ABS 1 Yr 7.0% 16.0% 19.0% 20.0% 82.0% 100.0% 100.0% 5 Yrs 35.0% 80.0% 76.0% 80.0% 82.0% 100.0% 100.0% 10 Yrs 42.0% 80.0% 76.0% 80.0% 82.0% 100.0% 100.0% Covered Bonds 1 Yr 0.7% 0.9% 1.4% 2.5% 4.5% 7.5% 7.5% 5 Yrs 3.5% 4.5% 7.0% 12.5% 22.5% 37.5% 37.5% 10 Yrs 6.0% 7.0% 10.5% 20.0% 35.0% 58.5% 58.5% Corp bonds/ loans 1 Yr 0.9% 1.1% 1.4% 2.5% 4.5% 7.5% 7.5% 5 Yrs 4.5% 5.5% 7.0% 12.5% 22.5% 37.5% 37.5% 10 Yrs 7.2% 8.4% 10.5% 20.0% 35.0% 58.5% 58.5% 2. Proposed Capital Weightings under Solvency II: Result: • Declining ABS issuance • Banks less active in loan origination • Banks withdrawing from holding longer-dated assets on balance sheets • Uneconomical for insurance companies to hold longer- dated, lower rated assets • Opportunity for pension schemes to fill funding gap
    • Private & Confidential Redington Ltd 29 August 2013 As Pension Schemes in General have a Defined Liability Profile, They Can Often Tolerate Illiquidity Risk 22 Corporate Bonds Direct Lending Corporate Linkers Infrastructure Debt / Long Leases Ground Rents Gilts Cash
    • Private & Confidential Redington Ltd 29 August 2013 The Illiquid Investment Universe 23 Higher-Rated Lower-Rated “Shorter-Dated” “Liability Matching” Infrastructure CRE Debt Ground Rents Long Leases Aircraft Finance Direct Lending Distressed Debt
    • Private & Confidential Redington Ltd 29 August 2013 Infrastructure Debt 24 Maturity Profile 15 years + Liquid Alternative Publicly-Traded Debt of Utility Companies Expected Spread / Rate 225-300bps Approx. Premium over Liquid Alternative 125-200bps What is it? • Can refer to: • Privately-negotiated deals with infrastructure- rich corporates, secured on specific assets • Project finance-style lending to individual infrastructure assets or clusters of assets • Infrastructure debt managers can finance projects during the construction phase to diversify return sources Why is it Interesting? • Secured lending • Long-dated cashflows • Possibility to structure index-linked returns • Government support for sector via PFI • Many projects are likelier to experience lower return volatility due to the natural bias towards essential service sectors Indicative risk breakdown: • Education • Rail • Water • Pipelines • Airports • Satellites
    • Private & Confidential Redington Ltd 29 August 2013 Commercial Real Estate Debt 25 What is it? • Consists of loans made to owners of real estate assets secured on underlying commercial property • About 75% of property market finance in Europe traditionally provided by banks, rest through covered bonds and CMBS • Risk / return profile can vary depending on level of subordination: senior, ‘stretch senior’ & mezzanine lending available Why is it interesting? • Bank deleveraging & drying up of CMBS market have arguably created fundamental dislocation in asset class • Falls in LTVs provide a cushion to senior loan providers from falling property values • Security on underlying asset mitigates default risk Maturity Profile 5-10 years (varies) Liquid Alternative Sterling ABS Expected Spread / Rate 225-350bps for Senior Loans Approx. Premium over Liquid Alternative 75-200bps Sponsor (Property Owner) Lender Commercial Property Tenants The lender has a lien on the underlying property Principal + Interest Loan Advance
    • Private & Confidential Redington Ltd 29 August 2013 Direct Mid-Market Lending 26 Maturity Profile 24 – 72 Months Liquid Alternative BB/B Non-Distressed US High Yield Expected Spread / Rate 650bps prior to defaults, 450bps after defaults Approx. Premium over Liquid Alternative 250bps prior to defaults What is it? • Refers to asset managers taking the place of banks in directly originating loans to primarily mid-market borrowers • Asset managers are not subject to the same capital requirements as banks and can hence lend money at more competitive levels • Varying degrees of subordination can be targeted Why is it interesting? • Secured lending • Attractive spreads available relative to other illiquid opportunities • Direct origination allows greater capture of loan economics, as well as opportunity to tailor deals to suit requirements (e.g. prepayment protection) Corporate (borrower) Corporate (borrower) Bank Asset Manager Bank Asset Manager Bank Asset Manager Bank Typical syndication structure: Typical direct lending structure: Loan made Loan syndicated Loan made Certain loans part-syndicated
    • Private & Confidential Redington Ltd 29 August 2013 Redington Has Seen Substantial Client Demand For Manager Searches in Illiquid Credit 27 570 1,520 1,765 260 Liquid Non-Credit Liquid Credit Illiquid Credit Illiquid Non-Credit Assets Allocated (ex-LDI), Jan 2012-Jun 2013, (£m) 0 2 4 6 8 10 12 Number of Searches Conducted, Jan 2012-Jun 2013 Asset Class Search Breakdown LDI Pooled LDI, Segregated LDI, Segregated LDI within a multi-manager structure Liquid Non-Credit Diversified Growth Funds, CTA/Managed Futures, Risk Parity, Emerging Market Equity, Equity Income Liquid Credit ABS, Investment Grade Credit, Secured Loans, Absolute Return Bond Funds Illiquid Credit CRE Debt, Distressed Debt, Infrastructure Debt, Secured Leases, Direct Mid-Market Lending Illiquid Non-Credit Hedge Funds, Insurance-Linked Securities Searches Conducted: Jan 2012-Jun 2013 • Since January 2012, Redington’s Manager Research Team has conducted more searches for a higher value of assets in illiquid credit than in any other asset class (for a full breakdown, see the table below). • Over the past six months we have conducted six manager searches in illiquid credit for a combined value of assets of c. £1.2bn.
    • Private & Confidential Redington Ltd 29 August 2013 13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.ukContacts Dawid Konotey-Ahulu Co-Founder & Co-CEO Direct Line: 020 3326 7101 dawid@redington.co.uk 28 Pete Drewienkiewicz Head of Manager Research Direct Line: 020 3326 7138 pete.drewienkiewicz@redington.co.uk Disclaimer 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 message 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 . Please note, the accurate calculation of the liability profile used as the basis for implementing any capital markets transactions is the sole responsibility of the Trustees' actuarial advisors. Redington Ltd will estimate the liabilities if required but will not be held responsible for any loss or damage howsoever sustained as a result of inaccuracies in that estimation. Additionally, the client recognizes that Redington Ltd does not owe any party a duty of care in this respect. Redington Ltd are investment consultants regulated by the Financial Conduct Authority. We do 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. ©Redington Limited 2013. All rights reserved. No reproduction, copy, transmission or translation in whole or in part of this presentation may be made without permission. Application for permission should be made to Redington Limited at the address below. Redington Limited (6660006) is registered in England and Wales. Registered office: 13-15 Mallow Street London EC1Y 8RD Dan Mikulskis Co-Head of ALM & Investment Strategy Direct Line: 020 3326 7129 dan.mikulskis@redington.co.uk