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Please see important disclosures at the end of this document.
Deutsche Bank Pension Strategies & Solutions is a part of Global Markets Institutional Client Group.
This material was prepared by a Sales and Trading function within Deutsche Bank AG or one of its
affiliates (collectively “ Deutsche Bank”). This material is not a research report and was not prepared or
reviewed by the Deutsche Bank Research Department.
Asset Owner Survey
Second-half 2010 Institutional Survey
November 2010
Summary
Asset shifts: USEquitiesout; EM, alternatives and debt in
We surveyed 103 institutional investors with assets under management of
$1.2tn. Our results indicate a continued desire to reduce USequity
exposure and increase exposure to emerging markets (equity and debt),
alternatives, and long-dated corporate debt going forward.
Hedge funds: Special Situations, L/ Sequity and macro most desired
Hedge funds are one of the most popular areas for upcoming investment,
particularly among public and corporate defined benefit plans. Special
situations, L/ Sequity, and macro funds are the most sought-after in the
coming year.
LDI: Smaller plansshow most interest, significant rate increase still
needed
Our results show a continued desire to reduce surplus volatility. However,
the majority of plan sponsors believe LDI makes sense only with rates
increases of >200bp. This, coupled with a historically-low average funded
status may mean that true LDI will take time. In our current environment,
plan sponsors can use the options market to express their LDI conviction
and earn a premium in the process.
Tail risk hedging: Greater awarenessof risksand risk management
The results of our survey show a greater awareness of risks and risk
management: only 35% of the respondents will not look at tail risk. Equities
appear to be at the forefront for investors in the future, with 55% indicating
equity tail risk hedging focus.
Pension Strategies & Solutions
John Haugh, CFA
212-250-8970
john.haugh@db.com
Ken Akoundi, PhD
212-250-5437
ken.akoundi@db.com
Deutsche Bank Pension Strategies
& Solutions – a dedicated team in
the Global Markets Institutional
Client Group – serves as a single
point of contact for the
institutional community, servicing
public and private pensions,
endowments, and foundations.
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Asset Owner Survey
November 2010 2
Respondents
The Deutsche Bank Pension Strategies & Solutions Group has conducted this survey in order to report
the investment considerations, trends, and thoughts of asset owners in the U.S. pension, endowment,
and foundation community. Starting in mid-September, we surveyed chief investment officers and other
senior investment officers at these institutions in order to take the pulse of the market and gain insight
into the decisions that will drive pension, endowment, and foundation investing in the end of 2010 and
through 2011.
We received responses from 103 asset owners with total reported assets of over $1.2 trillion at 30
September 2010, distributed across the institutional investor universe:
Institutional Market
In Table 1 below, we present the estimated average asset allocation (as of 9/ 30/ 2010) for the investor
types we surveyed. In total, we estimate that these investors manage about $6 trillion.
Public DB Plans Corporate DB Plans Endowments & Foundations
Equity
Domestic 29.8% 23.3% 32.6%
International 20.9% 18.2% 16.0%
Total Equity 50.7% 41.5% 48.6%
Fixed Income
Domestic 24.9% 38.1% 18.5%
International 1.3% 1.3% 0.9%
Total Fixed Income 26.2% 39.4% 19.4%
Alternative Investments
Private Equity 7.7% 6.6% 6.9%
Real Estate Equity 6.8% 3.9% 4.2%
Hedge Funds 4.2% 2.7% 11.4%
Other 2.8% 3.8% 2.8%
Total Alternative 21.5% 17.0% 25.3%
Cash 1.6% 2.1% 6.7%
Total 100.0% 100.0% 100.0%
Total assets ($bn)
$2,755 $2,212 $1,102
Chart 1: Respondents by institution type
Source: Deutsche Bank 2H2010 Institutional Survey
Chart 2: Respondents by AUM (count)
Source: Deutsche Bank 2H2010 Institutional Survey
Table 1: Average US institutional asset class constituent characteristics (as of 9/ 30/ 2010)
Source: P&I, Nacubo, Commonfund, Cambridge Associates, S&P Money Market
15%
19%
21%
36%
9%
<200mm (15%)
200mm-500mm (19%)
500mm-1bn (21%)
1bn-10bn (36%)
10bn+ (9%)
39%
27%
17%
12%
5%
Corporate Pension (39%)
Public Pension (27%)
Endowment (17%)
Foundation (12%)
Other (5%)
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Asset Owner Survey
November 2010 3
Chart 3: Corporate Pension Funded Status
Source: Company 10K data, Bloomberg, DB estimates
Funded status continues to be a
foremost concern for both
corporate and public pension
plans. We calculate aggregate US
corporate funded status to be
74% at 9/ 30/ 2010 (Chart 3).
Pension funded status levels are
lower than any seen in recent
memory and will no doubt
increasingly drag on corporate
earnings and cashflows for the
foreseeable future. We will most
likely see increased involvement
from corporate finance
departments as they wrestle with funding and its effects on the overall corporate structure.
Public pensions have had their own
struggles and state/ pension woes
have been recently well
documented in the press. Please
find aggregate funding levels in
Chart 4 at left. We estimate
aggregate public pension funded
status to currently be 65%
1
.
With pressure on funded status, plans are paying special attention to investment returns, asset
allocation, liability-driven investing (LDI), and protection from downside tail risk. Our survey of
institutional asset owners addressed each of these topics, the results of which are now discussed in the
Survey Results section. From here, we marshal our survey results into: 1) Asset Allocation, 2) Liability
Driven Investing (LDI) and 3) Tail Risk Hedging.
1
Public and private funding levels are not apples-to-apples. Our corporate figures are marked-to-market using
asset fair value and a market-based discounting function for liabilities (approximated long-dated AA yield). The
public figures are based on smoothed asset values and a liability discounting function based on a static expected
return on plan assets (on average, public plans use approximately 8% expected return to discount liabilities).
65%
75%
85%
95%
105%
115%
125%
(600)
(500)
(400)
(300)
(200)
(100)
0
100
200
300
97 98 99 00 01 02 03 04 05 06 07 08 09 10E
YTD
Funded Status (Assets - Liabilities) (left axis $bn)
Aggregate Funded Status % (right axis)
79
82
85 86
89
96
102
98
92
89
87 86 86 85
72
65
60
70
80
90
100
110
90 92 94 96 98 00 01 02 03 04 05 06 07 08 09 10(E)
Fiscal Year End
Chart 4: Public Funded Levels
Source: Public Fund Survey, Bloomberg, DB Estimates
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Asset Owner Survey
November 2010 4
Survey results
Anticipated Asset Allocation Shift
The survey results confirm anecdotal evidence of continuing asset owner migration away from U.S.
equities into other asset classes. 44% of survey respondents would like to decrease USlarge Cap
Equities, and 38% would like to decrease USsmall Cap Equities (Chart 5). Distantly following these two
are international developed equities, UStreasury bonds (<10 years), and cash at 18% a piece.
The desire to expand globally is evident from a strong respondent intention to move to EM equities and
EM debt. Hedge funds also appear to be a clear winner in this continued shift away from long-only US
equity mandates (more on this later). In addition, adding alternative asset classes such as private equity,
commodities, real estate and natural resources appear to be on the minds of institutional investors.
Please see our LDI section for more on Investment Grade Corporate Bonds >10yr.
Please see the Appendix for investor-type specific subsets of the chart above.
Further, comparative analysis was performed on public DB plan sponsors and corporate DB plans with
keen interest in the similarities and differences in desired asset allocation shifts over the next 12
months. Interestingly, public plan response is more uniform in its conviction to increase allocation to
many different asset classes (HF, Commodities, EM debt, infrastructure, etc.), and also in its shared
uncertainty regarding the asset classes from which these allocations would be removed. On the
corporate DB side, only long-duration IG bonds garnered a unanimous vote of “increase” confidence.
Similarities between public and corporate include:
Decrease: USsmall cap and large cap equities
Increase: Hedge funds, emerging equities and debt, IG corp >10 years
Chart 5: Anticipated Allocation Changes for next 12 months
46%
41%
26% 26% 26% 25%
22%
20%
16%
15% 15% 14%
12%
10% 9% 9% 8% 8% 7% 6%
5% 4% 4%
7%
8%
3%
9%
2%
5%
1%
13%
9%
3%
9%
18%
14%
1%
5%
1% 1%
7%
18% 18%
1%
38%
44%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Increase
Decrease
Source: Deutsche Bank 2H2010 Institutional Survey
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Emerging Markets is a clear winner. Chart 7
provides insight into which regions are
expecting increased allocation. Investors are
overwhelmingly looking to Asia and Latin
America for growth.
The majority of growth in hedge fund assets
will NOT only be limited to public DB plans’
allocation, but equally from corporate DB
plans.
57%
23%
11%
7%
2% 2% 1%
0%
10%
20%
30%
40%
50%
60%
Asia Latin
America
US Eastern
Europe
Western
Europe
Canada Other EM
Chart 6: Anticipated Allocation Changes: Public DB vs Corporate DB
Chart 7: Region expected to show best growth/ value (5yrs)
Source: Deutsche Bank 2H2010 Institutional Survey
Source: Deutsche Bank 2H2010 Institutional Survey
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Chart 8: Anticipated HF Allocation Shift (next 12 months)
Source: Deutsche Bank 2H2010 Institutional Survey
Anticipated Hedge Fund Allocation Shift (next 12 months)
To look further into anticipated hedge fund allocation shift, we particularly notice a telling trend in
Fund-of-Fund allocations. We see
a relatively strong conviction to
decrease Fund-of-Fund investment
while others are intending to
increase Fund-of-Fund investment.
This shows that there are investors
who have been invested in
alternatives via Fund-of-Funds
who have become more
sophisticated and are now looking
to move to direct hedge fund
investment. At the same time,
there are investors new to the hedge fund space who are looking to “dip their toe” into hedge fund
investing via a Fund-of-Fund allocation (please see Chart 9 below for more granular data on this). In
sum, the market in general is, as a whole, taking a step forward in hedge fund investment involvement.
Among the most popular strategies, Macro, L/ S Equity, Special Situations, and Distressed funds are in
favor, while arb funds (Vol, Merger, Fixed, or Convert) are less popular. The structural differences
between public DB allocations and corporate DB allocations to hedge fund strategies are shown side by
side here:
3%
3%
3%
3%
6%
6%
6%
10%
10%
13%
13%
16%
16%
17%
26%
3%
3%
3%
3%
6%
3%
3%
6%
3%
6%
3%
6%
3%
3%
0%
0% 5% 10% 15% 20% 25% 30%
Short Sellers
Fixed Arb
CTA, Other
HFReplication
RV M ulti-strat
Convert Arb
M erger Arb
Equity: M arket Neutral
Volatility Arb
Fund of Funds
Special Situations
Distressed
Credit L/ S
M acro
L/ SEquity
HF Allocation Changes for next 12mo - Corporates
11%
11%
16%
5%
16%
5%
11%
16%
11%
28%
17%
22%
21%
21%
21%
0%
0%
0%
5%
0%
0%
0%
0%
0%
6%
0%
0%
0%
0%
5%
0%
5%
10%
15%
20%
25%
30%
HF Allocation Changes for next 12mo -
Publics
Decrease
Increase
Chart 9: Hedge Fund Allocation Changes for the next 12 months – Public DB vs Corporate DB
23% 23% 23%
22%
21%
15%
13%
11%
10%
9%
8%
6%
5%
4% 4%
6%
3%
6% 6%
5%
12%
5% 5%
3%
5% 5%
4% 4% 4% 4%
0%
5%
10%
15%
20%
25%
Increase
Decrease
Source: Deutsche Bank 2H2010 Institutional Survey
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Liability Driven Investing (LDI)
The desire to hedge surplus-volatility
appears to have gained solid footing here
in the US among corporate pension plan
sponsors. From an overall equity-
reduction standpoint, we clearly see plan
sponsors continuing to sell equities and
buy bonds. This is shown best in the most
recent Federal Flow of Funds data in Chart
10 at right. In fact, according to the Flow
of Funds, corporate defined benefit plan
sponsors have sold a net $882bn in
equities and bought a net $489bn in
fixed income since 2003
2
.
But what about the future of LDI?
In order to gain insight into what is currently weighing on the minds of corporate plan sponsors, we
asked if, how, and when they plan to adopt LDI strategies. In Chart 11 below, we show long-duration
fixed income shifts for corporate pension plans with assets >$1bn as well as those for corporate plans
with <$1bn assets. We see that the intention to add long-dated corporate debt is strong (~36% will look
to add, 0% to decrease), but that long-dated Treasuries and interest rate swaps see mixed results for
larger plans (24% plan to add treasuries >10yr, 16% intend to decrease). This desire for corporate debt is
ultimately driven by both yield enhancement and regulatory concerns as liabilities are discounted by
“credit-like” discount rates. For plan sponsors with assets <$1bn we see that approximately 64% want to
add long-dated corporate bonds (0%
decrease) and 36% want to add long-dated
Treasuries (9% decrease). These are the two
most prominent areas of interest for this
investor type (corporate plans <$1bn), clearly
showing a significant paradigm shift among
smaller plan sponsors toward LDI mandates.
This is unsurprising as many of the larger
corporate plan sponsors have embraced an
LDI approach, and we are seeing the smaller
plan sponsors (which tend to move a bit more
slowly than their larger counterparts) now
following suit by starting to shift assets away
from equities in a more meaningful way.
Further, our results show 50% of corporate
2
To be clear, not all of the flow into fixed income should be attributed to liability-driven trading. While we do
believe that a good portion of this flow was indeed LDI-related, we also believe that some of the flow can be
attributed to an unrelated increase in fixed income investment. Remember that a fundamental reason to include
fixed income in a portfolio is to provide a liquidity cushion in times of market stress. We believe that this
consideration has also weighed on the minds of corporate pension plan sponsors and have no doubt that it has
contributed to this $489bn figure.
Chart 10: Corporate Defined Benefit Bond and Equity Flows($bn)
-200
-150
-100
-50
0
50
100
150
85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10*
Bond flows ($bn)
Equity flows ($bn)
Source: aggregated from Federal Reserve Flow of Funds Report;
2010 figures are annualized
Source: Deutsche Bank 2H2010 Institutional Survey
Chart 11: Long-duration bond allocation shifts – Corporates by size
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Asset Owner Survey
November 2010 8
67%
42%
22% 19% 17% 14%
6% 3% 0%
0%
10%
20%
30%
40%
50%
60%
70%
plan sponsors already implementing some form of LDI within their portfolio (Chart 12), which is a large
jump from what we have seen previously.
25% of our survey participants are considering
starting the LDI process by first extending their
fixed income duration. This is the first step in the
LDI process and involves extending the duration of
the fixed income portfolio from approximately 5
years to a duration that is typically 10+ years –
from an allocation that would be benchmarked to a
broad market index (Barclays Aggregate) to a
longer-dated index (Barclays Long
Government/ Credit). This desire to extend fixed
income duration may also manifest itself (at least in
the current environment) as an increased
weighting to longer-duration investment grade
corporate bonds.
Interest rate levelsand funded status: the major impediments
With average S&P 500 funded status in the low
70’s (see Chart 3), it is not surprising that 42% of
respondents view low funded status as a major
impediment to implementing LDI. Simply put,
many plan sponsors believe that matching assets
to liabilities at this time would lock-in a currently-
poor funded status.
Further, from Chart 14 at left, we see that we are
unlikely to experience significant LDI implementation
while funded status levels remain below 85%.
Most plan sponsors agree, however, that the major impediment to LDI implementation is the current
historically-low rate environment (67% name this as an impediment, see Chart 13). This market
conviction then begs another question: how much do rates have to rise in order for LDI to make sense?
Chart 12: Do you plan to adopt an LDI framework, and
how will you implement?
Chart 13: What are the current impedimentsto adopting
an LDI framework?
Chart 14: Funded Statusat which LDI makes sense
50%
25%
17% 17%
14%
8%
6%
3% 3%
0%
10%
20%
30%
40%
50%
60%
Source: Deutsche Bank 2H2010 Institutional Survey
Source: Deutsche Bank 2H2010 Institutional Survey
3%
24%
27%
9%
3%
33%
<80% (3%)
80-90%(24%)
90-100%(27%)
100-110%(9%)
>110%(3%)
Any Funded Status (33%)
Source: Deutsche Bank 2H2010 Institutional Survey
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We don’t believe this question has been answered in the past, but in Chart 15 below it can be clearly
seen that the majority of plan sponsors answered that rates would have to rise more than 200bp
3
(61%
indicated this).
Pick up premium until rate levelsare where you want them to be
All else unchanged, a 200bp rise in rates would bring the average S&P plan sponsor’s funded status from
its current level of 74% to nearly fully funded
4
, well within the funded status range in which most would
consider LDI implementation unimpeded by funded status. But when do rates get to that point? The
most recent median economist-forecast 30-year yield estimate published by Bloomberg does not expect
the 30-year swap yield to touch 4.75% until 2Q 2012 (see Chart 16). In other words, if correct, this
median forecast portends low rates for the foreseeable future
5
.
# in
survey 39 39 39 38 38 28 26
Source: Bloomberg News Monthly Survey of Economists, 2010
3
When we asked this question, we stated to assume that the 30-year Treasury is at a 4% yield.
4
We simply duration adjusted the liabilities and assumed they were at 12 years.
5
As we have previously asserted in the past, the track record for economist forecasts is poor at best, so take this
with a grain of salt.
Chart 15: Rates increase at which LDI makes sense
Chart 16: 30-year Treasury Rates Forecast
Source: Deutsche Bank 2H2010 Institutional Survey
3%
8%
18%
11%
61%
0-50 bp (3%)
50-100 bp (8%)
100-150 bp (18%)
150-200 bp (11%)
>200 bp (61%)
4.98
5.13 5.21
5.30
5.50
6.00
6.50
3.70
3.80
3.90
4.13
4.32
4.58
4.75
3.00 3.00
3.25
3.50 3.58 3.60
3.50
2.50
3.00
3.50
4.00
4.50
5.00
5.50
6.00
6.50
4Q 10 1Q 11 2Q 11 3Q 11 4Q 11 1Q 12 2Q 12
High Forecast Median Forecast Low Forecast
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Asset Owner Survey
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Source: Deutsche Bank Rates Structuring
Sell payersto pick up premium
So assuming you believe economist forecast, does this mean that a plan sponsor waits idly until rates
move to more desirable levels? We believe that the answer is “no.”
Consider a plan sponsor that is committed to LDI but will not implement in the current rate environment
and also believes that the rate environment will not sufficiently change in the near future. This plan
sponsor could straightforwardly
6
determine the rate level at which they would implement LDI with
conviction (in doing so they should consider a number of factors, including the projected plan funded
status at that rate level), as well as the time horizon at which they believe that rate level will be realized.
Once this target rate and time horizon are determined, the plan can capitalize on this conviction by
selling 30-year out-of-the-money (OTM) payer swaptions. Effectively, this trade would enter the plan
into an interest rate swap at the plan’s target level, given that rates indeed reach that level in the
expected time horizon (at expiry). In addition, the plan would earn an immediate premium for the sale
of the option. This yield pickup particularly makes sense in this low asset-return environment.
Ultimately, this trade expresses LDI conviction and earns a premium in the process.
In the matrix below, we present some of the swaption premium figures at different tenors and strikes at
the time of this writing
7
.
% OTM 1.00% 2.00% 3.00%
Strike (forward 30-year swap rate):
3y 5.00% 6.00% 7.00%
5y 5.19% 6.19% 7.19%
7y 5.25% 6.25% 7.25%
Premium:
3y 4.60% 2.00% 0.90%
5y 6.00% 3.20% 1.80%
7y 7.00% 4.10% 2.60%
For example, with 30-year spot swap rates currently around 3.5%, a plan sponsor can sell a 30-year
payer swaption struck 2.0% OTM (at 6.19%) expiring in 5 years and earn an immediate 3.2% premium. If
in 5 years (at expiry) the then-spot 30-year swap rate is at least 6.19%, the plan sponsor would be
entered into a 30-year swap at this level (the plan would be receiving fixed at 6.19%). This scenario
reflects an over-200bp rise in rates and in this case (all else unchanged), the majority of plan sponsors
would have achieved healthy funding levels.
In the event that the 30-year swap rate has not reached the strike of 6.19% at expiry, then the swaption
expires worthless, the plan is under no obligation to enter into a swap, and has collected a premium for
the trade upfront.
6
Based on a select number of assumptions.
7
Special thanks to Steve Blasdell and the Deutsche Bank Rates Structuring team. Please note that these figures are
for indicative purposes only. For live tradable levels, please contact DB Pension Strategies & Solutions.
Table 2: Indicative levels: 30-year swaptions
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Source: Deutsche Bank 2H2010 Institutional Survey
Source: Deutsche Bank 2H2010 Institutional Survey
What are the risks?
In making a decision to enter into a trade like this, plan sponsors should consider a number of factors,
including:
1. Swap basis to corporate discount rates. There is a risk that swap rates do not move in the same
direction as discount rates
8
. This is particularly relevant if swap rates rise above corporate rates.
We checked the long-end of the Citigroup Pension Liability Index, and we have not seen this
happen in available index history (data starts in beginning of 1995). At least historically, this
appears to be ‘right-way risk’ for pension plan sponsors.
2. Rates experience a significant increase. If rates increase significantly, a plan sponsor will not
capture the gains above the strike. However, we believe that most plan sponsors would be
comfortable with this loss of this potential upside, as funded status has an asymmetrical pay-off
(i.e., a plan sponsor cannot extract excess money from the plan).
Tail Risk
The recent turmoil has brought to the
forefront the issue of risk management, as
can be gleaned from the fact that only 37%
of survey respondents are uninterested in
or restricted from the concept (Chart 17 at
right).
As could be expected, over half (55%) of
those concerned with the downside risk are
focused specifically on equity assets. This is
particularly unsurprising in context of the
fact that at least 44% of investors
expressed intention to decrease equity exposure (Chart 5).
These findings confirm our own experience, and that
which we presented in our May 2010 Tail Risk Hedging
paper
9
, that asset owners continue to be keenly
interested in downside protection.
8
For example, during the 2008-2009 crisis when corporate bond rates increased, the corresponding swap rate
decreased
9
Tail Risk Hedging: A Roadmap for Asset Owners by Deutsche Bank Pension Strategies & Solutions, M ay 2010
Chart 17: Investor plansto hedge tail risk
Chart 18: Tail Risk Hedging: Assets of Focus
18%
35%
37%
2%
8%
Yes (18%)
No (35%)
Undecided (37%)
The fund is restricted from
doing so (2%)
Need further information
(8%)
55%
28%
8% 6% 3%
0%
10%
20%
30%
40%
50%
60%
Equities Whole
Portfolio
Bonds Other Alternatives
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Chart 19: What instruments will you use to hedge tail risk?
Source: Deutsche Bank 2H2010 Institutional Survey
It is also worth noting that 28% of respondents communicated concern for the “whole portfolio” as
opposed to equities alone. There are a number of plausible explanations for this broad unease,
including:
Increasing awareness of managing assets and liabilities in this low interest rate
environment.
Concern for a “black swan” event. Perhaps hidden behind the “whole portfolio” label is
recognition that the source of the next crisis will be difficult to foresee and that its effects
would likely not be isolated to a single asset class.
To this end, we are encouraged to see that as many as 17% of respondents recognized the importance
of “macro” hedging via volatility strategies (such as those described in our tail risk paper) and managed
futures. We also recognize that most of the appropriate risk-reducing strategies will usually be asset-
specific– such as equity option strategies, which were selected by 17% of respondents as the product
they would most likely employ to reduce risk.
17%
13% 12%
9% 8% 8% 6% 5% 4% 4%
1%
0%
5%
10%
15%
20%
Equity option
strategies
IRoptions Credit
strategies
Commodities M anaged
futures
Other Treasuries Inflation
options
Variance
Swaps
Tail risk
protection
indices
Longevity
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Source: Deutsche Bank 2H2010 Institutional Survey
Source: Deutsche Bank 2H2010 Institutional Survey
Source: Deutsche Bank 2H2010 Institutional Survey
Appendix
50% 50%
40%
38% 38% 38%
31%
25% 25%
19% 19% 19%
13%
6% 6% 6% 6% 6%
0% 0% 0% 0% 0%
0%
6% 7%
0% 0% 0% 0% 0%
6%
0%
6%
13%
0% 0% 0% 0%
6%
19%
0%
6%
13%
50%
56%
0%
10%
20%
30%
40%
50%
60%
Increase
Decrease
Chart 20: Anticipated Allocation Changes for next 12 months – Corporate DB >1bn
Chart 21: Anticipated Allocation Changes for next 12 months – Public DB >1bn
Chart 22: Anticipated Allocation Changes for next 12 months – E& F >500mm
42%
40%
36%
32%
28%
24% 24%
20%
16% 16% 16%
13% 12% 12%
8% 8%
4% 4% 4% 4% 4% 4%
0%
8%
12%
0%
8%
24%
8%
16%
8%
4% 4%
8%
0%
4% 4% 4%
16%
0%
4%
12%
28%
48%
56%
4%
0%
10%
20%
30%
40%
50%
60%
Increase
Decrease
78%
50%
33% 33% 33% 33%
22% 22% 22%
13% 11% 11% 11% 11% 11%
0% 0% 0% 0% 0% 0% 0% 0%
0% 0% 0% 0% 0%
22%
0%
11% 11%
13%
0% 0%
22%
44%
67%
0% 0%
11% 11%
22% 22% 22%
33%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Increase
Decrease
SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
Asset Owner Survey
November 2010 14
Disclaimer
This material was prepared by a Sales or Trading function within Deutsche Bank AG or one of its affiliates
(collectively “Deutsche Bank”). This material is not a research report and was not prepared or reviewed by the
Deutsche Bank Research Department, and the views expressed herein may differ from those of the Research
Department. Sales and Trading functions are subject to additional potential conflicts of interest which the Research
Department does not face, so this material should not necessarily be considered objective or unbiased. Sales and
Trading personnel are compensated in part based on the volume of transactions effected by them.
The information herein is believed to be reliable and has been obtained from sources believed to be reliable, but
we make no representation or warranty, express or implied, with respect to the fairness, correctness, accuracy,
reasonableness or completeness of such information. In addition we have no obligation to update, modify or
amend this communication or to otherwise notify a recipient in the event that any matter stated herein, or any
opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. We are
not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. We therefore strongly
suggest that recipients seek their own independent advice in relation to any investment, financial, legal, tax,
accounting or regulatory issues discussed herein. Analyses and opinions contained herein may be based on
assumptions that if altered can change the analyses or opinions expressed. Nothing contained herein shall
constitute any representation or warranty as to future performance of any financial instrument, credit, currency
rate or other market or economic measure. Furthermore, past performance is not necessarily indicative of future
results. Deutsche Bank may engage in transactions in a manner inconsistent with the views discussed herein.
Deutsche Bank trades or may trade as principal in the instruments (or related derivatives), and may have
proprietary positions in the instruments (or related derivatives) discussed herein, and these may be known to the
author. Deutsche Bank may make a market in the instruments (or related derivatives) discussed herein.
This communication is provided for information purposes only. It is not an offer to sell, or a solicitation of an
offer to buy, any security, nor to enter into any agreement or contract with Deutsche Bank or any affiliates. Any
offering or potential transaction that may be related to the subject matter of this communication will be made
pursuant to separate and distinct documentation and in such case the information contained herein will be
superseded in its entirety by such documentation in final form.
Securities and investment banking activities in the United States are performed by Deutsche Bank Securities Inc.,
member NYSE, FINRA and SIPC, and its broker-dealer affiliates. Lending and other commercial banking activities in
the United States are performed by Deutsche Bank AG, and its banking affiliates. This communication and the
information contained herein is confidential and may not be reproduced or distributed in whole or in part without
our prior written consent.
The trading and investment ideas described in this document are not appropriate for everyone, so you should
make your own informed investment decision based on your financial circumstances, investment objectives and
risk tolerance. Before entering into any transaction you should take steps to ensure that you understand and have
made an independent assessment of the appropriateness of the transaction in light of your own objectives and
circumstances, including the possible risks and benefits of entering into such transaction. You should also consider
making such independent investigations as you consider necessary or appropriate for such purpose.
Deutsche Bank AG, including its subsidiaries and affiliates, does not provide legal, tax or accounting advice. This
material is not intended or written to be used, and cannot be relied upon, by any taxpayer for the purposes of
avoiding any U.S. federal tax penalties. The recipient of this communication should seek advice from an
independent tax advisor regarding any tax matters addressed herein based on its particular circumstances.
© 2010 Deutsche Bank AG.
SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e

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Asset Owner Survey Second-Half 2010 Institutional Survey

  • 1. Please see important disclosures at the end of this document. Deutsche Bank Pension Strategies & Solutions is a part of Global Markets Institutional Client Group. This material was prepared by a Sales and Trading function within Deutsche Bank AG or one of its affiliates (collectively “ Deutsche Bank”). This material is not a research report and was not prepared or reviewed by the Deutsche Bank Research Department. Asset Owner Survey Second-half 2010 Institutional Survey November 2010 Summary Asset shifts: USEquitiesout; EM, alternatives and debt in We surveyed 103 institutional investors with assets under management of $1.2tn. Our results indicate a continued desire to reduce USequity exposure and increase exposure to emerging markets (equity and debt), alternatives, and long-dated corporate debt going forward. Hedge funds: Special Situations, L/ Sequity and macro most desired Hedge funds are one of the most popular areas for upcoming investment, particularly among public and corporate defined benefit plans. Special situations, L/ Sequity, and macro funds are the most sought-after in the coming year. LDI: Smaller plansshow most interest, significant rate increase still needed Our results show a continued desire to reduce surplus volatility. However, the majority of plan sponsors believe LDI makes sense only with rates increases of >200bp. This, coupled with a historically-low average funded status may mean that true LDI will take time. In our current environment, plan sponsors can use the options market to express their LDI conviction and earn a premium in the process. Tail risk hedging: Greater awarenessof risksand risk management The results of our survey show a greater awareness of risks and risk management: only 35% of the respondents will not look at tail risk. Equities appear to be at the forefront for investors in the future, with 55% indicating equity tail risk hedging focus. Pension Strategies & Solutions John Haugh, CFA 212-250-8970 john.haugh@db.com Ken Akoundi, PhD 212-250-5437 ken.akoundi@db.com Deutsche Bank Pension Strategies & Solutions – a dedicated team in the Global Markets Institutional Client Group – serves as a single point of contact for the institutional community, servicing public and private pensions, endowments, and foundations. SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 2. Asset Owner Survey November 2010 2 Respondents The Deutsche Bank Pension Strategies & Solutions Group has conducted this survey in order to report the investment considerations, trends, and thoughts of asset owners in the U.S. pension, endowment, and foundation community. Starting in mid-September, we surveyed chief investment officers and other senior investment officers at these institutions in order to take the pulse of the market and gain insight into the decisions that will drive pension, endowment, and foundation investing in the end of 2010 and through 2011. We received responses from 103 asset owners with total reported assets of over $1.2 trillion at 30 September 2010, distributed across the institutional investor universe: Institutional Market In Table 1 below, we present the estimated average asset allocation (as of 9/ 30/ 2010) for the investor types we surveyed. In total, we estimate that these investors manage about $6 trillion. Public DB Plans Corporate DB Plans Endowments & Foundations Equity Domestic 29.8% 23.3% 32.6% International 20.9% 18.2% 16.0% Total Equity 50.7% 41.5% 48.6% Fixed Income Domestic 24.9% 38.1% 18.5% International 1.3% 1.3% 0.9% Total Fixed Income 26.2% 39.4% 19.4% Alternative Investments Private Equity 7.7% 6.6% 6.9% Real Estate Equity 6.8% 3.9% 4.2% Hedge Funds 4.2% 2.7% 11.4% Other 2.8% 3.8% 2.8% Total Alternative 21.5% 17.0% 25.3% Cash 1.6% 2.1% 6.7% Total 100.0% 100.0% 100.0% Total assets ($bn) $2,755 $2,212 $1,102 Chart 1: Respondents by institution type Source: Deutsche Bank 2H2010 Institutional Survey Chart 2: Respondents by AUM (count) Source: Deutsche Bank 2H2010 Institutional Survey Table 1: Average US institutional asset class constituent characteristics (as of 9/ 30/ 2010) Source: P&I, Nacubo, Commonfund, Cambridge Associates, S&P Money Market 15% 19% 21% 36% 9% <200mm (15%) 200mm-500mm (19%) 500mm-1bn (21%) 1bn-10bn (36%) 10bn+ (9%) 39% 27% 17% 12% 5% Corporate Pension (39%) Public Pension (27%) Endowment (17%) Foundation (12%) Other (5%) SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 3. Asset Owner Survey November 2010 3 Chart 3: Corporate Pension Funded Status Source: Company 10K data, Bloomberg, DB estimates Funded status continues to be a foremost concern for both corporate and public pension plans. We calculate aggregate US corporate funded status to be 74% at 9/ 30/ 2010 (Chart 3). Pension funded status levels are lower than any seen in recent memory and will no doubt increasingly drag on corporate earnings and cashflows for the foreseeable future. We will most likely see increased involvement from corporate finance departments as they wrestle with funding and its effects on the overall corporate structure. Public pensions have had their own struggles and state/ pension woes have been recently well documented in the press. Please find aggregate funding levels in Chart 4 at left. We estimate aggregate public pension funded status to currently be 65% 1 . With pressure on funded status, plans are paying special attention to investment returns, asset allocation, liability-driven investing (LDI), and protection from downside tail risk. Our survey of institutional asset owners addressed each of these topics, the results of which are now discussed in the Survey Results section. From here, we marshal our survey results into: 1) Asset Allocation, 2) Liability Driven Investing (LDI) and 3) Tail Risk Hedging. 1 Public and private funding levels are not apples-to-apples. Our corporate figures are marked-to-market using asset fair value and a market-based discounting function for liabilities (approximated long-dated AA yield). The public figures are based on smoothed asset values and a liability discounting function based on a static expected return on plan assets (on average, public plans use approximately 8% expected return to discount liabilities). 65% 75% 85% 95% 105% 115% 125% (600) (500) (400) (300) (200) (100) 0 100 200 300 97 98 99 00 01 02 03 04 05 06 07 08 09 10E YTD Funded Status (Assets - Liabilities) (left axis $bn) Aggregate Funded Status % (right axis) 79 82 85 86 89 96 102 98 92 89 87 86 86 85 72 65 60 70 80 90 100 110 90 92 94 96 98 00 01 02 03 04 05 06 07 08 09 10(E) Fiscal Year End Chart 4: Public Funded Levels Source: Public Fund Survey, Bloomberg, DB Estimates SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 4. Asset Owner Survey November 2010 4 Survey results Anticipated Asset Allocation Shift The survey results confirm anecdotal evidence of continuing asset owner migration away from U.S. equities into other asset classes. 44% of survey respondents would like to decrease USlarge Cap Equities, and 38% would like to decrease USsmall Cap Equities (Chart 5). Distantly following these two are international developed equities, UStreasury bonds (<10 years), and cash at 18% a piece. The desire to expand globally is evident from a strong respondent intention to move to EM equities and EM debt. Hedge funds also appear to be a clear winner in this continued shift away from long-only US equity mandates (more on this later). In addition, adding alternative asset classes such as private equity, commodities, real estate and natural resources appear to be on the minds of institutional investors. Please see our LDI section for more on Investment Grade Corporate Bonds >10yr. Please see the Appendix for investor-type specific subsets of the chart above. Further, comparative analysis was performed on public DB plan sponsors and corporate DB plans with keen interest in the similarities and differences in desired asset allocation shifts over the next 12 months. Interestingly, public plan response is more uniform in its conviction to increase allocation to many different asset classes (HF, Commodities, EM debt, infrastructure, etc.), and also in its shared uncertainty regarding the asset classes from which these allocations would be removed. On the corporate DB side, only long-duration IG bonds garnered a unanimous vote of “increase” confidence. Similarities between public and corporate include: Decrease: USsmall cap and large cap equities Increase: Hedge funds, emerging equities and debt, IG corp >10 years Chart 5: Anticipated Allocation Changes for next 12 months 46% 41% 26% 26% 26% 25% 22% 20% 16% 15% 15% 14% 12% 10% 9% 9% 8% 8% 7% 6% 5% 4% 4% 7% 8% 3% 9% 2% 5% 1% 13% 9% 3% 9% 18% 14% 1% 5% 1% 1% 7% 18% 18% 1% 38% 44% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50% Increase Decrease Source: Deutsche Bank 2H2010 Institutional Survey SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 5. Asset Owner Survey November 2010 5 Emerging Markets is a clear winner. Chart 7 provides insight into which regions are expecting increased allocation. Investors are overwhelmingly looking to Asia and Latin America for growth. The majority of growth in hedge fund assets will NOT only be limited to public DB plans’ allocation, but equally from corporate DB plans. 57% 23% 11% 7% 2% 2% 1% 0% 10% 20% 30% 40% 50% 60% Asia Latin America US Eastern Europe Western Europe Canada Other EM Chart 6: Anticipated Allocation Changes: Public DB vs Corporate DB Chart 7: Region expected to show best growth/ value (5yrs) Source: Deutsche Bank 2H2010 Institutional Survey Source: Deutsche Bank 2H2010 Institutional Survey SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 6. Asset Owner Survey November 2010 6 Chart 8: Anticipated HF Allocation Shift (next 12 months) Source: Deutsche Bank 2H2010 Institutional Survey Anticipated Hedge Fund Allocation Shift (next 12 months) To look further into anticipated hedge fund allocation shift, we particularly notice a telling trend in Fund-of-Fund allocations. We see a relatively strong conviction to decrease Fund-of-Fund investment while others are intending to increase Fund-of-Fund investment. This shows that there are investors who have been invested in alternatives via Fund-of-Funds who have become more sophisticated and are now looking to move to direct hedge fund investment. At the same time, there are investors new to the hedge fund space who are looking to “dip their toe” into hedge fund investing via a Fund-of-Fund allocation (please see Chart 9 below for more granular data on this). In sum, the market in general is, as a whole, taking a step forward in hedge fund investment involvement. Among the most popular strategies, Macro, L/ S Equity, Special Situations, and Distressed funds are in favor, while arb funds (Vol, Merger, Fixed, or Convert) are less popular. The structural differences between public DB allocations and corporate DB allocations to hedge fund strategies are shown side by side here: 3% 3% 3% 3% 6% 6% 6% 10% 10% 13% 13% 16% 16% 17% 26% 3% 3% 3% 3% 6% 3% 3% 6% 3% 6% 3% 6% 3% 3% 0% 0% 5% 10% 15% 20% 25% 30% Short Sellers Fixed Arb CTA, Other HFReplication RV M ulti-strat Convert Arb M erger Arb Equity: M arket Neutral Volatility Arb Fund of Funds Special Situations Distressed Credit L/ S M acro L/ SEquity HF Allocation Changes for next 12mo - Corporates 11% 11% 16% 5% 16% 5% 11% 16% 11% 28% 17% 22% 21% 21% 21% 0% 0% 0% 5% 0% 0% 0% 0% 0% 6% 0% 0% 0% 0% 5% 0% 5% 10% 15% 20% 25% 30% HF Allocation Changes for next 12mo - Publics Decrease Increase Chart 9: Hedge Fund Allocation Changes for the next 12 months – Public DB vs Corporate DB 23% 23% 23% 22% 21% 15% 13% 11% 10% 9% 8% 6% 5% 4% 4% 6% 3% 6% 6% 5% 12% 5% 5% 3% 5% 5% 4% 4% 4% 4% 0% 5% 10% 15% 20% 25% Increase Decrease Source: Deutsche Bank 2H2010 Institutional Survey SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 7. Asset Owner Survey November 2010 7 Liability Driven Investing (LDI) The desire to hedge surplus-volatility appears to have gained solid footing here in the US among corporate pension plan sponsors. From an overall equity- reduction standpoint, we clearly see plan sponsors continuing to sell equities and buy bonds. This is shown best in the most recent Federal Flow of Funds data in Chart 10 at right. In fact, according to the Flow of Funds, corporate defined benefit plan sponsors have sold a net $882bn in equities and bought a net $489bn in fixed income since 2003 2 . But what about the future of LDI? In order to gain insight into what is currently weighing on the minds of corporate plan sponsors, we asked if, how, and when they plan to adopt LDI strategies. In Chart 11 below, we show long-duration fixed income shifts for corporate pension plans with assets >$1bn as well as those for corporate plans with <$1bn assets. We see that the intention to add long-dated corporate debt is strong (~36% will look to add, 0% to decrease), but that long-dated Treasuries and interest rate swaps see mixed results for larger plans (24% plan to add treasuries >10yr, 16% intend to decrease). This desire for corporate debt is ultimately driven by both yield enhancement and regulatory concerns as liabilities are discounted by “credit-like” discount rates. For plan sponsors with assets <$1bn we see that approximately 64% want to add long-dated corporate bonds (0% decrease) and 36% want to add long-dated Treasuries (9% decrease). These are the two most prominent areas of interest for this investor type (corporate plans <$1bn), clearly showing a significant paradigm shift among smaller plan sponsors toward LDI mandates. This is unsurprising as many of the larger corporate plan sponsors have embraced an LDI approach, and we are seeing the smaller plan sponsors (which tend to move a bit more slowly than their larger counterparts) now following suit by starting to shift assets away from equities in a more meaningful way. Further, our results show 50% of corporate 2 To be clear, not all of the flow into fixed income should be attributed to liability-driven trading. While we do believe that a good portion of this flow was indeed LDI-related, we also believe that some of the flow can be attributed to an unrelated increase in fixed income investment. Remember that a fundamental reason to include fixed income in a portfolio is to provide a liquidity cushion in times of market stress. We believe that this consideration has also weighed on the minds of corporate pension plan sponsors and have no doubt that it has contributed to this $489bn figure. Chart 10: Corporate Defined Benefit Bond and Equity Flows($bn) -200 -150 -100 -50 0 50 100 150 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10* Bond flows ($bn) Equity flows ($bn) Source: aggregated from Federal Reserve Flow of Funds Report; 2010 figures are annualized Source: Deutsche Bank 2H2010 Institutional Survey Chart 11: Long-duration bond allocation shifts – Corporates by size SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 8. Asset Owner Survey November 2010 8 67% 42% 22% 19% 17% 14% 6% 3% 0% 0% 10% 20% 30% 40% 50% 60% 70% plan sponsors already implementing some form of LDI within their portfolio (Chart 12), which is a large jump from what we have seen previously. 25% of our survey participants are considering starting the LDI process by first extending their fixed income duration. This is the first step in the LDI process and involves extending the duration of the fixed income portfolio from approximately 5 years to a duration that is typically 10+ years – from an allocation that would be benchmarked to a broad market index (Barclays Aggregate) to a longer-dated index (Barclays Long Government/ Credit). This desire to extend fixed income duration may also manifest itself (at least in the current environment) as an increased weighting to longer-duration investment grade corporate bonds. Interest rate levelsand funded status: the major impediments With average S&P 500 funded status in the low 70’s (see Chart 3), it is not surprising that 42% of respondents view low funded status as a major impediment to implementing LDI. Simply put, many plan sponsors believe that matching assets to liabilities at this time would lock-in a currently- poor funded status. Further, from Chart 14 at left, we see that we are unlikely to experience significant LDI implementation while funded status levels remain below 85%. Most plan sponsors agree, however, that the major impediment to LDI implementation is the current historically-low rate environment (67% name this as an impediment, see Chart 13). This market conviction then begs another question: how much do rates have to rise in order for LDI to make sense? Chart 12: Do you plan to adopt an LDI framework, and how will you implement? Chart 13: What are the current impedimentsto adopting an LDI framework? Chart 14: Funded Statusat which LDI makes sense 50% 25% 17% 17% 14% 8% 6% 3% 3% 0% 10% 20% 30% 40% 50% 60% Source: Deutsche Bank 2H2010 Institutional Survey Source: Deutsche Bank 2H2010 Institutional Survey 3% 24% 27% 9% 3% 33% <80% (3%) 80-90%(24%) 90-100%(27%) 100-110%(9%) >110%(3%) Any Funded Status (33%) Source: Deutsche Bank 2H2010 Institutional Survey SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 9. Asset Owner Survey November 2010 9 We don’t believe this question has been answered in the past, but in Chart 15 below it can be clearly seen that the majority of plan sponsors answered that rates would have to rise more than 200bp 3 (61% indicated this). Pick up premium until rate levelsare where you want them to be All else unchanged, a 200bp rise in rates would bring the average S&P plan sponsor’s funded status from its current level of 74% to nearly fully funded 4 , well within the funded status range in which most would consider LDI implementation unimpeded by funded status. But when do rates get to that point? The most recent median economist-forecast 30-year yield estimate published by Bloomberg does not expect the 30-year swap yield to touch 4.75% until 2Q 2012 (see Chart 16). In other words, if correct, this median forecast portends low rates for the foreseeable future 5 . # in survey 39 39 39 38 38 28 26 Source: Bloomberg News Monthly Survey of Economists, 2010 3 When we asked this question, we stated to assume that the 30-year Treasury is at a 4% yield. 4 We simply duration adjusted the liabilities and assumed they were at 12 years. 5 As we have previously asserted in the past, the track record for economist forecasts is poor at best, so take this with a grain of salt. Chart 15: Rates increase at which LDI makes sense Chart 16: 30-year Treasury Rates Forecast Source: Deutsche Bank 2H2010 Institutional Survey 3% 8% 18% 11% 61% 0-50 bp (3%) 50-100 bp (8%) 100-150 bp (18%) 150-200 bp (11%) >200 bp (61%) 4.98 5.13 5.21 5.30 5.50 6.00 6.50 3.70 3.80 3.90 4.13 4.32 4.58 4.75 3.00 3.00 3.25 3.50 3.58 3.60 3.50 2.50 3.00 3.50 4.00 4.50 5.00 5.50 6.00 6.50 4Q 10 1Q 11 2Q 11 3Q 11 4Q 11 1Q 12 2Q 12 High Forecast Median Forecast Low Forecast SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 10. Asset Owner Survey November 2010 10 Source: Deutsche Bank Rates Structuring Sell payersto pick up premium So assuming you believe economist forecast, does this mean that a plan sponsor waits idly until rates move to more desirable levels? We believe that the answer is “no.” Consider a plan sponsor that is committed to LDI but will not implement in the current rate environment and also believes that the rate environment will not sufficiently change in the near future. This plan sponsor could straightforwardly 6 determine the rate level at which they would implement LDI with conviction (in doing so they should consider a number of factors, including the projected plan funded status at that rate level), as well as the time horizon at which they believe that rate level will be realized. Once this target rate and time horizon are determined, the plan can capitalize on this conviction by selling 30-year out-of-the-money (OTM) payer swaptions. Effectively, this trade would enter the plan into an interest rate swap at the plan’s target level, given that rates indeed reach that level in the expected time horizon (at expiry). In addition, the plan would earn an immediate premium for the sale of the option. This yield pickup particularly makes sense in this low asset-return environment. Ultimately, this trade expresses LDI conviction and earns a premium in the process. In the matrix below, we present some of the swaption premium figures at different tenors and strikes at the time of this writing 7 . % OTM 1.00% 2.00% 3.00% Strike (forward 30-year swap rate): 3y 5.00% 6.00% 7.00% 5y 5.19% 6.19% 7.19% 7y 5.25% 6.25% 7.25% Premium: 3y 4.60% 2.00% 0.90% 5y 6.00% 3.20% 1.80% 7y 7.00% 4.10% 2.60% For example, with 30-year spot swap rates currently around 3.5%, a plan sponsor can sell a 30-year payer swaption struck 2.0% OTM (at 6.19%) expiring in 5 years and earn an immediate 3.2% premium. If in 5 years (at expiry) the then-spot 30-year swap rate is at least 6.19%, the plan sponsor would be entered into a 30-year swap at this level (the plan would be receiving fixed at 6.19%). This scenario reflects an over-200bp rise in rates and in this case (all else unchanged), the majority of plan sponsors would have achieved healthy funding levels. In the event that the 30-year swap rate has not reached the strike of 6.19% at expiry, then the swaption expires worthless, the plan is under no obligation to enter into a swap, and has collected a premium for the trade upfront. 6 Based on a select number of assumptions. 7 Special thanks to Steve Blasdell and the Deutsche Bank Rates Structuring team. Please note that these figures are for indicative purposes only. For live tradable levels, please contact DB Pension Strategies & Solutions. Table 2: Indicative levels: 30-year swaptions SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 11. Asset Owner Survey November 2010 11 Source: Deutsche Bank 2H2010 Institutional Survey Source: Deutsche Bank 2H2010 Institutional Survey What are the risks? In making a decision to enter into a trade like this, plan sponsors should consider a number of factors, including: 1. Swap basis to corporate discount rates. There is a risk that swap rates do not move in the same direction as discount rates 8 . This is particularly relevant if swap rates rise above corporate rates. We checked the long-end of the Citigroup Pension Liability Index, and we have not seen this happen in available index history (data starts in beginning of 1995). At least historically, this appears to be ‘right-way risk’ for pension plan sponsors. 2. Rates experience a significant increase. If rates increase significantly, a plan sponsor will not capture the gains above the strike. However, we believe that most plan sponsors would be comfortable with this loss of this potential upside, as funded status has an asymmetrical pay-off (i.e., a plan sponsor cannot extract excess money from the plan). Tail Risk The recent turmoil has brought to the forefront the issue of risk management, as can be gleaned from the fact that only 37% of survey respondents are uninterested in or restricted from the concept (Chart 17 at right). As could be expected, over half (55%) of those concerned with the downside risk are focused specifically on equity assets. This is particularly unsurprising in context of the fact that at least 44% of investors expressed intention to decrease equity exposure (Chart 5). These findings confirm our own experience, and that which we presented in our May 2010 Tail Risk Hedging paper 9 , that asset owners continue to be keenly interested in downside protection. 8 For example, during the 2008-2009 crisis when corporate bond rates increased, the corresponding swap rate decreased 9 Tail Risk Hedging: A Roadmap for Asset Owners by Deutsche Bank Pension Strategies & Solutions, M ay 2010 Chart 17: Investor plansto hedge tail risk Chart 18: Tail Risk Hedging: Assets of Focus 18% 35% 37% 2% 8% Yes (18%) No (35%) Undecided (37%) The fund is restricted from doing so (2%) Need further information (8%) 55% 28% 8% 6% 3% 0% 10% 20% 30% 40% 50% 60% Equities Whole Portfolio Bonds Other Alternatives SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 12. Asset Owner Survey November 2010 12 Chart 19: What instruments will you use to hedge tail risk? Source: Deutsche Bank 2H2010 Institutional Survey It is also worth noting that 28% of respondents communicated concern for the “whole portfolio” as opposed to equities alone. There are a number of plausible explanations for this broad unease, including: Increasing awareness of managing assets and liabilities in this low interest rate environment. Concern for a “black swan” event. Perhaps hidden behind the “whole portfolio” label is recognition that the source of the next crisis will be difficult to foresee and that its effects would likely not be isolated to a single asset class. To this end, we are encouraged to see that as many as 17% of respondents recognized the importance of “macro” hedging via volatility strategies (such as those described in our tail risk paper) and managed futures. We also recognize that most of the appropriate risk-reducing strategies will usually be asset- specific– such as equity option strategies, which were selected by 17% of respondents as the product they would most likely employ to reduce risk. 17% 13% 12% 9% 8% 8% 6% 5% 4% 4% 1% 0% 5% 10% 15% 20% Equity option strategies IRoptions Credit strategies Commodities M anaged futures Other Treasuries Inflation options Variance Swaps Tail risk protection indices Longevity SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 13. Asset Owner Survey November 2010 13 Source: Deutsche Bank 2H2010 Institutional Survey Source: Deutsche Bank 2H2010 Institutional Survey Source: Deutsche Bank 2H2010 Institutional Survey Appendix 50% 50% 40% 38% 38% 38% 31% 25% 25% 19% 19% 19% 13% 6% 6% 6% 6% 6% 0% 0% 0% 0% 0% 0% 6% 7% 0% 0% 0% 0% 0% 6% 0% 6% 13% 0% 0% 0% 0% 6% 19% 0% 6% 13% 50% 56% 0% 10% 20% 30% 40% 50% 60% Increase Decrease Chart 20: Anticipated Allocation Changes for next 12 months – Corporate DB >1bn Chart 21: Anticipated Allocation Changes for next 12 months – Public DB >1bn Chart 22: Anticipated Allocation Changes for next 12 months – E& F >500mm 42% 40% 36% 32% 28% 24% 24% 20% 16% 16% 16% 13% 12% 12% 8% 8% 4% 4% 4% 4% 4% 4% 0% 8% 12% 0% 8% 24% 8% 16% 8% 4% 4% 8% 0% 4% 4% 4% 16% 0% 4% 12% 28% 48% 56% 4% 0% 10% 20% 30% 40% 50% 60% Increase Decrease 78% 50% 33% 33% 33% 33% 22% 22% 22% 13% 11% 11% 11% 11% 11% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 22% 0% 11% 11% 13% 0% 0% 22% 44% 67% 0% 0% 11% 11% 22% 22% 22% 33% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% Increase Decrease SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e
  • 14. Asset Owner Survey November 2010 14 Disclaimer This material was prepared by a Sales or Trading function within Deutsche Bank AG or one of its affiliates (collectively “Deutsche Bank”). This material is not a research report and was not prepared or reviewed by the Deutsche Bank Research Department, and the views expressed herein may differ from those of the Research Department. Sales and Trading functions are subject to additional potential conflicts of interest which the Research Department does not face, so this material should not necessarily be considered objective or unbiased. Sales and Trading personnel are compensated in part based on the volume of transactions effected by them. The information herein is believed to be reliable and has been obtained from sources believed to be reliable, but we make no representation or warranty, express or implied, with respect to the fairness, correctness, accuracy, reasonableness or completeness of such information. In addition we have no obligation to update, modify or amend this communication or to otherwise notify a recipient in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate. We are not acting and do not purport to act in any way as an advisor or in a fiduciary capacity. We therefore strongly suggest that recipients seek their own independent advice in relation to any investment, financial, legal, tax, accounting or regulatory issues discussed herein. Analyses and opinions contained herein may be based on assumptions that if altered can change the analyses or opinions expressed. Nothing contained herein shall constitute any representation or warranty as to future performance of any financial instrument, credit, currency rate or other market or economic measure. Furthermore, past performance is not necessarily indicative of future results. Deutsche Bank may engage in transactions in a manner inconsistent with the views discussed herein. Deutsche Bank trades or may trade as principal in the instruments (or related derivatives), and may have proprietary positions in the instruments (or related derivatives) discussed herein, and these may be known to the author. Deutsche Bank may make a market in the instruments (or related derivatives) discussed herein. This communication is provided for information purposes only. It is not an offer to sell, or a solicitation of an offer to buy, any security, nor to enter into any agreement or contract with Deutsche Bank or any affiliates. Any offering or potential transaction that may be related to the subject matter of this communication will be made pursuant to separate and distinct documentation and in such case the information contained herein will be superseded in its entirety by such documentation in final form. Securities and investment banking activities in the United States are performed by Deutsche Bank Securities Inc., member NYSE, FINRA and SIPC, and its broker-dealer affiliates. Lending and other commercial banking activities in the United States are performed by Deutsche Bank AG, and its banking affiliates. This communication and the information contained herein is confidential and may not be reproduced or distributed in whole or in part without our prior written consent. The trading and investment ideas described in this document are not appropriate for everyone, so you should make your own informed investment decision based on your financial circumstances, investment objectives and risk tolerance. Before entering into any transaction you should take steps to ensure that you understand and have made an independent assessment of the appropriateness of the transaction in light of your own objectives and circumstances, including the possible risks and benefits of entering into such transaction. You should also consider making such independent investigations as you consider necessary or appropriate for such purpose. Deutsche Bank AG, including its subsidiaries and affiliates, does not provide legal, tax or accounting advice. This material is not intended or written to be used, and cannot be relied upon, by any taxpayer for the purposes of avoiding any U.S. federal tax penalties. The recipient of this communication should seek advice from an independent tax advisor regarding any tax matters addressed herein based on its particular circumstances. © 2010 Deutsche Bank AG. SR-UPM-FETCH-BEACON b33c2f1c45c442778ebb5b909e88435e