Alternative Investments for Capital
Accumulation Plans (CAP)
What Plan Sponsors Should Know
Bradley N. Rowe, CFA
Principal
Start with the “Risk Free” Asset
1991
2000
2010
2013
0%
2%
4%
6%
8%
10%
12%
14%
3Months
1Year
3Years
5Years
7Years
10Years...
‘W Y S I W Y G’
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
19...
‘W Y S I W Y G’
-20%
-10%
0%
10%
20%
30%
40%
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
19...
‘W Y S I W Y G’
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
19...
Asset Allocation – DB Plans (Canada)
Data Source: PIAC, Asset Mix Composites
Asset Class 2000 2003 2006 2009 2012
Fixed In...
Asset Allocation – DB vs. DC (Canada)
72%
28%
Asset Allocation – DB Plans
December 31, 2012
"Traditional" Assets
"Non-Trad...
Asset Allocation – DB vs. DC (U.S.)
84%
16%
Asset Allocation – DB Plans
December 31, 2011
"Traditional" Assets
"Non-Tradit...
Does it Really Matter? (U.S.)
-6%
-4%
-2%
0%
2%
4%
6%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
200...
Does it Really Matter?
• From 1995-2011, DB Plans outperformed DC Plans by
an average of 0.76%
• From 2000 – 2011, DB Plan...
Key DB and CAP Differences
1. Investment Strategy
– Managing uncertainty
– Behavioural constraints
2. Structure and Resour...
1. Investment Strategy
• DB Plan Sponsor
– Single Fund
– Relatively predictable
liabilities and cash flow
– Potential for ...
Spectrum of CAP Participants
• Investment offering must consider needs of all participants
– Defaulter: offer a suitable d...
2. Structure and Resources
• DB Plan Sponsor
– Dedicated staff and/or
external consultants to
assist with oversight
– Cent...
Characteristics of Alternatives
• Relative to traditional fixed income, alternatives
are expected to generate higher cash ...
Some Common Alternatives
Asset Class
Role Relative
to Equities
Liquidity
Need for
Specialized
Resources
Expected
Returns v...
Gaining Access to Alternatives
Asset Class DB Plans DC Plans
Private Equity Private Equity Limited Partnership
Invest in p...
Typical Private Equity Cash Flow
1 2 3 4 5 6 7 8 9 10
InvestorCashFlows
Time
The “J” Curve
Distributions
Capital Calls
Cum...
Example: Infrastructure
• Refers to facilities and services essential for the
economic productivity of society.
• Typicall...
Example: Infrastructure
Investment Characteristics
• Backbone of the global economyEssential Services
• High capital costs...
Issues for CAP Sponsors
• Investment Liquidity
– The need for daily liquidity
• Member Education
– Placing complex choices...
Is There a Solution?
• Publically traded / listed options
– REIT’s
• Companies that invest in direct real estate
– Listed ...
Is There a Solution?
• Pre-built asset allocation funds
– Target Date funds
– Target Risk funds
• Member selects the “targ...
Is There a Solution?
• Unallocated CAP Plan
– No participant investment choice
– Single fund
– Like a DB Plan without bene...
Alternative Investments for Capital
Accumulation Plans (CAP)
What Plan Sponsors Should Know
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Alternative Investments for Capital Accumulation Plans (CAP)

  1. 1. Alternative Investments for Capital Accumulation Plans (CAP) What Plan Sponsors Should Know Bradley N. Rowe, CFA Principal
  2. 2. Start with the “Risk Free” Asset 1991 2000 2010 2013 0% 2% 4% 6% 8% 10% 12% 14% 3Months 1Year 3Years 5Years 7Years 10Years 15Years 20Years 25Years 30Years Government of Canada Bonds and Treasury Bills (Zero Coupon Yield Curve – Start of Year) Data Source: Bank of Canada
  3. 3. ‘W Y S I W Y G’ 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Government of Canada (Mid to Long Term Bond Yield) Bond Yield: 1982 was 14.3% Bond Yield: 1998 was 5.5% Bond Yield: 2012 was 2.3% Data Source: CIA Report on Canadian Economic Statistics
  4. 4. ‘W Y S I W Y G’ -20% -10% 0% 10% 20% 30% 40% 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Median Pension Fund Return Average Return 1982-1996 was 13.2% Average Return 1998-2012 was 6.4% Data Source: CIA Report on Canadian Economic Statistics
  5. 5. ‘W Y S I W Y G’ 0% 2% 4% 6% 8% 10% 12% 14% 16% 18% 20% 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Government of Canada (Mid to Long Term Bond Yield) vs. Median Pension Fund Returns (15 year - plotted at Start of period) Yield Fund Return Data Source: CIA Report on Canadian Economic Statistics Bond Yield: 1982 was 14.3% Average Return 1982-1996 was 13.2% Bond Yield: 1998 was 5.5% Average Return: 1998-2012 was 6.4% Bond Yield: 2012 was 2.3% Average Return: 2012-2026 will be ??%
  6. 6. Asset Allocation – DB Plans (Canada) Data Source: PIAC, Asset Mix Composites Asset Class 2000 2003 2006 2009 2012 Fixed Income 37.5% 35.9% 31.1% 33.0% 30.7% Equities 54.9% 52.2% 51.9% 43.9% 41.1% Total “Traditional” 92.4% 88.1% 83.0% 76.9% 71.8% Private Equity 1.5% 3.6% 3.5% 6.0% 7.5% Real Estate 5.2% 6.7% 7.3% 8.9% 10.2% Infrastructure Not Reported Not Reported 2.4% 3.8% 5.0% Hedge Funds Not Reported Not Reported 2.3% 2.0% 1.7% Other 0.9% 1.6% 1.5% 2.4% 3.8% Total “Non-Traditional” 7.6% 11.9% 17.0% 23.1% 28.2%
  7. 7. Asset Allocation – DB vs. DC (Canada) 72% 28% Asset Allocation – DB Plans December 31, 2012 "Traditional" Assets "Non-Traditional" Assets 99% 1% Asset Allocation – DC Plans December 31, 2012 "Traditional" Assets "Non-Traditional" Assets Data Source: PIAC, Asset Mix Composites Total assets reporting: $ 1,164,506 million Total assets reporting: $ 16,041 million
  8. 8. Asset Allocation – DB vs. DC (U.S.) 84% 16% Asset Allocation – DB Plans December 31, 2011 "Traditional" Assets "Non-Traditional" Assets 92% 8% Asset Allocation – DC Plans December 31, 2011 "Traditional" Assets "Non-Traditional" Assets Data Source: Towers Watson
  9. 9. Does it Really Matter? (U.S.) -6% -4% -2% 0% 2% 4% 6% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Net Investment Performance Difference (DB less DC) Asset-Weighted Median Returns DC Plans Outperform DB Plans Outperform Data Source: Towers Watson
  10. 10. Does it Really Matter? • From 1995-2011, DB Plans outperformed DC Plans by an average of 0.76% • From 2000 – 2011, DB Plans outperformed DC Plans by an average of 1.10% • From 2007 – 2011, DB Plans outperformed DC Plans by an average of 0.39% – DB Plan volatility was 1.5% lower • Fees also play a role!
  11. 11. Key DB and CAP Differences 1. Investment Strategy – Managing uncertainty – Behavioural constraints 2. Structure and Resources – Professional oversight – Scale – Flexibility
  12. 12. 1. Investment Strategy • DB Plan Sponsor – Single Fund – Relatively predictable liabilities and cash flow – Potential for additional funding – Liability immunization – Dedicated staff and/or consultants to assist with investment choices • CAP Sponsor – Uncertain length of retirement and expense amounts – Limited potential for additional funding – Likely a need to continue to grow assets in retirement – Investment choices left to the member – limited knowledge and/or interest
  13. 13. Spectrum of CAP Participants • Investment offering must consider needs of all participants – Defaulter: offer a suitable default option – Passive Selector: offer structure and limited choice – Active Selector: offer suitable range of options Unwilling or unable to make investment choices Defaulter Able to make investment choices but choose not to Passive Selector Make their own investment choices Active Selector
  14. 14. 2. Structure and Resources • DB Plan Sponsor – Dedicated staff and/or external consultants to assist with oversight – Centralized control – Single investment policy with established objectives and goals – Economies of scale • Broad opportunity set – Flexibility in making changes to asset classes • CAP Sponsor – Expectation of full liquidity – Recordkeeping is predicated on the ability for participants to view daily account values – Different objectives – Daily pricing requirement – Limited flexibility for changing investment options • Participant notice required
  15. 15. Characteristics of Alternatives • Relative to traditional fixed income, alternatives are expected to generate higher cash yields and deliver higher capital appreciation • Relative to traditional equities, alternatives can serve two distinct roles: – Return enhancement – Risk diversification • The choice of alternative as well as the source of the funding will depend on investor goals
  16. 16. Some Common Alternatives Asset Class Role Relative to Equities Liquidity Need for Specialized Resources Expected Returns vs. Equities Expected Volatility vs. Equities Expected Correlation to Equities Private Equity Return Enhancer Low - None Medium - High Higher Higher High Real Estate Risk Diversifier Depends Low - Medium Slightly Lower Lower Low Infrastructure Risk Diversifier Low - None Medium Similar Lower Low - None Hedge Funds Risk Diversifier Lower Medium - High Depends Lower – Much Lower Depends
  17. 17. Gaining Access to Alternatives Asset Class DB Plans DC Plans Private Equity Private Equity Limited Partnership Invest in public companies involved in Private Equity deals Real Estate Private Equity Limited Partnership Real Estate Investment Trusts (REITS) Direct Investments Comingled Real Estate Investment Trusts (REITS) Pooled funds Infrastructure Private Equity Limited Partnership Direct Investments Comingled Invest in public companies involved in Infrastructure Hedge Funds Hedge Fund Limited Partnerships Mutual Funds using hedge fund-like strategies
  18. 18. Typical Private Equity Cash Flow 1 2 3 4 5 6 7 8 9 10 InvestorCashFlows Time The “J” Curve Distributions Capital Calls Cumulative Cash Flows Investment Period Harvest Period
  19. 19. Example: Infrastructure • Refers to facilities and services essential for the economic productivity of society. • Typically involve the movement of goods, people, water and energy.
  20. 20. Example: Infrastructure Investment Characteristics • Backbone of the global economyEssential Services • High capital costs, regulation, advantageous locations, economies of scaleBarriers to Entry • Regulatory framework provides indexation mechanismInflation Protection • Demand has low sensitivity to price changesLow Demand Elasticity • Long duration. Low reinvestment risk. Matches long duration obligationsLong Life • Long term contracts. Low maintenance requirements. “Take or Pay” commitments from customersPredictable Cash Flows • Relative long term independence from financial marketsLow Correlation to Other Assets
  21. 21. Issues for CAP Sponsors • Investment Liquidity – The need for daily liquidity • Member Education – Placing complex choices in the hands of participants who may lack understanding • Governance and oversight – Complex investments
  22. 22. Is There a Solution? • Publically traded / listed options – REIT’s • Companies that invest in direct real estate – Listed infrastructure • Public companies that have exposure to infrastructure – Private equity • Listed companies that invest in private equity deals • Offers indirect exposure to the “direct” investment, with higher volatility (i.e. the price of liquidity)
  23. 23. Is There a Solution? • Pre-built asset allocation funds – Target Date funds – Target Risk funds • Member selects the “target” fund option and opts for an automatic rebalancing along the glide path through time – Member choice limited / restricted – Gain reasonable certainty around liquidity needs – Liquidity managed by Plan sponsor • Combination of liquid and illiquid options
  24. 24. Is There a Solution? • Unallocated CAP Plan – No participant investment choice – Single fund – Like a DB Plan without benefit guarantees – Liquidity managed by Plan sponsor • Joint employee / employer sponsorship – All participants earn the same total fund rate of return – Ease of administration and communication – Build “guarantees” around participants approaching retirement • Risk sharing – Legal implications?
  25. 25. Alternative Investments for Capital Accumulation Plans (CAP) What Plan Sponsors Should Know

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