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The Credit Conundrum- Strategic Asset Allocation

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The Credit Conundrum- Strategic Asset Allocation

  1. 1. 26th March 2009The Credit ConundrumSession 1: Strategic asset allocation
  2. 2. AgendaStrategic Asset AllocationAgenda2ContextStrategic Asset Allocation• Importance• HistoryCurrent Markets• Impact• Strategy vs TacticsGovernanceWhy Credit?
  3. 3. Strategic Asset AllocationTrustee GovernanceInvestmentStrategyPortfolioStrategyMonitoringALM AnalysisSet Goals / ObjectivesImplementationTrustee Governance• Strategic asset allocation forma key part of the Investmentand Portfolio Strategy• Setting goals and objectives ofthe stakeholders is an absolutepre-requisite3
  4. 4. Strategic Asset AllocationRelative ImportanceInvestmentStrategyPortfolio StrategyMonitoringALM AnalysisSet Goals / ObjectivesImplementationRelative Importance• Historically insufficientfocus on goals andobjectives of the keystakeholders and overallinvestment strategy• Necessary inputs to aneffective Portfolio Strategyand in particular a StrategicAsset Allocation• But what do they reallymean...4
  5. 5. Strategic Asset AllocationDestination “Fully Funded” – Flight PlanMinimum Funding LevelCone of UncertaintyCone of UncertaintyFRS 17/IAS 19BUYOUT S755
  6. 6. Strategic Asset AllocationUnderstanding the Players6Fuel EfficiencyCommon Objectives• Shut down un(der) rewardedrisks• Optimise portfolioperformance• Funding level• Value at Risk• Contribution volatility• IAS19 Expected Return• Solve for risk• Set risk budget using 3 lenses• Build consensus• Implement hedging strategy• Seek to optimise risk adjusted return(Fuel Efficiency)• Be proactive in changing marketconditions• Apply regular risk monitoring andrisk managementRedington ApproachRisk ReturnVirtuous CircleTrustees Sponsor
  7. 7. Strategic Asset AllocationTrustee Time SpentInvestmentStrategyPortfolio StrategySet Goals / ObjectivesImplementationTrustee Time Spent• Significant time spent onmanager structures andselection• Monitoring focused onmanager performance versusbenchmark• Until recently not enoughtime spent on• Volatility and impact ofliabilities• Monitoring funding vsobjectives• Sponsor covenantMonitoringALM Analysis7
  8. 8. Importance of Asset Allocation – Academic ResearchStrategic Asset AllocationImportance of Asset AllocationStudy 1 /2 Study 3 Study 4AuthorsBrinson, Hood & Beebower /Brinson, Singer & BeebowerIbbotson & Kaplan Drobetz & KohlerPublisher and DateFinancial Analyst Journal(1986/1991)Financial Analyst Journal(2000)Universities of Basel and StGallen (2002)Data Used91 Large US Balanced PensionFunds 1974 –1983 / 82 Large USBalanced Pension Funds 1977-198758 US Balanced PensionFunds 1993 –1997 and 94US Balanced Mutual Funds1987 –19951 German and SwissBalanced Mutual Funds1995 –2001Findings% of the Variability ofPortfolio Return over TimeExplained by Strategic AssetAllocation94% / 92%Pension Funds 88.0% *Mutual Funds 81.4%83%% of the of Total Long-TermPortfolio Return Explainedby Strategic AssetAllocation112% / 101%Pension Funds 99% *Mutual Funds 104%134%Source: Evercore Pan-Asset Capital Management Limited8
  9. 9. A Brief History – Who is Responsible?Strategic Asset AllocationA Brief History9Balanced Mandates – Delegation to managerCore Satellite – More active management of satelliteGrowth vs Matching AssetsDiversification – Wider range of optionsLiability Driven Investment (LDI)Global Tactical Asset Allocation (GTAA) – Back to delegation?
  10. 10. Strategic Asset AllocationImpact of Recent Market Changes10
  11. 11. Equity Indices rebased – Returns• Since the beginning of 2008, World Equitymarkets have produced very poor performance:• FTSE ALL Share TR: -40%• S&P 500: -50%• Eurostoxx 50: -56%• Nikkei 225: -53%• Pacific ex Japan: -39%Equity Indices rebased - Volatility• The volatility of world equities has increased tounprecedented levels.• FTSE ALL Share TR: +19%• S&P 500: +27%• Eurostoxx 50: +24%• Nikkei 225: +27%• Pacific ex Japan: +15%Market ChangesWorld Equities – High Negative Returns/High Volatility11Market Changes – World EquitiesDo future expectation of the equity risk premium provideadequate reward for the higher volatility?Source: BloombergSource: Bloomberg
  12. 12. 12Market ChangesHistorical Credit SpreadsSource: Bloomberg / Barclays Capital RedingtonMarket Changes – Credit SpreadIs credit spread just reward for corporate risk? What about an illiquidity premium?
  13. 13. 13Market ChangesAsset PerformanceMarket Changes – 12-Month Rolling Asset PerformanceSource: Bloomberg / Barclays Capital Redington• Most growth assetscorrelated?• Matching-like assetsuncorrelated to growthassets ?Is diversification working?
  14. 14. 14Market ChangesGilts yield vs. SwapsSwap spreads• Nominal swap spread widening has been concentratedin the longer tenors (beyond 10 years)Index-linked gilts & swaps• Index-linked gilt yields remain well above rates onequivalent real rate swapsMarket Changes – Gilts Yield vs. SwapsMarket anomalies persist. Opportunities for real money investors?Source: Bloomberg Source: Bloomberg
  15. 15. Governance StructureScheme Governance StructureDelegates fromSponsorRisk/FinanceDelegates fromInvestmentManagerExperienced LDIManagerTrusteesInvestment Sub-Committee/Working PartyRedingtonPartnersRedingtonInvestmentConsultants15Strategic Asset AllocationEffective Governance Process• When do tactics take over?• Transition – Implementation and execution• Monitoring – Progress and adapting to changes
  16. 16. Where on the SpectrumStrategic Asset AllocationWhere on the SpectrumLower Return,Lower RiskHigher Return,Higher RiskMatchingAssetsGrowthAssetsCredit CreditIn 2009• Credit has Growth characteristics.• ...as well as maintaining its matching characteristics16

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