A large UK pension scheme with a £3.5 billion deficit sought to reduce risk while maintaining returns. They implemented a volatility-controlled equity index with a put option to limit downside risk. This reduced equity risk exposure from 30% to 10% while delivering equity-like returns with lower volatility. It also lowered the cost of downside protection compared to purchasing puts directly on a passive equity index. The scheme's risk-return profile improved, allowing it to better fund its deficit over time with lower vulnerability to market stress.

1. Private & Confidential Case Study: Volatility Control Equities 19 August 2013
Case Study: Volatility
Controlled Equities
August 2013
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2. Private & Confidential Case Study: Volatility Control Equities 19 August 2013
Situation: A mature, underfunded pension scheme with a weak sponsor covenant
• A c£3.5bn closed pension scheme with a deficit of c£300m on self sufficiency basis and a weak sponsor covenant
• Mature scheme with annual pension payments of c5% of its assets
Investment Strategy
• Primary source of return to fund the Scheme’s deficit in the absence of sponsor contributions
• Highly path dependent and vulnerable to stress events which can throw the Scheme off course its flight path
• Operates on a very tight risk budget with a well defined Pension Risk Management Framework (PRMF) driving the Scheme’s asset
allocation
Governance Framework
• Quarterly Board Trustee Meeting responsible for setting overall risk and return parameters for the Scheme
• A sophisticated ISC which meets at least 8 times a year or more if required
• An in-house team led by a CIO for management and implementation of investment strategy
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3. Private & Confidential Case Study: Volatility Control Equities 19 August 2013
Task: Reduce downside risk while maintaining expected returns
• Adopting an equity benchmark which controls the amount of risk the Scheme is exposed to fits well with the Scheme’s objectives and
constraints by allowing it to capture growth while providing protection from severe market events, which might affect the Scheme’s Flight
Plan
• In a volatility controlled equity index, the Scheme’s exposure to equities is dynamically managed to achieve a target volatility level.
• By varying exposure in response to market conditions, volatility controlled equity indices have historically limited drawdowns and
delivered equity-like returns with substantially lower volatility (see Appendix I)
• A further advantage of using an equity index that carefully controls the level of risk is that it cheapens the cost of buying explicit
downside protection via a “put option. For example, to protect a global equity portfolio against a fall in value of more than 10%, over a
one year period would cost between 3 - 4%(depending on market conditions). The same protection for a global, volatility-controlled index
costs less than 1%
3
Left: Volatility-controlled
equity index allocation
As equity volatility rises (red
line), exposure to equities
(black line) is reduced
towards cash (and vice
versa) to keep the volatility
at the target level.

4. Private & Confidential Case Study: Volatility Control Equities 19 August 2013
Action: Implementation of the first volatility controlled equity structure
4
April 2013
Redington presents the
principles underlying
volatility control as part of
an overall strategic review
of the Scheme to the
Investment Committee(IC)
June 2013
A follow up detailed presentation to
the IC covering:
• Historical performance
• Potential structures available for
investment
• Cost of implementation (including
indicative pricing for put option)
• Impact of replacing Scheme’s
equity exposure by volatility
controlled equities + Put on risk and
return profile
July 2013
Training for the full
Trustee Board on the
structureIC agrees allocation subject to
Board approval
Redington starts preliminary
discussions with the LDI
manager re: implementation
Trustee Board approval
Aug 2013
1st volatility controlled
equity with put structure
implemented (see
Appendix II)
Close discussions with the LDI
manager and one conference call
with the IC to finalise:
• Underlying index for equities
• Management of currency
hedging
• Term sheet and formulae for
calculating volatility
• Dealing dates to avoid being out
of market
Timeline
Redington works
with banks and
fund managers
to establish
feasibility of idea

5. Private & Confidential Case Study: Volatility Control Equities 19 August 2013
Result: A better risk adjusted return profile for the Scheme
• The Scheme changed its approach to managing equities and
adopted a volatility controlled index as its benchmark with a put
option at 90% strike on the index.
• As a result, the Scheme:
o Manages its equity exposure in a risk controlled way through
a target volatility of 10%
o Reduced its equity risk by two thirds i.e. from c30% to 10%
of notional equity exposure
o Decreased downside risk by buying explicit protection at
affordable levels while still maintaining its path to full funding
o Diversified its portfolio further between different risk factors
such as credit, illiquidity, insurance risks
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0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
0% 5% 10% 15% 20% 25% 30%
ExpectedReturnoverswaps(bps)
VaR95 (% of notional exposure)
Starting Point
Stages Description
Starting Point 100% allocation in equities
Stage 1 100% allocation in volatility control equities
Stage 2 Add a put option to the volatility control equities
Stage 1
Stage 2
Risk-Return Illustration of Scheme’s equity portfolio

6. Private & Confidential Case Study: Volatility Control Equities 19 August 2013
Appendix I: Historical Performance
6
0
40
80
120
160
200
May-01 May-02 May-03 May-04 May-05 May-06 May-07 May-08 May-09 May-10 May-11 May-12
Passive Equity Vol Controlled Equity Vol Controlled Equity with Put
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 YTD
Passive Equity -17.26% 38.04% 16.54% 12.92% 17.77% 11.36% -46.47% 41.97% 13.63% -9.60% 16.07% 7.30%
Vol-Controlled equity -11.59% 31.92% 21.94% 14.53% 21.78% 5.74% -26.79% 17.11% 7.58% -6.42% 7.81% 7.01%
Vol-controlled Equity with Put Option -11.93% 31.28% 21.35% 13.99% 21.19% 5.26% -17.92% 16.53% 7.09% -6.84% 7.29% 6.54%
-60.00%
-40.00%
-20.00%
0.00%
20.00%
40.00%
60.00%
Passive Equity Vol-Controlled equity Vol-controlled Equity with Put Option
Source: Redington, Bloomberg
The chart and table below compares the historical performance of a 70% MSCI developed world, 30% EM index (“70:30 index”), 10% volatility
controlled 70:30 index and 10% volatility controlled 70:30 index with 85% put.

7. Private & Confidential Case Study: Volatility Control Equities 19 August 2013
Appendix II: Implementation Structure
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Case Study
Pension Scheme
Bank
3m Libor + X
Volatility controlled index with a 1y put option at
90% on the index
Key Terms of 1y Total Return Swap
Client pays 3m USD Libor + X
Client receives Return on [Index] – 3m LIBOR + Put option at [Strike] on the [Index]
Index
10% volatility controlled equity index (70% MSCI World Net of Dividend Tax + 30% MSCI Emerging Markets Index Net of
Dividend Tax)
Strike for Put Option 90%
Volatility Measure Maximum of exponentially Weighted Moving Average with = 3% and 6%

8. Private & Confidential Case Study: Volatility Control Equities 19 August 2013
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Contacts
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