The document summarizes a presentation given by Robert Gardner and Pete Drewienkiewicz of Redington on using credit as a key building block for defined benefit pension schemes. It discusses using credit strategies to increase returns in a low yield environment. It provides examples of restructuring a client's credit portfolio to incorporate more absolute return and illiquid credit strategies. It also presents a framework for overcoming governance hurdles to implementing credit strategies and concludes that credit offers pension funds tools to increase returns in a risk-controlled manner.

1. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Credit: A Core Building Block
for DB Schemes Investing in a
Low Yield Environment
Robert Gardner
Pete Drewienkiewicz
1

2. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
7 Steps to Full Funding TM
2
Design an efficient investment
strategy
Mission Statement
To assist our clients achieve full-funding with the minimum level of risk

3. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
1,000
1,500
2,000
2,500
3,000
3,500
4,000
2012
2013
2013
2014
2014
2015
2015
2016
2017
2017
2018
2018
2019
2020
2020
2021
2021
2022
2022
2023
2024
2024
2025
2025
2026
£mm
Flight Plan
liability (swapflat) asset(swapsflat)
1,000
1,500
2,000
2,500
3,000
3,500
4,000
2012
2013
2013
2014
2014
2015
2015
2016
2017
2017
2018
2018
2019
2020
2020
2021
2021
2022
2022
2023
2024
2024
2025
2025
2026
£mm
Flight Plan
liability (swapflat) asset(swapsflat)
The Flight Plan
3
100% - Swaps Flat by 2026
Required Returns Libor + 300bps
Expected Returns Libor + 200bps
Contributions & Asset
Returns
Liability
Basis
Time Horizon

4. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Credit Spread and Gilt Yield Evolution
4
-100
0
100
200
300
400
500
600
bps
20-Year Gilt Real Yield Sterling IG 15+ Corporate Spread IG Spread + Real Yield

5. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
The Pension Risk Management Framework
Objective Measurement Performance Indicators Performance RAG
Primary Funding
Objective
To reach 100% funded on a swaps flat
basis by 2026
Expected Returns (ER) > Required
Returns (RR)
RR: Libor + 300bps
ER: Libor + 200bps
Difference: -100bps
Investment
Strategy
Actual Returns should exceed
Expected Returns
Actual Returns (AR) > Expected Returns
(ER)
AR: Libor + 210bps
ER: Libor + 200bps
Difference: +10bps
Risk Budget
The investment strategy should not risk
the deficit worsening by £600mm over
a 1 year period
VaR95 < £600mm VaR95: £700mm
Hedging
Strategy
Nominal and inflation hedge ratio
should be maintained within +/- 5% of
the funding ratio
Funding Ratio (swaps flat) 70% n/a
Nominal Hedge Ratio (swaps flat) 50%
Inflation Hedge Ratio (swaps flat) 85%
Collateral
Maintain sufficient eligible for the
purposes of covering margin calls that
may arise from the Scheme’s current
derivative positions over a 1 year
period.
Total available eligible collateral £900mm
Remaining collateral after VaR95 event £600mm
5
RAG Status Metric is at or above target Metric is within [10%] of target Metric is more than [10%] away

6. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Calls To Action
6
Summary
 The Scheme needs to simultaneously:
1. Increase Expected Returns to equal (at a minimum) the Minimum Required Returns, but should aim to target
the Required Returns; and
2. Reduce the risk it is exposed to (as measured by VaR95); while
3. Maintaining sufficient levels of eligible collateral to withstand a VaR95 event.
Objective RAG Comments Call to Action
Primary Funding
Objective
Expected Returns are 100bps below the Required
Returns to reach 100% funded on a swaps flat basis by
2026
 Amend/adjust the investment strategy to increase
Expected Returns
Investment
Strategy
Actual Returns are 10bps above the Expected Returns  No Action Required
Risk Budget
The current investment strategy risks the deficit
worsening by more than the £600mm Risk Budget
 Reduce risk in the investment strategy
Hedging Strategy
The nominal and inflation hedge ratios are below and
above the target hedge ratio (i.e. the funding ratio),
respectively
 Increase nominal hedge ratio
 Decrease inflation hedge ratio
Collateral
Maintains £600mm collateral in excess of what might be
required after a VaR95 event
 No Action Required

7. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Credit as a Core Building Block for Flight Planning
7

8. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Credit Spread Evolution: January 2007
8

9. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Credit Spread Evolution: January 2009
9

10. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Credit Spread Evolution: December 2012
10

11. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Annual Returns of Credit Sub-Asset Classes
11
-40%
-20%
0%
20%
40%
60%
80%
2004 2005 2006 2007 2008 2009 2010 2011 2012
Sub Financials
High Yield
Emerging Markets
Investment Grade
ABS
Leveraged Loans

12. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Volatility in Returns of Credit Sub-Asset Classes
12
0%
5%
10%
15%
20%
25%
30%
Dec 2004 Dec 2005 Dec 2006 Dec 2007 Dec 2008 Dec 2009 Dec 2010 Dec 2011 Dec 2012
Sub Financials
High Yield
Emerging Markets
Investment Grade
ABS
Leveraged Loans
Rolling annualised standard deviation of monthly returns

13. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Absolute Return Credit Strategies
13
Key Features:
• Unconstrained fixed income mandate
• Cash or credit return-generating base with derivative
overlays
• Low volatility target
• Focus on strict risk management
Reasons for Popularity:
• Ability to generate returns from both credit and
interest rate cycles
• Pressure to allocate away from traditional corporate
bond mandates given low gilt yields
• Identification of weaknesses in market cap
weighted bond indices
• Increased demand for Libor + return strategies to
back LDI portfolios
Interest Rate Cycle
Credit Spread Cycle

14. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Liquid & Semi-Liquid Credit Strategies
14
Step 4. Description Implementation-to-date
• Credit consists of a range of sub-classes with
different risk-return characteristics.
• Includes Alpha oriented mandates where the
manager can operate in the entire fixed
income universe. This enables the manager to
take advantage of relative value between
different instruments, aiming to earn long run
risk premia throughout the credit and economic
cycle.
• 14% to Liquid Credit (corporate bonds (passive))
• 2% to Semi-Liquid Credit Strategies (distressed
debt, fixed income arbitrage, relative value credit)
• Total exposure 16%
Considerations:
The 7 Steps to Full Funding TM
framework and the PRMF act as a prompt to the scheme to dynamically shift its
credit allocation to target spreads at appropriate levels (i.e. above the scheme’s required returns).
Dynamically altering the scheme’s allocation could potentially be achieved by allocating to an ‘absolute return’ credit
mandate, or via the use of specialist managers.

15. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Illiquid Credit Strategies
15
Step 5. Description Implementation-to-date
• We believe there are a number of opportunities
available which can provide “long-dated,
inflation-linked” cash flows at a higher yield
than traditional matching assets (we call them
“Flight Plan Consistent Assets”).
• Typically, these assets tend to fit well with the
overall objectives of pension schemes when
assessed in the context of a scheme’s PRMF
• Total 0%
Considerations:
Assess possibility of making allocations to the following opportunities to increase credit diversification and
expected returns:
• SME lending
• Secondary UK PFI and core infrastructure refinancing
• Social housing
• Secured leases
• Ground rents

16. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
18%
18%
20%
10%
10%
25%
New Allocation
GBP Corporate Bond Buy & Hold
Alpha Orientated Manager
Flight-Plan Consistent Assets
High Yield/Leveraged Loans
ABS
"Conventional"
Large Client: Credit Portfolio Restructuring
16
This slide gives details of a credit portfolio review
undertaken by Redington in February and March 2012.
47%
38%
14%
Original Credit Allocation
Manager 1 Manager 2 Manager 3
Mgr Asset Class Benchmark
1 GBP Long-dated
corporate bonds
Buy & Hold portfolio
2 GBP Corporate
bonds
Bank of America/Merrill Lynch
Sterling Non-Gilt ex Insurance
3 GBP Corporate
bonds
Bank of America/Merrill Lynch
Sterling Non-Gilt ex Insurance

17. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Large Client: Credit as an Equity Replacement
17
40%
20%
20%
20%
Sample Equity Replacement Portfolio
Risk Parity
Long / Short
Credit
Direct Lending
(SMEs)
Distressed Debt
Sources of Funding
Developed
Equity
EM Equity
Private Equity
50%
35%
15%
Current Allocation
25%
50%
25%
Replacement Portfolio
Portfolio Weightings: Whole Scheme
• Overall risk in the return-seeking
assets bucket reduced by a fifth
• Overall expected return on scheme
assets increased by more than 10%
Equities Credit Alternatives

18. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Overcoming the Governance Hurdle: Sample Report
18
USD
Credit
EUR
Credit
GBP
Credit
Total
Market
Value (%)
26.3 9.6 64.1 100
Yield to
Worst (%)
4 11.9 5 5.4
Duration
(yrs)
13.6 0.6 7.8 8.7
Spread
Duration
Contribution
(yrs)
3.4 0.5 5.4 9.3
Libor
Spread
(bps)
177.9 799.5 236 274.8
UK
France
Netherlands
Italy Switzerland
Jersey Chan Isle
Australia
Denmark
Finland
Germany
Japan
Norway
Spain
United States
0
100
200
300
400
500
600
700
800
LiborSpread(bps)
Market Value and Libor Spread by Country
Portfolio Benchmark
21.1%
24.2%
10.9% 10.2%
7.0%
26.6%
0%
5%
10%
15%
20%
25%
30%
< 5 yrs 5 - 10 yrs 10 - 15 yrs 15 -20 yrs 20 - 25 yrs 25+ yrs
MarketValue
Market Value by Maturity Bucket

19. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
Conclusion
19
• The credit universe is large and diverse, and offers pension funds a large
range of tools for increasing the return on scheme assets in a risk-controlled
way.
• Having a robust Pensions Risk Management Framework and Flight Plan
means that pension funds can move quickly to access attractive
opportunities as and when they emerge.
• Market dislocation subsequent to the 2008 and Eurozone crises means that
an investment strategy that spans the entire credit spectrum is now more
important than ever.
• Methods of implementing credit allocations differ according to scheme size
and governance requirements. Potential solutions exist for both large and
small pension funds.

20. ACA Conferences Credit: A Key Building Block for DB Schemes 8 February 2013
13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk
Contacts
Robert Gardner
Founder & Co-CEO
Direct Line: 020 7250 3416
robert.gardner@redington.co.uk
20
Pete Drewienkiewicz
Director | Head of Manager Research
Direct Line: 020 3326 7138
pete.drewienkiewicz@redington.co.uk
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