The Credit Conundrum- Strategic Asset Allocation
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This document provides an agenda for a session on strategic asset allocation. It discusses the importance of setting goals and objectives for stakeholders, and focuses on how trustee time has traditionally been spent more on manager selection than asset allocation, liability risks, and funding objectives. It also outlines how recent market changes have increased volatility in equities and credit spreads, and presents examples of governance structures for strategic asset allocation.
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The Credit Conundrum- Strategic Asset Allocation
- 1. 26th March 2009 The Credit Conundrum Session 1: Strategic asset allocation
- 2. Agenda Strategic Asset Allocation Agenda 2 Context Strategic Asset Allocation • Importance • History Current Markets • Impact • Strategy vs Tactics Governance Why Credit?
- 3. Strategic Asset Allocation Trustee Governance Investment Strategy Portfolio Strategy Monitoring ALM Analysis Set Goals / Objectives Implementation Trustee Governance • Strategic asset allocation form a key part of the Investment and Portfolio Strategy • Setting goals and objectives of the stakeholders is an absolute pre-requisite 3
- 4. Strategic Asset Allocation Relative Importance Investment Strategy Portfolio Strategy Monitoring ALM Analysis Set Goals / Objectives Implementation Relative Importance • Historically insufficient focus on goals and objectives of the key stakeholders and overall investment strategy • Necessary inputs to an effective Portfolio Strategy and in particular a Strategic Asset Allocation • But what do they really mean... 4
- 5. Strategic Asset Allocation Destination “Fully Funded” – Flight Plan Minimum Funding Level Cone of Uncertainty Cone of Uncertainty FRS 17/IAS 19 BUYOUT S75 5
- 6. Strategic Asset Allocation Understanding the Players 6 Fuel Efficiency Common Objectives • Shut down un(der) rewarded risks • Optimise portfolio performance • 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 market conditions • Apply regular risk monitoring and risk management Redington Approach Risk Return Virtuous Circle Trustees Sponsor
- 7. Strategic Asset Allocation Trustee Time Spent Investment Strategy Portfolio Strategy Set Goals / Objectives Implementation Trustee Time Spent • Significant time spent on manager structures and selection • Monitoring focused on manager performance versus benchmark • Until recently not enough time spent on • Volatility and impact of liabilities • Monitoring funding vs objectives • Sponsor covenant Monitoring ALM Analysis 7
- 8. Importance of Asset Allocation – Academic Research Strategic Asset Allocation Importance of Asset Allocation Study 1 /2 Study 3 Study 4 Authors Brinson, Hood & Beebower / Brinson, Singer & Beebower Ibbotson & Kaplan Drobetz & Kohler Publisher and Date Financial Analyst Journal (1986/1991) Financial Analyst Journal (2000) Universities of Basel and St Gallen (2002) Data Used 91 Large US Balanced Pension Funds 1974 –1983 / 82 Large US Balanced Pension Funds 1977- 1987 58 US Balanced Pension Funds 1993 –1997 and 94 US Balanced Mutual Funds 1987 –199 51 German and Swiss Balanced Mutual Funds 1995 –2001 Findings % of the Variability of Portfolio Return over Time Explained by Strategic Asset Allocation 94% / 92% Pension Funds 88.0% * Mutual Funds 81.4% 83% % of the of Total Long-Term Portfolio Return Explained by Strategic Asset Allocation 112% / 101% Pension Funds 99% * Mutual Funds 104% 134% Source: Evercore Pan-Asset Capital Management Limited 8
- 9. A Brief History – Who is Responsible? Strategic Asset Allocation A Brief History 9 Balanced Mandates – Delegation to manager Core Satellite – More active management of satellite Growth vs Matching Assets Diversification – Wider range of options Liability Driven Investment (LDI) Global Tactical Asset Allocation (GTAA) – Back to delegation?
- 10. Strategic Asset Allocation Impact of Recent Market Changes 10
- 11. Equity Indices rebased – Returns • Since the beginning of 2008, World Equity markets 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 to unprecedented levels. • FTSE ALL Share TR: +19% • S&P 500: +27% • Eurostoxx 50: +24% • Nikkei 225: +27% • Pacific ex Japan: +15% Market Changes World Equities – High Negative Returns/High Volatility 11 Market Changes – World Equities Do future expectation of the equity risk premium provide adequate reward for the higher volatility? Source: Bloomberg Source: Bloomberg
- 12. 12 Market Changes Historical Credit Spreads Source: Bloomberg / Barclays Capital Redington Market Changes – Credit Spread Is credit spread just reward for corporate risk? What about an illiquidity premium?
- 13. 13 Market Changes Asset Performance Market Changes – 12-Month Rolling Asset Performance Source: Bloomberg / Barclays Capital Redington • Most growth assets correlated? • Matching-like assets uncorrelated to growth assets ? Is diversification working?
- 14. 14 Market Changes Gilts yield vs. Swaps Swap spreads • Nominal swap spread widening has been concentrated in the longer tenors (beyond 10 years) Index-linked gilts & swaps • Index-linked gilt yields remain well above rates on equivalent real rate swaps Market Changes – Gilts Yield vs. Swaps Market anomalies persist. Opportunities for real money investors? Source: Bloomberg Source: Bloomberg
- 15. Governance Structure Scheme Governance Structure Delegates from Sponsor Risk/Finance Delegates from Investment Manager Experienced LDI Manager Trustees Investment Sub- Committee /Working Party Redington Partners Redington Investment Consultants 15 Strategic Asset Allocation Effective Governance Process • When do tactics take over? • Transition – Implementation and execution • Monitoring – Progress and adapting to changes
- 16. Where on the Spectrum Strategic Asset Allocation Where on the Spectrum Lower Return, Lower Risk Higher Return, Higher Risk Matching Assets Growth Assets Credit Credit In 2009 • Credit has Growth characteristics. • ...as well as maintaining its matching characteristics 16