112 PD, Using - Member | SOA · Session 112 PD, Using ... Session 112: Using Derivatives ... with your own legal counsel or the SOA before raising any matter or making any statement

Session 112 PD, Using Derivatives in Pension Investment Strategies

Moderator:

Colyar Waring Pridgen, FSA, EA

Presenters: R. Evan Inglis, FSA, FCA, MAAA

Rene Martel, FSA James Peter Walton, FSA

SOA Antitrust Disclaimer SOA Presentation Disclaimer

Colyar Pridgen, Standish (Moderator)Rene Martel, PIMCOJames Walton, River and Mercantile GroupEvan Inglis, Nuveen Asset Management

Session 112: Using Derivatives in Pension Investment StrategiesOctober 25, 2016

SOCIETY OF ACTUARIESAntitrust Notice for Meetings

Active participation in the Society of Actuaries is an important aspect of membership. However, any Society activity that arguably could be perceived as a restraint of trade exposes the SOA and its members to antitrust risk. Accordingly, meeting participants should refrain from any discussion which may provide the basis for an inference that they agreed to take any action relating to prices, services, production, allocation of markets or any other matter having a market effect. These discussions should be avoided both at official SOA meetings and informal gatherings and activities. In addition, meeting participants should be sensitive to other matters that may raise particular antitrust concern: membership restrictions, codes of ethics or other forms of self‐regulation, product standardization or certification. The following are guidelines that should be followed at all SOA meetings, informal gatherings and activities:

• DON’T discuss your own, your firm’s, or others’ prices or fees for service, or anything that might affect prices or fees, such as costs, discounts, terms of sale, or profit margins.

• DON’T stay at a meeting where any such price talk occurs.

• DON’T make public announcements or statements about your own or your firm’s prices or fees, or those of competitors, at any SOA meeting or activity.

• DON’T talk about what other entities or their members or employees plan to do in particular geographic or product markets or with particular customers.

• DON’T speak or act on behalf of the SOA or any of its committees unless specifically authorized to do so.

• DO alert SOA staff or legal counsel about any concerns regarding proposed statements to be made by the association on behalf of a committee or section.

• DO consult with your own legal counsel or the SOA before raising any matter or making any statement that you think may involve competitively sensitive information.

• DO be alert to improper activities, and don’t participate if you think something is improper.

• If you have specific questions, seek guidance from your own legal counsel or from the SOA’s Executive Director or legal counsel.

2

Presentation Disclaimer

Presentations are intended for educational purposes only and do not replace independent professional judgment. Statements of fact and opinions expressed are those of the participants individually and, unless expressly stated to the contrary, are not the opinion or position of the Society of Actuaries, its cosponsors or its committees. The Society of Actuaries does not endorse or approve, and assumes no responsibility for, the content, accuracy or completeness of the information presented. Attendees should note that the sessions are audio‐recorded and may be published in various media, including print, audio and video formats without further notice.

3

Derivatives 101

4

5

What Is a Derivative Instrument?

Information provided is for illustrative purposes only and is not to be relied upon as advice or interpreted as a recommendation.

Der

ivat

ives

101

SBLDIQ3102314GA

Defining financial derivatives instruments

Financial derivative instruments (“derivatives”) derive their value from that of an underlying asset, commodity, index or rate

There can be many different types of derivatives for the same underlying asset, each type giving a particular exposure with unique sensitivities to various risk factors

Derivatives enable different parties to exchange specific financial risks

Derivatives can be exchange-traded or trade over-the-counter under a bi-lateral contract governed by the International Swaps and Derivatives Association (ISDA)

6

Elements Common to Derivatives


Der

ivat

ives

101

SBLDIQ3102314GA

Comparison with physical instruments

Physical assets are pre-defined when issued Derivatives can often be customized

The amount physical assets traded is limited to existing stock Derivatives instruments can be created based on supply/demand dynamics

Physical assets need to be cash settled upfront for the full purchase price Derivatives are often purchased on margin with a fraction of the capital

Derivatives can be cash settled or physically settled with the delivery of the underlying asset

Physical assets typically need to be owned in order to be sold Derivatives can typically provide “short” and “long” exposures

7

Types of Derivatives


Der

ivat

ives

101

SBLDIQ3102314GA

Derivatives broadly fall into three types:

1. Forward looking derivatives, for which the value closely tracks the price of the underlying asset (also referred to as “delta-one” instruments) Forward contracts

Futures contracts

Swaps

2. Options contracts, for which the value exhibits a non-linear behavior with respect to the changes in price of the underlying asset (also referred to as instruments which exhibits “convexity”) Call options

Put options

Swaptions

3. Event derivatives, for which the value is related to the probability or risk of a certain event occurring Credit default swaps

8

Derivatives Risks


Der

ivat

ives

101

SBLDIQ3102314GA

Source: ISDA

Primary risks involved with the use derivatives

Liquidity risk: The risk that a derivatives instrument becomes less liquid, leading to an increase in bid-ask spread or the inability to get out of a position at a fair level.

Basis risk: The risk that a derivative instrument fails to deliver the underlying exposure intended.

Funding risk: The risk that the implied funding rate of a derivative increases leading to higher funding costs for using the instrument over time.

Counterparty risk: Mostly related to non-cleared bi-lateral derivatives trades. The risk that a counterparty defaults under its obligations of the trade.

Collateral risk: The risk of running out of collateral for margining derivatives due to negative market movements.

Using derivatives to efficiently manage pension investment risk

9

The analysis contained herein is intended to provide you a sample representation as to the type of custom analysis we can provide and are not intended to be a recommendation for your particular needs. Performance data contained herein may be dated and should not be relied upon for investment decisions.

10

Funded status 80% 85% 90% 95% 100% 105% 110%

Allocation:

Fixed income (LDI) 40% 46% 52% 58% 63% 69% 75%

Return-seeking 60% 54% 48% 42% 37% 31% 25%

12.5%10.8%

9.3%7.8%

6.4%5.1%

4.0%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Estim

ated

sur

plus

vol

atili

ty2

Dynamic de-risking strategiesIllustrative DB plan glide path

As of 31 December 2015. SOURCE: PIMCO, Sample client. See additional information section for glide path analysis information. Hypothetical example for illustrative purposes only1 Additional diversified return-seeking allocation consists of an equal weighted blend of hedge funds [HFRI Fund Weighted Composite Index], inflation sensitive multi-asset index blend [45% Barclays U.S.

TIPS, 20% DJ UBS Commodity, 15% JPM ELMI+ (Unhedged), 10% DJ U.S. REIT, 10% DJ UBS Gold], and credit absolute return strategy [PIMCO Credit Absolute Return Representative Account] starting with 15% and gradually decreasing along the glide path. Includes equity, real estate, and additional diversified return-seeking allocations

2 See Appendix for additional information regarding volatility estimatesRefer to Appendix for additional glide path, hypothetical example, investment strategy, representative account and risk information

LDI_Glidepath_review_21a

11

Adjustment in custom LDI mandates to achieve hedge ratio targets

Aspiring to hit a trigger on the glide path? Be careful what you wish for

A derivatives completion strategy can streamline implementation

Execute asset allocation changes

Need to implement quickly to lock-in funding ratio gains

Transaction costs management

Avoid harmful competition between own managers

Monitor funding

Trigger execution can be cumbersome and delay glide path implementation

Refer to Appendix for additional outlook and risk information.

12

60% 55% 50% 45% 40%30%

20%

40% 45% 50% 55% 60%70%

80%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

80% 85% 90% 95% 100% 105% 110%

Ass

et a

lloca

tion

Funding ratio

Return-seeking LDICurrent position

Streamline glide path execution with a derivatives completion strategySample glide path

Source: PIMCOHypothetical example for illustrative purposes only. Not intended to represent any specific PIMCO product or strategy, nor is it intended to be a recommendation for your particular needsRefer to Appendix for additional glide path, hypothetical example, investment strategy, portfolio analysis and risk information.

LDI_CompMgmt_review_10

13

50 50

Equity LDI

30

70

Equity LDI

Corresponds to current funding ratio of 90%

Corresponds to 105% funding ratio on the glide path

Before completion

With completion –Step 1


Streamline glide path execution with a derivatives completion strategyStep 1: Immediately bring physical portfolio in line with closer to end-state asset allocation

Return-seeking

Return-seeking


14

30

7020

Equity LDI

30

70

Equity LDI

Net exposure

Phys

ical

Phys

ical

Duration offset

overlay

-20

50 50

Equi

ty

Ove

rlay



7030

Streamline glide path execution with a derivatives completion strategyStep 2: Use derivatives to adjust asset allocation back to glide path levels


Return-seeking

Return-seeking


15

Duration offset

overlay

30

7015

Return-seeking LDI

30

7020

Return-seeking LDI

Duration offset

overlay

Funding ratio improves

Net exposure

50 50

Phys

ical

Equi

ty

Ove

rlay

Phys

ical

-20

Phys

ical

Equi

ty

Ove

rlay

Phys

ical

-15

90% Funding Ratio 95% Funding Ratio

45 55

Streamline glide path execution with a derivatives completion strategyStep 3: Dial down derivatives exposure as funding ratio improves



16

Funding Ratio 90% 95% Physical Trading

Equity Manager A $100 $100 $0Equity Manager B $100 $100 $0Alternatives $100 $100 $0Completion Synthetic Equity $200 $150 $0Equity Total $500 $450 $0

Completion Manager $300 $300 $0LDI Manager #2 $200 $200 $0LDI Manager #3 $200 $200 $0Completion Interest Rate Swaps -$200 -$150 $0Fixed Income Total $500 $550 $0

Total $1,000 $1,000 $0

With Completion Mandate

Funding Ratio 90% 95% Physical Trading

Equity Manager A $200 $175 -$25Equity Manager B $200 $175 -$25Alternatives $100 $100 $0Equity Total $500 $450 -$50

LDI Manager #1 $300 $300 $0LDI Manager #2 $100 $125 $25LDI Manager #3 $100 $125 $25Fixed Income Total $500 $550 $50Total $1,000 $1,000 $0

Without Completion Mandate

Derivatives completion strategyAn illustration

Long_duration_review_65

Without completion strategy

With completion strategy

As of 31 December 2015. SOURCE: PIMCO., Sample Client Hypothetical example for illustrative purposes only. Not intended to represent any specific PIMCO product or strategy, nor is it intended to be a recommendation for your particular needs. Allocations may not sum to totals due to rounding. Index proxies: The equity proxy is the MSCI ACWI Index; the alternatives proxy is the HFRI Fund of Funds Composite Index; the fixed income proxy is the Barclays Long Credit Index.Refer to Appendix for additional glide path, hypothetical example, index, investment strategy, portfolio analysis and risk information

17

Derivatives completion strategyPotential benefits

Enables plan sponsors to quickly lock-in funding ratio gains

Avoids competition with several other investors to buy long bonds in times of high demand

Significantly reduces operational complexity and risk of glide path implementation

Helps manage transaction costs

Streamlines hedge ratio adjustment


18

Appendix

19

Private Equity12% Real

Estate 13%

Non-U.S.

Equity22%

US. Small Cap8%

U.S. Large Cap33%

Bonds12%

Private Equity

4%

Real Estate

5%

Non-U.S.

Equity14%

US. Small Cap5%U.S.

Large Cap20%

Bonds52%

Bonds100%

Maintaining estimated return targets has gotten riskier over time

Potential implications of lower asset class return estimates for DB plans:– May have to lower estimated return on assets– May have to dial up risk to maintain return estimates– Both implications are undesirable for most plan sponsors

1995

Estimated Return: 7.5%Standard Deviation: 6.0%

2005


2015


As of 31 May 2016. Hypothetical example for illustrative purposes only.1 For indices, return estimates are based on the product of risk factor exposures and projected risk factor premia. The projections of risk factor premia rely on historical data, valuation metrics and

qualitative inputs from senior PIMCO investment professionals. Refer to Appendix for additional performance and fee, hypothetical example, index, return assumptions and risk information.

Long_duration_review_66

SOURCE: Callan Associates

20

Appendix

!mk_LDI_Trends_Appendix

PERFORMANCE AND FEEPast performance is not a guarantee or a reliable indicator of future results. Certain performance figures do not reflect the deduction of investment advisory fees (for Pacific Investment Management Company LLC described in Part 2 of its Form ADV) in the case of both separate investment accounts and mutual funds; but they do reflect commissions, other expenses (except custody), and reinvestment of earnings. Such fees that a client may incur in the management of their investment advisory account may reduce the client's return. For example, over a five-year period, annual advisory fees of 0.425% would reduce compounding at 10% annually from 61.05% before fees to 57.96% after fees. The “net of fees’ performance figures reflect the deduction of actual investment advisory fees but do not reflect the deduction of custodial fees. All periods longer than one year are annualized. Separate account clients may elect to include PIMCO sector funds in their portfolio; sector funds may be subject to additional terms and fees. For a copy of net of fees performance, unless included otherwise, please contact your PIMCO representative.

CHARTPerformance results for certain charts and graphs may be limited by date ranges specified on those charts and graphs; different time periods may produce different results.

COMPOSITEComposite performance is preliminary until the 12th business day of the month.

CORRELATIONThe correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility.

CREDIT QUALITYThe credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. The quality ratings of individual issues/issuers are provided to indicate the credit worthiness of such issues/issuer and generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody’s, and Fitch respectively.

DEFINED BENEFIT GLIDE PATHDe-risking strategy based on a function of plan funded status. As plan funded status improves, clients may be interested in reducing their plan funded status volatility by shifting out of risk assets and into liability hedging fixed income.

GLIDE PATHGlide Path is the asset allocation within a Target Date Strategy (also known as a Lifecycle or Target Maturity strategy) that adjusts over time as the participant’s age increases and their time horizon to retirement shortens. The basis of the Glide Path is to reduce the portfolio risk as the participant’s time horizon decreases. Typically, younger participants with a longer time horizon to retirement have sufficient time to recover from market losses, their investment risk level is higher, and they are able to make larger contributions (depending on various factors such as salary, savings, account balance, etc.). Generally, older participants and eligible retirees have shorter time horizons to retirement and their investment risk level declines as preserving income wealth becomes more important.

HEDGE RATIODuration Hedge Ratio = asset duration exposure / liability duration exposure. Credit Spread Duration Hedge Ratio (Beta-Adjusted) = asset duration exposure / credit spread duration exposure.

HYPOTHETICAL EXAMPLENo representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown. Hypothetical or simulated performance results have several inherent limitations. Unlike an actual performance record, simulated results do not represent actual performance and are generally prepared with the benefit of hinds ight. There are frequently sharp differences between simulated performance results and the actual results subsequently achieved by any particular account, product, or strategy. In addition, since trades have not actually been executed, simulated results cannot account for the impact of certain market risks such as lack of liquidity. There are numerous other factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results.

INVESTMENT STRATEGYThere is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown.

21

Appendix

ISSUERReferences to specific securities and their issuers are not intended and should not be interpreted as recommendations to purchase, sell or hold such securities. PIMCO products and strategies may or may not include the securities referenced and, if such securities are included, no representation is being made that such securities will continue to be included.

OASThe Option Adjusted Spread (OAS) measures the spread over a variety of possible interest rate paths. A security's OAS is the average return an investor will earn over Treasury returns, taking all possible future interest rate scenarios into account.

PIMCO OPTIMIZERThis material contains hypothetical results based on a proprietary tool, PIMCO OPTIMIZER. PIMCO OPTIMIZER enables PIMCO to: (1) analyze client liability streams; (2) construct a customized benchmark to help meet the client’s liability streams; (3) calculate tracking error; (4) graphically display the differences between the client’s liability stream and PIMCO OPTIMIZER customized benchmark. Like any model, PIMCO OPTIMIZER may be useful to help identify portfolio strategies, but it does not represent a prediction of actual portfolio results. The results may vary with each use and over time.

PORTFOLIO ANALYSISThe portfolio analysis is based on several sample client portfolios. No representation is being made that the structure of the average portfolio or any account will remain the same or that similar returns will be achieved. Results shown may not be attained and should not be construed as the only possibilities that exist. Different weightings in the asset allocation illustration will produce different results. Actual results will vary and are subject to change with market conditions. There is no guarantee that results will be achieved. No fees or expenses were included in the estimated results and distribution. The scenarios assume a set of assumptions that may, individually or collectively, not develop over time. The analysis reflected in this information is based upon data at time of analysis. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product.

PIMCO routinely reviews, modifies, and adds risk factors to its proprietary models. Due to the dynamic nature of factors affecting markets, there is no guarantee that simulations will capture all relevant risk factors or that the implementation of any resulting solutions will protect against loss. All investments contain risk and may lose value. Simulated risk analysis contains inherent limitations and is generally prepared with the benefit of hindsight. Realized losses may be larger than predicted by a given model due to additional factors that cannot be accurately forecasted or incorporated into a model based on historical or assumed data.

RISKInvesting in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Absolute return portfolios may not fully participate in strong positive market rallies. Investing in foreign denominated and/or domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Sovereign securities are generally backed by the issuing government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. Inflation-linked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Municipals may realize gains may be subject to state and local taxes and may at times be subject to the alternative minimum tax. High-yield, lower-rated, securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Mortgage and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally backed by a government, government-agency or private guarantor there is no assurance that the guarantor will meet its obligations. Derivatives and commodity-linked derivatives may involve certain costs and risks such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Commodity-linked derivative instruments may involve additional costs and risks such as changes in commodity index volatility or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Investing in derivatives could lose more than the amount invested. Swaps are a type of privately negotiated derivative; there is no central exchange or market for swap transactions and therefore they are less liquid than exchange-traded instruments. Investors should consult their investment professional prior to making an investment decision.

STRATEGY AVAILABILITYStrategy availability may be limited to certain investment vehicles; not all investment vehicles may be available to all investors. Please contact your PIMCO representative for more information.


22

Appendix

VOLATILITY (ESTIMATED)We employed a block bootstrap methodology to calculate volatilities. We start by computing historical factor returns that underlie each asset class proxy from January 1997 through the present date. We then draw a set of 12 monthly returns within the dataset to come up with an annual return number. This process is repeated 25,000 times to have a return series with 25,000 annualized returns. The standard deviation of these annual returns is used to model the volatility for each factor. We then use the same return series for each factor to compute covariance between factors. Finally, volatility of each asset class proxy is calculated as the sum of variances and covariance of factors that underlie that particular proxy. For each asset class, index, or strategy proxy, we will look at either a point in time estimate or historical average of factor exposures in order to determine the total volatility. Please contact your PIMCO representative for more details on how specific proxy factor exposures are estimated.

This material contains the current opinions of the manager and such opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660. 800.387.4626. ©2016, PIMCO.


23

Appendix

INDEX DESCRIPTIONSThe Barclays Intermediate Government/Corporate Index is an unmanaged market index comprised of a blend of intermediate government and the investment grade corporate fixed income universe.

The Barclays Intermediate Investment Grade Corporate Index is an unmanaged index of publicly issued U.S. corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements.

Barclays Long-Term Treasury consists of U.S. Treasury issues with maturities of 10 or more years.

Barclays Long Term Government/Credit Index is an unmanaged index of U.S. Government or Investment Grade Credit Securities having a maturity of 10 years or more.

The Barclays Long Corporate Index is a component of the Barclays U.S. Long Credit index. Barclays U.S. Long Credit Index is the credit component of the Barclays U.S. Government/Credit Index, a widely recognized index that features a blend of U.S. Treasury, government-sponsored (U.S. Agency and supranational), and corporate securities limited to a maturity of more than ten years.

Barclays U.S. Aggregate Index represents securities that are SEC-registered, taxable, and dollar denominated. The index covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. These major sectors are subdivided into more specific indices that are calculated and reported on a regular basis.

Barclays U.S. Long Credit Index is the credit component of the Barclays U.S. Government/Credit Index, a widely recognized index that features a blend of U.S. Treasury, government-sponsored (U.S. Agency and supranational), and corporate securities limited to a maturity of more than ten years.

Citigroup STRIPS Index, 20+ Year Sub-Index represents a composition of outstanding Treasury Bonds and Notes with a maturity of at least twenty years. The index is rebalanced each month in accordance with underlying Treasury figures and profiles provided as of the previous month-end. The included STRIPS are derived only from bonds in the Citigroup U.S. Treasury Bond Index, which include coupon strips with less than one year remaining to maturity. The index does not reflect deductions for fees, expenses or taxes.

LIBOR (London Interbank Offered Rate) is the rate banks charge each other for short-term Eurodollar loans.

The MSCI EAFE (Morgan Stanley Capital International Europe, Australasia, Far East Index) is an unmanaged index of over 900 companies, and is a generally accepted benchmark for major overseas markets. Index weightings represent the relative capitalizations of the major overseas markets included in the index on a U.S. dollar adjusted basis.

The NCREIF (National Council of Real Estate Investment Fiduciaries) Property Index is a quarterly time series composite total rate of return measure of performance of a very large pool of individual commercial real estate properties acquired in the private market for investment purposes only.

The S&P 500 Index is an unmanaged market index generally considered representative of the stock market as a whole. The index focuses on the Large-Cap segment of the U.S. equities market.

It is not possible to invest directly in an unmanaged index.

CMR2016-0915-212197


Structured equity

24

Experienced Provider, Innovative Approach

Agenda

25

1. Introduction to structured equity

• What is structured equity?

• When does structured equity make sense?

2. Structure design and use in asset allocation

• Example hedge

• Portfolio De‐Risking alternatives

INTRODUCTIONTO STRUCTURED EQUITY


What is Structured Equity?

27

Mechanically shaped and protected equity exposure

Implemented in a way that solves LDI challenges


Other tools rely on assumptions…

28

Stay invested(Wait for the Equity Risk Premium)

Asset allocation(Diversified Growth Funds, Active

Equity)

(Un)Correlated assets(VIX, Gold etc)

Algorithms(Smart Beta)

Structured Equity

Reliant on assumptions playing out in practice to

deliver the outcome required

Mechanical delivery of outcome


The issues with traditional equity investing

29

Equity market return

Equity investment

return

Painful

Assumed return for

fundingNot ideal

What we need

Nice but don’t need


Structured Equity – shaping equity returns illustration

30

Step One –cost of full protection

Cost equals 12%

Step Two – limit downside protection

Cost drops 7% to 5%

Protecting 30% decline, then start to participate

Step Three – give away some upside

Cost neutral

Cap upside above 20%


Structured Equity is not an off the shelf product

31

Preferable to have at least:

1. Quantifiable reason to manage downside risk

…or….

2. Strong investment viewpoint.

Structured Equity Shape

Client Needs

Client & Consultant

Market View

Market Conditions


The shape is not fixed

32

2007 2008 2009

Return with protection

Cautious

BenignMarket

Views

Needs Sideways moves return

Cautiously bullish

Stressed, volatileMarket

Views

Needs Recovery

Bullish

Stressed, volatileMarket

Views

Needs

STRUCTURE DESIGN AND USE IN ASSETALLOCATION


Total return 7‐9% pa compounded = equity market + dividend returns

Capital protection for equity index falls from 0% to ‐20%

Forgo participation above 21.5% indexrise(receive +27.5%

total return)

Example equity portfolio hedge at zero cost

Based on market conditions as at 31 August 2015. Options on MSCI World Index. Index value at date 1,720.

34


Cash Equities + Hedge (25%)

Portfolio De‐Risking alternatives

Cash Equities (50%)

Liability Matching Bonds (50%)

1. Current Allocation

Equity options maintain desired exposure to equity returns

Cash Equities (35%)


2. Traditional derisking(15% to bonds/LDI)


Cash Equities (25%)

3. Equity hedging overlay (50% of

equities)

4. Equity replacement (10% to bonds with derivative overlay)

Cash Equities (35%)


Bonds + Options (15%)

35


Portfolio De‐Risking alternatives: Best Allocation For Each Outcome?

Interest Rates

Equity Returns Up

Dow

nUp Down

2. Traditional derisking

3. Equity hedging overlay

4. Equity replacement

1. Current Allocation

36


Equity stress (+40% price), 91%

87% 87%

92%

Expected Equites (+5% price pa), unchanged rates, 82% 81% 82%

84%

Equity stress (unchanged price), 77% 77%75%

77%

Equity stress (‐30% price), 65%

69% 69%68%

Equity stress (+25% price), 86%

84%85%

88%

60%

65%

70%

75%

80%

85%

90%

95%

1. Current 2. Traditional De‐Risk 4. Equity replacement3. Equity hedging

De‐risking: Equity stress comparison

3. and 4. provide protection in equity downside scenarios compared to the current strategy while maintaining or increasing expected returns.

Hedging equities can achieve similar risk reduction compared to traditional derisking (moving from physical equities into bonds/LDI).

Traditional derisking . …or Equity hedging Equity replacement

37


Expected Equites (+5% price pa), unchanged rates, 82% 81% 82%

84%

Rate Stress (+150bps), 92%

86%

91% 91%

Rate Stress (‐150bps), 76%77%

76%

80%

70%

75%

80%

85%

90%

95%

1. Current 2. Traditional De‐Risk 4. Equity replacement3. Equity hedging

De‐risking: Interest rate stress comparison

Derisking into bonds (2, 4) reduces exposure to rising or falling interest rates.

Interest risk under the equity hedge (3.) remains similar to the current strategy.

Outcomes under 4. are shifted higher compared to traditional derisking (2.) due to returns from the equity structure overlay.

38


•Close to a buy and hold mandate

•Low governance•Low cost

•Not reliant on assumptions

•Pension plan tailors outcome

•Objective meets needs of clients

•Alternative or a compliment to traditional derisking and interest rate

hedging

Summary

39

Passive governance and fees

Equity like returns with better journey

Mechanical exposure to markets

Issued by P‐Solve LLC

A River and Mercantile Group Company

200 West Street, Waltham, MA 02451

Telephone: 781.373.6900

Facsimile: 781.373.6902

Email: [email protected]

www.psolve.us

CONFIDENTIAL INFORMATION: The information herein has been provided solely to the addressee in connection with a presentation by P‐Solve LLC, on condition that it not be shared, copied, circulated or otherwise disclosed to any person without the express consent of P‐Solve LLC.

INVESTMENT ADVISOR: Investment advisory services are provided by P‐Solve LLC, an investment advisor registered with the US securities and Exchange Commission.

GROSS PERFORMANCE DATA:While portfolio performance does reflect the fees and expenses of underlying mutual funds and other investments, the portfolio performance shown does not reflect the deduction of P‐Solve’s investment advisory fees, which are charged directly to each P‐Solve client. Information about P‐Solve’s fees is contained in its Brochure (Form ADV Part 2A) which is available upon request and is posted at its website, psolve.com. Advisory fees and other expenses will reduce returns, and this reduction will have a cumulative effect over a number of years. As an example of this cumulative effect, an investment of $1,000,000 with an annual return of 5% and an annual investment advisory fee of 0.25% of assets under management would reduce the investment return by $2,500 over one year, with a cumulative effect of $15,122 over 5 years and $38,370 after 10 years.

PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS.

SECURITY INDICES: This presentation includes data related to the performance of various securities indices which may provide an appropriate basis for comparison with underlying investments and the client’s total investment portfolio. The performance of securities indices is not subject to fees and expenses associated with investment funds. Investments cannot be made directly in the indices. The information provided herein has been obtained from sources which P‐Solve LLC believes to be reasonably reliable but cannot guarantee its accuracy or completeness.

Important Performance and Legal Information

40

Volatility‐managed strategies

41

42

43

53

59

43

44

45

46

47

48

49

50

51

52

53

54

55

56

57

58

59

60

61

62

63

64

Documents

112 PD, Using - Member | SOA · Session 112 PD, Using ... Session 112: Using Derivatives ... with your own legal counsel or the SOA before raising any matter or making any statement