Investment Strategies for Pension Funds Christopher Nichols - PowerPoint PPT Presentation

Investment Strategies for Pension Funds Christopher Nichols Investment Director, Multi ‐ Asset Investing Standard Life Investments (UK)

Pensions need consistency but markets deliver chaos Discrete Yearly Performance (%) by Market 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 55.03 25.30 26.07 ‐ 14.29 73.43 27.48 18.55 40.36 40.24 29.46 44.76 22.51 23.73 ‐ 21.61 71.56 26.65 10.88 21.34 26.67 27.89 39.44 20.45 6.15 ‐ 24.12 68.24 23.63 10.38 20.74 22.04 22.06 27.84 19.15 ‐ 3.39 ‐ 25.44 56.93 23.06 6.06 17.48 21.85 20.76 25.75 19.06 ‐ 3.43 ‐ 25.66 41.58 21.81 5.53 16.80 17.77 17.39 22.57 18.60 ‐ 4.85 ‐ 33.73 30.67 21.21 3.36 15.66 8.12 13.76 22.43 4.77 ‐ 5.00 ‐ 41.15 22.52 18.74 ‐ 0.97 14.42 3.29 11.80 20.89 3.58 ‐ 6.57 ‐ 42.25 17.62 18.71 ‐ 11.32 14.22 ‐ 0.83 9.63 16.91 2.69 ‐ 7.09 ‐ 46.77 11.19 11.77 ‐ 12.51 6.70 ‐ 1.92 8.46 12.08 2.56 ‐ 13.29 ‐ 49.12 9.58 11.16 ‐ 12.55 5.77 ‐ 3.02 7.78 11.21 1.56 ‐ 13.55 ‐ 50.75 7.54 9.66 ‐ 12.96 5.40 ‐ 6.35 7.37 5.85 ‐ 4.88 ‐ 24.71 ‐ 60.73 3.07 4.37 ‐ 15.44 3.79 ‐ 6.49 4.33 Global High Yield Bonds UK Equities UK Direct Property Cash UK Investment Grade Bonds European Equities Asia Equities Ex Japan Japanese Equities UK Gilts UK Small Cap Emerging Market Equities US Equities Source: Lipper, total returns, in € terms, 31 December 2014

Rotate based on outlook? Real GDP 8 Recovery Overheat 1984 6 1999 1988 1998 4 1994 1986 Inflation ‐ 1 0 1 2 3 2006 4 5 6 7 2 1990 2014 2002 2007 2001 0 2008 1991 ‐ 2 1982 2009 Recession Stagflation ‐ 4

Conventional diversification Governance structure: Derived using: • Strategic Benchmark • Historical data • Asset classes • Asset class volatilities • Broad weights • Correlations • TAA (e.g. +/ ‐ 5%) • Capital market outlook • Tracking ‐ Error limit • Intuitive beliefs More likely exactly wrong than approximately right

Unstable risk characteristics Correlation to Global Equities of “diversifying assets” 90% 2000 ‐ 2007 2008 ‐ 2011 80% 70% 60% 50% 40% 30% 20% 10% 0% FX Emerging High Yield Corporate Property Commodities Basket Bonds Market Bonds Bonds Source: IPD UK Monthly Property Index, All Property; Federal Reserve Trade ‐ Weighted Exchange Value of US Dollar vs 6 Countries; Dow Jones UBS – Commodity Index; Barclays Capital Global Corporate Index, Excess Returns; Barclays Capital Emerging Markets Index, Excess Returns; Barclays Capital US High Yield Index, Excess Returns; Standard Life Investments, 31 December 2011

Buy portfolio insurance? 1800 S&P 500 Total Return Index Protected index, no cost Cash Return Index (3m rates) Protected index allowing for cost 1600 1400 1200 Tail risk protection as many imagine it would be 1000 800 600 2.2% p.a. 400 200 0 Historically you would have needed to pay 1.7% per quarter, on average, to cap losses at 5%

Characteristics of strongly ‐ diversified portfolios • Benchmark agnostic / adaptable to changing conditions • Broad Investment freedom • Risk controls – guard against hubris, concentration and event risk • Sound philosophy and process

Broad Opportunity Set Traditional risk ‐ premia • Selective Equity, Credit and Real ‐ Estate exposures • Security selection – ‘alpha’ Cyclical / Directional opportunities Interest rates Australian Short ‐ Term Duration, Brazilian Gov’t Bonds Currencies Long Mexican Peso vs Australian Dollar Volatility Long Equity Variance Relative value Geography Japanese vs Korean Equity Sector/Size Large US Tech vs US Small Cap Interest rates EU 10 year vs US and Japan 10 year rates

USD vs CAD and European equity performance 450 1.15 Investment thesis Stoxx Europe 600 Total Return Index (LHS) USD/CAD (RHS) • US dollar undervalued and safe 1.10 400 haven status • Canadian economy debt issues and 1.05 resource based 350 1.00 • Canadian exporters priced out 300 • USD / CAD is a risk ‐ off strategy 0.95 • European equities is a risk ‐ on 250 position 0.90 • Negatively correlated ( ‐ 0.17 last 2 yrs) but positive return from each 200 0.85 Jan 10 Jan 11 Jan 12 Jan 13 Jan 14 Source: Standard Life Investments & Bloomberg

Broad based return potential with genuine diversity Correlation to Global Equity -1.0 -0.5 0.0 0.5 1.0 US equity European equity Global equity miners High yield credit Short US Duration Long European payer swaptions Mexican rates v EUR German v French equity Long INR v EUR Brazilian government bonds European v US and Japanese duration Long MXN v AUD European v US and Japanese duration EU corporate bonds Australian forward ‐ start interest rates US equity tech v small cap Long USD v EUR US butterfly Long USD v CAD Source: Standard Life Investments, Sungard APT, 31 March 2015

Step 1: Evaluate Current Risk Profile 14% • Ensure portfolio Security Selection exposed to multiple 12% Relative Value risks & none dominate Total stand ‐ alone risk 10% • Total stand ‐ alone 8% 8.8% Diversification investment risk Directional 6% adequate to achieve 4% the objective Market Returns 2% 3.7% Expected volatility • Portfolio risk analysis 0% shows the benefits of investment diversification Source: Standard Life Investments GARS SICAV portfolio, 31 March 2015

Step 2: Historical Scenario Analysis MSCI World (EUR) move over same period* GARS Portfolio Black Monday 1987 Gulf War 1990 Rate Rise 1994 Mexican Crisis 1995 Asian Crisis 1997 Russian/LTCM Tech Wreck (April 07 ‐ 14, 2000) Sept 11th Equity Sell ‐ Off (August 23 ‐ October 09, 2002) Equity Rally (October 10 ‐ November 27, 2002) Gulf War 2 (March 01 ‐ 23, 2003) Bond Rally (May 01 ‐ June 13, 2003) Bond Sell ‐ Off (June 14 ‐ July 31, 2003) Emerging Market Sell ‐ Off 2006 (May 01 ‐ June 08, 2006) Subprime Debacle 2007 (July 15 ‐ August 15, 2007) Bank Meltdown 2008 (September 12 ‐ October 15, 2008) Euro Crisis (July 22 ‐ August 23, 2011) QE jitters (May 22 ‐ June 24, 2013) ‐ 28 ‐ 26 ‐ 24 ‐ 22 ‐ 20 ‐ 18 ‐ 16 ‐ 14 ‐ 12 ‐ 10 ‐ 8 ‐ 6 ‐ 4 ‐ 2 0 2 4 6 8 10 12 14 16 18 % Move * MSCI World Returns prior to 2000 denoted in European Currency Units, except for 1987 which is denoted in German Marks Source: GARS SICAV, RiskMetrics, 31 March 2015

Step 3: Forward ‐ looking Scenarios World Economic Forum 2013: • Economic / Environmental • Geopolitical / Societal • Technological What do you envisage the flashpoints could be? Cold War 2 Acropolis China crisis Now Dunkin’ Trade war Disappointment Commodity shock

China Crisis Key Factor Shock Description (examples) (estimates) Oil ‐ 47% Property market slowdown causes growth to drop sharply Australian Dollar ‐ 15% Fixed asset investment deteriorates HSI ‐ 60% Labour market strained, wage growth and consumption slows 10y US Treas. Yld. ‐ 50bps Risk of banking crises as defaults rise Social/political unrest as government forced to recapitalise banks Combining expert judgement with quantitative discipline Sources: Standard Life Investments & Bloomberg, March 2015

Acropolis Now Key Factor Shock Description (examples) (estimates) European Equity ‐ 40% Debt re ‐ profiling unsuccessful so Greek exit is prepared Euro ‐ 15% Depositors withdraw bank deposits and gov’t bonds default Italian 10y yld +300bps QE fails to stem contagion through Europe and beyond German 10y yld ‐ 30bps Political uncertainty in UK and Spain makes investors nervous Sources: Standard Life Investments & Bloomberg, March 2015

Dunkin’ Disappointment Key Factor Shock Description (examples) (estimates) Wages slow, suppressing confidence and spending US Large Cap ‐ 12% Margins and revenue static, earnings disappoint pressuring wages US$ ‐ 5% Rate hikes delayed, curve flattens and USD sells off Brazilian Real ‐ 5% US, as engine for world recovery, causes EM currencies to weaken 10y US Treas. Yld. ‐ 40bps Sources: Standard Life Investments & Bloomberg, March 2015

A word on market volatility and outcome uncertainty… Longer investment time periods appear to make the return more consistent Source: Standard Life Investments, Datastream, S&P500 Index total return from 1965 to 2014

Market volatility and outcome uncertainty In fact the outcome for investors becomes more varied Source: Standard Life Investments, Datastream, S&P500 Index total return from 1965 to 2014

Investment Strategies for Pensions Portfolio governance that enables: • Broad Investment freedom • Balance of portfolio risk • Sound philosophy and process