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Asset Allocation
Solutions for
Pension &
Insurance
Companies
John McLaughlin
Head of Multi Asset Solutions
The Great Court at
the British Museum
May 2010 | For professional investors only. This material is not suitable for retail clients
Getting the balance right
Is a traditional balanced approach the answer?
1. Diversification is limited to 2 or 3 asset classes
2. Benchmark is not aligned to the client’s ultimate objective
3. Focus is greatest where the opportunity is least
4. Asset allocation is slow moving and lacks conviction
5. Risk management amounts to monitoring a tracking error
6. Liabilities are difficult to match using bonds and are not particularly capital efficient
Liabilities
Bonds
1
Equities
Static diversification is not enough
You must also rebalance dynamically
Simple static diversification provides protection as the
tech bubble collapses June 2000 – April 2006
Simple static diversification offers little protection in the
current down turn April 2006 – June 2009
140
140
130
130
120
120
110
110
100
100
90
90
80
80
70
70
60
60
50
Jun 00
50
May 06
Jun 01
Jun 02
Jun 03
Jun 04
MSCI AC World £ hedged
Diversified Index £ hedged
Jun 05
May 07
May 08
Schroder Diversified Growth Acc £
MSCI AC World £ hedged
Diversified Inex £ hedged
*Diversified Index: 50% MSCI AC World TR $,10% HFRI Fund of Funds Composite TR $, 7% JPM EMBI Global Composite TR $, 10% ML
Global High Yield TR $, 10% FTSE EPRA/NAREIT Developed TR $, 3% LPX50 TR $, 10%DJ UBS Future Commodity Index ER $. Rebalanced
on monthly basis.
Source: Thomson DataStream, Schroders. Updated 30 th June 2009.
2
May 09
Dynamic multi-asset investing
Say ‘No’ to the traditional approach
No Benchmark
 Target an absolute risk/return outcome
No Limits
Asset type
 Broad diversification by
Risk source
Investment vehicle
Equity
Cash
Private
Equity
Equity
Property
Infrastructure
Illiquidity
High
Yield
Term
Commodities
Hedge
Funds
Credit
Volatility
Currency
Skill
No Fear
No Surprises
 High conviction asset allocation:
 Construct portfolios based on risk weighting, not trade weighting
• Capital rotation through the market cycle
• Taking advantage of valuation opportunities
 Observe and control the portfolio through different risk lenses
e.g. VaR, factor risk, liquidity risk
• Realising investment themes
 Use customised, quantitative risk management tools
Easy to say, not so easy to do ….. successfully
Schroders asset allocation model
Asset allocation is hard to do well
Fund Managers
& Analysts
Equity
Fixed
Income
163
53
Alternatives 67
Quarterly
Monthly
Daily
Cyclical Market
Forum
Global Asset
Allocation Committee
Fund Management
& Analysis
40+ Senior
5 Independent
22 Fund Managers and
Fund Managers / Analysts
Multi-Asset Specialists
Analysts
Gather Information
Determine Investment Policy
Construct Portfolios
– Outlook for asset classes
– Asset class preferences
– Sizing positions
– Specialist views
– Conviction & Accountability
– Fund / Vehicle selection
– Discuss economic
scenarios
– Set stop-loss/take-profit
– Monitor risk & return
Investment
Strategy
Risk
Management
5 macro economists
16 quants and
derivative experts
Models & economic
cycle analysis
Specialist resources are necessary - lots of them
Source: Schroders, 31 December 2009
*Team of 30 includes portfolio management, quant analysis, research, trading and support
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Optimisation, risk
analysis, hedging
Asset allocation in practice
Getting ideas into the portfolio – the Schroders way
−
−
Global asset allocation
committee members sponsor
and co-sponsor ideas
Challenged by colleagues
Alan Brown, Keith Wade, Johanna Kyrklund,
Simon Doyle and Richard Coghlan
Sponsor
Co-Sponsor
Long High
Yield Debt
vs.
Cash
Cash
Johanna Kyrklund
Alan Brown
Long
Investment
Grade
vs.
US
Government
Government
Bonds
Bonds
Keith Wade
Johanna Kyrklund
−
All ideas structured as
long/short positions
−
Analysis to ensure risk control
and diversification
−
Implemented quickly, to take
advantage of market conditions
Short
Long Equities
Equities vs.
Cash
Cash
−
Accountable and transparent
process
Long
LongPacific
Can $
vs.
Basin Equities
Australian
US Equities$
Richard Coghlan
Simon Doyle
Long
Emerging
Market
Currencies
G3
G3
Currencies
Currencies
Johanna Kyrklund
Keith Wade
Source: Schroders, for illustration only
5
5 Voting Members
GlobalAsset
AssetAllocation
Allocation
Global
Committee
Committee
(monthly)
vs.
Keith Wade
Richard Coghlan
Implementing your ideas efficiently – Active or Passive funds ?
Getting “Bang for your Buck”
Efficient
(Passive)
– Some benchmarks are much
harder to beat than others
– Focus on selecting actively
managed strategies only in
inefficient asset classes where
high probability of achieving
positive alpha exists
– Avoid paying active
management fees where
probability of positive alpha is
low by selecting low cost
passive funds
Inefficient
(Active)
Source: Lipper Hindsight, February 2010
Percentage of funds outperforming benchmark
+1%
1
2
+2%
+3%
European Money market
Swiss Equities
European Govt Bonds
Japanese Small Caps
UK Equities
US Agg Bonds
Emerging Market Debt
Index
5
12
15
16
20
21
23
10
16
9
4
6
8
5
3
3
3
4
2
Emerging Market Equity
24
13
8
5
Japanese Equities
24
18
13
9
European Corp Bonds
28
14
4
European Equity
32
22
14
13
Global Equities
35
30
24
18
Global Energy
40
16
9
European Small Caps
46
36
32
27
European Financials
50
23
21
19
US Small Caps
UK Agg Bonds
53
57
45
25
36
9
29
2
Portfolio construction
The right tools also make a big difference
SMART (Schroders Multi-Asset Risk Tool)
Quantitative framework
Cyclical model1
Expansion
Recession
Recession
Valuation
4
3
2
1
0
-1
-2
-3
Estimated US
Output Gap
Baseline forecast
model2
Equities cheap
Normalised over
10 years
+/- 1 SD
Equities expensive
90
92
94
96
98
00
02
04
06
08
10
Momentum model3
40
BUY equities
20
Equity total return
Y-on-Y %
0
-20
Sell equities
-40
-60
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
1
Source: Congressional Budget Office (CBO), Thomson DataStream, Schroders
Source: Thomson Datastream. Normalised Earnings yield minus bond yield
3 Source: Thomson Datastream. Equity year on year return
2
Multi-Asset Portfolio Construction
•
Risk Reporting and Decomposition
•
Portfolio Simulations
•
… and much much more
Slowdown
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
60
•
Recovery
4
2
0
-2
-4
-6
-8
-10
Solution 1: Global Asset Allocation
Proof that the processes and the resources work!
Investment Features
125
– Aims to provide absolute returns which are
uncorrelated with other asset classes
120
– Performance target of 10% above cash gross
of fees over rolling 12 months
115
Ann. strategy return:
Ann. strategy volatility:
Ann. LIBOR return:
Ann. excess return:
9.80%
6.41%
2.93%
6.87%
– Volatility target of 10-15% p.a.
110
Benefits
– Almost all positions implemented through
derivatives, keeping transaction costs low
105
– Fund uses Schroder’s proprietary risk software
to optimise allocations and manage risks
100
– More liquid and transparent than many macro
funds
Jan Mar May Jul Sep Nov Jan Mar May Jul Sep Nov Jan Mar
08 08 08 08 08 08 09 09 09 09 09 09 10 10
Global Tactical Asset Allocation
– Diversifying within portfolio
Source: Schroders. Chart shows monthly performance for the Global Tactical Asset Allocation portfolio. The Strategy was operating on a live
basis in a managed account with £4 million of Schroder seed capital from January 2008 until April 2009.
Performance shown is past performance. Past performance is not necessarily a guide to future performance. The value of investment can go
down as well as up and is not guaranteed.
8
3 month £ LIBOR
Solution 2: Diversified Growth Fund
Equity like returns with 2/3 the risk of equities
Equities 44%
A smoother path of returns over time
170
Em. Market Debt 11%
160
High Yield
Bonds 9%
Schroder ISF Global High Yield 6%
Bluebay High Yield Fund 3%
130
Infrastructure 3%
120
Absolute Return 2%
Private Equity 2%
Schroder ISF Asia Pacific Property Securities 3%
Invista Foundation Property Trust REIT 1%
International Public Partnerships 2%
HSBC Infrastructure Company Ltd Ordinary1%
JP Morgan Highbridge Statistical Market Neutral Fund 2%
Private Equity* 2%
Schroder ISF EURO Corporate Bond 3%
Vanguard Inv Grade Credit Fund 3%
Tactical
Inv. Grade
Bonds 6%
100
Strategic
Schroder AS Commodity Fund 4%
Schroder ISF Global Energy 4%
ETFS Gold 2%
Property 4%
110
Schroder ISF Emerging Market Debt Absolute Return 6%
PIMCO Emerging Market Bond Fund 5%
Commodities 10%
150
140
Schroder ISF US Small & Mid Cap 9%
Schroder ISF QEP Global Quality 7%
Schroder ISF QEP Global Active Value 6%
Schroder ISF European Special Situations 3%
Schroder ISF Emerging Markets 3%
Schroder ISF Asian Equity Yield 3%
Schroder ISF European Equity Alpha 2%
Schroder ISF European Allocation1%
Passive Equity Derivatives 10%
Time
Convertibles 4%
CPI +5%
Global Equities
Cash 8%
Schroder ISF Global Convertible Bond 4%
Cash 8%
Diversified Growth Fund
Source: Schroders as at 26 February 2010. Please note that this is indicative exposure only and may change, subject to market conditions and outlook
*Private Equity includes allocation to Schroder PEFOF IV plus 1 listed externally managed fund. Total may not sum to 100 due to rounding
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Externally Sourced
Solution 3: Diversified Completion Fund
Fully managed access to alternative investments
Designed specifically to ‘complete’ a growth portfolio of equities
Asset Allocation as at 1 March 2010
Targets cash + 4% p.a. over rolling 5 year periods
Maintains a beta of less than 0.5 to equities
Full ongoing governance responsibility
– Manager selection
– New asset classes as appropriate
Transparent fees
Return from Dec 07 to Dec 09: +5.8% p.a.
Source: Schroders, as at 1 March 2010
10
High Yield Debt 19%
Commodities 14%
Hedge Funds 11%
Emerging Market Debt 11%
Infrastructure 7%
Catastrophe Risk 6%
Property 6%
Leveraged Loans 4%
Private Equity 3%
Active Currency 2%
Convertible Debt 2%
Cash 15%
Solution 4: Global Dynamic Balanced Fund
Limiting the downside
Schroder Global Dynamic Balanced Fund
Calendar Year Performance
Return %
– Like the Diversified Growth
Fund, but with a systematic
overlay that exits the market
during a downturn
40
30
20
10
– Aims to limit drawdowns to
-10% in the worst years for
risk assets
– Active allocation to risk assets,
between 0% and 60%
0
-10
-20
Avoiding bursting of tech bubble
-30
-40
Avoiding worst of credit crunch
Strategy
Source: Schroders, Datastream as at 31st December 2009. Backtested performance until 31st December 2008, live performance from 1st January
2009. Live performance is gross of fees using NAV for I shares. The simulated results must be considered as no more than approximate
representation of the strategy’s potential performance. They are the result of back-testing quantitative research results, which are based on a number
of assumptions. There are a number of limitations on the retroactive reconstruction of any performance results based on simulations. Past
performance is not a guarantee of future results
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Equity Market
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
-50
New solutions: Real assets fund
Durable goods
% contribution to CPI- U y/y
Rent of shelter
80%
60%
40%
20%
0%
-20%
-40%
-60%
Asset
Strategic Current
Weights Views
DJ AIG CMCI
Commodity Index
25%
28%
80%
TIPS
20%
10%
60%
40%
CS Leveraged Loans
10%
12%
ELMI+
10%
20%
FTSE EPRA/NAREIT
Global
10%
3%
MSCI Energy
10%
10%
88
90
92
94
96
98
00
02
04
06
08
20%
0%
-20%
-40%
-60%
% contribution to CPI- U y/y
Commodities*
% contribution to CPI- U y/y
The ‘real’ answer to future inflation?
88
90
92
94
96
98
00
02
04
06
08
30%
20%
10%
0%
-10%
MSCI Metal and Mining 10%
7%
MSCI EM
5%
5%
High dividend stocks
n/a
5%
-20%
-30%
88
90
92
94
96
98
00
02
04
06
08
Source: Bureau of Labour Statistics, Data Stream, Schroders. *Food and beverages & non durables less food and beverages
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New solutions: DC pensions market
‘Pension Plus’ – your retirement supplement
Accumulation Period
Drawdown Period
Maximum allocation to growth assets
No drawdown distribution
Monthly drawdown payments
from Year 11 to Year 25.
Coupons are deducted from the NAV
NAV
Highest NAV
100%
Inception
Year 25
Protected Drawdown
Bonus Payout*
Payments set at 5% p.a.
of highest recorded NAV
during the accumulation period
Final NAV is paid out to the investor.
A proportion of the Bonus Payout
will be incrementally protected
if the NAV of the fund is high.
* Subject to market conditions
Source: Schroders
13
Year 10
Matching liabilities – bonds or swaps?
A Comparison
Bonds for liability coverage
Swaps for liability coverage
– Accuracy of liability matching is limited
– Better accuracy of liability matching
– Extent of coverage broadly limited to size of bond
portfolio
– Extent of coverage can be much larger than assets
in LDI portfolio
– Low expected return
– Frees up assets to pursue growth strategies
– However, longer dated gilt yields are higher than
swap yields
– Lower yields at longer maturities than gilts
Liabilities
Liability
coverage
Backing
assets
Liabilities
Bonds
Bonds
Source: Schroders, for illustration only
LDI Swaps
Equities
Swaps
Growth assets
Liability Driven Investment
Reducing liability risks - using swaps rather than bonds
Liabilities
Key :
Dynamic Allocation
Portfolio Structure
Swap Overlay
Cash
Cash Holdings
Return Generating Assets
Portfolio Management
Interest rates fall / Inflation rises
Interest rate and
inflation swaps
Cash
Buffer
10%
5%
Interest rates rise / Inflation falls
Note: Percentages shown above for illustration only. Actual amounts depend on the structure of the hedge
Source: Schroders, for illustration only
Return Generating Assets
85%
Schroders LDI – the third generation solution
Platform structure and management
Liabilities
Portfolio structure
Liability management
Collateral
Key :
Dynamic Allocation
Cash Holdings
Return Generating Assets
Portfolio management
Cash movement
Synthetic credit
Cash Fund
Longevity swaps
Collateral
IRS and inflation hedge
Cash movement
Return generating
assets
Conclusion
– Diversification is your first defence against market uncertainty
– But diversification by itself is not enough, it must also be dynamic
– Your asset allocation is what matters most – so make it your main focus
– Be obsessive about risk, and the returns will look after themselves
– Risk and return objectives should be ‘real’, not ‘relative’
– Be capital efficient when matching your liabilities
Say ‘No’ to a traditional balanced approach; say ‘Yes’ to dynamic asset allocation
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Important information
For Professional Investors only. Not Suitable for Retail Clients
This presentation is for information purposes only and it is not intended as promotional material in any respect. The material
is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Schroders has expressed its
own views and opinions in this document and these may change. Information herein is believed to be reliable but Schroder
Investment Management Ltd (SIM) does not warrant its completeness or accuracy. This does not exclude or restrict any duty
or liability that SIM has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time)
or any other regulatory system
The forecasts stated in the presentation are the result of statistical modelling, based on a number of assumptions. Forecasts
are subject to a high level of uncertainty regarding future economic, and market factors that may affect actual future
performance. The forecasts are provided to you for information purposes as at today's date. Our assumptions may change
materially with changes in underlying assumptions that may occur, among other things, as economic and market conditions
change. We assume no obligation to provide you with updates or changes to this data as assumptions, economic and
market conditions, models or other matters change
Issued in July 2009 by Schroder Investment Limited, 31 Gresham Street, London EC2V 7QA. Registration No 2015527
England
Authorised and regulated by the Financial Services Authority
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