De-risking and Beyond
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This document summarizes a presentation given by Robert Gardner of Redington on de-risking pension strategies and alternative investments. The presentation covers the current challenging economic environment for UK pensions, introduces the concept of liability driven investments (LDI) and dynamic de-risking, and provides examples of alternative investments that can provide long-term inflation-linked cash flows like infrastructure and social housing assets. The document emphasizes setting clear objectives and using a risk management framework to monitor investments and adapt strategies over time to better meet pension goals and de-risk liabilities.
![Objective Triggers Performance Indicators Actual Performance
What is the overall objective? Full funding on self-sufficiency basis By 2020 on a swaps + [50]bps basis with
contributions of £[25]m p.a.
How will we measure the objective? Required return on the scheme’s assets Required return of assets is swaps +
[160]bps
What are the primary risk targets? Required return at risk (RRaR)
Contributions at Risk (CaR)
RRaR < swaps +[200]bps
CaR should be kept below £[50]m
What is the secondary risk target? Value at Risk (VaR) VaR should not exceed [20]% of the
liabilities
What are the primary aspirational
targets?
To be fully inflation and interest rate
hedged
Hedge ratios should be equal to [100%]
What are the secondary aspirational
targets?
Increase efficiency of hedges by earning
more return for same risk
Regular monitoring of relative value of
swaps vs. gilts
What is the primary scheme
constraint?
Liquidity Sufficient liquidity to make pension
payments
What is the secondary scheme
constraint?
Collateral requirements Enough available collateral to cover the 1-
year derivative [VaR95]
Metric is at or
above target
Metric is within
10%of target
Metric is more
than 10% away
from target
Setting Clear Goals & Objectives
The Pensions Risk Management Framework](https://image.slidesharecdn.com/rob-gardner-aca-de-risking-and-beyond-3-feb-2012-130503091517-phpapp02/85/De-risking-and-Beyond-8-320.jpg)
De-risking and Beyond
- 1. Redington 13-15 Mallow Street London EC1Y 8RD T. 020 7250 3331 www.redington.co.uk twitter.com/redingtontweets ACA Members’ Conference – 2012: Challenging Times De-risking and beyond Robert Gardner, Redington 3rd February 2012
- 2. 2 Contents Where are we? • UK Pensions Today – 30-year gilt yield Where are we going? • Liability Driven Investments • Setting Clear Goals & Objectives Importance of Strong Governance The Pensions Risk Management Framework The Flight Plan How do we get there? • Dynamic De-Risking • Alternative Sources of Inflation-Linked Assets Key Features Examples Water Infrastructure
- 3. 3 UK Pensions Today 30 Year Nominal Gilt Yield
- 4. 4 Liability Driven Investments (LDI) Maximise your Toolset
- 5. Liability Driven Investments (LDI) A Chronology 5 0.0 0.5 1.0 1.5 2.0 2.5 3.0 30-YearGiltRealYieldin% Boots Pension Fund shifts to 100% AAA long- dated sterling bond allocation DMO issues 50-year inflation-linked gilt F&C launches equity-linked pooled bond fund 30-Year Gilt Real Yield & Key Events in LDI Inflation concerns elevated after oil price hits record $145 per barrel Friends Provident implements first derivative-based inflation and interest rate hedge Collapse of Lehman Brothers, traditional gilt/swap spread inverts Barclays Global Investors launches segregated and pooled funds for LDI Source: Bloomberg, Redington
- 6. 6 Setting Clear Goals & Objectives Good Governance = Ability to ACT
- 7. 7 Setting Clear Goals & Objectives The PRMF Dashboard
- 8. Objective Triggers Performance Indicators Actual Performance What is the overall objective? Full funding on self-sufficiency basis By 2020 on a swaps + [50]bps basis with contributions of £[25]m p.a. How will we measure the objective? Required return on the scheme’s assets Required return of assets is swaps + [160]bps What are the primary risk targets? Required return at risk (RRaR) Contributions at Risk (CaR) RRaR < swaps +[200]bps CaR should be kept below £[50]m What is the secondary risk target? Value at Risk (VaR) VaR should not exceed [20]% of the liabilities What are the primary aspirational targets? To be fully inflation and interest rate hedged Hedge ratios should be equal to [100%] What are the secondary aspirational targets? Increase efficiency of hedges by earning more return for same risk Regular monitoring of relative value of swaps vs. gilts What is the primary scheme constraint? Liquidity Sufficient liquidity to make pension payments What is the secondary scheme constraint? Collateral requirements Enough available collateral to cover the 1- year derivative [VaR95] Metric is at or above target Metric is within 10%of target Metric is more than 10% away from target Setting Clear Goals & Objectives The Pensions Risk Management Framework
- 9. 2012 2013 2014 2015 2016 2017 2018 2019 2020 GBPMillions Liabilities Path ActualLiabilities Assets Path ActualAssets Time Horizon Liability Basis Contributions &Asset Returns 9 Setting Clear Goals & Objectives The Flight Plan – from “set and forget” to “anticipate and react”
- 10. 10 Case Study – A Redington Client: Dynamic De-Risking The Pension Risk Management Framework in Action Original strategy 78.4% Dynamic de-risking 79.2% Low risk allocation (no derisking) 79.2% Original strategy 70.6% Low risk allocation (no de-risking) 71.8% Dynamic de-risking 76.2% Original strategy 82.3% Low risk allocation (no de-risking) 84.9% Dynamic de-risking 85.1% Funding level comparison 01/10/2010 – 07/09/2011 Fundinglevel Funding Level Volatility Original strategy 18% Low Risk Allocation 16% Dynamic de-risking 13% Source: Redington
- 11. 11 Growth “Flight Plan Consistent Assets” Matching Flight Plan Consistent Assets Key Features
- 12. 12 -6 -4 -2 0 2 4 6 8 0 5 10 15 20 25 30 GBPMillions Years Initial investment Attractive real returns Inflation-linked cashflows Providing a match for liabilities Inflows Outflows Source: Redington Flight Plan Consistent Asset – Example Cashflow Profile Flight Plan Consistent Assets Key Features
- 13. • Take advantage of attractive yields on long-term secured property leases • Yields may be in excess of yields on corporate bonds issued by same borrower • Long-dated index-linked cashflows Secured Leases • Ground rent created when freehold land or building is sold on long lease • Typically “pepper-corn” rent for land only (not buildings) • Offers attractive returns, limited credit risk and high level of security Ground Rents • Low-cost rental housing provided for disadvantaged people in need of housing • Generally provided by local councils and housing associations • Offers long-dated, inflation-linked cashflows from secured borrowers (i.e. housing associations) with quasi-government guarantee Social Housing • Investing in public sector projects through, for example, Private Finance Initiatives (PFIs), bespoke investments structures or by purchasing a suitable infrastructure asset • Wide range of possible assets, from roads to power generation • Long-term, potentially inflation-linked revenue streams Infrastructure Flight Plan Consistent Assets Examples
- 14. • Bought by HSBC in August 2011 (for warehousing) for £74m • Provides water for 300,000 people in Cambridgeshire • 2010/2011: Revenue of £20m with profits of £7m before tax with no external debt except for a revolving credit facility to cover working capital • Attractive purchase opportunity for a large pension fund or a consortium of funds • Redington advised two UK schemes who bid for this asset. However, although this bid was acceptable on price, it could not compete with the winning cash bid which had an accelerated timetable and no due diligence Flight Plan Consistent Assets Water Infrastructure Example: Tapping the illiquidity premium in water The UK water sector is an excellent example of a Flight Plan Consistent Asset, providing the security, returns and cashflows that pension funds need. • Economic environment has small impact on returns: water is a necessity and will therefore be demanded irrespective of economic growth. • Inflation-linked cashflows and returns: water companies’ regulatory regime means they can increase prices in line with the agreed price review which in turn is based on a formula related to RPI. • Low regulatory risk: The regulator’s desire to increase competition in the area could have a negative impact on returns but the Government is likely to block any such move. Water sector: key characteristics Case study: Cambridge Water 14
- 15. 15 Questions?
- 16. Contacts Disclaimer 16 Contacts Direct Line: +44 (0) 20 7250 3416 Telephone: +44 (0) 20 7250 3331 Redington 13-15 Mallow Street London EC1Y 8RD Robert Gardner Founder & Co-CEO robert.gardner@redington.co.uk www.redington.co.uk THE DESTINATION FOR ASSET & LIABILITY MANAGEMENT Disclaimer For professional investors only. Not suitable for private customers. The information herein was obtained from various sources. We do not guarantee every aspect of its accuracy. The information is for your private information and is for discussion purposes only. A variety of market factors and assumptions may affect this analysis, and this analysis does not reflect all possible loss scenarios. There is no certainty that the parameters and assumptions used in this analysis can be duplicated with actual trades. Any historical exchange rates, interest rates or other reference rates or prices which appear above are not necessarily indicative of future exchange rates, interest rates, or other reference rates or prices. Neither the information, recommendations or opinions expressed herein constitutes an offer to buy or sell any securities, futures, options, or investment products on your behalf. Unless otherwise stated, any pricing information in this message is indicative only, is subject to change and is not an offer to transact. Where relevant, the price quoted is exclusive of tax and delivery costs. Any reference to the terms of executed transactions should be treated as preliminary and subject to further due diligence . Please note, the accurate calculation of the liability profile used as the basis for implementing any capital markets transactions is the sole responsibility of the Trustees' actuarial advisors. Redington Ltd will estimate the liabilities if required but will not be held responsible for any loss or damage howsoever sustained as a result of inaccuracies in that estimation. Additionally, the client recognizes that Redington Ltd does not owe any party a duty of care in this respect. Redington Ltd are investment consultants regulated by the Financial Services Authority. We do not advise on all implications of the transactions described herein. This information is for discussion purposes and prior to undertaking any trade, you should also discuss with your professional tax, accounting and / or other relevant advisers how such particular trade(s) affect you. All analysis (whether in respect of tax, accounting, law or of any other nature), should be treated as illustrative only and not relied upon as accurate. ©Redington Limited 2012. All rights reserved. No reproduction, copy, transmission or translation in whole or in part of this presentation may be made without permission. Application for permission should be made to Redington Limited at the address below. Redington Limited (reg no 6660006) is registered in England and Wales. Registered office: 13-15 Mallow Street London EC1Y 8RD
- 17. Redington Publications 17 Spring Collection Highlights: LDI 2.0, Secured Leases, Ground Rents, Equity Release Mortgages, Social Housing, Insurance-Linked Securities, Infrastructure http://www.redington.co.uk/Redington/media/PDFs/ knowledge/Other%20Publications/Redington-Spring- Collection-2010.pdf Spring/Summer 2011 Collection: Enhanced Matching Assets, Socially Responsible Investing and Long-Term Growth Assets http://www.redington.co.uk/Redington/media/PDFs/knowledge/Other%20Publications/Re dington-Spring-Summer-Collection-2011.pdf Keeping up with the latest in LDI Redington publications