Aspects of risk
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Aspects of Risk. Risk Management Within The Investment Portfolio. September 28, 2011. © 2011 Towers Watson. All rights reserved. Conference Logistics. This conference is being recorded.

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Aspects of risk

Aspects of Risk

Risk Management Within The Investment Portfolio

September 28, 2011

© 2011 Towers Watson. All rights reserved.


Conference logistics

Conference Logistics

  • This conference is being recorded.

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  • The presentation and a replay will emailed to participants on September 30, 2011.


Today s presenters

Today’s Presenters

  • Jon Pliner, Investment Strategy Consultant

  • Mark Ruloff, Director of Asset Allocation


Today s discussion

Today’s Discussion

  • Opening Thoughts

  • Payout/Liability Hedging

  • Better Diversification

  • Risk Steering

  • Risk Pricing

  • Long-Termism Risk Return Concepts

  • Beyond Investment Policy

  • Closing Thoughts

4


Opening thoughts

Opening Thoughts

  • Holistic

  • Many tools beyond diversification and liability hedging

  • Risk return management

5


Standard efficient frontier

Standard Efficient Frontier

Most

Desirable

Efficient Frontier

Point Labels represent % fixed income

6


Asset liability efficient frontier

Asset/Liability Efficient Frontier

Most Desirable

7


Liability hedging

Liability Hedging

Desirable

8


An eventful couple of months

An Eventful Couple of Months

Consumer confidence indicators

Sources: Thomson, Towers Watson

EM: Emerging Markets DM: Developed Markets

9


Government bonds

Government Bonds

Bond Yield Curves (As of August 31, 2011)

Source: Bank of England, Deutsche Bundesbank, Federal Reserve, Bank of Japan

10


Diversified portfolio risk return buckets

Diversified Portfolio: Risk/Return Buckets

Source of returns as a percentage of total return

Typical portfolio

Well diversified portfolio

Skill risk premium

Insurance risk premium

Equity risk premium

Skill risk premium

Equity risk premium

Inflation risk premium

Inflation risk premium

Credit risk premium

Credit risk premium

Term risk premium

Term risk premium

11


Sample db pension fund

Sample DB Pension Fund

Traditional

Unconstrained

Emerging wealth

Emerging wealth

Private markets

Private markets

Alternative beta

Developed equities

Liability hedging overlay

Hedge funds

Alternative beta

Developed equities

Alternative credit

Corporate bonds

Corporate bonds

Treasuries and cash

Treasuries and cash

Source: Towers Watson

12


Equities

Equities

Most markets look attractive based on simple valuation metrics

Sources: Bloomberg LP, Towers Watson

Markets have failed to rally significantly from the August lows

Sources: Bloomberg LP, Towers Watson

13


Sample analysis of dynamic asset allocation cumulative contributions plus deficits

Sample Analysis of Dynamic Asset Allocation: Cumulative Contributions plus Deficits

Asset/Liability Frontier Year 2019

$200

6%

8%

4%

10%

$210

2%

12%

4%

6%

14%

2%

8%

16%

Combined: PV of Cumulative Contribution + TL Deficit ($M)

50th Percentile

20%FI (LGC)

30%FI (LGC)

18%

10%

40%FI (LGC)

20%

22%

12%

24%

26%

28%

14%

30%

50%FI (LGC)

$220

16%

18%

20%

22%

24%

26%

28%

30%

$230

$320

$330

$340

$350

$360

$370

$380

Combined: PV of Cumulative Contribution + TL Deficit ($M)

14

95th Percentile


Risk steering

Risk Steering

  • Dynamic Asset Allocation

    • Separating funded status trigger into interest rates, returns, and contributions

    • In declining markets

  • Enterprise Risk Management

    • Compare investment portfolio options with core operations

  • Consideration of investments compared to core business risks

    • Sponsor Beta

    • Commodities

    • Inflation

    • Cash contributions

15


Collared vs uncollared domestic equities annual return

Collared vs. Uncollared Domestic Equities: Annual Return

50th %ile – both

75th %ile – Collar

25th %ile – both

75th %ile – no Collar

5th %ile – Collar

5th %ile – no Collar

95th %ile – Collar

95th %ile – no Collar

16

16


Development of liability hedging elements

Development of Liability Hedging Elements

Sources: BarCap, Towers Watson

17


Risk pricing

Risk Pricing

  • Puts, calls, and collars

  • Swaps, Swaptions, and Swaption collars

  • Generally would be a loss of value if done always and passively

  • Requires good governance to know when to use and how to implement

  • Could depend on connection with enterprise risks

    • Put on swaption to avoid “unbearable” situation, like breaking of bond covenants

18


Long termism risk return concepts in model portfolio

Long-Termism Risk/Return Concepts in Model Portfolio

  • Risk framework

    • Risk return framework

    • Risk return management, not just measurement

    • Long-term risk return management framework

  • Risk scenarios

  • Theme investing

  • Extreme risks


Sustainability

Sustainability

Universal Owner

Social and Environmental Goals

Return Goals

Sustainable Investing

Risk Management Goals

20


Beyond investment policy

Beyond Investment Policy

Effective at managing short-term plan cost and volatility

Effective at managing active liability risk profile and long-term plan cost

FUNDING STRATEGY

BENEFIT STRATEGY

PensionRisk

Effective at managing long-term plan cost and volatility

Effective only for short-term issues

INVESTMENTSTRATEGY

ASSUMPTIONS & METHODS

21


Closing thoughts

Closing Thoughts

  • Holistic

  • Many tools beyond diversification and liability hedging

  • Risk return management

22


Questions

Questions

23


Disclaimer

Disclaimer

  • The information included in this presentation is general information only and should not be relied upon without further review by the appropriate professional advisors. Towers Watson is not a law firm or accounting firm, and we are not providing legal, accounting or tax services or advice. Some of the information included in this presentation might involve the application of law; accordingly, we strongly recommend that audience members consult with and involve their legal counsel and other professional advisors as appropriate to ensure that they are fully advised concerning such matters. Additionally, material developments may occur subsequent to this presentation rendering it incomplete and inaccurate. Towers Watson assumes no obligation to advise you of any such developments or to update the presentation to reflect such developments.


Contact details

Contact Details

  • Jon Pliner

    • 335 Madison Avenue, New York, NY 10017-4605

    • 212-309-3811

    • [email protected]

  • Mark Ruloff

    • 901 N. Glebe Road, Arlington, VA 22203

    • 703.258.8058

    • [email protected]

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