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Asset Allocation Solutions for Pension & Insurance Companies. John McLaughlin Head of Multi Asset Solutions. May 2010 | For professional investors only. This material is not suitable for retail clients. Getting the balance right. Liabilities. Bonds. Equities.

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slide1

Asset Allocation Solutions for Pension & Insurance Companies

John McLaughlin

Head of Multi Asset Solutions

May 2010 |For professional investors only. This material is not suitable for retail clients

getting the balance right
Getting the balance right

Liabilities

Bonds

Equities

Is a traditional balanced approach the answer?

  • Diversification is limited to 2 or 3 asset classes
  • Benchmark is not aligned to the client’s ultimate objective
  • Focus is greatest where the opportunity is least
  • Asset allocation is slow moving and lacks conviction
  • Risk management amounts to monitoring a tracking error
  • Liabilities are difficult to match using bonds and are not particularly capital efficient

1

slide3

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

*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 30th June 2009.

2

slide4

Cash

Equity

Illiquidity

Term

Credit

Volatility

Skill

Equity

Private Equity

Property

Infra-structure

High Yield

Com-modities

Hedge Funds

Currency

Dynamic multi-asset investing

Say ‘No’ to the traditional approach

No Benchmark

  • Target an absolute risk/return outcome
  • No Limits
  • Broad diversification by

Asset type

Risk source

Investment vehicle

  • No Fear
  • High conviction asset allocation:
    • Capital rotation through the market cycle
    • Taking advantage of valuation opportunities
    • Realising investment themes
  • No Surprises
  • Construct portfolios based on risk weighting, not trade weighting
  • Observe and control the portfolio through different risk lenses e.g. VaR, factor risk, liquidity risk
  • Use customised, quantitative risk management tools

Easy to say, not so easy to do ….. successfully

slide5

Schroders asset allocation model

Asset allocation is hard to do well

Quarterly

Monthly

Daily

Cyclical Market Forum

Global Asset Allocation Committee

Fund Management & Analysis

Fund Managers & Analysts

40+ Senior Fund Managers / Analysts

5 Independent Multi-Asset Specialists

22 Fund Managers and Analysts

Equity

163

Gather Information

  • Outlook for asset classes
  • Specialist views
  • Discuss economic scenarios

Determine Investment Policy

  • Asset class preferences
  • Conviction & Accountability
  • Set stop-loss/take-profit

Construct Portfolios

  • Sizing positions
  • Fund / Vehicle selection
  • Monitor risk & return

Fixed Income

53

Alternatives

67

Risk Management

InvestmentStrategy

16 quants and derivative experts

5 macro economists

Models & economic cycle analysis

Optimisation, risk analysis, hedging

Specialist resources are necessary - lots of them

Source: Schroders, 31 December 2009

*Team of 30 includes portfolio management, quant analysis, research, trading and support

4

slide6

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
  • All ideas structured as long/short positions
  • Analysis to ensure risk control and diversification
  • Implemented quickly, to take advantage of market conditions
  • Accountable and transparent process

5 Voting Members

Global Asset Allocation

Global Asset Allocation

Alan Brown, Keith Wade, Johanna Kyrklund,

Committee (monthly)

Committee

Simon Doyle and Richard Coghlan

Sponsor

Sponsor

Co

Co

-

-

Sponsor

Sponsor

Long High

Long High

vs.

vs.

Cash

Cash

Johanna Kyrklund

Johanna Kyrklund

Alan Brown

Alan Brown

Yield Debt

Yield Debt

Long

Long

vs.

vs.

US

US

Keith Wade

Keith Wade

Johanna Kyrklund

Investment

Investment

Government

Government

Grade

Grade

Bonds

Bonds

Short Equities

Long Equities

vs.

vs.

Cash

Cash

Keith

Wade

Richard Coghlan

Long Pacific

Long Can $

vs.

vs.

Australian $

US Equities

Richard Coghlan

Simon Doyle

Basin Equities

Long

Long

vs.

vs.

G3

G3

Johanna Kyrklund

Johanna Kyrklund

Keith Wade

Emerging

Emerging

Currencies

Currencies

Market

Market

Currencies

Currencies

Source: Schroders, for illustration only

5

implementing your ideas efficiently active or passive funds
Implementing your ideas efficiently – Active or Passive funds ?

Getting “Bang for your Buck”

  • Efficient (Passive)
  • Percentage of funds outperforming benchmark
  • 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

slide8

Portfolio construction

The right tools also make a big difference

Quantitative framework

  • SMART (Schroders Multi-Asset Risk Tool)
  • Multi-Asset Portfolio Construction
  • Risk Reporting and Decomposition
  • Portfolio Simulations
  • … and much much more

Cyclical model1

Valuation model2

Momentum model3

1 Source: Congressional Budget Office (CBO), Thomson DataStream, Schroders

2 Source: Thomson Datastream. Normalised Earnings yield minus bond yield

3 Source: Thomson Datastream. Equity year on year return

slide9

Solution 1: Global Asset Allocation

Proof that the processes and the resources work!

Investment Features

  • Aims to provide absolute returns which are uncorrelated with other asset classes
  • Performance target of 10% above cash gross of fees over rolling 12 months
  • Volatility target of 10-15% p.a.

Benefits

  • Almost all positions implemented through derivatives, keeping transaction costs low
  • Fund uses Schroder’s proprietary risk software to optimise allocations and manage risks
  • More liquid and transparent than many macro funds
  • Diversifying within portfolio

Ann. strategy return: 9.80%Ann. strategy volatility: 6.41%Ann. LIBOR return: 2.93%Ann. excess return: 6.87%

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

solution 2 diversified growth fund
Solution 2: Diversified Growth Fund

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%

Equity like returns with 2/3 the risk of equities

Equities 44%

A smoother path of returns over time

Schroder ISF Emerging Market Debt Absolute Return 6%

PIMCO Emerging Market Bond Fund 5%

Em. Market Debt 11%

Schroder AS Commodity Fund 4%

Schroder ISF Global Energy 4%ETFS Gold 2%

Commodities 10%

Strategic

Schroder ISF Global High Yield 6%

Bluebay High Yield Fund 3%

High Yield Bonds 9%

Schroder ISF Asia Pacific Property Securities 3%

Invista Foundation Property Trust REIT 1%

Property 4%

International Public Partnerships 2%

HSBC Infrastructure Company Ltd Ordinary1%

Infrastructure 3%

JP Morgan Highbridge Statistical Market Neutral Fund 2%

Absolute Return 2%

Private Equity* 2%

Private Equity 2%

Schroder ISF EURO Corporate Bond 3%

Vanguard Inv Grade Credit Fund 3%

Inv. Grade Bonds 6%

Time

Tactical

Schroder ISF Global Convertible Bond 4%

Convertibles 4%

CPI +5%

Externally Sourced

Cash 8%

Cash 8%

Global Equities

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

9

slide11
Designed specifically to ‘complete’ a growth portfolio of equities

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.

Solution 3: Diversified Completion Fund

Fully managed access to alternative investments

Asset Allocation as at 1 March 2010

Source: Schroders, as at 1 March 2010

10

slide12

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
  • Aims to limit drawdowns to -10% in the worst years for risk assets
  • Active allocation to risk assets, between 0% and 60%

Avoiding bursting of tech bubble

Avoiding worst of credit crunch

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

11

slide13

New solutions: Real assets fund

The ‘real’ answer to future inflation?

Commodities*

Rent of shelter

Durable goods

Source: Bureau of Labour Statistics, Data Stream, Schroders. *Food and beverages & non durables less food and beverages

12

slide14

Drawdown Period

Accumulation Period

Monthly drawdown payments

from Year 11 to Year 25.

Coupons are deducted from the NAV

Maximum allocation to growth assets

No drawdown distribution

Bonus Payout*

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.

Protected Drawdown

Payments set at 5% p.a.

of highest recorded NAV

during the accumulation period

New solutions: DC pensions market

‘Pension Plus’ – your retirement supplement

NAV

Highest NAV

100%

Inception

Year 10

Year 25

* Subject to market conditions

Source: Schroders

13

slide15

Matching liabilities – bonds or swaps?

A Comparison

Bonds for liability coverage

  • Accuracy of liability matching is limited
  • Extent of coverage broadly limited to size of bond portfolio
  • Low expected return
  • However, longer dated gilt yields are higher than swap yields

Swaps for liability coverage

  • Better accuracy of liability matching
  • Extent of coverage can be much larger than assets in LDI portfolio
  • Frees up assets to pursue growth strategies
  • Lower yields at longer maturities than gilts

Liabilities

Liabilities

Liability coverage

Bonds

LDI Swaps

Swaps

Backing assets

Bonds

Growth assets

Equities

Source: Schroders, for illustration only

slide16

Key

:

Liability Driven InvestmentReducing liability risks - using swaps rather than bonds

Liabilities

Dynamic Allocation

Portfolio Structure

Swap Overlay

Cash Holdings

Cash

Return Generating Assets

Portfolio Management

Interest rates fall / Inflation rises

Cash Buffer

Interest rate and inflation swaps

Return Generating Assets

85%

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

schroders ldi the third generation solution platform structure and management

Key

:

Schroders LDI – the third generation solutionPlatform structure and management

Liabilities

Dynamic Allocation

Portfolio structure

Liability management

Cash Holdings

Collateral

Return Generating Assets

Portfolio management

Cash movement

Synthetic credit

Return generating assets

Cash Fund

Collateral

Longevity swaps

IRS and inflation hedge

Cash movement

conclusion
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

17

slide19
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

Important information