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

Transcription

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

2 Pensions need consistency but markets deliver chaos Discrete Yearly Performance (%) by Market 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

3 Rotate based on outlook? Recovery Real GDP 8 Overheat Inflation Recession 4 Stagflation

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

5 Unstable risk characteristics Correlation to Global Equities of diversifying assets 90% 80% % 60% 50% 40% 30% 20% 10% 0% Property FX Basket Commodities Corporate Bonds Emerging Market Bonds High Yield 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

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

7 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

8 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

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

10 Broad based return potential with genuine diversity 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 Correlation to Global Equity Source: Standard Life Investments, Sungard APT, 31 March 2015

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

12 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) * 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 % Move

13 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 Now China crisis Dunkin Disappointment Trade war Commodity shock

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

15 Acropolis Now Description Key Factor (examples) Shock (estimates) Debt re profiling unsuccessful so Greek exit is prepared European Equity 40% Depositors withdraw bank deposits and gov t bonds default Euro 15% QE fails to stem contagion through Europe and beyond Italian 10y yld +300bps Political uncertainty in UK and Spain makes investors nervous German 10y yld 30bps Sources: Standard Life Investments & Bloomberg, March 2015

16 Dunkin Disappointment Description Key Factor (examples) Shock (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

17 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

18 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

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

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