Preparing for the Unknown Unknowns - Forward-looking Portfolio Stress Testing. Canadian Investment Review Risk Conference

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1 This presentation is intended for investment professionals and must not be relied on by anyone else Preparing for the Unknown Unknowns - Forward-looking Portfolio Stress Testing Canadian Investment Review Risk Conference Rahul Khasgiwale, CFA, CAIA Investment Director A Scot will do anything to protect his pension!

2 Agenda Why? How? Examples Next steps 3 Why? 4

3 Limitations of traditional asset allocation Governance structure: Strategic Benchmark What asset Broad weights TAA limits e.g. +/-5% Tracking Error limit Derived Using: Historical data Asset class volatilities Correlations Capital market outlook Intuitive beliefs 5 Correlations can change quickly 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

4 Buy insurance? Tail risk protection as many imagine it would be Fantastic if it was affordable % p.a S&P 500 Total Return Index Cash Return Index (3m rates) Protected index, no cost Protected index allowing for cost Historical scenarios have limitations Historical scenario analysis Black Monday 1987 Gulf War 1990 Rate Rise 94 Mexican Crisis 1995 Asian Crisis 1997 Russian/LTCM Tech Wreck ( April 7-14, 2000) Sept 11th Equity Sell-Off (August 23 - October 9, 2002) Equity Rally (October 10 - November 27,2002) Gulf War 2 (March 1-23,2003) Bond Rally (May 1 - June 13, 2003) Bond Sell-Off (June 14 - July 31, 2003) Emerging Market Sell-Off 2006 (May 1 - June Subprime Debacle 2007 (July 15 - August 15, 2007) Bank Meltdown 2008 ( September 12 - October Euro Crisis (July 22 - August 23, 2011) QE jitters (May 22 - June 24, 2013) % Move * MSCI World Returns prior to 2000 denoted in European Currency Units, except for 1987 which is denoted in German Marks Source: Standard Life Investments GARS SICAV, RiskMetrics, 31/12/2013 AR portfolio MSCI World History is only a sample of what might have happened 8

5 How? Scenario construction Multi-variate model for tail-risk analysis Entropy pooling 9 Scenario Construction 10

6 Multi-variate model for tail-risk analysis Weekly returns S&P 500 index vs. Merrill Lynch Corporate Master Source: Bloomberg, Standard Life Investments (as of July 2013) 11 Multi-variate model for tail-risk analysis Weekly returns S&P 500 index vs. Merrill Lynch Corporate Master Source: Bloomberg, Standard Life Investments (as of July 2013) 12

7 Credit return Entropy pooling Equity Return 13 Entropy pooling Separate regimes have their own characteristics 14

8 Credit return Entropy pooling Equity Return Setting parameters makes the most relevant regimes appear 15 Entropy pooling Re-weighted outcomes (size corresponds to weight) Source: Standard Life Investments (as of July 2013) 16

9 Examples Abrupt end to QE EU moves apart Commodity shock China crisis Trade war QE continues Russia West standoff 17 Example: Absolute Return portfolio China Crisis Rebalancing causes growth to slow significantly Compounded by rising inflation / wages Demographics limits future development Key Factor Shock CNY Volatility 4.8% Australian Dollar -15% MSCI EM -75% Copper -60% Sources: Standard Life Investments & Bloomberg. May

10 Example: Absolute Return portfolio US Dollar v Canadian Dollar Long equity volatility US Dollar v Euro US equity technology v small cap Asian v S&P volatility US Dollar V Japanese Yen European short dated interest rates Japan v Korea equity European v US and Japanese duration Australian short dated interest rates German v French Equity Mexican Government Bonds High yield credit Mexican Peso v Australian Dollar Global equity oil majors Global equity Global REITs Chinese Equity European equity Source: Standard Life Investments May % -2% -1% 0% 1% 2% 3% 4% 19 12% Example: Absolute Return portfolio China crisis Global Equity (-37.20%), Multi-Asset AR Portfolio (-6.15%) 10% 8% 6% 4% 2% 0% Equity Multi-Asset AR Portfolio Source: Standard Life Investments May

11 Next steps Add forward stress-testing to your suite of risk tools Review existing processes Consider incorporating absolute return strategies 21 The information shown relates to the past. Past performance is not a guide to the future. The value of investment can go down as well as up. Any data contained herein which is attributed to a third party ("Third Party Data") is the property of (a) third party supplier(s) (the Owner ) and is licensed for use by Standard Life**. Third Party Data may not be copied or distributed. Third Party Data is provided as is and is not warranted to be accurate, complete or timely. To the extent permitted by applicable law, none of the Owner, Standard Life** or any other third party (including any third party involved in providing and/or compiling Third Party Data) shall have any liability for Third Party Data or for any use made of Third Party Data. Past performance is no guarantee of future results. Neither the Owner nor any other third party sponsors, endorses or promotes the fund or product to which Third Party Data relates. **Standard Life means the relevant member of the Standard Life group, being Standard Life plc together with its subsidiaries, subsidiary undertakings and associated companies (whether direct or indirect) from time to time." Montréal Toronto Calgary Investissements Standard Life inc. Standard Life Investments Inc. Standard Life Investments Inc. 1001, de Maisonneuve Blvd. West 121 King Street West 639 5th Avenue S.W. Suite 1000 Suite 810 Suite 1700 Montréal, Québec Toronto, Ontario Calgary, Alberta H3A 3C8 M5H 3T9 T2P 0M9 Standard Life Investments Inc., with offices in Calgary, Montréal and Toronto, is a wholly owned subsidiary of Standard Life Investments Limited. Standard Life Investments Limited is registered in Scotland (SC123321) at 1 George Street, Edinburgh EH2 2LL. Standard Life Investments Limited is authorised and regulated in the UK by the Financial Conduct Authority. Calls may be monitored and/or recorded to protect both you and us and help with our training Standard Life, images reproduced under licence 22