Presentation Transcript

1. Liability Surrogates Workshop Nick Spencer, Director, Client Strategy & Research Crispin Lace, Director, UK Pension Solutions 6 MARCH 2013
2. Imagine the perfect retirement investment
3. Imagine the perfect retirement investment II Arguably, the perfect investment for a pension fund would be: highly secure inflation-linked long term cashflows, matched to their future pension payments, and rates above government bonds even if the returns were expected to be below equities.
4. Sloth Alert... Are we just being lazy?
5. Today’s workshop: Liability Surrogates What are Liability Surrogates? Why are they of interest? Where do they fit? What are the issues?
6. What are Liability Surrogates? A steady contractual stream of future cashflows An income based return A return premium to compensate for illiquidity Some inflation hedging (typically real assets)
7. What are Liability Surrogates?
8. Why are they of interest?Liabilities above flight path, assets below – wrong type of outcome! Rates lower, longer: liabilities remain above flight path Longer flight paths: refocusing on growth & risk-efficient returns Source: Russell Investments: For illustrative purposes only, Asset proxy - Russell UK index, Liability proxy – 40% FTSE Actuaries Govt. Securities over 15 Years, 60% Actuaries Govt. Securities UK index linked over 15 Years, data from Jan 2007 to Dec 2012
9. I’m underfunded: get me out of here!Getting real on the yield you need Source: Russell Investments, Bloomberg , data from 31/05/1981 – 14/02/2013
10. Seek additional returns LIBOR+ Maximise return/marginal risk Duration adds to portfolio risk Where do they fit?Have we created an artificial divide in the portfolio? Hedge embedded interest and inflation exposures Hedge or not-hedging is active choice Gilts, futures or swaps Liability Hedging Growth Assets LIABILITY SURROGATES A third way? Modest additional return, but low risk to liabilities.
11. What are the issues? CAN WE MAKE THE SAME MONEY IN 7 YEARS? VALUATION...BY ANY OTHER NUMBER INVESTING FOR THE LONG TERM RISING ABOVE THE NOISE RISK: WHAT RISK?
12. Can we make the same money in 7 years?Better than over 25 years? 7 year opportunity, 6% premium and then match Represents 1.6% premium for 25 years Is 7 years the better choice? It is NOT the same but should be considered!
13. Valuation...by any other number Imagine an asset which was guaranteed to give exactly matching cashflows over the next 25 years. What’s the value to: And then there are different allowances for risks, costs orapproximations! a private equity manager an accountant an economist an actuary
14. Are we used to investing for the very long term? Almost no one invests simply for the long term...even a long term manager is looking for factors that in 3 to 5 years time will make a long term asset look more attractive than it does today enabling them to sell the asset at a premium to today's price. —Overheard For illustrative purposes only
15. Circle of Life: Shoreditch estate - Arnold Circus 2010’s Young Professionals 1890’s Rebuild: Semi-professionals, rising 1970’s Derelict 1950’s Declining 1880’s Slum http://boundarylaunderette.wordpress.com/boundary-estate-a-history/
16. What’s that noise...
17. Rising above the noise: back to basics Aims of Liability Surrogate To harvest excess returns of series of long term cashflows illiquidity providing most of excess return, not credit or investment risk ideally with strong link to inflation Need to test each proposition against these aims
18. Risk: What risk? Discovering potential flaws Caution & humility Long term Risk Perception “Ability and willingness” Credit (skew) risk Little up & long way down Beware balloons Especially real ones Selling availability Will anyone want in when you want out? Asset allocation funds Most available vs most attractive? Costs and feeses spread dis-eases Long term lock up vsattractive shorter term vehicles Quality of inflation linkage Investment (manager) selection
19. 3 examples of potential Liability Surrogates SOCIAL HOUSING STUDENT ACCOMMODATION GROUND RENTS Note: Examples of properties in this presentation are sourced from managers such as AEW, Aviva, Axa & IFM.  These are for illustrative purposes only, some details have been altered and they do not represent endorsement for a particular deal or manager.
20. Social Housing: Example Heavily regulated sector, well established entities Deep need for financing: much reduced access to banking capital Available in £10 - £50 m sizes Inflation plus structures Proposal for 50 year sale & lease back; net ILG + 2.5% Illustrative purposes only, please see notes on slide 19.
21. Student Accommodation: Example Student numbers up by 27% from 2000 - 2010 Accommodation not kept pace Sizes: £10m – £150 m Often a squeeze on rents especially in town based universities PROPOSAL FOR FREEHOLD WITH REVERSION AFTER 45 LEASE; ILG + 2.5% Illustrative purposes only, please see notes on slide 19.
22. Ground Rents: Example Ground Rents existed for 400+ years Small payment; extreme loan value – delays occur but forfeit effectively not going to happen Active secondary market Size £1m - £20 m Historic ground rents nominal increases PROPOSAL FOR 125 LEASE; NET ILG + 3.0% Illustrative purposes only, please see notes on slide 19.
23. Infrastructure Debt: Example Infrastructure has attractive long term, inflation-related features Debt provides tighter return distribution & asset backing Nascent UK/Europe but huge potential and large deals £50 m - £1 bn+ Broad range of asset choice PROPOSAL FOR 25 YEAR ASSET BACKED LOAN; NET ILG + 2.0% Illustrative purposes only, please see notes on slide 19.
24. Long Lease: Example Long leases (20+ years) provide long term visibility of cashflows High quality tenants, inflation related businesses Inflation linked cashflows: direct and indirect linkage Sizes £5 m to £100 m PROPOSAL FOR 25 YEAR SALE AND LEASEBACK NET 4.4% Cap/collared annual RPI Illustrative purposes only, please see notes on slide 19.
25. Liability Surrogates Exist! Provide elements of both growth and matching assets Beware the bandwagon Scrutinise carefully AAA investment for long term is hard Consider alternatives Shorter term or as part of growth portfolio
26. But getting there takes real workBeware the sloths...because life’s not a beach
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