Christopher Nichols
Investment Director, Multi‐Asset Investing Standard Life Investments (UK)
Investment Strategies for Pension Funds
Pensions need consistency but markets deliver chaos
Discrete Yearly Performance (%) by Market
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
55.03 25.30 26.07 ‐14.29 73.43 27.48 18.55 40.36 40.24 29.46
44.76 22.51 23.73 ‐21.61 71.56 26.65 10.88 21.34 26.67 27.89
39.44 20.45 6.15 ‐24.12 68.24 23.63 10.38 20.74 22.04 22.06
27.84 19.15 ‐3.39 ‐25.44 56.93 23.06 6.06 17.48 21.85 20.76
25.75 19.06 ‐3.43 ‐25.66 41.58 21.81 5.53 16.80 17.77 17.39
22.57 18.60 ‐4.85 ‐33.73 30.67 21.21 3.36 15.66 8.12 13.76
22.43 4.77 ‐5.00 ‐41.15 22.52 18.74 ‐0.97 14.42 3.29 11.80
20.89 3.58 ‐6.57 ‐42.25 17.62 18.71 ‐11.32 14.22 ‐0.83 9.63
16.91 2.69 ‐7.09 ‐46.77 11.19 11.77 ‐12.51 6.70 ‐1.92 8.46
12.08 2.56 ‐13.29 ‐49.12 9.58 11.16 ‐12.55 5.77 ‐3.02 7.78
11.21 1.56 ‐13.55 ‐50.75 7.54 9.66 ‐12.96 5.40 ‐6.35 7.37
5.85 ‐4.88 ‐24.71 ‐60.73 3.07 4.37 ‐15.44 3.79 ‐6.49 4.33
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
Rotate based on outlook?
1982
1984
1986
1988
1990
1991 1994
1998
1999
2001 2002
2006
2007
2008
2009
2014
‐4
‐2 0 2 4 6 8
‐1 0 1 2 3 4 5 6 7
Inflation Real GDP
Recession
Recovery Overheat
Stagflation
• Historical data
• Asset class volatilities
• Correlations
• Capital market outlook
• Intuitive beliefs
Conventional diversification
More likely exactly wrong than approximately right
• Strategic Benchmark
• Asset classes
• Broad weights
• TAA (e.g. +/‐5%)
• Tracking‐Error limit
Governance structure: Derived using:
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
Unstable risk characteristics
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
Property FX
Basket Commodities Corporate Bonds
Emerging Market Bonds
High Yield Bonds
2000‐2007 2008‐2011
Correlation to Global Equities of “diversifying assets”
Buy portfolio insurance?
Historically you would have needed to pay 1.7% per quarter, on average, to cap losses at 5%
0 200 400 600 800 1000 1200 1400 1600
S&P 500 Total Return Index Protected index, no cost
Protected index allowing for cost Cash Return Index (3m rates)
Tail risk protection as many imagine it would be
2.2% p.a.
1800
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
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
USD vs CAD and European equity performance
0.85 0.90 0.95 1.00 1.05 1.10 1.15
200 250 300 350 400 450
Jan 10 Jan 11 Jan 12 Jan 13 Jan 14
Stoxx Europe 600 Total Return Index (LHS) USD/CAD (RHS)
Source: Standard Life Investments & Bloomberg
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
Broad based return potential with genuine diversity
Correlation to Global Equity
-1.0 -0.5 0.0 0.5 1.0
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
Source: Standard Life Investments, Sungard APT, 31 March 2015
Step 1: Evaluate Current Risk Profile
• 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
To ta l sta n d ‐alone risk
8.8%
3.7%
0%
2%
4%
6%
8%
10%
12%
14%
Diversification
Expected volatility
Directional Market Returns
Relative Value
Security Selection
‐28 ‐26 ‐24 ‐22 ‐20 ‐18 ‐16 ‐14 ‐12 ‐10 ‐8 ‐6 ‐4 ‐2 0 2 4 6 8 10 12 14 16 18
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)
% Move
MSCI World (EUR) move over same period* GARS Portfolio
Step 2: Historical Scenario Analysis
* 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
World Economic Forum 2013:
• Economic / Environmental
• Geopolitical / Societal
• Technological
What do you envisage the flashpoints could be?
Step 3: Forward‐looking Scenarios
China crisis Trade war
Commodity shock Acropolis
Now Dunkin’
Disappointment
Cold War 2
China Crisis
Combining expert judgement with quantitative discipline
Description Key Factor
(examples)
Shock
(estimates)
Property market slowdown causes growth to drop sharply Oil ‐47%
Fixed asset investment deteriorates Australian Dollar ‐15%
Labour market strained, wage growth and consumption slows HSI ‐60%
Risk of banking crises as defaults rise 10y US Treas. Yld. ‐50bps
Social/political unrest as government forced to recapitalise banks
Sources: Standard Life Investments & Bloomberg, March 2015
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
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
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
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
