Innovative Strategies to Manage Equity Risk...Nilesh T. Patel, FSA, FCIA . Presenters: Jean Masson, Ph.D. James Peter Walton, FSA . SOA Antitrust Compliance Guidelines SOA Presentation

Session 129 PD - Innovative Strategies to Manage Equity Risk

Moderator:

Nilesh T. Patel, FSA, FCIA

Presenters: Jean Masson, Ph.D.

James Peter Walton, FSA

SOA Antitrust Compliance Guidelines SOA Presentation Disclaimer

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Society of Actuaries 2017 Annual Meeting Innovative Strategies to Manage Equity Risk: Low Volatility Investing

SECURITIES AND INVESTMENTS

NOT FDIC INSURED NO BANK GUARANTEE MAY LOSE VALUE

Jean Masson, Ph.D.Managing Director

October 17, 2017

Risk vs. expected return:– Theory vs. reality

Why has low volatility investing become so popular for pension plans?

Overview of the low volatility market place

Examining three recent concerns about low volatility equities

The future of low volatility investing

Agenda

TD Asset Management | For Use with Society of Actuaries 2017 Annual Meeting Only 2

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Risk - Beta

Why has low volatility investing become so popular?Finance 101: Risk averse investors demand reward to invest in riskier assets


Note: For illustrative purposes only.

Higher risk has not translated into higher returns

S&P 500 Equity Returns and RisksAugust 1978 – June 2017

Source: TD Asset Management, Standard & Poor's.Note: Quintiles represent equally-weighed portfolios rebalanced monthly from equities sorted by trailing 60 months standard deviation (minimum of 20 months for partial data).Compounded annual returns on S&P 500 constituents, from August 1, 1978 to June 30, 2017. For illustrative purposes only.

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Annu

aliz

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Low risk Moderate risk High risk

Low risk Moderate risk High riskLow risk Moderate risk High riskLow risk Moderate risk High risk-16%

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Investors in high volatility equities typically receive most of their compensation for bearing risk during strong bull markets

Why has low volatility investing become so popular?Pay-offs for U.S. stocks depend on different market conditions


Source: TD Asset Management, Standard & Poor's.Note: Quintiles represent equally-weighed portfolios rebalanced monthly from equities sorted by trailing 60 months standard deviation (minimum of 20 months for partial data). 1Average monthly returns on S&P 500 constituents from August 1978 through June 2017. For illustrative purposes only.

Strong Up MarketsAverage return > 4%(occurs 24% of time)

Strong Down Markets

Average return ≤ -4%(occurs 11% of time)

"Normal" MarketsAverage return within ±4%

(occurs 65% of time)

Based on Dollars(Cap-weighted Strategy)

Based on Risk(Cap-weighted Strategy)

Based on Risk(Lower Volatility Equities)

Equity Risk ReductionLower volatility equity strategies


Low volatility appeals to investors who allocate on the basis of risk

Note: For illustrative purposes only. Numbers may not add due to rounding. There can be no assurance that efforts to manage or mitigate risk will be successful.This illustration is based on the assumption that risk (defined as volatility of returns) is 5 times as high for equity as it is for fixed income, which is typical for cap-weighted strategies.

U.S. Equity35%

Non-U.S. Equity25%

Fixed Income40% U.S. Equity

51%Non-U.S. Equity37%

Fixed Income

12%Lower Volatility

U.S. Equity34%

Lower Volatility Non-U.S. Equity

25%

Fixed Income

12%

Total Risk Reduction

29%

Tracking Error Risks of Equities vs. Bonds

MSCI ACWI MSCI ACWI Minimum Volatility

Bloomberg Barclays U.S. Long Credit 15% 11%

Bloomberg Barclays U.S. Long Govt/Credit 17% 12%

Periods used for computation June 30, 1997 through July 31, 2017

Low Volatility Equities within an Liability Driven Investing context Closer to long-term bonds than traditional capitalization-weighted equities


Source: TD Asset Management, Bloomberg Finance L.P., and MSCI Inc. Note: MSCI ACWI = MSCI All Country World Index. MSCI ACWI Minimum Volatility = MSCI ACWI Minimum Volatility Index. The tracking error risk numbers are annualized from monthly index returns in U.S. dollars.

Lower tracking errors against traditional pension plan liabilities

Strategy Objective


Delivering market-like returns with less risk

Low Volatility

HigherRisk

•Cap-Weighted Index

Higher Return

Note: Risk = Total Return Volatility. For illustrative purposes only.

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Overview of the Low Volatility Market PlaceRapid growth of low volatility assets


Source: TD Asset Management, eVestment Alliance. As of December 31, 2016.

Institutional Low Volatility Equities AUM

Global Low Volatility Equity Universe

TD Asset Management 10

Source: eVestment Alliance. For illustrative purposes only. DMC = down market capture. eVestment Global Large Cap Equity – Actively managed Global, ACWI, or Global ex-Japan Equity products that primarily invest in large capitalization stocks regardless of the style (growth, value or core) focus.

Low volatility equities have delivered better risk-adjusted returns

MSCI ACWI Minimum Volatility-ND 8.30 9.46 1.12 46.81MSCI ACWI-ND 10.61 9.08 0.84 100.00eVestment Global Low Vol Universe Median 8.80 10.54 1.20 61.01

1. Have historical low volatility returns been outsized?

2. Are low volatility stocks currently overvalued?

3. Is there a negative correlation to interest rate movements?

Three Recent Concerns about Low Volatility Equities


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MSCI ACWI Minimum Volatility IndexMSCI All Country World Index

Have historical low volatility returns been outsized?Performance review


Source: MSCI Inc. As of July 31, 2017. All returns on the MSCI All Country World Indices in US dollars.

Financial Crisis Aug. 2008 – Mar. 2009

Euro Debt CrisisOct. 2011

Taper Tantrum Jun. 2013

China, Greece, OilEM weakness

Jun. 2015 – Dec. 2015

Recent market environment favorable to low volatility strategies

Tech BubbleAug. 1998 – Oct. 2001

Last decades have witnessed a series of impactful market events– Tech Bubble burst in 2001 and crushed Information Technology stocks

– Financial Crisis of 2008-2009 was the worst market since Great Depression

– European Debt Crisis of 2011 crushed European financial stocks

– Commodity crisis of 2015-2016 brought materials and energy stocks to all-time lows

Market performance during this timeframe:– MSCI All Country World Index returned 7.5%/year

– MSCI ACWI Minimum Volatility Index returned 8.9%/year

Higher risk adjusted returns expected during volatile market environments

Have historical low volatility returns been outsized?Explained


Performance within expectations given market turbulence

Source: TD Asset Management, MSCI Inc. As of June 30, 2017.

As of June 30, 2017 Price toBook

Price toTrailing Earnings

Price toForward Earnings

MSCI AC World Index 2.2 21.9 15.7

MSCI ACWI Minimum Volatility Index 2.7 20.9 18.7

MSCI World Index 2.3 21.1 16.4

MSCI World Minimum Volatility Index 2.8 21.5 19.1

S&P 500 Index 3.1 23.8 17.5

S&P 500 Low Volatility Index 3.5 21.0 19.7

MSCI USA Minimum Volatility Index 3.5 22.8 19.9

Are low volatility stocks currently overvalued?Multiples comparison


Source: TD Asset Management, MSCI Inc., Bloomberg Finance L.P. As of June 30, 2017.

Minimum Volatility Indices only marginally more expensive than cap-weighted indices

Minimum volatility equity indices have slightly higher valuation multiples– They have been even higher in the past

Possible to construct low volatility portfolios with lower valuation multiples

Are low volatility stocks currently overvalued?Explained


How much higher would multiples need to rise to worry investors?

Source: TD Asset Management. As of June 30, 2017.

Is there a negative correlation to interest rate movements?Historical interest rates


Source: Federal Reserve Economic Data (FRED). As of July 31, 2017.

…?

10-Year U.S. Treasury Bond Yield

What is the future direction of interest rates?

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Is there a negative correlation to interest rate movements?Correlation analysis


Source: TD Asset Management, CRSP (prior to 1979) and Standard & Poor's. As of July 31, 2017.

There does not appear to be a correlation to interest rates

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-15%

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5%

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20%U.S. Equities: Low minus high volatility

10-year US Treasury Yield

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VIX IndexAverage level

Market Risk is LowIs this the new normal or should we expect a rebound?


Source: TD Asset Management & CBOE. As of July 31, 2017.

VIX index much closer to its minimum than its maximum

We believe there is little empirical support for the CAPM– In the absence of empirical evidence, in our view, the minimum volatility portfolio

preferable over the market

– Potentially well suited for DB pension plans

We have witnessed outperformance of low volatility strategies– Higher returns expected during volatile market environments

Low volatility equities trade at slightly higher multiples– Possible to create portfolios that trade at lower multiples

There does not appear to be a correlation to interest rates– Low volatility equities have performed well in rising and falling interest rate regimes

Key Takeaways


Low volatility equities may continue to deliver strong risk-adjusted returns

This presentation is presented on a confidential basis and is for the use of its intended recipients only. No portion of this document may be copied, reproduced, republished or distributed in any way without the express written consent of TD Asset Management.Registration with the SEC does not imply a certain level of skill or training.TDAM USA Inc. is a Delaware corporation registered as an investment adviser with the U.S. Securities and Exchange Commission (SEC). In providing investment management services and advice, TDAM USA Inc. has available to it, and draws on, the personnel, resources and experience of TD Asset Management Inc. TD Asset Management Inc. is not registered in the United States as an investment adviser with the SEC and does not offer its services within the United States. Epoch Investment Partners, Inc. (Epoch) is a federally registered investment adviser that provides investment management services in the United States.

TD Asset Management operates through TD Asset Management Inc. in Canada and through TDAM USA Inc. in the United States. TD Asset Management, TDAM USA and Epoch Investment Partners are wholly-owned subsidiaries of The Toronto-Dominion Bank.

The information contained in this presentation has been provided by TD Asset Management Inc. (“TDAM”) and is for information purposes only. The information has been drawn from sources believed to be reliable. Where such statements are based in whole or in part on information provided by third parties, they are not guaranteed to be accurate or complete. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance of any fund. The information does not provide financial, legal, tax or investment advice. Particular investment or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance. TDAM, The Toronto-Dominion Bank and its affiliates and related entities are not liable for any errors or omissions in the information or for any loss or damage suffered.

This material is not an offer to any person in any jurisdiction where unlawful or unauthorized.

Certain statements in this document may contain forward-looking statements (“FLS”) that are predictive in nature and may include words such as “expects”, “anticipates”, “intends”, “believes”, “estimates” and similar forward-looking expressions or negative versions thereof. FLS are based on current expectations and projections about future general economic, political and relevant market factors, such as interest and foreign exchange rates, equity and capital markets, the general business environment, assuming no changes to tax or other laws or government regulation or catastrophic events. Expectations and projections about future events are inherently subject to risks and uncertainties, which may be unforeseeable. Such expectations and projections may be incorrect in the future. FLS are not guarantees of future performance. Actual events could differ materially from those expressed or implied in any FLS. A number of important factors including those factors set out above can contribute to these digressions. You should avoid placing any reliance on FLS.

It is not possible to invest directly in an index. Investors pursuing a strategy similar to an index may experience higher or lower returns and will bear the cost of fees and expenses that will reduce returns.

The MSCI Minimum Volatility Indexes are designed to serve as transparent benchmarks for minimum variance (or managed volatility) equity strategies. The indexes aim to reflect the performance characteristics of a minimum variance strategy focused on absolute returns as well as volatility with the lowest absolute risk. Each Minimum Volatility Index is calculated by optimizing a parent MSCI index to produce an index with the least volatility for a given set of constraints and to ensure index replicability and investability.The MSCI ACWI is a market capitalization weighted index designed to provide a broad measure of equity-market performance throughout the world. The MSCI ACWI is maintained by Morgan Stanley Capital International, and captures large and mid cap representation across 23 Developed Markets (DM) and 23 Emerging Markets (EM) countries. With 2,476 constituents, the index covers approximately 85% of the global investable equity opportunity set.

Comparison to an index should not be understood to mean there will be a correlation between low volatilies returns and the returns of the index. The index reflects the reinvestment of interest and dividends but does not reflect deductions for fees or expenses.

Investing entails risks, including possible loss of some or all of the investor's principal. All trademarks are the property of their respective owners. ®The TD logo and other trademarks are the property of The Toronto-Dominion Bank.

Disclaimer

20TD Asset Management | For Use with Society of Actuaries 2017 Annual Meeting Only

For more information contact River and Mercantile Group on 0203 327 5100 or at [email protected]

Structured Equity

James Walton FSA, CERA

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Structured Equity

Pension Plan De-risking Private Equity replacement

Implementation Examples

Bespoke strategies possible Efficient use of cash

Equity derivatives with defined payoffs An alternative return seeking asset class

What Is It?

Design

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Approaches to Return Seeking Assets

Asset Class: Principle Key Challenge

EquitiesStay invested to achieve long

term Equity Risk PremiumLiving with volatility

Defensive Equities

Lower volatility than average equities

Impact on expected returns Relies on judgement if

managed actively

Sell to Bonds/Cash

Less exposure to equity-like assets

Low yieldsRisk of rising interest rates

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Approaches to Return Seeking Assets

Asset Class: Principle Key Challenge

Asset Allocation Algorithms or ‘Smart Beta’

Rules based allocations driven by market or company

metrics

Reliant on model assumptions.

Not transparent

Diversify with Alternatives

Reduced volatility by diversification to other asset

classes

Relies on correlation assumptions playing out in

practice

Structured Equity

Buy derivatives with tailored payoff for different market

levels

Option pricing - reliant on ability to achieve payoff

required

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What does Structured Equity involve?

Structured Equity is a derivative contract.

It derives its value from that of an underlying equity index, such as the S&P500 or MSCI World. The value at maturity is contractually defined at outset referencing the index levels.

Unlike physical assets, derivatives do not need to be cash settled for the full purchase price.

A contract that can only generate zero or positive payoff is like buying insurance and requires an upfront ‘premium’.

Often designed with zero upfront premium, with the potential to both make and lose money.

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Structured Equity Characteristics

1. Lower volatility than equities achieved with low cost and transparency

Returns are pre-defined as a function of the overall equity market and not

reliant on manager skill.

Expected returns can be similar to conventional equities. Typically falls

between bonds and equities in terms of volatility.

2. A derivative contract that can require little cash to be deployed

This capital can be invested in bonds, for example, generating yield and

reducing pension funding volatility.

Designing a Structure

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The issues with traditional equity investing

Equity market return

Equity investment

return

Painful

Assumed return for

fundingNot ideal

What we need

Nice but don’t need

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Structured Equity – shaping equity returns illustrationStep One – cost of

full protection

Cost equals 8%

Step Two – limit downside protection

Cost drops 5% to 3%

Protecting 20% decline, then start to participate

Step Three – give away some upside

Cost neutral

Cap upside above 20%

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Structured Equity is not an off the shelf product

Preferable to have at least:

1. Quantifiable reason to manage downside risk

…or….

2. Strong investment viewpoint.

Structured Equity Shape

Client Needs

Client & Consultant

Market View

Market Conditions

Pension Plan De-risking Example

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Portfolio De-risking Alternatives

Equity exposure through derivatives

Physical assets

Long Bonds$25m

Long Bonds$75m

Long Bonds$75m

Equity$75m

Equity$25m

Equity$25m

Derivatives$50m

1: Current 2: Buy Bonds 3: Structure d Equity

1: Current 2: Buy Bonds 3: Structured Equity

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Return vs Liabilities over 3 years

50%-tile, 2.3%0.8%

2.4%

25%-tile, 8.1%

3.0%

5.9%

75%-tile, -3.3%-1.4% -1.7%

95%-tile, -11.2%

-4.1%

-7.9%

5%-tile, 16.9%

6.6%

9.8%

-10%

-5%

0%

5%

10%

15%

20%

0.00 1.00 2.00 3.00 4

1: Current 2: Buy Bonds

3: Structured Equity

Holding 75% of assets in liability matching gives a tighter range of outcomes, but reduced expected return.

*This chart shows an estimated potential range of outcomes based on Monte Carlo simulation and using information. These projections are indicative only and are designed to show the relative risk of various asset allocationsPlan duration is 12 years, liability discount rate 3.6%.

Structured Equity strategy maintains expected returns, but with a tighter range of outcomes than the current strategy

Private Equity Completion Strategies

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Private Equity returns have historically been higher than public markets.

Much of this performance can be attributed to higher leverage in underlying companies

Buying call options on the Russell 2000 index with strike of 40%, would create leverage 1.7x. This would take the total leverage to that of a typical private equity fund.

Can Private Equity Returns be replicated Using Call Options ?

Volatility of actual private equity holdings on a monthly/quarterly/annual basis is materially lower as PE valuations are largely model based

1 U.S Private Equity Index and Selected Benchmark Statistics – Cambridge Associates, December 2016. Figures based on quarterly returns, compounded. 2 Index Synthetic Private Equity Portfolio: rolling call options, ranging from 1 year to 5 year terms, purchased referencing Russell 2000 index.3 Volatility based of rolling 1 year returns. Returns presented from December 2002 to December 2016.

Private Equity Universe¹

S&P 500 + 3% S&P400

Russell 2000

Synthetic Private Equity on Russell

2000²

Geometric Average Return 14.4% 12.4% 11.7% 10.9% 14.1%

Volatility 13% 16% 19% 20% 32%

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Synthetic Private Equity Portfolio vs Comparators

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700%C

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Portfolio Return

Private Equity Universe(Cambridge Associates)

S&P500 + 3% pa

Russell 2000 TR

S&P 500 TR

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Conclusion

Use of leverage can de-risk a pension plan An alternative to Private Equity.

Implementation

Typically some downside protection Adaptive to views or market conditions

Equity like returns with smoother journey … or can be used to target higher returns Low governance and low cost

Return Seeking Asset Class

Bespoke Design

Issued by P-Solve LLC dba River and Mercantile Derivatives, a Registered Investment Advisor A River and Mercantile Group Company 200 West St., Waltham, MA 012451 Telephone: 781 373 6900Facsimile: 781 373 6902

CONFIDENTIAL INFORMATION: The information herein has been provided solely to the addressee in connection with a presentation by P-Solve LLC dba River and Mercantile Derivatives, oncondition that it not be shared, copied, circulated or otherwise disclosed to any person without the express consent of P-Solve LLC.

INVESTMENT ADVISOR: Investment advisory services are provided by P-Solve LLC (dba River and Mercantile Derivatives or River and Mercantile Group), an investment advisor registered withthe US Securities and Exchange Commission and the National Futures Association. Derivative portfolio collateral management is provided by P-Solve Investments Limited (dba River andMercantile Derivatives or River and Mercantile Group), a UK-based affiliate of P-Solve LLC regulated by the Financial Conduct Authority.

PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS.

SECURITY INDICES: This presentation includes data related to the performance of various securities indices. The performance of securities indices is not subject to fees and expenses associatedwith investment funds. Investments cannot be made directly in the indices. The information provided has been obtained from sources which P-Solve LLC believes to be reasonably reliable butcannot guarantee its accuracy or completeness.

Documents

Innovative Strategies to Manage Equity Risk...Nilesh T. Patel, FSA, FCIA . Presenters: Jean Masson, Ph.D. James Peter Walton, FSA . SOA Antitrust Compliance Guidelines SOA Presentation