PP Investment Conference 11Nov2015 Slides

7/24/2019 PP Investment Conference 11Nov2015 Slides

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LDI: Solving the low yield conundrumBen Gold Head of Investment Consulting Leeds

November 2015


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1. Our clients experience of LDI

2. Impact of LDI on funding volatility

3. What next for gilt yields?4. LDI market developments

5. Strategic considerations

Agenda for Today


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Our clients experience of LDI

We and our clients are big supporters of LDI as a risk management tool

With LDI, 60%

Without LDI,40%

With LDI, 60%

Without LDI,40%

All schemes Schemes with assets under 50m

Hedged,

65%

Unhedged,

35%

Average hedge ratio

Source: Xafinity


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Accessible to all

Wide range of providers, many pooled solutions, minimum investments in thousands


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Impact of LDI on funding volatility

LDI is a hugely impactful tool in the toolkit for managing funding level volatility

Source: Xafinity (Assets 80m, Liabilities 100m, Liabili ty duration 20 years, Assets 50% growth/50% matching)

Equities and gilts DGF and gilts

Equities and LDI

0.7 1.2

8.8

2.3

8.5

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Inte re st Rate s Inflation Gr owth Dive rsific ation Total

VaR(m)

12.1

9.0

8.8

16.5

13.4

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Inte re st Rates Inflation Gr owth Dive rsific ation Total

VaR(m)

12.1

9.0

3.5

15.1

9.5

0.0

5.0

10.0

15.0

20.0

25.0

30.0


VaR(m)

DGF and LDI

0.7 1.23.5

2.3

3.20.0

5.0

10.0

15.0

20.0

25.0

30.0


VaR(m)

35% 65%


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What next for gilt yields?Yields have been falling for a generation...

Over the past 15 years, index-linked gilt yields have steadily fallen by around 3%

Source: Datastream

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

1996 1999 2002 2005 2008 2011 2014

FTSEBritishGovernment3%Inflation-Linked

Gilts-AllStocks-Yield

FTSEBritishGovernmentGilts-AllStocks-

Yield

Fixe d Gilts ( LHS) Index -L inked Gilts (RHS)


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The market is already pricing in

yield rises:

Base rates are expected to be

1.6% in 3 years

Long term yield rises of 0.5% pa

are already priced in

What next for gilt yields?...but yield rises are already priced in...

Yield rises of 0.5% pa are already priced in and supply of gilts is limited

Source: Bank of England, Debt Management Office

Rising interest rates will only impactpension schemes positively if the

realised yields are above the position

already priced in

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

1 5 9 13 17 21 25

Yield

Term

Spot rate

Spot rate 3-years forward

Yield rises are already priced in


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0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

BoEBaseRa

te

Year

31 Mar 10

30 Sep 10

31 Mar 11

30 Sep 11

31 Mar 12

30 Sep 12

31 Mar 13

30 Sep 13

31 Mar 14

30 Sep 14

31 Mar 15

30 Sep 15

BoE Base Rate

What next for gilt yields?...and the market has continuously over-anticipated Base Rate rises

The market has continuously priced in rate increases ... and continuously been wrong

Source: Bank of England


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30 years

127

30 years

112

What next for gilt yields?Plus, dont forget supply and demand

There arent enough gilts to cover pension liabilities and existing available supply is

limited

Bank of England

(QE), 27.7%

Pension Funds

and Insurance

Companies,

29.0%

Other financial

institutions,

16.9%

Overseas,

24.7%

Other, 1.7%

DB scheme

liabiliti es 2.0tn

Source: Bank of England, Debt Management Office, The Pensions Regulator

Total gilt market 1.45tn

There arent enough gilts to

cover liabilitiesThere arent many index-

linked or long gilts

Perhaps 55% of gilts are tied

up

Light blue is ILGs, dark blue

is nominal gilts, values in bn


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2010

2020

2030

2040

2050

2060

2070

2080

1 1.5 2 2.5 3

GiltMaturity

Subscription ratio (Demand/Supply)

-50

0

50

100

150

200

250

1991 1996 2001 2006 2011 2016

Netgiltissuance(bn)

What next for gilt yields?Plus, dont forget supply and demand

New issuance is projected to significantly decrease and it is consistently oversubscribed

Source: Debt Management Office

Net gilt issuance is likely to fall Demand for new issuance in 2015 is high (especially ILGs)

Blue dots are fixed gilts, grey

index-linked gilts. The size of

the dot reflects the amount ofthe issue


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-1.1%

-1.0%

-0.9%

-0.8%

-0.7%

-0.6%

-0.5%

-0.4%

1.5%

1.7%

1.9%

2.1%

2.3%

2.5%

2.7%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct

Realyield

Nominalyield

Fixed Gilts (LHS) Index-L inked Gilts (RHS)

What next for gilt yields?Gilt yields are volatile so implement changes with care

Timing of any increase in hedging can make a big difference

Source: Datastream


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LDI market developments

Using growth assets as collateral enables additional de-risking

Monetising LDI triggers to improve the funding position

Source: Bank of England, Debt Management Office

Efficient collateral management

Cash

collateral,

20%

Other

growth, 80%

Cash

collateral,

20%

Growth

collateral,30%

Other

growth, 50%

Get paid to de-risk

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

2013 2014 2015

Premium(

%

ofswaption

nominal)


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Strategic considerations Start point is to fully hedge under the assumption that liability risks are unrewarded in

the long term

Consider your tactical views

Understand the market dynamics

Consider the impact of hedging on your whole portfolio

May need to review your other assets

Consider whether market innovations help

1. How much do you want to hedge now?

2. How might this change over time?

We advocate reviewing your hedging strategy and looking to pragmatically increase

unless theres a reason not to


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Questions ?


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Contact

Ben Gold

[email protected]

Telephone: 0113 887 9045


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Xafinity is one of the UKs leading specialists in pensions and employee benefits. Our expertise addresses the needs of both trustees and

companies in pensions and actuarial services, flexible benefits, and healthcare.

Xafinity has been providing professional services for over 40 years, and strives to be the provider of choice in pension and employee benefit

services. We are committed to providing a professional and proportionate service, tailored to our clients needs and delivered cost effectively.

www.xafinity.com

Registered Address:

Phoenix House

1 Station Hill

Reading

RG1 1NB

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PP Investment Conference 11Nov2015 Slides