The Bond Market Conference

Annuity Portfolio Management

By: Dr. Zoumana Kone, CFAFixed Income Strategist, Bifm

Agenda

1. Annuity Management

2. Market Trends

3. Regulatory Framework

4. Challenges

5. Capital Markets

6. Risks

7. Asset Liability Management

Annuity Management

Tittle Name Years with Bifm Total Experience

What are annuities?

o It is the conversion of retirement savings into a series of regular payments at

regular intervals

Salient property:

o It insures longevity: it guarantees the annuitant against outliving retirement

savings in the event of living long

It is the decumulation of retirement savings phase - final phase of

retirement savings

Annuity Management (continued)

Tittle Name Years with Bifm Total Experience

Ways of accessing retirement savings:

o In Botswana, the law prescribes that you buy annuities with 2/3 of

retirement funds.

Phased approach with limits on withdrawals amounts

Annuitisation (only option providing longevity insurance)

Obligations by the Issuer to pay when due

Market Trends

Tittle Name Years with Bifm Total Experience

Following the Global economic downturn starting in 2008:

o Annuitants age: increased incidences of early retirements

o Retirement ages decreased from 60 to 50 years

o Reduction in interest rates to historical low levels

Market Trends - Challenges

Tittle Name Years with Bifm Total Experience

Shortage of long term Government bonds

Reduction in annuity rates:

o resultant lower effective draw down rates due to declining interest rates

Eg: P1 million will purchase pension worth P7,400 per month for a male aged

65, compared to P10,000 per month, 10 years ago

Long end: supply and Potential demand

Tittle Name Years with Bifm Total Experience

400

200250

250

100

250

707

432

513

417

218

352

307232 263

167 118

102

0

100

200

300

400

500

600

700

800

Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16

Long end: Supply Vs Indicative Demand (P million)

Supply at Long end (BW011+BW012) Demand Potential Gap

Regulatory Framework

Tittle Name Years with Bifm Total Experience

Insurance companies, pension funds and asset management

companies are all regulated by NBFIRA

Capital Markets

Tittle Name Years with Bifm Total Experience

Assets availability: some route

Origination of assets:

o To find assets to match the liabilities issued

o This entails involvement in the capital market to lend to suitable companies,

which carries the least credit risk

Credit risk may erode the value of assets set aside to meet the

annuities

Capital Markets Development

Tittle Name Years with Bifm Total Experience

A side of our involvement: In the process: we lend to companies, to

fund their projects:

o Another way: companies issue bonds

We lend to companies, which are solid in terms of credit:

o Default undermines the capability of the funds to meet annuities payments

o Hence screening through the credit process

Using the Bond Market

Tittle Name Years with Bifm Total Experience

Assets are broadly of two categories:

o Unlisted mainly through Private Placement:

• The issues can be tailored made to be sold to the investors needs without

listing (unlisted).

o Listed bonds:

• The bonds will have to fulfil the listing requirements of the BSE

Using the Bond Market

Tittle Name Years with Bifm Total Experience

Unlisted bonds present opportunities:

o they can better suit the clients specific needs

They restrict tradeability:

o credit issues and specific agreements

They require credit monitoring, and may subject the buyers to credit

issues and greater information asymmetry

The Bond Market

Tittle Name Years with Bifm Total Experience

The bonds may be acquired through the following markets:

o Primary market: when the bonds first issued are bought

• Government is the large player in the primary market

o Secondary market: when the bonds already issued are traded in the local

market

Secondary market reinforces the primary market

Capital Markets - Fixed rate bonds

Tittle Name Years with Bifm Total Experience

Preference is for fixed rate bonds. The cash flows are known to a large

extent

o (ignoring default and market valuation impact)

Spreading along the yield curve

The yield curve allows the pricing of assets and facilitates asset liability

management

Capital Markets – Yield Curve

Tittle Name Years with Bifm Total Experience

The risk free yield curve represents a valuation tool for us for assets

and Liabilities

The current risk yield curve extends to BW012, which matures in June

2040

Yields have come down in Botswana on the back of low domestic

inflation, low and unstable worldwide growth environment, low

domestic growth environment

Capital Markets – Yield curve (Continued)

Tittle Name Years with Bifm Total Experience

Capital Markets – Yield Curve (Continued)

Tittle Name Years with Bifm Total Experience

-0.16

-0.22

-0.58 -0.57

-0.77

-0.40-0.38

-0.35 -0.36

-0.90

-0.80

-0.70

-0.60

-0.50

-0.40

-0.30

-0.20

-0.10

0.0014-day 91-Day T-BILL BW010 BW005 BW008 BW007 BW011 BW012

Risks of the Annuity Management

Tittle Name Years with Bifm Total Experience

Interest rate risk:

o Value will fluctuate with change in interest rate and mismatch losses can

occur

o The portfolio is exposed to the Botswana yield curve as the liabilities are

denominated in Pula

Credit risk:

o Default and deterioration in the credit quality

Asset Liability Management

Tittle Name Years with Bifm Total Experience

In order to match asset and Liability

Some key elements:

o Duration

o Convexity

o The total value of our assets and Liabilities

o The sensitivity or hedging position along the YC curve

Summary

Tittle Name Years with Bifm Total Experience

The important role of the capital market cannot be emphasized

enough

With a developed local bond market, trading can allow the funds to

align the portfolio to meet its objectives

The limited trading opportunities limits the portfolio flexibility: the

portfolio may sit in an unwanted position

Summary (Continued)

Tittle Name Years with Bifm Total Experience

We have seen some building blocks in the local market that facilitates

the management of the annuity funds

The building blocks of a risk free yield curve

The regular issuance of Government bonds

The availability of data on the markets in general through Bloomberg

and Reuters

THANK YOU