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Investment Strategy Webinar
July 17, 2013
2
Presenters
Bob Penter, CFA, PartnerPension Risk ManagementPhone: 770.690.7674Email: [email protected]
Francois Otieno, Senior ConsultantGIM / Fixed IncomePhone: 312.715.3344Email: [email protected]
Saif Choudhury, ConsultantInvestment SolutionsPhone: 312-715-4367Email: [email protected]
Lucinda Downing, Sr. Research AnalystGlobal Asset Allocation TeamPhone: 011 +44 207 086 9440Email: [email protected]
Beth Hanig, Associate PartnerInvestment ConsultingPhone: 203.523.8161Email: [email protected]
3
Discussion Topics
Opening Remarks Market Outlook: Focus on Recent Volatility Spotlight on Fixed Income Thought Leadership Solution Packages Overview Defined Contribution Lifetime Income Solutions Closing RemarksQ&A Session
Market Outlook: Focus on Recent Volatility
Lucinda Downing
5
Global Economic Environment Remains Weak
Macroeconomic support for equities is not strong
However, economic news flow has improved. Even the struggling UK and Eurozone economies have delivered positive surprises. China, however, continues to report weak economic data
Good US jobs data and rising house prices but fiscal cuts have hit economic activity
Citigroup Economic Surprise Indicator (G10 economies)
-80
-60
-40
-20
0
20
40
60
Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13
Mixed US Economic Indicators
48
49
50
51
52
53
54
55
56
57
Apr-12 Jul-12 Oct-12 Jan-13 Apr-13
Manufacturing ISM Non-manufacturing ISM
6
Equities are Focused on the Short-Term
6% US equity market correction, but now back to all time highs -25% on year-ago levels
Fed’s tapering statement on May 22nd was nothing new, but markets appear to have been unprepared for it
Market has returned to short-term focus and is once again ignoring the challenge of less stimulus in the future
Emerging markets continue to fall but, as a consequence, valuations have become compelling
Valuations CheapeningEmerging market valuations as a ratio to developed
0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
1.2
1.3
Apr-03 Apr-04 Apr-05 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13Price to Book Ratio Forw ard Price-Earnings Ratio
Emerging markets cheaper
Emerging markets more expensive
Source: Datastream
S&P500 makes new highs
600
800
1000
1200
1400
1600
1800
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
7
Pronounced Move Up in Bond Yields
Bond yields rose strongly since May and are now back up to levels last reached in August 2012
TIPS real yields are up significantly (120bp rise in real yields since April)
Relative move indicates more confidence in the economic recovery
We expect some correction to this upward move, although multi-year bond bear market will remain intact
We have increased our yield expectations over next 5 years as the risk of a policy error has increased
Aon Hewitt expectationMarket
Expectation*20yr
durationIncrease from
todayIncrease from
todayNow 3.5%In 1yrs 4.0% 0.5% 0.2%In 3yrs 4.3% 0.8% 0.5%In 5yrs 4.7% 1.2% 0.7%
* Based on end June 2013 yield curve
US real yields have risen more than nominal yields
0.0%
0.5%
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
4.0%
Dec 10 Mar 11 Jun 11 Sep 11 Dec 11 Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
10 year US Treasury 10 year US Index Linked Treasury
8
Uncertain Future is Not Fully Reflected in Markets
Equity volatility has fallen with new highs reached by S&P 500
Falling gold price reflects market perception of low risk of extreme events
FX markets have been destabilized by the huge move in the Yen and emerging currencies
Excessive bullish sentiment vulnerable to further upsets
Source: Deutsche Bank’s CVIX
Gold price is trending down
0
500
1000
1500
2000
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Currency volatility has moved up
0
5
10
15
20
25
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Equity volatility has rapidly fallen from June peak
10
12
14
16
18
20
22
Jan 2013 Feb 2013 Mar 2013 Apr 2013 May 2013 Jun 2013 Jul 2013
9
Which Uncertainties Dominate?
Will global economic conditions hold up? Major economic downside risk is small as long as yields rise gradually
How disruptive will the sovereign bond environment be?This is a bigger risk than macro risk
Will monetary stimulus be withdrawn in an orderly way?QE stimulus to continue for another year as economic removal conditions not yet achieved. Move to higher rates is a long way out
We expect equities will avoid a period of sustained decline BUT underlying trend in equities is turning flatter as the risk-reward in equities has deteriorated
We don’t anticipate a bond market meltdown. Yields are likely to normalize over several years
Uncertainties around monetary policy mean that there is likely to be more equity and bond market volatility
Spotlight on Fixed Income
Francois Otieno
11
Fixed Income Market Review – Index Returns
-9.0
-7.0
-5.0
-3.0
-1.0
1.0
3.0
BarclaysAggregate
BarclaysLong
Govt/Credit
BofA ML USHigh YieldMaster II
CSLeveraged
Loan
JPM EMBIGlobal
Diversified
JPM GBI-EMGlobal
Unhedged
JPM CEMBI
Ret
urns
(%)
Index Returns
June 2013
3-Month
YTD (June 2013)
Sources: eVestment, Barclays Live
12
Manager Performance by Strategy Type: Bank Loans
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
June Q2 YTD
Ret
urns
Bank Loans
Average Return
CSAM Leveraged Loan Index
Average Excess Return
Sources: eVestment, Managers
13
Manager Performance by Strategy Type: EMD
*50% JPM EMBI Global Diversified, 40% JPM GBI-EM Global Unhedged, 10% JPM CEMBI
-8.0%
-7.0%
-6.0%
-5.0%
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
June Q2 YTD
Ret
urns
EMD Blended
Average Return
JPM EMD Custom Weighted Index*
Average Excess Return
Sources: eVestment, Managers
14
Manager Performance by Strategy Type: Unconstrained
-4.0%
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
June Q2 YTD
Ret
urns
Unconstrained
Average Return
Barclays Aggregate Index
Average Excess Return*
3-Month LIBOR**
*Against the Barclays Aggregate**Standard Benchmark
Sources: eVestment, Barclays Live, Managers
15
Managers have generally characterized this recent sell off as a re-pricing of risk, which is vastly different from what we experienced in the last credit cycle of 2007/2008
In general, managers are staying the course but are selectively taking advantage of investment opportunities in light of the recent market pullback
HEK continues to advocate Bank Loans; EMD; and Unconstrained Bond Strategies
Opportunities Within Fixed Income Going Forward
16
Portfolio Implications for Switching from BC Aggregate to the BC Intermediate Index
Portfolio Implications Investors looking to manage the volatility of the return-seeking portfolio should consider investing the
risk-reducing portfolio in intermediate fixed income For those that are concerned about cash flow yield, recognize the yield reduction relative to the
volatility reduction is minimal− Reposition from Aggregate Index to Intermediate Aggregate Index− Shorten the duration by 1.35 years− Yield reduction of 30 basis points− One year breakeven yield change is only 22 basis points
Implementation Considerations Separate account clients could switch their BC Aggregate mandate to the Intermediate Aggregate
Index with the same manager There are also a number of Mutual Fund and/or Commingled Fund options available
17
Defined Contribution Lifetime Income Solutions
Beth HanigSaif Choudhury
18
Type of Option
Managed Payout—Existing Funds
Managed Payout—New Fund
Deferred Guaranteed Monthly Withdrawal Benefit
Deferred Guaranteed Monthly Income Benefit
Deferred Fixed Annuity
Traditional annuity—End of Plan*
Annuity Platform*
Longevity Insurance*
What is Retirement Income?
* Out of Plan Annuity Options
19
Plan Sponsor 2013 priorities (highest to lowest)*– Participation Rates– Diversification– Leakage– Savings Rates– Retirement Readiness– Distributions (retirement income)
Current Market
Regulatory / Fiduciary Issues– Treasury Department proposed guidance on lifetime income options– Government continue not to mandate, but to encourage– Current Safe Harbor passed in 2008 provides greater fiduciary clarity– Due diligence assistance is paramount– Counterparty risk is top of mind
* 2013 Aon Hewitt Hot Topics in Retirement
20
1%
2%
6%
14%
14%
12%
18%
44%
3%
6%
5%
16%
20%
Ability to transfer assetsto a DB plan to receive
annuity
In-plan Annuity
In-plan managed payoutfunds
Annuities outside the plan
In-plan managedaccounts with drawdown
feature
Distributions fromplan/auto payment
Online modeling toolsretirement planning
Very likely in 2013 Somewhat likely in 2013
3%
10%
12%
13%
19%
37%
61%
Ability to transfer assetsto a DB plan to receive
annuity
In-plan Annuity
In-plan managed payoutfunds
Annuities outside the plan
In-plan managedaccounts with drawdown
feature
Distributions fromplan/auto payment
Online modeling toolsretirement planning
Already offer
Prevalence—Currently Available Plans for 2013 Among Those Not Already Offering
Plan Sponsor Adoption*
Last year, plans sponsors continued to add new lifetime income options. The largest increase was managed payout with drawdown feature (9%). In-plan annuity additions were flat.
* 2013 Aon Hewitt Hot Topics in Retirement
21
Fiduciary Implications
Criteria for selection process includes:
1. Engaging in objective, thorough, analytical search
2. Assessing insurers future claim paying abilities
3. Considering all fees relative to benefits under contract
4. Assessing whether insurer is financially viable at time of selection
5. Consulting with expert(s) to assist with assessment as necessary
The selection of an annuity provider for benefit distributions from an individual account plan satisfies the requirements of section 404(a)(1)(B)
of ERISA if the fiduciary complies with the following criteria
22
Projected Income by Age—All OptionsExpected, Downside, and Upside Scenarios
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
$80,000
65 70 75 80 85 90 95 100 105
Annu
al In
come
Age
Annual Income for All Options 50th Percentile
4% Systematic Withdrawal GMWB Age 65 Annuity Managed Account
$0
$5,000
$10,000
$15,000
$20,000
$25,000
$30,000
$35,000
65 70 75 80 85 90 95 100 105
Annu
al In
come
Age
Annual Income for All Options 5th Percentile
4% Systematic Withdrawal GMWB Age 65 Annuity Managed Account
$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$140,000
$160,000
$180,000
65 70 75 80 85 90 95 100 105
Annu
al In
come
Age
Annual Income for All Options 95th Percentile
4% Systematic Withdrawal GMWB Age 65 Annuity Managed Account
23
Projected Account Balance (Bequest) by Age—All OptionsExpected, Downside, and Upside Scenarios
$0
$50,000
$100,000
$150,000
$200,000
$250,000
$300,000
$350,000
$400,000
$450,000
65 70 75 80 85 90 95 100 105
Accoun
t Balan
ce
Age
Account Balance for All Options 5th Percentile
4% Systematic Withdrawal GMWB Age 65 Annuity Managed Account
$0
$100,000
$200,000
$300,000
$400,000
$500,000
$600,000
$700,000
$800,000
$900,000
$1,000,000
65 70 75 80 85 90 95 100 105
Accoun
t Balan
ce
Age
Account Balance for All Options 50th Percentile
4% Systematic Withdrawal GMWB Age 65 Annuity Managed Account
$0
$500,000
$1,000,000
$1,500,000
$2,000,000
$2,500,000
$3,000,000
$3,500,000
65 70 75 80 85 90 95 100 105
Accoun
t Balan
ce
Age
Account Balance for All Options 95th Percentile
4% Systematic Withdrawal GMWB Age 65 Annuity Managed Account
24
Percentile of Income by Age—All OptionsMultiple of Final Pay, Inflation-Adjusted
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
65 70 75 80 85 90 95 100 105
Annu
al In
come as a % of Final Pay
(adjusted for inflatio
n)
Age
4% Systematic Withdrawal
5% to 10% 10% to 25% 25% to 50% 50% to 75% 75% to 90% 90% to 95%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
65 70 75 80 85 90 95 100 105
Annu
al In
come as a % of Final Pay
(adjusted for inflatio
n)
Age
Age 65 Annuity
5% to 10% 10% to 25% 25% to 50% 50% to 75% 75% to 90% 90% to 95%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
65 70 75 80 85 90 95 100 105
Annu
al In
come as a % of Final Pay
(adjusted for inflatio
n)
Age
GMWB
5% to 10% 10% to 25% 25% to 50% 50% to 75% 75% to 90% 90% to 95%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
65 70 75 80 85 90 95 100 105
Annu
al In
come as a % of Final Pay
(adjusted for inflatio
n)
Age
Managed Account
5% to 10% 10% to 25% 25% to 50% 50% to 75% 75% to 90% 90% to 95%
25
Our Advisory Position
Generally supportive of Lifetime Income options
– DC plans will become critical source for generating retirement income
– Product landscape has evolved
– Major corporations have began to implement these solutions
– Government has provided solid fiduciary guidance and support
Initial concerns are being mitigated
– Greater fee transparency and improved portability through middleware
– Lower counterparty risk through better risk structures
– Design changes through integration with target date funds
Sponsors need to continue assessing these options
– Contemplate non-insurer and insurer solutions
– Need to assess the right time to add these options
– Assess any short term and long term fiduciary implications
26
Retirement Income Implementation Plan
Process Steps Goals and ObjectivesPhase One: General Overview, Scoping and Asset Class Decision Making
• Review the current market and trends• Understand the asset classes• Focus on optimal plan design and participant needs• Determine most suitable asset classes for further review
Phase Two: Product Analysis and Review
• Understand detailed due diligence on asset classes• Review of products and nuances• Focus on plan demographics and need
Phase Three: Final Fiduciary Analysis, Product Manufacturer Meeting and Finalist Interviews
• Understand Safe Harbor guidance and fiduciary implications
• Review benchmarking rules and participant disclosures• Contemplate future on-going due diligence requirements• Meet with income providers and select best solution(s)
Phase Four: Recordkeeping and Product Implementation
• Focus on Participant Experience and Integration• Review Participant Communication• Discuss Rollout Strategy• Review and understand timeframe for Record-keeper
implementation
Closing Remarks
Bob Penter, CFA
28
Question & Answer
Questions may be submitted at any time during the web seminar by typing the question in the "Ask a Question" text field and clicking "Submit." Questions will be answered live as time permits during the question and answer session.
29
Our next investment strategy update call is scheduled for Wednesday, August 21, at 10 a.m. CDT.