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SU
RR
EY
CO
UN
TY
CO
UN
CIL
PE
NS
ION
FU
ND
TR
AIN
ING
ON
:L
IAB
ILIT
Y R
ISK
MA
NA
GE
ME
NT
& I
NF
RA
ST
RU
CT
UR
E
20
Se
pte
mb
er
20
13
Ste
ve T
urn
er,
Part
ner
Marc
Devere
ux, P
rin
cip
al
To
by B
usco
mb
e, P
rin
cip
al
Minute Item 30/13
Page 13
ME
RC
ER
Import
ant notices
Refe
rences t
o M
erc
er
shall
be c
onstr
ued t
o inclu
de M
erc
er
LLC
and/o
r its
associa
ted c
om
panie
s.
© 2
013 M
erc
er
LLC
. A
ll rights
rese
rved.
•T
his
conta
ins c
onfid
ential and p
roprieta
ry info
rmatio
n o
f M
erc
er
and is inte
nded f
or
the e
xclu
siv
e u
se o
f th
epart
ies t
o w
hom
it w
as p
rovid
ed b
y M
erc
er.
Its
conte
nt
may n
ot
be m
odifi
ed,
sold
or
oth
erw
ise p
rovid
ed,
inw
hole
or
in p
art
, to
any o
ther
pers
on o
r entit
y, w
ithout
Merc
er’s p
rior
written p
erm
issio
n.
•T
he f
indin
gs,
ratings
and/o
r opin
ions
exp
ress
ed h
ere
in a
re t
he inte
llectu
al pro
pert
y of
Merc
er
and a
resubje
ct
to c
hange w
ithout
notice.
They a
re n
ot in
tended t
o c
onvey a
ny g
uara
nte
es a
s t
o the f
utu
reperf
orm
ance o
f th
e investm
ent
pro
ducts
, asset
cla
sses o
r capita
l m
ark
ets
dis
cussed.
Past
perf
orm
ance
does n
ot
guara
nte
e f
utu
re r
esults
. M
erc
er’s r
atin
gs d
o n
ot
constit
ute
indiv
idualiz
ed investm
ent
advic
e.
•In
form
ation c
onta
ined h
ere
in h
as b
een o
bta
ined f
rom
a r
ange o
f th
ird p
art
y s
ourc
es.
While
the info
rmatio
n is
belie
ved t
o b
e r
elia
ble
, M
erc
er
has n
ot
sought
to v
erify
it
independently
. A
s s
uch,
Merc
er
makes n
ore
pre
senta
tions o
r w
arr
antie
s a
s to t
he a
ccura
cy o
f th
e info
rmation p
resente
d a
nd t
akes n
o r
esponsib
ility
or
liabili
ty (
incl
udin
g f
or
indirect, c
onsequentia
l or
inci
denta
l dam
ages)
, fo
r any
err
or,
om
issi
on o
r in
acc
ura
cy in
the d
ata
supplie
d b
y a
ny t
hird p
art
y.
•T
his
does n
ot
constit
ute
an o
ffer
or
a s
olic
itatio
n o
f an o
ffer
to b
uy o
r sell
securitie
s,
com
moditi
es a
nd/o
r any
oth
er
financia
l in
str
um
ents
or
pro
ducts
or
constit
ute
a s
olic
itation o
n b
ehalf
of
any o
f th
e investm
ent
managers
, th
eir a
ffili
ate
s,
pro
ducts
or
str
ate
gie
s t
hat
Merc
er
may e
valu
ate
or
recom
mend.
•F
or
Merc
er’s c
onfli
ct
of
inte
rest
dis
clo
sure
s,
conta
ct
your
Merc
er
repre
senta
tive o
r see
ww
w.m
erc
er.
com
/con
flicts
ofinte
rest.
•T
he a
naly
sis
show
n in t
his
pre
senta
tion i
s appro
xim
ate
and f
or
illust
ratio
n p
urp
ose
s only
.
1
Page 14
ME
RC
ER
2
Sta
ge
s o
f d
efin
ed
be
ne
fit p
en
sio
n r
isk m
an
ag
em
en
t
“F
utu
re”
low
ris
k
sta
te
•F
un
de
d s
tatu
sm
on
ito
rin
g
•C
ove
na
nt
asse
ssm
en
t
•In
ve
stm
en
ta
dvic
e
•G
ove
rna
nce
ove
rvie
w a
nd
train
ing
•F
utu
rea
ccru
al
de
sig
no
ptio
ns
•Lia
bili
tym
an
ag
em
en
t
•LD
Ip
rep
ara
tio
n
•In
ve
stm
en
tb
elie
fs r
ere
wa
rde
d /
un
rew
ard
ed
•L
on
ge
vity
he
dg
ing
•B
uy-
in
•D
yn
am
icd
e-r
iskin
gp
rog
ram
•T
rig
ge
rse
ttin
g
•D
eri
vatives /
eq
uity c
olla
rs
•S
uita
ble
targ
et
•O
ng
oin
g r
isk
ma
na
ge
me
nt
•B
uyo
ut
Un
ders
tan
d
risk
Ad
dre
ss
Pla
n
desig
n
Red
uce
un
rew
ard
ed
risk
Red
uce
rew
ard
ed
risk
Tra
nsfe
r
go
vern
an
ce
an
d r
isk
"C
urr
en
t"
sta
te
Str
ate
gy
Imp
lem
en
tati
on
Red
uce
co
ven
an
t
risk
•C
on
tin
ge
nt
asse
ts (
or
SP
Vs)
•R
evie
w o
fP
lan
ru
les
Page 15
ME
RC
ER
Un
de
rsta
ndin
g th
e li
ab
ilitie
sM
ain
fa
cto
rs in
flue
nci
ng
th
e F
un
d’s
lia
bili
ties
3
Dis
co
un
t fa
cto
r(i
nte
rest
rate
s)
Pen
sio
n i
ncre
ases
Lif
e e
xp
ecta
ncy
Aff
ects
am
ou
nt
need
ed
no
wto
pay f
or
futu
re c
ash
flo
ws
Usu
ally l
inked
to
in
flati
on
or
kn
ow
n i
n a
dvan
ce
Aff
ects
nu
mb
er
of
years
for
wh
ich
pen
sio
n i
s p
aid
Big
im
pact
Big
im
pact
Infl
ati
on
Aff
ects
am
ou
nt
of
pen
sio
n i
flin
ked
to
in
flati
on
/ s
ala
ries
Big
im
pact
Su
bsta
nti
al
pro
po
rtio
no
f im
pact
thro
ug
h l
ink
to i
nfl
ati
on
LiabilityDrivenInvestments
Longevityhedging
Page 16
ME
RC
ER
Lia
bili
ty D
riven Investm
ent (L
DI)
What is
it?
4
0%
He
dg
ed
Lia
bil
itie
sA
ssets
Defi
cit
Lia
bil
itie
s
Assets
Defi
cit
Yie
lds
fall
10
0%
He
dg
ed
Lia
bil
itie
sA
ssets
Defi
cit
Lia
bil
itie
sA
ssets
Yie
lds
fall
Defi
cit
•‘L
iabili
ty h
edgin
g’ sim
ply
means t
hat
you o
ffset
the im
pact
of m
ovem
ents
in inte
rest
rate
s a
nd infla
tion o
n t
he
valu
e o
f th
e lia
bili
ties
by
hold
ing a
n a
sset
that
resp
onds
in t
he s
am
e w
ay
as
the lia
bili
ties
to m
ovem
ents
in
inte
rest
rate
s a
nd infla
tion. A
‘hedge r
atio
’ of
50%
means t
hat
the c
hange in v
alu
e o
f th
e a
sset
is e
xpecte
d t
obe a
round 5
0%
of
the c
hange in t
he v
alu
e o
f th
e lia
bili
ties.
•A
ssum
ing t
he F
und h
as
no inte
rest
rate
hedgin
g,
then a
fall
in inte
rest
rate
s re
sults
in a
ris
e in lia
bili
ties,
whils
t th
e a
ssets
rem
ain
unch
anged,
thus
incr
easi
ng t
he d
efic
it. H
ad t
he F
und b
een 1
00%
hedged o
nin
tere
st
rate
s,
then t
he a
ssets
would
ris
e b
y the s
am
e a
mount as t
he lia
bili
ties,
and t
he d
efic
it w
ould
rem
ain
the s
am
e s
ize.
•S
imila
r analy
sis
applie
s w
ith c
hanges
in infla
tion a
nd t
he a
mount
of
infla
tion e
xposu
re t
hat
is h
edged.
Page 17
ME
RC
ER
Surr
ey -
curr
ent in
vestm
ent polic
y
Un
de
rsta
nd
lia
bilit
y m
is-m
atc
h r
isk
So
urc
es
of
ex
pe
cte
d r
etu
rn (
gilts
+ 3
.2%
p.a
.)B
en
ch
ma
rk a
sse
t a
llo
ca
tio
n
5
Lia
bilit
y r
isk
s a
re s
ign
ific
an
t
Eq
uit
y d
om
inate
s t
he s
ou
rce
s o
f e
xp
ecte
d r
etu
rns
Fu
nd
ing
le
ve
l w
ill
be h
igh
ly v
ola
tile
Div
ers
ifyin
g t
he a
sse
ts a
nd
mo
re f
oc
us o
n lia
bilit
y r
isk
s i
s
req
uir
ed
to
eff
ec
tive
ly m
an
ag
e o
ve
rall f
un
din
g le
ve
l ri
sk
Page 18
ME
RC
ER
Index-L
inked G
ilts (
ILG
) are
your
best lia
bili
ty m
atc
hin
g a
sset…
But th
ere
is a
massiv
e lo
ng-t
erm
str
uctu
ral d
em
and &
supply
imb
ala
nce
Ind
ex-L
inke
d G
ilts
in
Issu
e
-10-505
10
15
20
25
30
35
40
2000-01
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
2014-15
2015-16
2016-17
(£bn)
Gro
ss Is
suance
Net
Issuan
ce
6
Sourc
es:
Merc
er
based o
n D
MO
and P
PF
“P
urp
le B
ook”
data
and R
BS
data
-1.00.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0 Au
g-95
Aug-
96Au
g-97
Aug-
98Au
g-99
Aug-
00Au
g-01
Aug-
02Au
g-03
Aug-
04Au
g-05
Aug-
06Au
g-07
Aug-
08Au
g-09
Aug-
10Au
g-11
Aug-
12Au
g-13
Yield(%)
FT A
15
Year
an
d O
ver
5 Y
ear
Gilt
s In
dice
s: h
isto
ric
yiel
ds
FT B
rit G
ov Is
sues
15
Year
FTSE
ILG
> 5
Yea
rS
ourc
e: T
hom
son
Reu
ters
Dat
astr
eam
2.
De
ma
nd
fo
r IL
G e
xp
os
ure
ou
tstr
ips
su
pp
ly
Com
parison o
f in
dex-
linke
d g
ilts
inis
sue,
plu
s in
flatio
n s
waps
transacte
d w
ith U
K p
ensio
n s
chem
ere
al
liabili
ties
(fig
ure
s are
very
appro
xim
ate
estim
ate
s in
£bn)
Real yie
lds a
re lik
ely
to
rem
ain
at
dep
ressed
levels
fo
r an
exte
nd
ed
peri
od
of
tim
e d
ue
to
su
pp
ly a
nd
dem
an
d im
bala
nce
Str
on
g a
rgu
men
t to
pu
t in
pla
ce
a p
lan
to
in
tro
du
ce
lia
bil
ity
hed
gin
g,
e.g
. b
ased
on
fu
nd
ing
level im
pro
vem
en
ts
3. N
et
iss
ua
nc
e o
f IL
Gs
is
ex
pe
cte
d t
o f
all
1.
Lo
ng
-te
rm d
ec
lin
e i
n IL
G y
ield
s
Page 19
ME
RC
ER
7
Estim
ate
d fu
nd
ing
leve
l vo
latil
ity
Typ
ical LG
PS
Fund
50%
55%
60%
65%
70%
75%
80%
Fundinglevel
Ex
am
ple
of
typ
ica
l L
GP
S f
un
din
g le
ve
l
A!
L"
A!
L"
L"
L!
A!
A"
•B
ase
d o
n a
n 8
0 / 2
0 G
row
th/ B
on
d a
sse
t sp
lit a
nd
typ
ica
l LG
PS
lia
bili
ties
•F
un
din
g le
ve
ls r
em
ain
bro
ad
ly u
nch
an
ge
d o
ve
r th
ep
eri
od
sh
ow
n,
bu
t £
de
ficits
are
exp
ecte
d to
ha
ve
incre
ase
d m
ate
ria
lly d
ue
to
hig
he
r lia
bili
tie
s.
•F
or
the
Fu
nd
, b
etw
ee
n th
ela
st tw
o v
alu
atio
n d
ate
s th
ed
eficit h
as in
cre
ase
d b
yc£
50
0m
to
c£
1.3
bn
. T
he
mo
ne
tary
va
lue
of th
elia
bili
tie
s w
ill c
ontin
ue
tog
row
with
in
tere
st a
nd
fu
ture
accru
al o
f b
en
efits
•V
ola
tilit
y in
fu
nd
ing
leve
lcle
arl
y e
vid
en
t –
ma
y b
eu
na
cce
pta
ble
to
so
me
Em
plo
ye
rs
Page 20
ME
RC
ER
8
Surr
ey C
C &
LG
PS
There
’s a
lot
on y
our
pla
te…
..
New
LG
PS
2014
sch
em
e d
esig
n
Au
ste
rity
an
d
aff
ord
ab
ilit
y
Call f
or
Evid
en
ce
New
go
vern
an
ce
str
uctu
res
Po
ten
tial
Sch
em
e
Me
rge
rs
Actu
ari
al
Valu
ati
on
year
Imp
rove
d r
isk
ma
na
ge
me
nt
is g
oin
g t
o b
e a
ke
yw
ay
of
he
lpin
g t
o a
dd
res
s m
an
y o
f th
e c
ha
lle
ng
es
ah
ea
d
Page 21
HE
DG
ING
IN
ST
RU
ME
NT
S
Page 22
ME
RC
ER
Hedgin
g in
str
um
ents
‘To
olk
it’
10
Ind
ex-L
inked
Gil
tsN
etw
ork
Rail
Bo
nd
s
Co
rpo
rate
Bo
nd
sF
ixed
-In
tere
st G
ilts
Inte
rest
Rate
Sw
ap
sIn
flati
on
Sw
ap
sG
ilt
Rep
os
LP
I S
wap
sA
sset
Sw
ap
sE
qu
ity
Op
tio
ns
Fo
rward
sC
DS
Fu
ture
sS
pre
ad
Lo
cks
Overn
igh
t C
ash
AB
S
Sw
ap
tio
ns
Co
vere
d B
on
ds
To
tal R
etu
rn S
wap
s
Mo
ney M
ark
et
Fu
nd
ed
instr
um
en
ts
Un
fun
ded
instr
um
en
ts
Mo
st
co
mm
on
Page 23
ME
RC
ER
Hedgin
g in
str
um
ents
Com
mon featu
res a
mong u
nfu
nded in
str
um
ents
11
Receiv
e f
ixed
or
infl
ati
on
-lin
ked
cash
flo
ws
•T
he F
und w
ould
receiv
e fix
ed o
r in
flation-lin
ked c
ash
flow
s fr
om
the c
ounte
rpart
y.
•T
hese
would
be u
sed t
o m
atc
h the F
und’s
fix
ed o
r in
flation-lin
ked li
abili
ty c
ash
flow
s.
Pay f
loati
ng
cash
flo
ws
•T
he F
und w
ould
pay
a f
loating rate
of in
tere
st in e
xch
ange for
the f
ixed o
r in
flation-lin
ked c
ash
flow
s.
•F
or
exam
ple
, in the c
ase
of sw
aps
this
inte
rest
rate
would
most
lik
ely
be L
IBO
R.
Ch
an
ge
in
valu
e o
f th
e in
str
um
en
t
hed
ges c
han
ge in
lia
bil
ity v
alu
e
•A
s in
tere
st r
ate
s ch
ange o
ver tim
e, th
e v
alu
e o
f th
e in
stru
ments
change.
•T
hese
changes
in v
alu
e h
edge the c
hanges
in the li
abili
ty v
alu
e.
Lim
ited
in
itia
l cap
ital re
qu
ired
•In
theory
, apart
fro
m tra
nsa
ctio
n c
ost
s and initia
l colla
tera
l, n
o initia
l capital i
s re
quir
ed to e
nte
r in
to these
transa
ctio
ns.
It
is for
this
reaso
n t
hat geari
ng is
poss
ible
.
Su
bje
ct to
co
un
terp
art
y c
red
it r
isk
•In
stru
ments
are
tra
ded d
irectly
with invest
ment b
anks
. H
ow
ever,
som
e d
eri
vativ
es
will
be m
oved to
centr
al c
leari
ng h
ouse
s.
•If the c
ounte
rpart
y defa
ults,
the F
und m
ay
make
a loss
.
•T
his
is p
art
ially
mitig
ate
d b
y co
llate
ralis
ation, b
ut so
me r
isks
still
rem
ain
, fo
r exam
ple
:
–T
he F
und m
ay
be o
ut of th
e m
ark
et fo
r so
me tim
e a
fter defa
ult.
–T
he c
olla
tera
l receiv
ed m
ay
fall
in v
alu
e o
r th
e F
und m
ay
have p
ost
ed c
olla
tera
l wort
h m
ore
than its
loss
on d
eri
vative
posi
tions.
On
go
ing
co
llate
ral re
qu
irem
en
ts•
The F
und m
ust
have c
olla
tera
l to p
ost
to c
over any
loss
es
on t
he d
eri
vative
posi
tions.
•S
imila
rly, t
he F
und w
ill r
eceiv
e c
olla
tera
l on a
ny
gain
s on its
deri
vative
posi
tions.
Mo
st
un
fun
de
d i
ns
tru
me
nts
in
vo
lve
th
e p
aym
en
t o
f a
flo
ati
ng
in
tere
st
rate
in
ex
ch
an
ge
fo
r fi
xe
d o
r in
fla
tio
n-
lin
ke
d c
as
hfl
ow
s.
Page 24
ME
RC
ER
Hedgin
g in
str
um
ents
Inte
rest ra
te s
waps a
nd Inflation s
waps
12
Pu
rpo
se
•P
en
sio
n s
che
me
s u
se
inte
rest r
ate
sw
ap
s to
he
dg
e in
tere
st
rate
ris
k
–P
ay a
flo
atin
g “ca
sh”
rate
(u
su
ally
LIB
OR
)
–R
ece
ive
fix
ed
“sw
ap
” ra
te.
Me
ch
an
ics
•A
ze
ro c
ou
po
n s
wa
p is
qu
ote
d in
te
rms o
f th
e fix
ed
ra
te a
nd
the
no
tio
na
l exp
osu
re, w
hic
h e
qu
ate
s to
th
e p
rese
nt va
lue
of
the
ca
shflo
ws. F
or
exa
mp
le:
–2
0-y
ea
r ze
ro c
ou
po
n s
wa
p r
ate
of 4
.5%
p.a
.
–C
ash
flo
w o
f £
10
0 in
20
ye
ars
–N
otio
na
l of £
41
.46
.
•In
tere
st ra
te s
wa
ps p
rovid
e fix
ed
pa
ym
en
ts.
•In
fla
tio
n s
wa
ps c
an
be
use
d in
ad
ditio
n to
pro
vid
e in
fla
tio
n-
linke
d p
aym
en
ts:
–P
ay a
fix
ed
ra
te (
bre
ake
ven
“sw
ap
” in
fla
tion
)
–R
ece
ive
actu
al R
PI.
•C
ash
flo
ws h
ave
eq
ua
l va
lue
at o
uts
et –
in th
eo
ry n
o p
aym
en
tis
re
qu
ire
d (
ap
art
fro
m tra
nsa
ctio
n c
ost
s).
•B
oth
inte
rest r
ate
an
d in
fla
tio
n s
wa
ps c
ou
ld b
e tra
de
d w
ithte
rms o
f u
p to
50
ye
ars
.
Inte
res
t R
ate
an
d In
fla
tio
n S
wa
ps
Pen
sio
n
sch
em
e
receiv
es
+£100
Fix
ed
Pen
sio
n
sch
em
e
pays
+£41.4
6
plu
s
inte
rest
+£100
-£100
To
day
Pre
sen
t valu
e o
f
£100 in
20 y
ears
dis
co
un
ted
at
4.5
% p
.a. =
£41.4
6
20 y
ears
’ ti
me
Pay
LIB
OR
Receiv
e F
ixed
rate
Pen
sio
n S
ch
em
eC
ou
nte
rpart
y
Ban
k
Ho
w i
t w
ork
s
Page 25
ME
RC
ER
Hedgin
g in
str
um
ents
Tota
l Retu
rn S
waps
13
Pay L
IBO
R +
/-m
arg
in p
.a.
(or
eq
uiv
ale
nt fi
xed
rate
)
Asset
Retu
rn
TR
S
Sell
er
TR
S
Bu
yer
Ho
w i
t w
ork
s
•U
nd
er
a g
ilt T
RS
, a
pe
nsio
n p
lan
ag
ree
s to
:
–p
ay a
flo
atin
g ra
te (
LIB
OR
+/-
a m
arg
in)
on
a s
pe
cifie
dn
otio
na
l am
ou
nt
–re
ce
ive
th
e to
tal r
etu
rn o
n a
sp
eci
fie
d g
ilt a
pp
lied
to
th
esa
me
no
tio
na
l am
ou
nt
–fo
r a
sp
eci
fie
d te
rm
•N
o a
sse
ts a
re e
xch
an
ge
d u
p-f
ron
t, s
o th
e F
un
d w
ou
ldth
ere
fore
ob
tain
un
fund
ed
eco
no
mic
exp
osu
re to
th
e s
pe
cifie
dgilt
.
•U
nlik
e s
wa
ps, th
e te
rm o
f g
ilt T
RS
is li
mite
d to
2-3
ye
ars
. T
his
me
an
s th
at th
e p
ositio
n m
ust
be
ro
lled
fro
m tim
e to
tim
e. T
his
cre
ate
sro
ll r
isk
:
–T
he
ma
rgin
re
lative
to
LIB
OR
ma
y b
e u
na
ttra
ctiv
e
–It m
ay in
extr
em
e c
ase
s b
e im
po
ssib
le to
ro
ll th
ep
ositi
on
. If t
his
ha
pp
en
s o
the
r in
str
um
en
ts c
ou
ld b
eco
nsi
de
red
(e
.g. sw
ap
s o
r g
ilt r
ep
o).
•E
ach
tim
e a
gilt
TR
S p
ositio
n is
ro
lled
, it m
ust
be
ca
sh
se
ttle
d,
cre
atin
gliq
uid
ity r
isk
if in
suff
icie
nt c
ash
se
t a
sid
e (
an
d th
eF
un
d h
as m
ad
e a
loss)
–In
pra
ctic
e, p
oo
led
fu
nd
s a
nd
ma
na
ge
r p
roce
sse
s (a
nd
on
go
ing
co
llate
ral m
an
ag
em
en
t) a
re d
esig
ne
d to
en
su
reth
at th
is s
itu
atio
n d
oe
s n
ot h
ap
pe
n.
To
tal R
etu
rn S
wa
ps
Page 26
ME
RC
ER
Hedgin
g in
str
um
ents
Gilt
Re
po
14
Pay £
100 c
ash
+ r
ep
o r
ate
Retu
rn g
ilt
Gil
t S
ell
er
Gil
t B
uyer
AtMaturity
Sell
Gil
t fo
r £100
Pay £
100 c
ash
Gil
t S
ell
er
Gil
t B
uyer
Today
Ho
w i
t w
ork
s
To
da
y
!T
ransa
ct a
gilt
rep
o w
ith a
counte
rpart
y b
ank,
i.e
. se
ll a g
ilt a
nd
ag
ree to b
uy
it b
ack
at
a f
utu
re d
ate
at a p
re-d
ete
rmin
ed p
rice.
!P
ensi
on f
und r
eta
ins
eco
nom
ic e
xp
osu
re t
o g
ilt. C
ash m
ay
be
sub
ject to
a “
hair
cut”
reta
ined b
y b
ank
counte
rpart
y.
At
Matu
rity
!P
ensi
on f
und r
e-p
urc
hases
gilt
at th
e p
re-d
ete
rmin
ed p
rice.
!A
t th
e e
nd o
f each
rep
o c
ontr
act, t
he F
und w
ould
roll
the r
ep
o(i.e
. ente
r in
to a
noth
er
rep
o to c
ontinue b
orr
ow
ing
).
Co
mm
en
ts
!T
he F
und c
ould
use
its
exi
stin
g g
ilt h
old
ing
s to
held
esta
blis
h a
nLD
I p
ort
folio
. C
ash r
ais
ed f
rom
rep
os
could
be u
sed t
o p
urc
hase
furt
her
gilt
s. A
t th
e e
nd o
f each
rep
o c
ontr
act, t
he F
und w
ould
roll
the r
ep
o (
i.e.
ente
r in
to a
noth
er
rep
o to c
ontin
ue b
orr
ow
ing
).
!E
conom
ically
, th
e t
ransa
ctio
n is
bro
adly
eq
uiv
ale
nt
to the u
se o
fg
ilt T
RS
, th
e k
ey
diffe
rence b
ein
g the f
undin
g c
ost
(i.e
. th
ediffe
rence b
etw
een the g
ilt r
ep
o r
ate
and t
he g
ilt T
RS
rate
).
!G
ilt r
ep
o typ
ically
have term
s of
up t
o 1
year
and m
ust
be r
olle
dfr
om
tim
e to t
ime, so
lik
e g
ilt T
RS
they
are
sub
ject to
roll r
isk.
Gil
t re
po
Page 27
ME
RC
ER
Hedgin
g in
str
um
ents
Key r
isks in
the u
se o
f O
ver
The C
ounte
r (O
TC
) deriva
tives a
nd r
epos
15
Co
un
terp
art
y r
isk
Reg
ula
tory
/ leg
al
risk
Op
era
tio
nal
Ris
ks
Geari
ng
•T
he
Fu
nd
sh
ou
ld u
nd
ers
tan
d th
e a
pp
roa
ch
ta
ke
n b
y a
ny
inve
stm
en
t m
an
ag
er
to s
ele
ctio
n a
nd
mo
nito
rin
g o
f co
un
terp
art
ies
an
d m
ea
su
res o
f co
ntr
olli
ng
th
is r
isk
•D
ocu
me
nta
tio
n w
ill n
ee
d to
be
re
vie
we
d fro
m b
oth
leg
al a
nd
inve
stm
en
t p
ers
pe
ctive
s. T
he
sco
pe
of
the
re
vie
ws d
ep
en
d o
nd
eliv
ery
me
ch
an
ism
, str
uctu
re, in
str
um
en
ts a
nd
te
ch
niq
ue
s u
se
d.
An
y s
tru
ctu
re w
ou
ld n
ee
d to
be
“fu
ture
-pro
of”
to a
cco
mm
od
ate
reg
ula
tory
ch
an
ge
s, su
ch
as c
en
tra
l cle
ari
ng
of
de
riva
tive
s.
•L
iqu
idity a
nd
co
sts
of
on
go
ing
ma
na
ge
me
nt
of
syn
the
tic/r
ep
op
ositio
ns n
ee
ds to
be
un
de
rsto
od
. F
or
gilt
re
po
, ‘th
e r
oll
risk’ i
np
art
icu
lar.
•If
po
sitio
ns a
re g
ea
red
th
e le
ve
l of g
ea
rin
g w
ill v
ary
with
th
ech
an
ge
s in
yie
lds. T
he
pro
ce
ss w
ill n
ee
d to
be
un
de
rsto
od
an
da
gre
ed
on
ho
w to
ma
na
ge
th
e g
ea
rin
g w
ith
in th
e p
ort
folio
.
•R
isks a
sso
cia
ted
with
LIB
OR
an
d/o
r R
ep
o r
ate
ne
ed
s to
be
un
de
rsto
od
.L
IBO
R/R
ep
o r
ate
gen
era
tio
n
Page 28
GIL
T M
AR
KE
T U
PD
AT
E
Page 29
ME
RC
ER
Gilt
s m
ark
et update
Spot and forw
ard
yie
lds (
as a
t 30 J
une 2
013)
17
•T
he
ch
art
s s
ho
w g
ilt y
ield
s (
da
rk b
lue
cu
rve
) a
s a
t 3
0 J
un
e 2
01
3 a
nd
th
e y
ea
r-b
y-y
ea
r fo
rwa
rd r
ate
s im
plie
d b
y t
he
se
yie
lds
(lig
ht
blu
e b
ars
). F
orw
ard
ra
tes s
ho
w th
e p
ath
of ca
sh
re
turn
s th
at w
ou
ld r
esu
lt in
th
e s
am
e r
etu
rn a
s t
he
gilt
yie
ld o
ve
r th
ere
leva
nt p
eri
od
.
•A
fo
rwa
rd r
ate
is th
e e
xpe
cte
d r
ate
at a
po
int in
th
e fu
ture
. F
or
exa
mp
le,
–B
ase
d o
n 3
0 J
un
e 2
01
3 p
ricin
g, th
e m
ark
ets
exp
ect th
at th
e n
om
ina
l (le
ft-h
an
d c
ha
rt)
ca
sh
re
turn
in 2
03
3 (
i.e
. in
20
ye
ars
tim
e)
will
be
just
ove
r 4
.5%
. T
his
is s
ign
ific
an
tly h
igh
er
tha
n th
e c
urr
en
t n
om
ina
l ca
sh
re
turn
of c.0
.5%
.
•A
sp
ot ra
te is
th
e e
xpe
cte
d a
ve
rag
e r
ate
be
twe
en
to
da
y a
nd
a p
oin
t in
th
e fu
ture
, e
.g.
–A
20
ye
ar
sp
ot n
om
ina
l ra
te is th
e a
ve
rag
e e
xpe
cte
d r
ate
fro
m y
ea
rs 1
to
20
(i.e
. it is th
e a
vera
ge
of fo
rwa
rd r
ate
s o
ve
rth
e n
ext
20
ye
ars
). U
sin
g th
e s
am
e e
xam
ple
, th
e g
ilt y
ield
(sp
ot ra
te)
is c
.3.6
% p
.a.
Gil
t y
ield
s a
re b
ein
g d
rag
ge
d d
ow
n b
y c
urr
en
t lo
w s
ho
rt-t
erm
in
tere
st
rate
s. T
his
is
co
ns
iste
nt
wit
h B
an
k o
f
En
gla
nd
’s c
urr
en
t b
as
e r
ate
of
0.5
% p
.a.
Page 30
ME
RC
ER
18
Wh
at is
fa
ir v
alu
e?
Fair
valu
e i
s…
•A
consi
dera
tion f
or
when h
edgin
gsh
ould
be u
ndert
aken.
•A
hig
hly
subje
ctiv
e judgem
ent.
Fair
valu
e i
s n
ot…
•A
targ
et
for
all
hedgin
g.
•M
ore
im
port
ant
than b
roader
str
ate
gic
consi
dera
tions
(e.g
. risk
tole
rance
).
•A
short
-mediu
m t
erm
pre
dic
tion f
or
reve
rsio
n o
f lo
ng-t
erm
inte
rest
rate
s.Long-t
erm
inte
rest
rate
s m
ay b
e b
elo
wfa
ir v
alu
e f
or
a long t
ime.
Lo
ng
-term
in
tere
st
rate
s (
or
yie
lds)
are
said
to
be f
air
valu
e i
f th
ere
is a
bro
ad
ly e
ven
ch
an
ce o
f cash
retu
rns b
ein
g h
igh
er
or
low
er
over
the s
am
e p
eri
od
…
Flo
ati
ng
Rate
(ty
pic
all
y L
IBO
R)
Pe
nsio
nsch
em
e o
rfu
nd
ma
na
ge
r
Fix
ed
Rate
Pen
sio
n p
lan
Investm
en
t
ban
k
… o
r in
oth
er
wo
rds i
f th
e f
ixed
(in
tere
st)
rate
is b
road
ly i
n l
ine w
ith
the e
xp
ecte
d f
loati
ng
(cash
) ra
te
over
the t
erm
of
a s
wap
.
(No
te:
the e
co
no
mic
s o
f an
in
tere
st
rate
sw
ap
are
akin
to
bo
rro
win
g t
o
invest
in a
bo
nd
.)
Page 31
ME
RC
ER
Gilt
s m
ark
et update
Me
rce
r ‘fa
ir v
alu
e’ f
or
lon
g te
rm n
om
ina
l an
d r
ea
l gilt
inte
rest ra
tes –
defin
ed a
s 5
yr+
forw
ard
rate
s
19
RP
Ic
.3.4
%R
ea
l ra
tec
.1.1
%
1.0
% t
o 1
.25
%
CP
I ta
rge
t2
.0%
RP
I/C
PI
we
dg
e1
.0%
Ris
k P
rem
ium
0.2
5%
to
0.5
0%
No
min
al
rate
c.4
.5%
4.2
5%
to
4.7
5%
+=
•T
he
Me
rce
r R
ate
s C
om
mitte
e (
MR
C)
se
ts‘fa
ir v
alu
e’ v
iew
s f
or
gilt
yie
lds a
nd
in
fla
tion
(RP
I).
•S
pe
cific
ally
, ta
kin
g a
vie
w o
n fo
rwa
rd r
ate
sb
eyo
nd
five
ye
ar
ma
turi
tie
s. T
he
fir
st five
ye
ars
are
assu
me
d t
o b
e fa
ir v
alu
e.
•M
erc
er
fair
va
lue
vie
ws a
re in
form
ed
by
his
tori
c a
ve
rag
es fo
r re
al r
ate
s, p
roje
ctio
ns
for
infla
tio
n, a
nd
th
e e
xpe
cta
tio
n th
at th
eB
an
k o
f E
ng
lan
d w
ill b
e s
ucce
ssfu
l in
me
etin
g it
s in
fla
tio
n ta
rge
t. T
he
no
min
al r
ate
is th
e b
y-p
rod
uct o
f th
e tw
o.
•T
he
re
al r
ate
an
d in
fla
tio
n v
iew
s a
rere
vie
we
d o
n a
qu
art
erl
y b
asis
or
mo
refr
eq
ue
ntly s
ho
uld
a s
ign
ific
ant e
ve
nt o
ccu
rsu
ch
as th
e C
PA
C r
evie
w o
f th
e m
eth
od
of
ca
lcu
lating
RP
I in
fla
tio
n.
Fa
ir v
alu
e v
iew
s a
re s
ub
jec
tiv
e a
nd
sh
ou
ld n
ot
be
so
lely
re
lie
d o
n w
he
n s
ett
ing
he
dg
ing
po
lic
ies
.
Page 32
ME
RC
ER
Gilt
s m
ark
et update
Forw
ard
rate
s v
s. S
pot ra
tes (
curr
ent vs
. M
erc
er
‘Fair V
alu
e’ v
iew
s a
s a
t30 J
une 2
013)
–assum
ed 1
.25%
real a
nd 4
.5%
nom
inal
20
Page 33
ME
RC
ER
21
Are
yie
lds too lo
w to h
edge?
Yie
lds a
re n
ot as u
nattra
ctive a
s they a
ppear
0.0
0%
0.5
0%
1.0
0%
1.5
0%
2.0
0%
2.5
0%
3.0
0%
3.5
0%
4.0
0%
4.5
0%
5.0
0%
16
11
16
21
26
31
36
41
46
Term
(years
)
No
min
al gilt
sp
ot
curv
e 3
0 J
une 2
013
No
min
al gilt
5-y
ear
forw
ard
curv
e 3
0 J
une
20
13
Me
rce
r fa
ir v
alu
e fo
rwa
rd
•S
ignifi
cant
incr
ease
s in
nom
inal yi
eld
s are
already
price
d in
•U
nder
a t
raditi
onal appro
ach
to v
alu
ing
liabili
ties,
the s
teepness
in y
ield
curv
e im
plie
sfix
ed lia
bili
ties
would
incre
ase
in v
alu
e o
ver
5ye
ars
by
aro
und 6
%
•If y
ield
s r
em
ain
unchanged,
the v
alu
e o
f a 2
0-
year
fixe
d lia
bili
ty w
ould
incre
ase
by
aro
und
25%
ove
r 5 y
ears
•A
ny
fall
in y
ield
s w
ould
lead t
o e
ven g
reate
rlo
sses
•S
imila
rly fo
r re
al yi
eld
s
Nom
inal spot
and f
orw
ard
curv
es
Valu
e o
f £180m
cash
flow
in 2
0 y
ears
at 3.6
% d
isco
unting =
£89m
Valu
e o
f £180m
cash
flow
in 1
5 y
ears
at 3.3
% d
isco
unting =
£111m
Valu
e o
f £180m
cash
flow
in 1
5 y
ears
at 4.4
% d
isco
unting =
£94m
1 32
1
32
6%
in
cre
as
e2
5%
in
cre
as
e
Sc
op
e f
or
sig
nif
ica
nt
los
se
s i
n a
“m
ud
dle
-th
rou
gh
” s
ce
na
rio
Page 34
IMP
LE
ME
NTA
TIO
N
Page 35
ME
RC
ER
Imp
lem
en
tatio
n c
on
sid
era
tio
ns
Ove
rvie
w o
f m
ain
ap
pro
ach
es
23
IMM
ED
IAT
E E
XE
CU
TIO
N
PH
AS
ED
OV
ER
TIM
E
TR
IGG
ER
BA
SE
D
COMPLEXITY
Set
min
imum
prici
ng c
rite
ria (
e.g
. tr
igger
leve
l or
leve
ls)
whic
h,
once s
atis
fied,
will
actio
n s
witc
hes t
ow
ard
s t
he t
arg
et
str
ate
gy
Phase t
he s
witc
hin
g o
ver
time b
y s
plit
ting t
he t
rade into
tra
nches (
e.g
. 10 s
witc
hes
of
equal siz
es).
T
he s
witc
hes a
re d
one irr
espectiv
e o
f price.
Imm
edia
te s
witc
h f
rom
the c
urr
ent
to the t
arg
et
str
ate
gy,
irr
espectiv
e o
f th
e p
rice
(e.g
. yi
eld
leve
ls)
SIMPLICTY
No
sin
gle
rig
ht
an
sw
er
–d
riven
by b
eliefs
an
d r
isk t
ole
ran
ce
In t
he f
ollo
win
g s
lid
es w
e s
ho
w h
ow
th
e F
un
d c
ou
ld f
inan
ce a
n L
DI m
an
date
wit
ho
ut
red
ucin
g t
he e
xp
ecte
d r
etu
rn o
n t
he a
ssets
Page 36
ME
RC
ER
24
Ma
ke
th
e F
un
d’s
pa
ssiv
e e
qu
itie
s w
ork
ha
rde
r
Phys
ical equity
can b
e r
eplic
ate
d b
ycash/b
onds a
nd e
quity
derivativ
es
Usin
g d
erivatives c
an r
eta
in e
quity r
etu
rns b
ut
reduce inte
rest
rate
and
inflatio
n r
isk
Pa
ss
ive
Eq
uit
ies
10
0%
Eq
uit
y D
eri
va
tive
s 1
00
%
+ C
as
h 1
00
%+
Ca
sh
25
% &
IL
Gil
ts 7
5%
Eq
uit
y D
eri
va
tive
s 1
00
%
Page 37
ME
RC
ER
25
Ac
tive
eq
uit
ies
(3
6.0
5%
)
Gil
ts (
5.0
%)
+
E
qu
ity
ov
erl
ay
Cu
rre
nt
allo
cati
on
Ad
deff
icie
nt
eq
uit
y
IL G
ilts
(3
.8%
)
Pa
ss
ive
eq
uit
ies
(2
3.7
5%
)
Ph
ys
ica
l a
ss
ets
Usin
g c
ap
ita
l effic
ien
tly to
incre
ase
lia
bili
ty h
ed
ge
wh
ilst m
ain
tain
ing
expecte
d r
etu
rn thro
ugh e
xposure
to r
etu
rn s
eekin
g a
ssets
Pro
pe
rty
(6
.7%
)
Cre
dit
(1
0.2
%)
Ph
ys
ica
l a
ss
ets
Liability hedge
Pa
ss
ive
eq
uit
ies
(2
3.7
5%
)
DG
F (
9.5
%)
Liabilityhedge
IL G
ilts
+ C
as
h (
23
.75
%)
Pro
pe
rty
(6
.7%
)
Pri
va
te E
qu
ity
(5
%)
DG
F (
9.5
%)
Cre
dit
(1
0.2
%)
IL G
ilts
(3
.8%
)
Gil
ts (
5.0
%)
Ac
tive
eq
uit
ies
(3
6.0
5%
)
Pri
va
te E
qu
ity
(5
%)
Page 38
LO
NG
EV
ITY
HE
DG
ING
Page 39
ME
RC
ER
Lo
ng
evity s
wa
p a
nd
bu
y-in
co
mp
are
d
Pe
ns
ion
er
Lo
ng
ev
ity
sw
ap
Pe
ns
ion
er
bu
y-i
n
Pro
s•
Rem
ove
s pensi
oner
longevi
ty r
isk
at
belo
wre
cent
trends
•“B
uy n
ow
while
sto
cks last”
•A
void
lock
ing into
curr
ent
low
yie
lds
•R
eta
in a
sset
fle
xib
ility
•P
oss
ible
ste
ppin
g s
tone t
o la
ter
full
risk
transf
er
or
self-
suffic
ient
run o
ff
•C
lose m
atc
hin
g o
n p
ort
ion o
f lia
bili
ties
•In
vestm
ent
mark
et dis
locations c
an p
resent
prici
ng o
pport
uniti
es
•C
onsi
stent
with
a long t
erm
com
ple
te e
xit
Co
ns
•P
ossib
le a
dvers
e f
undin
g/a
ccountin
gim
plic
atio
ns
(alth
ough c
an p
ote
ntia
lly b
efu
nded b
y a
dju
sting investm
ent
str
ate
gy)
•E
xtra
adm
in r
equirem
ents
•Ill
iquid
so c
onstr
ain
t on investm
ent
str
ate
gy
•If p
aid
for
by
sale
of gilt
s, p
ote
ntia
lly lim
ited
risk r
eductio
n o
r even incre
ase in r
isk
•If p
aid
for
by s
ale
of gro
wth
assets
, lo
ck in
underf
undin
g
27
A lo
ng
evit
y s
wap
is e
co
no
mic
ally s
imilar
to a
n u
nfu
nd
ed
bu
y-i
n,
reta
inin
g a
sset
flexib
ilit
y (
so
risk a
nd
re
ward
) an
d s
pre
ad
ing
paym
en
t o
f lo
ng
evit
y r
isk p
rem
ium
to
th
e t
hir
d p
art
y o
ver
the
co
ntr
act’
s l
ife
Page 40
ME
RC
ER
At a h
igh le
vel, the m
echanis
m o
f a longevity s
wap is
rela
tively
sim
ple
…alth
oug
h m
ultip
le p
art
ies a
re in
volv
ed
28
Pe
nsio
nS
che
me
or
fun
d m
an
ag
er
Pe
ns
ion
Sc
he
me
Co
un
terp
art
y
Mo
nth
ly c
ash
flo
w p
aid
un
til li
fe
deceased
(3)
Mo
nth
ly c
ash
flo
w p
aid
fo
r
fixed
term
(2)
Pe
ns
ion
er
Mo
nth
ly p
en
sio
n p
aym
en
t
paid
un
til li
fe d
eceased
(1)
Sp
on
so
r
Tru
ste
e
Sc
he
me
Fro
nti
ng
co
un
terp
art
y(s
ub
sid
iary
of
ba
nk
/in
su
rer)
Fin
al
ris
k c
arr
ier
e.g
. R
ein
su
rer
Co
lla
tera
l ve
hic
le
Ne
ed
to
co
nsid
er:
•M
em
be
rsco
ve
red
•N
am
ed
life
vs.
ind
ex
•In
su
ran
ce
vs.
de
riva
tive
•C
olla
tera
lstr
uctu
re e
tc
•P
en
sio
n s
ch
em
e a
dm
inis
tra
tor ty
pic
ally
pro
vid
es a
mo
nth
ly f
ile o
f p
en
sio
ne
r sta
tus m
ove
me
nts
(d
ea
ths, co
ntin
ge
nt
sp
ou
se
pe
nsio
ns b
eco
me
s d
ue
, su
sp
en
sio
ns, r
ein
sta
tem
en
ts)
Page 41
ME
RC
ER
A n
um
ber
of lo
ngevity s
waps h
ave a
lready tra
nsacte
d a
nd the m
ark
et
continues to d
evelo
p
29
2010
2009
2011
2012
Schem
e:
Babcock
Pro
vid
er:
Cre
dit
Su
isse
Siz
e:
£1,2
00m
Schem
e:
RS
A
Pro
vid
er:
Gold
man
Sachs/R
oth
esa
y Life
Siz
e:
£1,9
00m
Feb
ruary
2009 –
Ju
ne 2
010
Ju
ly 2
009 S
ch
em
e:
CD
C
Pro
vid
er:
Gold
man
Sachs/R
oth
esa
y Life
Siz
e:
£400m
Decem
ber
2009
Schem
e:
BA
Pro
vid
er:
Gold
man
Sachs/R
oth
esa
y Life
Siz
e:
£1,3
00m
x 2
Ju
ne 2
010/
Dec 2
011
Schem
e:
BM
W
Pro
vid
er:
Deuts
che B
ank/
Abbey
Life
Siz
e:
£3,0
00m
Feb
ruary
2010
No
vem
ber
2009
Schem
e:
County
of
Berk
shire
Pro
vider:
Sw
iss R
e/W
indsor
Life
Siz
e:
£750m
Schem
e:
Pall
Pro
vid
er:
JP
Morg
an
;in
dex
trade f
or
defe
rreds
Siz
e:
£70m
Jan
uary
2011
Schem
e:
Rolls
Royc
e
Pro
vid
er:
Deuts
che B
ank
Siz
e:
£3,0
00m
No
vem
ber
2011
Au
gu
st
2011
Decem
ber
2011
Schem
e:
ITV
Pro
vid
er:
Cre
dit
Su
isse
Siz
e:
£1,7
00m
Schem
e:
Akz
o N
obel
Pro
vider:
Sw
iss R
e
Siz
e:
£1,4
00m
May 2
012
Schem
e:
LV
=
Pro
vider:
Sw
iss R
e
Siz
e:
£800m
Decem
ber
2012
2013
Schem
e:
Pilk
ingto
n
Pro
vider:
L&
G
Siz
e:
£1,0
00m
Schem
e:
BA
e
Pro
vider:
L&
G
Siz
e:
£3,2
00m
Feb
ruary
2013
Schem
e:
Bentle
yP
rovi
der:
Deuts
che
Bank/
Abbey
Life
Siz
e:
£500m
May 2
013
•R
ed
bo
xes d
en
ote
invo
lve
me
nt o
f M
erc
er
co
nsu
lta
nt
Page 42
INF
RA
ST
RU
CT
UR
E
Page 43
ME
RC
ER
Asse
t cla
ss o
verv
iew
De
fin
ing
eco
no
mic
ch
ara
cte
ristics
31
31
Hig
h b
arr
iers
to
en
try
Eco
no
mie
s o
f scale
Inela
sti
c d
em
an
d
Lo
ng
lif
e d
ura
tio
n
Infl
ati
on
lin
ka
ge
Page 44
ME
RC
ER
Asse
t cla
ss o
verv
iew
Com
pariso
n to o
ther
asset cla
sse
s
32
“IN
FR
AS
TR
UC
TU
RE
”
Pri
vate
Eq
uit
y:
Illiq
uid
equity
Due d
iligence
requir
em
ent
Act
ive m
anagem
ent
Pro
pe
rty:
Tangib
le u
nderlyi
ng a
ssets
/ c
oncessio
nIm
port
ance o
f capita
l str
uctu
reLong d
ura
tion
Inte
rest
rate
sensiti
ve
Fix
ed
In
co
me:
Curr
ent
cash
yie
ldIn
flatio
n l
inkage (
for
ILG
s)
Vis
ibili
ty a
nd
pre
dic
tab
ility
Infr
as
tru
ctu
re:
Polit
ical and r
egula
tory
ris
kLarg
e-s
cale
investm
ents
Uniq
ue m
ark
et posi
tionin
gE
quity &
Debt
investm
ent
channels
Page 45
ME
RC
ER
Curr
ent in
vestm
ent case
Mark
et backdro
p
33
On
go
ing
infla
tion
un
ce
rta
inty
& c
on
ce
rns
Hig
h u
nce
rta
inty
aro
un
d tra
ditio
na
l asse
t p
ricin
g
De
ma
nd
sid
e
Su
pp
ly s
ide
Sys
tem
ic fa
cto
rs d
rivin
g s
up
ply
of n
ew
op
po
rtu
nitie
s
Asse
t g
ea
rin
g le
vels
co
min
g d
ow
n
Str
on
g fo
cu
s o
n a
va
ilab
ility
sty
le lo
w r
isk a
sse
ts
Need
to
co
nsid
er
alt
ern
ati
ve
investm
en
to
pti
on
s
So
lid
su
pp
ly o
fassets
Att
racti
ve
investm
en
ten
vir
on
men
t o
na r
isk-a
dju
ste
db
asis
Ove
rbid
tra
ditio
na
l ma
rke
ts fo
r in
fla
tio
n
Page 46
ME
RC
ER
Po
sitio
nin
g th
e a
sse
t cla
ss
A r
an
ge
of ri
sk p
rofile
s
34
Develo
pm
ent
Em
erg
ing
Mark
ets
OP
PO
RT
UN
IS
TIC
Senio
r +
Junio
r D
ebt
DEB
TRegula
ted
PPP
CO
RE
Contr
acte
dPrice
Concessio
nC
ontr
act
CO
RE P
LU
S
Ris
k
Return
Develo
pm
ent
Em
erg
ing
Mark
ets
OP
PO
RT
UN
IS
TIC
Senio
r +
Junio
r D
ebt
DEB
TRegula
ted
PPP
CO
RE
Contr
acte
dPrice
Concessio
nC
ontr
act
CO
RE P
LU
S
Senio
r +
Junio
r D
ebt
DEB
TRegula
ted
PPP
CO
RE
Regula
ted
PPP
CO
RE
Contr
acte
dPrice
Concessio
nC
ontr
act
CO
RE P
LU
S
Contr
acte
dPrice
Concessio
nC
ontr
act
CO
RE P
LU
S
Ris
k
Return
Qu
asi-
matc
hin
g/m
id-r
isk
Defe
nsiv
eg
row
th
Typ
ical
focu
sare
as f
or
aU
Kp
en
sio
nsch
em
e
Page 47
ME
RC
ER
35
Positio
nin
g o
f th
e a
sset cla
ss
… a
nd d
iffe
ring p
ort
folio
role
s
Bas
e P
ort
foli
oG
row
th P
ort
foli
o
Lia
bil
ity
ma
tch
ing
ov
erl
ay
Inte
rest
rate
an
d/o
r
infl
ati
on
sen
sit
ive
assets
Flo
ati
ng
rate
assets
Cash
So
ve
reig
n b
on
ds
En
ha
nce
d c
ash
Asse
t B
acked
Se
cu
ritie
s, L
oa
ns
Inve
stm
en
t g
rad
ecre
dit
Re
al a
sse
ts (H
LV
pro
pe
rty,
gro
un
d le
ase
s, in
fra
stru
ctu
red
eb
t)
Th
e G
row
th P
ort
folio
co
mb
ines b
eta
an
d a
lph
a
so
urc
es
fro
m t
rad
itio
na
l a
nd
alt
ern
ati
ve
asse
t
cla
sse
s t
o p
rovid
e c
ap
ita
l a
pp
rec
iati
on
ove
r
the lo
ng
term
Ca
pit
al is
pla
ce
d a
t ri
sk
an
d a
sse
ts m
ay
be
su
bje
ct
to s
ign
ific
an
t illiq
uid
ity
Pri
ori
ty is g
ive
n t
o c
ap
ita
l p
rese
rva
tio
n
Th
e p
ort
folio
sh
ou
ld t
ak
e a
cco
un
t o
f in
co
me
gen
era
tio
n, liq
uid
ity a
nd
co
llate
ral re
qu
irem
en
ts
A d
eg
ree o
f illiq
uid
ity a
nd
ma
rk-t
o-m
ark
et
vo
lati
lity
may b
e a
cce
pta
ble
wit
hin
th
e p
ort
folio
Alp
ha r
etu
rn s
ourc
es
Beta
retu
rn s
ou
rces
He
dg
e fu
nd
s
Gro
wth
fix
ed
inco
me
(in
c.H
igh
Yie
ld)
Re
al a
sse
ts (p
rop
ert
y,
infr
ast
ructu
re e
tc)
Lis
ted
eq
uity
Priva
te e
qu
ity
etc
.e
tc.
Higher return
More risk to capital
Betterliquidity
More volatility
Co
llate
ral fo
r lia
bili
ty o
ve
rla
ys / s
yn
the
tic b
eta
Page 48
ME
RC
ER
Infr
astr
uctu
re d
ebt
What is
it?
•C
an
ta
ke
tw
o m
ain
fo
rms,p
ub
lic
(e.g
. N
etw
ork
Ra
il b
on
ds)
bu
t m
ore
co
mm
on
ly,
pri
va
te
•P
riva
tely
pla
ce
d lo
an
s (
ofte
n u
nlis
ted
an
d u
nra
ted
) a
re is
su
ed
by in
fra
str
uctu
reb
usin
esse
s to
fin
an
ce
ca
pita
l exp
en
ditu
re, a
cq
uis
itio
ns, a
nd
on
go
ing
asse
to
wn
ers
hip
•P
ricin
g a
nd
wid
er
term
s a
re ta
ilore
d to
ea
ch
tra
nsa
ctio
n th
rou
gh
a f
lexi
ble
de
al
str
uctu
re
•S
tab
le c
ash
flo
ws a
nd
hig
h o
pe
ratin
g m
arg
ins fro
m in
fra
str
uctu
re s
up
po
rt r
ela
tive
lyh
igh
de
bt le
ve
ls
–B
ut a
lso
me
an
ris
k le
ve
ls a
re lo
we
r th
an
oth
er
se
cto
rs o
f p
riva
te d
eb
t
–W
ith
a c
om
me
nsu
rate
re
du
ctio
n in
exp
ecte
d r
etu
rns (
co
mp
are
d to
oth
er
pri
va
ted
eb
t)
36
Page 49
ME
RC
ER
Infr
astr
uctu
re d
ebt
Ch
ara
cte
rist
ics
•C
om
pa
red
to
de
bt fr
om
oth
er
se
cto
rs, in
fra
str
uctu
re d
eb
t tr
ad
es o
ffc
red
it r
isk
for
liq
uid
ity
ris
k
•S
pre
ad
s a
t a
ttra
cti
ve
le
ve
lsco
mp
are
d to
his
tori
ca
l no
rms
37
indic
ative r
etu
rn b
reakdow
n
G'm
en
t Y
ield
G'm
en
t Y
ield
Cre
dit
Sp
read
Cre
dit
Sp
read
Liq
uid
ity
Pre
miu
m
Liq
uid
ity
Pre
miu
m
Co
rpo
rate
Bo
nd
Infr
astr
uctu
re D
eb
t
Page 50
ME
RC
ER
Com
paring in
frastr
uctu
re d
ebt to
equity
Key featu
res
•C
hara
cte
ristic
s o
f in
frastr
uctu
re le
ad t
o p
redic
table
busin
ess p
lans;
senio
r le
nder
pro
tectio
ns
furt
her
reduce t
he investm
ent risk p
rofil
e
–te
rms typic
ally
allo
w for
sig
nifi
cant re
covery
upon d
efa
ult
•S
ubord
inate
d d
ebt sits b
etw
een e
quity a
nd s
enio
r debt
on the r
isk s
pectr
um
–paym
ents
ahead o
f equity
dis
trib
utions
–unsecure
d o
r 2nd r
ankin
g c
laim
on a
sset
38
Sen
ior
de
bt
Su
bo
rdin
ate
d d
eb
tE
qu
ity
% o
f capital
stru
cture
! b
etw
een 4
0%
and 9
0%
! u
p to 2
5%
! b
etw
een 1
0%
and 6
0%
Rankin
g!
sen
ior
to a
ll oth
er
sta
kehold
ers
! s
ubord
inate
d to s
enio
r debt
! s
enio
r to
equity
! s
ubord
inate
d to a
ll cre
ditors
Term
! a
mort
isation p
rofile
genera
lly m
atc
hes
exp
ecte
d li
fe o
f asse
t (w
ith s
om
e b
uff
er)
! m
ay h
ave in
term
edia
te m
atu
rity
! m
atu
rity
after
Senio
r D
ebt
! a
vera
ge life lo
nger
than
Senio
r D
ebt
! p
erp
etu
al
Security
! 1
st
rankin
g c
harg
e o
ver
availa
ble
assets
! T
ypic
ally
does n
ot
inclu
de "
hard
" assets
,but
pro
vid
es lenders
contr
ol/ste
p-in r
ights
! u
nsecure
d o
f 2nd r
ankin
g
cha
rge
n/a
Page 51
ME
RC
ER
Infr
astr
uctu
re d
ebt
Mark
et pricin
g a
nd e
xpecte
d r
etu
rns
39
* In
dic
ative
retu
rns
for
indiv
idual in
vestm
ents
Th
ese
va
ry a
cco
rdin
g to
po
sitio
n in
ca
pita
l str
uctu
re, se
cto
r a
nd
ris
k p
rofile
Se
nio
r D
eb
tS
ub
ord
ina
ted
De
bt
Eq
uit
y
Fundin
g b
ase
! flo
ating o
r fix
ed r
ate
! flo
ating
or
fixed
rate
Form
of
retu
rn!
regula
r cash inte
rest
! p
rim
arily
regula
r cash
inte
rest
! p
ote
ntial fo
r accru
ed
inte
rest
and c
apital gain
s
! p
rim
arily
capital gain
s
! e
quity
div
idends
Retu
rn
expecta
tions
! L
IBO
R +
2.2
5%
-
3.2
5%
for
Core
! t
ypic
al pre
miu
m o
f >
=
3%
ove
r S
enio
r D
ebt
in
sam
e t
rans
action
! 1
0-1
4%
IR
R for
Core
/Core
Plu
s
! U
p t
o 2
0%
IR
R fo
r
Opport
unis
tic
Page 52
ME
RC
ER
Infr
astr
uctu
re d
ebt
Defa
ult r
ate
s c
om
pare
d to o
ther
asset cla
sses
40
Targ
et
assets
Targ
et
assets
…a
nd
hig
h h
isto
rica
l re
co
ve
ry r
ate
s
So
urc
e:
Seq
uo
ia, M
oo
dy
s
Page 53
ME
RC
ER
41
Imp
lem
en
tatio
n c
on
sid
era
tio
ns
Genera
l com
ments
•F
or
all
bu
t th
e la
rge
st in
vesto
rs, im
ple
me
nta
tion
will
ne
ed
to
be
via
th
ird
pa
rty
ma
na
ge
d fu
nd
s o
r se
pa
rate
acco
un
ts
•E
xistin
g u
niv
ers
e o
f in
fra
str
uctu
re s
en
ior
de
bt m
an
ag
ers
, w
ith
an
incre
asin
ga
rra
y o
f se
nio
r m
an
ag
ers
en
teri
ng
th
e m
ark
et in
re
sp
on
se
to
th
e e
me
rgin
go
pp
ort
un
ity
•P
refe
ren
ce
fo
r se
pa
rate
acco
un
t fo
r th
ose
inve
sto
rs th
at h
ave
th
e s
ca
le to
acce
ss th
is fo
rma
t (t
ypic
ally
$1
00
m a
lloca
tio
ns a
nd
up
wa
rds)
-g
rea
ter
tailo
rin
g p
ote
ntia
l-
gre
ate
r co
ntr
ol o
ve
r m
an
da
te m
an
ag
em
en
t a
nd
ho
ld p
eri
od
•In
cre
asin
g a
rra
y o
f p
oo
led
clo
se
d e
nd
fu
nd
s e
me
rgin
g fo
r sm
alle
r in
ve
sto
rs(f
urt
he
r d
eta
ils b
elo
w)
•P
ort
folio
pla
nn
ing
an
d o
bje
ctive
se
ttin
g a
s a
ne
ce
ssa
ry fir
st ste
p
Page 54
ME
RC
ER
Imp
lem
en
tatio
n c
on
sid
era
tio
ns
Imple
menta
tion r
oute
s c
om
pa
red
42
09 O
cto
ber
2013
Po
ten
tia
l A
dva
nta
ge
sP
ote
nti
al D
isa
dva
nta
ge
sIn
dic
ati
ve S
ize T
hre
sh
old
Dire
ct in
ve
stm
en
t•
Dire
ct in
flu
en
ceo
n in
ve
stm
en
tse
lectio
n a
nd
po
rtfo
lio c
om
po
siti
on
•P
ort
folio
ta
ilorin
g•
Fe
e s
avin
g
•N
ee
d fo
r in
-ho
use
or
ou
tso
urc
ed
cre
dit e
xp
ert
ise
•R
eq
uire
s la
rge
su
ms o
f ca
pita
l•
Po
rtfo
lio c
on
ce
ntr
atio
n e
sp
eci
ally
inth
e e
arl
y y
ea
rs
£1
50
m+
Ma
nd
ate
inve
stm
en
t•
De
leg
ate
d c
on
tro
l of in
ve
stm
en
ts•
Inve
stm
en
t se
lectio
n a
nd
ma
na
ge
me
nt u
nd
ert
aken
by a
de
dic
ate
d m
an
ag
er
•A
cce
ss to
ma
na
ge
r p
rop
rie
tary
de
al
flo
w•
Co
ntr
ol o
f p
ort
folio
de
sig
n a
nd
co
mp
ositi
on
lea
din
g to
po
rtfo
liota
ilorin
g p
ote
ntia
l
•P
ote
ntia
lfo
r a
ge
ncy ris
ks in
th
ea
bse
nce
of d
ed
ica
ted
po
rtfo
liom
an
ag
er su
pp
ort
/re
sou
rcin
g•
Po
ten
tial f
or
ag
en
cy ris
ks
•H
igh
er
fee
s th
an
dire
ct in
vestin
g•
Po
rtfo
lio c
on
ce
ntr
atio
n e
sp
eci
ally
inth
e e
arl
y y
ea
rs
£7
5m
+
Un
liste
dfu
nd
s•
Inve
stm
en
tse
lectio
n a
nd
ma
na
ge
me
nt u
nd
ert
aken
by a
de
dic
ate
d m
an
ag
er
•A
cce
ss to
pro
pri
eta
ry m
an
ag
er d
ea
lflo
w•
Ca
n a
cco
mm
od
ate
sm
alle
rin
vestm
en
ts•
Po
rtfo
lio m
on
ito
rin
g a
nd
re
po
rtin
gacce
ss
•H
igh
er
fee
s•
Acqu
isiti
on r
isk
•P
ote
ntia
l fo
r str
ate
gy d
rift
•P
ote
ntia
lla
ck o
f lo
ng
te
rm tra
ck
reco
rd•
Ma
na
ge
r re
lian
ce
giv
es r
ise
to
ag
en
cy
risk
£7
5m
Page 55
ME
RC
ER
43
Imp
lem
en
tatio
n c
on
sid
era
tio
ns
Indic
ative fund term
s Ma
na
ge
r A
Ma
na
ge
r B
Typ
e o
f str
ate
gy
Infr
astr
uctu
reS
en
ior
De
bt,
UK
On
lyP
oo
led
fu
nd
Infr
astr
uctu
re S
en
ior
De
bt,
UK
On
ly P
oo
led
fun
d
Re
turn
ta
rge
tsL
IBO
R +
2.8
5%
(g
ross)
LIB
OR
+ 2
.50
-2.7
5%
(n
et)
Ma
na
ge
me
nt
fee
sN
o fe
es o
n c
om
mitte
db
ut u
nd
raw
nca
pita
l
0.2
5%
p.a
. o
n d
raw
n c
ap
ita
l
0.4
5%
p.a
. o
n c
om
mitte
d c
ap
ita
l du
rin
gIn
ve
stm
en
tP
eri
od
0.2
5%
p.a
. o
n In
ve
ste
d C
ap
ita
l th
ere
aft
er
Dra
wd
ow
np
eri
od
12
mo
nth
ma
xim
um
5 y
ea
r m
axi
mu
m
Ma
rke
t ca
pa
city
$1
5 b
illio
n+
$3
0 b
illio
n+
Typ
ica
llo
ck u
p p
eri
od
10
ye
ars
10
ye
ars
with
ro
llin
g 5
ye
ar
ext
en
sio
n o
ptio
ns
the
rea
fte
r
Page 56
AP
PE
ND
ICE
S
Page 57
ME
RC
ER
2
2.
Tri
gg
er
bre
ach
ed
17/1
0/1
2
•P
rim
arily
result
of
incre
ase i
nre
al
yield
s;
•S
trate
gic
Gro
wth
Allo
cation r
educed
from
68%
to 6
5%
5.
Tri
gg
er
bre
ach
ed
22/0
5/1
3
•P
rim
arily
drive
n b
y in
cre
ase i
nre
al
yield
s.
Gro
wth
mark
ets
contin
ued t
o p
erf
orm
;
•S
trate
gic
Gro
wth
Allo
cation
reduced f
rom
62%
to 5
9%
1
4
Aff
ord
able
de-r
iskin
gB
ankin
g im
pro
vem
ents
in t
he f
undin
g t
o h
elp
de-r
isk
3.
Fu
nd
ing
lev
el
sp
ike 0
3/0
1/1
3
•P
rim
arily
result
of
one d
ay
incre
ase i
nre
al
yield
s;
•T
rigger
not
quite
bre
ach
ed,
gro
wth
allo
catio
n u
nchang
ed
3
1.
Tri
gg
er
bre
ach
ed
09/1
0/1
2
•In
cre
asin
gre
al
yield
sand
gro
wth
mark
ets
;
•S
trate
gic
Gro
wth
Allo
cation r
educed t
o 6
8%
from
70%
4.
Tri
gg
er
bre
ach
ed
13/0
2/1
3
•P
rim
arily
drive
n b
y in
cre
ase i
nre
al
yield
s.
Gro
wth
mark
ets
als
operf
orm
ed s
trongly
;
•S
trate
gic
Gro
wth
Allo
cation
reduced f
rom
65%
to 6
2%
5
•F
or
this
clie
nt, the f
undin
g le
vel h
as
incr
ease
d f
rom
72%
at in
ception to 7
9%
at end o
f peri
od;
•D
e-r
iske
d t
hro
ugh n
um
ero
us
trig
gers
, G
row
th p
ort
folio
allo
cation reduced f
rom
70%
to 5
9%
;
Th
e F
un
d c
ou
ld l
oo
k t
o d
yn
am
ica
lly
de
-ris
k t
o m
ove
to
th
e l
ow
es
t ri
sk
in
ve
stm
en
t s
tra
teg
y
tha
t w
ou
ld s
till
su
pp
ort
th
e f
un
din
g a
ssu
mp
tio
ns
45
Page 58
ME
RC
ER
Po
sitio
nin
g th
e a
sse
t cla
ss
A s
ub
set of th
e r
eal a
sset gro
up
46
Retu
rn-f
ocu
sed
Infl
ati
on
-sen
sit
ive
Div
ers
ifie
rs
Dir
ectio
na
l he
dg
e fu
nd
s
Co
re R
ea
l Esta
teC
ore
In
fras
tru
ctu
re
Tim
be
rA
gri
cu
ltu
re
Va
lue
-ad
d R
ea
l Est
ate
Co
mm
od
itie
s
Ta
il ri
sk h
ed
gin
gstr
ate
gie
s
Sh
ipp
ing
Insu
ran
ce
-lin
ke
d s
ecu
ritie
sN
on
-dir
ection
al h
ed
ge
fu
nd
sP
riva
te D
eb
t
Gro
wth
In
fra
str
uctu
re
Op
po
rtu
nis
tic R
ea
l Est
ate
*
Sh
ort
-bia
se
dh
ed
ge
fu
nd
sE
ne
rgy R
eso
urc
es*
Ene
rgy
PE
*M
inin
g &
Min
era
ls*
rea
l a
sse
tsin
ve
stm
en
tstr
ate
gie
s
HLV
Re
al E
sta
te*
Pri
va
te E
qu
ity
Co
re In
fras
tru
ctu
re
Tim
be
r
Gro
wth
In
fra
str
uctu
re
Infr
astr
uctu
reD
eb
t
Page 59
ME
RC
ER
Curr
ent m
ark
et opport
unity
The in
frastr
uctu
re d
ebt fu
ndin
g g
ap
•D
em
and for
infr
astr
uctu
re is s
ignifi
cant
–$500-$
600 b
illio
n e
stim
ate
d a
nnual n
eed a
mong O
EC
D m
em
bers
–$40 t
rilli
on o
r 2.4
% o
f w
orld G
DP
to b
e investe
d in
infr
astr
uctu
re to 2
030
•H
isto
rically
banks h
ave b
een m
ain
pro
vider
of in
frastr
uctu
re d
ebt
(pro
vid
ing u
p to 9
0%
of
debt)
; post financia
l crisis
, num
ero
us facto
rs a
re lim
iting b
ank p
art
icip
atio
n
–B
asel I
II a
nd b
ala
nce s
heet re
pair
–lo
wer
risk a
ppetite
–“t
ake-a
nd-h
old
” m
odel
–re
financin
g w
all
•O
ther
sourc
es o
f liq
uid
ity that w
ere
popula
r prior
to the f
inancia
l crisis
(bonds w
rapped b
ym
ono-lin
es, C
LO
s,
hedge funds)
are
no lo
nger
in the m
ark
et
•…
leavin
g a
key r
ole
for
oth
er
instit
utio
nal i
nvesto
rs
47
Page 60
ME
RC
ER
48
09 O
cto
ber
2013
Howe
ver, in
frastr
uctur
e is its
elf a d
iverse
asset
class
with a
rang
e of p
otenti
alris
k prof
iles, an
d it is
impor
tant to
defin
e a fo
cus po
int
Construction Risk
Maturity
Us
ag
e (
GD
P)
Ex
po
su
re (
gro
wth
)
Ava
ila
bil
ity
Pa
ym
en
ts (
yie
ld)
Op
era
tin
g T
oll r
oad
Pre
-co
nstr
ucti
on
PP
P
Op
era
tin
g U
tility
Air
po
rt i
n C
on
str
ucti
on
Maturity
Op
era
tin
g U
tility
Us
ag
e (
GD
P)
Ex
po
su
re (
gro
wth
)
Op
era
tin
g T
oll r
oad
Su
gg
es
ted
foc
us
are
as
to
ac
hie
ve
de
fen
siv
ed
ive
rsif
ica
tio
n
Ava
ila
bil
ity
Pa
ym
en
ts (
yie
ld)
Pre
-co
nstr
ucti
on
PP
P
Asse
t cla
ss o
verv
iew
A ra
ng
e o
f ri
sk p
rofile
s
Page 61
ME
RC
ER
Merc
er
Lim
ited i
s auth
oris
ed a
nd r
egula
ted b
y th
e F
inancia
l C
onduct
Auth
ority
Regis
tere
d i
n E
ngla
nd N
o.
984275 R
egis
tere
d O
ffic
e:
1 T
ow
er
Pla
ce W
est, T
ow
er
Pla
ce,
Lond
on E
C3R
5B
U
Page 62
