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Asset Allocation Solutions for Pension & Insurance Companies

Asset Allocation Solutions for Pension & Insurance Companies. John McLaughlin Head of Multi Asset Solutions. May 2010 | For professional investors only. This material is not suitable for retail clients. Getting the balance right. Liabilities. Bonds. Equities.

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Asset Allocation Solutions for Pension & Insurance Companies

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  1. Asset Allocation Solutions for Pension & Insurance Companies John McLaughlin Head of Multi Asset Solutions May 2010 |For professional investors only. This material is not suitable for retail clients

  2. Getting the balance right Liabilities Bonds Equities Is a traditional balanced approach the answer? • Diversification is limited to 2 or 3 asset classes • Benchmark is not aligned to the client’s ultimate objective • Focus is greatest where the opportunity is least • Asset allocation is slow moving and lacks conviction • Risk management amounts to monitoring a tracking error • Liabilities are difficult to match using bonds and are not particularly capital efficient 1

  3. Static diversification is not enough You must also rebalance dynamically Simple static diversification provides protection as the tech bubble collapses June 2000 – April 2006 Simple static diversification offers little protection in the current down turn April 2006 – June 2009 *Diversified Index: 50% MSCI AC World TR $,10% HFRI Fund of Funds Composite TR $, 7% JPM EMBI Global Composite TR $, 10% ML Global High Yield TR $, 10% FTSE EPRA/NAREIT Developed TR $, 3% LPX50 TR $, 10%DJ UBS Future Commodity Index ER $. Rebalanced on monthly basis. Source: Thomson DataStream, Schroders. Updated 30th June 2009. 2

  4. Cash Equity Illiquidity Term Credit Volatility Skill Equity Private Equity Property Infra-structure High Yield Com-modities Hedge Funds Currency Dynamic multi-asset investing Say ‘No’ to the traditional approach No Benchmark • Target an absolute risk/return outcome • No Limits • Broad diversification by Asset type Risk source Investment vehicle • No Fear • High conviction asset allocation: • Capital rotation through the market cycle • Taking advantage of valuation opportunities • Realising investment themes • No Surprises • Construct portfolios based on risk weighting, not trade weighting • Observe and control the portfolio through different risk lenses e.g. VaR, factor risk, liquidity risk • Use customised, quantitative risk management tools Easy to say, not so easy to do ….. successfully

  5. Schroders asset allocation model Asset allocation is hard to do well Quarterly Monthly Daily Cyclical Market Forum Global Asset Allocation Committee Fund Management & Analysis Fund Managers & Analysts 40+ Senior Fund Managers / Analysts 5 Independent Multi-Asset Specialists 22 Fund Managers and Analysts Equity 163 Gather Information • Outlook for asset classes • Specialist views • Discuss economic scenarios Determine Investment Policy • Asset class preferences • Conviction & Accountability • Set stop-loss/take-profit Construct Portfolios • Sizing positions • Fund / Vehicle selection • Monitor risk & return Fixed Income 53 Alternatives 67 Risk Management InvestmentStrategy 16 quants and derivative experts 5 macro economists Models & economic cycle analysis Optimisation, risk analysis, hedging Specialist resources are necessary - lots of them Source: Schroders, 31 December 2009 *Team of 30 includes portfolio management, quant analysis, research, trading and support 4

  6. Asset allocation in practice Getting ideas into the portfolio – the Schroders way • Global asset allocation committee members sponsor and co-sponsor ideas • Challenged by colleagues • All ideas structured as long/short positions • Analysis to ensure risk control and diversification • Implemented quickly, to take advantage of market conditions • Accountable and transparent process 5 Voting Members Global Asset Allocation Global Asset Allocation Alan Brown, Keith Wade, Johanna Kyrklund, Committee (monthly) Committee Simon Doyle and Richard Coghlan Sponsor Sponsor Co Co - - Sponsor Sponsor Long High Long High vs. vs. Cash Cash Johanna Kyrklund Johanna Kyrklund Alan Brown Alan Brown Yield Debt Yield Debt Long Long vs. vs. US US Keith Wade Keith Wade Johanna Kyrklund Investment Investment Government Government Grade Grade Bonds Bonds Short Equities Long Equities vs. vs. Cash Cash Keith Wade Richard Coghlan Long Pacific Long Can $ vs. vs. Australian $ US Equities Richard Coghlan Simon Doyle Basin Equities Long Long vs. vs. G3 G3 Johanna Kyrklund Johanna Kyrklund Keith Wade Emerging Emerging Currencies Currencies Market Market Currencies Currencies Source: Schroders, for illustration only 5

  7. Implementing your ideas efficiently – Active or Passive funds ? Getting “Bang for your Buck” • Efficient (Passive) • Percentage of funds outperforming benchmark • Some benchmarks are much harder to beat than others • Focus on selecting actively managed strategies only in inefficient asset classes where high probability of achieving positive alpha exists • Avoid paying active management fees where probability of positive alpha is low by selecting low cost passive funds • Inefficient (Active) Source: Lipper Hindsight, February 2010

  8. Portfolio construction The right tools also make a big difference Quantitative framework • SMART (Schroders Multi-Asset Risk Tool) • Multi-Asset Portfolio Construction • Risk Reporting and Decomposition • Portfolio Simulations • … and much much more Cyclical model1 Valuation model2 Momentum model3 1 Source: Congressional Budget Office (CBO), Thomson DataStream, Schroders 2 Source: Thomson Datastream. Normalised Earnings yield minus bond yield 3 Source: Thomson Datastream. Equity year on year return

  9. Solution 1: Global Asset Allocation Proof that the processes and the resources work! Investment Features • Aims to provide absolute returns which are uncorrelated with other asset classes • Performance target of 10% above cash gross of fees over rolling 12 months • Volatility target of 10-15% p.a. Benefits • Almost all positions implemented through derivatives, keeping transaction costs low • Fund uses Schroder’s proprietary risk software to optimise allocations and manage risks • More liquid and transparent than many macro funds • Diversifying within portfolio Ann. strategy return: 9.80%Ann. strategy volatility: 6.41%Ann. LIBOR return: 2.93%Ann. excess return: 6.87% Source: Schroders. Chart shows monthly performance for the Global Tactical Asset Allocation portfolio. The Strategy was operating on a live basis in a managed account with £4 million of Schroder seed capital from January 2008 until April 2009. Performance shown is past performance. Past performance is not necessarily a guide to future performance. The value of investment can go down as well as up and is not guaranteed. 8

  10. Solution 2: Diversified Growth Fund Schroder ISF US Small & Mid Cap 9% Schroder ISF QEP Global Quality 7% Schroder ISF QEP Global Active Value 6% Schroder ISF European Special Situations 3% Schroder ISF Emerging Markets 3% Schroder ISF Asian Equity Yield 3% Schroder ISF European Equity Alpha 2% Schroder ISF European Allocation1% Passive Equity Derivatives 10% Equity like returns with 2/3 the risk of equities Equities 44% A smoother path of returns over time Schroder ISF Emerging Market Debt Absolute Return 6% PIMCO Emerging Market Bond Fund 5% Em. Market Debt 11% Schroder AS Commodity Fund 4% Schroder ISF Global Energy 4%ETFS Gold 2% Commodities 10% Strategic Schroder ISF Global High Yield 6% Bluebay High Yield Fund 3% High Yield Bonds 9% Schroder ISF Asia Pacific Property Securities 3% Invista Foundation Property Trust REIT 1% Property 4% International Public Partnerships 2% HSBC Infrastructure Company Ltd Ordinary1% Infrastructure 3% JP Morgan Highbridge Statistical Market Neutral Fund 2% Absolute Return 2% Private Equity* 2% Private Equity 2% Schroder ISF EURO Corporate Bond 3% Vanguard Inv Grade Credit Fund 3% Inv. Grade Bonds 6% Time Tactical Schroder ISF Global Convertible Bond 4% Convertibles 4% CPI +5% Externally Sourced Cash 8% Cash 8% Global Equities Diversified Growth Fund Source: Schroders as at 26 February 2010. Please note that this is indicative exposure only and may change, subject to market conditions and outlook *Private Equity includes allocation to Schroder PEFOF IV plus 1 listed externally managed fund. Total may not sum to 100 due to rounding 9

  11. Designed specifically to ‘complete’ a growth portfolio of equities Targets cash + 4% p.a. over rolling 5 year periods Maintains a beta of less than 0.5 to equities Full ongoing governance responsibility Manager selection New asset classes as appropriate Transparent fees Return from Dec 07 to Dec 09: +5.8% p.a. Solution 3: Diversified Completion Fund Fully managed access to alternative investments Asset Allocation as at 1 March 2010 Source: Schroders, as at 1 March 2010 10

  12. Solution 4: Global Dynamic Balanced Fund Limiting the downside Schroder Global Dynamic Balanced Fund Calendar Year Performance Return % • Like the Diversified Growth Fund, but with a systematic overlay that exits the market during a downturn • Aims to limit drawdowns to -10% in the worst years for risk assets • Active allocation to risk assets, between 0% and 60% Avoiding bursting of tech bubble Avoiding worst of credit crunch Source: Schroders, Datastream as at 31st December 2009. Backtested performance until 31st December 2008, live performance from 1st January 2009. Live performance is gross of fees using NAV for I shares. The simulated results must be considered as no more than approximate representation of the strategy’s potential performance. They are the result of back-testing quantitative research results, which are based on a number of assumptions. There are a number of limitations on the retroactive reconstruction of any performance results based on simulations. Past performance is not a guarantee of future results 11

  13. New solutions: Real assets fund The ‘real’ answer to future inflation? Commodities* Rent of shelter Durable goods Source: Bureau of Labour Statistics, Data Stream, Schroders. *Food and beverages & non durables less food and beverages 12

  14. Drawdown Period Accumulation Period Monthly drawdown payments from Year 11 to Year 25. Coupons are deducted from the NAV Maximum allocation to growth assets No drawdown distribution Bonus Payout* Final NAV is paid out to the investor. A proportion of the Bonus Payout will be incrementally protected if the NAV of the fund is high. Protected Drawdown Payments set at 5% p.a. of highest recorded NAV during the accumulation period New solutions: DC pensions market ‘Pension Plus’ – your retirement supplement NAV Highest NAV 100% Inception Year 10 Year 25 * Subject to market conditions Source: Schroders 13

  15. Matching liabilities – bonds or swaps? A Comparison Bonds for liability coverage • Accuracy of liability matching is limited • Extent of coverage broadly limited to size of bond portfolio • Low expected return • However, longer dated gilt yields are higher than swap yields Swaps for liability coverage • Better accuracy of liability matching • Extent of coverage can be much larger than assets in LDI portfolio • Frees up assets to pursue growth strategies • Lower yields at longer maturities than gilts Liabilities Liabilities Liability coverage Bonds LDI Swaps Swaps Backing assets Bonds Growth assets Equities Source: Schroders, for illustration only

  16. Key : Liability Driven InvestmentReducing liability risks - using swaps rather than bonds Liabilities Dynamic Allocation Portfolio Structure Swap Overlay Cash Holdings Cash Return Generating Assets Portfolio Management Interest rates fall / Inflation rises Cash Buffer Interest rate and inflation swaps Return Generating Assets 85% 10% 5% Interest rates rise / Inflation falls Note: Percentages shown above for illustration only. Actual amounts depend on the structure of the hedge Source: Schroders, for illustration only

  17. Key : Schroders LDI – the third generation solutionPlatform structure and management Liabilities Dynamic Allocation Portfolio structure Liability management Cash Holdings Collateral Return Generating Assets Portfolio management Cash movement Synthetic credit Return generating assets Cash Fund Collateral Longevity swaps IRS and inflation hedge Cash movement

  18. Conclusion • Diversification is your first defence against market uncertainty • But diversification by itself is not enough, it must also be dynamic • Your asset allocation is what matters most – so make it your main focus • Be obsessive about risk, and the returns will look after themselves • Risk and return objectives should be ‘real’, not ‘relative’ • Be capital efficient when matching your liabilities Say ‘No’ to a traditional balanced approach; say ‘Yes’ to dynamic asset allocation 17

  19. For Professional Investors only. Not Suitable for Retail Clients This presentation is for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Schroders has expressed its own views and opinions in this document and these may change. Information herein is believed to be reliable but Schroder Investment Management Ltd (SIM) does not warrant its completeness or accuracy. This does not exclude or restrict any duty or liability that SIM has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system The forecasts stated in the presentation are the result of statistical modelling, based on a number of assumptions. Forecasts are subject to a high level of uncertainty regarding future economic, and market factors that may affect actual future performance. The forecasts are provided to you for information purposes as at today's date. Our assumptions may change materially with changes in underlying assumptions that may occur, among other things, as economic and market conditions change. We assume no obligation to provide you with updates or changes to this data as assumptions, economic and market conditions, models or other matters change Issued in July 2009 by Schroder Investment Limited, 31 Gresham Street, London EC2V 7QA. Registration No 2015527 England Authorised and regulated by the Financial Services Authority Important information

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