Geo-Political Headwinds are Risk Management Tailwinds Niagara Institutional Dialogue 2012 Niagara on the Lake, Ontario Bruce B. Curwood, MBA, CFA, CIMA, Acc.Dir. Director, Investment Strategy Don Ezra, M.A, FIA Co-Chairman Global Consulting June 11, 2012
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Geo-Political Headwinds are Risk Management Tailwinds€¦ · Source: Frederick Funston & Stephen Wagner, 2010, Surviving and Thriving in Uncertainty: Creating the risk intelligent
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Source: Pensions & Investments (in conjunction with Russell Investments) , 1st Risk Survey, February 2012
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90%
58% 52%
58%
73% 81%
Risk more
important than
5 years ago
Pension plan
presents higher
risk to balance
sheet than 5 years
ago
Pension plan
presents higher
risk to earnings
than 5 years ago
Investment portfolio
presents higher risk
to organizational
mission than 5 years
ago (E&F only)
Increase in scrutiny
from Board &
Investment
Committee vs.
5 years ago
Complexity of
manager selection
has increased from
5 years ago
Comparing Importance of Issues Today versus 5 Years Ago
Source: Pensions & Investments (in conjunction with Russell Investments), 1st Risk Survey February 2012
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Portfolio Changes Due to Risk Measures (Last 12 months)
p.23
Source: Pensions & Investments (in conjunction with Russell Investments), 2nd Risk Survey March 2012
Minor Tweaks 46%
Moderate Changes
28%
Major Overhaul
5%
No Changes 21%
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Risk Management: Perception vs. Action
p.24
Source: Pensions & Investments (in conjunction with Russell Investments), 2nd Risk Survey March 2012
90.0%
79.2%
35.5%
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
80.0%
90.0%
100.0%
Risk more important than 5 years ago
Made changes to portfolio due to Risk Management (last 12 months)
Need to spend more time on risk management
(i.e. currently spending "too little" time)
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Expect to Take Additional Steps to Increase Risk Management (within12 months)?
p.25
Source: Pensions & Investments (in conjunction with Russell Investments), 2nd Risk Survey, March 2012
18.3 18.8 23.2
32.9 37.5
39.3
48.8 43.8 37.5
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Corporate Public E&F
No (net)
Yes but no plan
Yes & Have a plan
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Top Steps Taken to Improve Governance
p.26
Source: Pensions & Investments (in conjunction with Russell Investments), 2nd Risk Survey, March 2012
Increase monitoring & supervision
69.2%
Hired investment consultant
28.4%
Added staff 19.9%
Purchased/built risk tools 19.9%
Outsourced 10.9%
No changes 17.4%
Other 5.5%
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Institutional investors fall behind USA Inc in conversation with Amanda White top1000funds.com May 9, 2012
› Institutional investors are clearly behind in risk management compared to the innovative techniques implemented in treasury departments of corporate America, chief investment officer of Wurts and Associates, Jeff Scott says.
› Scott, who spent his career managing the balance sheet at Microsoft, Dow Chemical, the Alaska Permanent Fund and now investment consultant Wurts, says institutional investors want to manage returns, which is impossible.
› “Returns are a function of animal spirits. They swing between fear and greed. Do companies really change in long-term valuation over the weekend?” he asks.
› And while he points to investors such as Warren Buffet who “thinks about risk constantly with his capital”, Scott says many institutions are not thinking about risk.
› “There is poor governance, and poor risk management. A lot of losses experienced by funds throughout the financial crisis were a function of missing simple risk-management concepts like custody of collateral and liquidity. You didn’t need fancy mathematical risk models instead of common sense you can get in Omaha.”
› Scott says that institutional investors are behind in their risk-management practices.
› Many asset-management firms and hedge funds have far superior approaches to risk management than institutional investors. There are steps to take and it has to start with governance, and then understanding the risks you are taking.
p.27
Any views or opinions made are solely representations of the cited author (Jeff Scott) and do not necessarily represent those of Russell Investments.
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Russell Hazard Report
Sample Pension, as of December 31, 2011
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Surplus Summary Risk Analysis
Sample Pension, As of December 31, 2011
Sources: The above analysis is based primarily on Russell’s Capital Markets Forecasts and data from Bloomberg and FactSet. Please see Slide 31 ’Supplemental Information’ for
further details on the analysis provided.
This is a sample report provided for illustrative purposes only and is not meant to represent any actual results.
Equity 45%
Canada Equity 20%
Global Equity 25%
Fixed Income 40%
Canadian Agg 40%
Other 15%Canada Real Estate 10%
Global Infrastructure 5%
Physicals 16%
Unhedged Liability 84%
Assets ($450)
Liability ($500)
95% Surplus VaR Forward looking/Non-normal inputs
Less Risk M ore Risk Assets Liabilit ies
Treasury Rates 2.4% 2.2%
Credit Spreads 0.6% 1.5%
Equity Beta 7.0%
Other Assets 5.6%
Currency 0.0%
Active M anagement 0.9%
Diversification 0.0%
Total 6.1% 3.7%
Sponsor ImpactFunded
Status
Surplus/
Def icit
$ millions
As of 12/31/2011 90% (50.0)
R isk Enviro nmentLess Risk M ore Risk
Immed.
Recog.
IAS 19
Recog.
Amort ize
1 year
Amort ize
5 years
Standard VaR 80% (109.7) 1.31 2.45 (19.7) 28.1
Stressed VaR 57% (231.6) (1.13) 2.35 (141.6) 3.7
Scenario s
2011 Debt Crisis 83% (89.6) 1.71 2.47 0.4 32.1
Global Financial Crisis 82% (80.0) 1.90 2.48 10.0 34.0
Tech Bubble 83% (91.9) 1.66 2.47 (1.9) 31.6
100 bp Int Rate Decr 80% (113.0) 1.24 2.45 (23.0) 27.4
10% Equity Decline 86% (70.3) 2.10 2.48 19.8 36.0
Volatility Environment5th, 50th and 95th Percentiles as of April 30, 2012
Equity
Currency
Fixed Income
2.50 40.0
10 Year
Expected Returns
2011
EPS
2011
Free Cash Flow
0 50 100 150 200
50th 95th5th HighLow
-100 -50 0 50 100
p.29
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Asset Only Summary Risk Analysis
Sample Pension, as of December 31, 2011
Sources: The above analysis is based primarily on Russell’s Capital Markets Forecasts and data from Bloomberg and FactSet. Please see Slide 31 ’Supplemental
Information’ for further details on the analysis provided.
This is a sample report provided for illustrative purposes only and is not meant to represent any actual results.
Equity 45%
Canada Equity 20%
Global Equity 25%
Fixed Income 40%
Canadian Agg 40%
Other 15%Canada Real Estate 10%
Global Infrastructure 5%
Physicals 16%
Unhedged Liability 84%
Assets ($450)
Liability ($500)
95% VaR Forward looking/Non-normal inputs
Less Risk M ore Risk
Treasury Rates
Credit Spreads
Equity Beta
Other Assets
Currency
Active M anagement
Diversification 0.0% 0.0%
Total
Sponsor ImpactAs of 12/31/2011
R isk Enviro nmentLess Risk M ore Risk
Immed.
Recog.
IAS 19
Recog.
Amort ize
1 year
Amort ize
5 years
Standard VaR 1.64 2.47 (3.0) 31.4
Stressed VaR (0.79) 2.37 (124.7) 7.1
Scenario s
2011 Debt Crisis 2.29 2.49 29.7 37.9
Global Financial Crisis 0.92 2.44 (38.8) 24.2
Tech Bubble 2.27 2.49 28.4 37.7
100 bp Int Rate Incr 2.26 2.49 28.0 37.6
10% Equity Decline 2.10 2.48 19.8 36.0
Volatility Environment5th, 50th and 95th Percentiles as of April 30, 2012
Equity
Currency
Fixed Income
438.0
429.8
407.0
285.3
439.7
371.2
438.4
2011
EPS
2011
Free Cash Flow
2.50 40.0
Assets
450.0
0.0%
10 Yr Exp. Asset
Returns
2.4%
0.6%
7.0%
5.6%
0.9%
6.1%
-40 -20 0 20 40 60
0 50 100 150 200
50th 95th5th HighLow
p.30
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Supplemental Information
Note: This supplemental information relates to Slide 29 and Slide 30
p.31
●
● Asset values are based on actual market values w here available, and are otherw ise estimated.
● The value of the liability and its behavior in different environments is estimated from the generalized pension plan cash flow s, reported liability values, sensitivity to interest
rates, and information regarding the status of the plan. This data is typically provided by the client or the plan’s actuary, or derived from corporate f inancial statements.
● The alpha and tracking error assumptions used in this analysis are based on published expectations for the Russell funds in the portfolio. For investments outside of Russell
funds, estimates are based on the Russell alpha assumptions for the asset class/strategy or they have been provided by the client.
● Free cash flow s and earnings per share f igures are based on the corporation’s most recent 10K filing as provided by FactSet or Bloomberg w here available.
● Value at Risk (VaR) calculation and decomposition is calculated follow ing industry standards.
● 95% VaR represents the 1 in 20 dow nside Value at Risk on a forw ard-looking, one-year basis.
● 95% VaR calculations are based on return, standard deviations, and correlations w hich are generated from a non-normal asset class return distributions w ith fat tails as
represented by Russell’s capital market forecasts.
● VaR is calculated independently for individual components, w ith a diversif ication component balancing to total VaR.
● The VaR associated w ith the liabilities is captured w ithin the Treasury and Credit Spreads components.
● Active management is defined as the difference betw een the actual allocation and policy w eights, combined w ith alpha and tracking error expectations for active managers.
●
●
●
● The volatility environment is represented as follow s:
● Equities – The average value of the S&P/TSX 60 VIX index over the previous month plotted against its historical range (October 2009 to present).
● Fixed Income – The standard deviation of the yield on the 10-yr Canadian government bonds over the previous month plotted against its historic range (January 1990 to
present).● Currency – The average standard deviation of the JP Morgan G7 Currency Volatility Index over the previous month plotted against its historic range (June 1992 to present).
V2.0.0009
All values are estimates and should not be relied upon for any regulatory or f inancial f iling.
10-Year Expected Return is the expected return for each asset and liability component (Russell’s capital market forecasts).
The Stressed VaR scenario (“2XVol/ ρ~1.0”) assumes standard deviations are 2 times Russell’s current forecast. Correlations betw een asset classes are assumed to be 1.0 ,
except for surplus calculations, w here Treasury returns are assumed to have a correlation of -1.0 w ith other asset classes.
Scenario calculations are based on actual events defined as follow s: Tech Bubble (March 24, 2000 through April 4, 2001), Global Financial Crisis (June 8, 2008 through March
9, 2009), 2011 Debt Crisis (April 11, 2011 through October 3, 2011).
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Q&A
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Appendix
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Practical Considerations for Risk Management: A customized approach
1. Practical first steps, define:
› What is the primary objective for your fund?
› How much risk do you need to take on to meet your primary objective?
› What is your organization’s risk tolerance and risk capacity?
› What is your relevant time horizon?
› What are current and projected cash flows?
› What is your comparative advantage in investments and what needs improvement?
› What are your risk-management beliefs (conservative or informed judgment) and are your
current strategies appropriate?
› Are your investment beliefs supported by appropriate research?
› What are the required resources and risk-management tools needed to succeed?
› Is your governance process structured to succeed and are you focusing on the appropriate
issues? Is your valuable fiduciary time appropriately allocated? Do you need to delegate more to
investment professionals?
› Do you understand the possible tail events (not just normal markets)?
› Are you measuring what matters and is your reporting appropriate and focusing your attention
correctly?
p.34
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Practical Considerations for Risk Management: A customized approach
2. Look at the impact of your fund on your organizations today vs. 10 or 20 years ago. Ask yourself:
› Is the impact considerably larger or smaller?
› Is the investment fund a significant exposure for your organization?
› How does this compare to peers in your industry?
3. Is an investment solution satisfactory or do you need to de-risk?
› If the latter, can you reduce the liabilities (based on the past or for the future)?
› With whom and how can you start the dialogue and negotiate this process?
4. Evaluate your depth of expertise in risk management and governance:
› Are you capable of handling this complex topic yourselves or do you need third-party assistance?
› Do you need a change agent to assist you or a 3rd party deep dive for governance and risk management?