LDI: Harder, Better, Faster, Stronger · Seth Finkelstein, CFA. Head of US Portfolio Solutions. Schroders. LDI: Harder, Better, Faster, Stronger. For attendees of the 2018 P&I LDI

Seth Finkelstein, CFAHead of US Portfolio SolutionsSchroders

LDI: Harder, Better, Faster, Stronger

For attendees of the 2018 P&I LDI conference only. Not for redistribution under any circumstances.

Improving outcomes from LDI program

• An inescapable truth

• Treasuries: The Utility Player

• Alpha how, Alpha where, Alpha what

• Multi-manager diversification

An Inescapable truth

As we add more LDI, the uphill battle against underperformance intensifies

Source: IRS, Society of Actuaries, Bloomberg Barclays POINT, Schroders as of December 31, 2017. Liability cash flows set every six months to those of the Bloomberg Barclays Long Corporate A or Better Index and remain static for start of next 5 months. Valuations use monthly full IRS yield curve (not 3 segment or HATFA) for funding valuation and Citi Pension Yield Curves (AA rated bond universe) for accounting valuation. Past performance is no guarantee of future performance.

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Long Corporate A or Better Funding Valuation

Funded ratio of liability-matched Long Corporate A or Better Index

Annualized underperformance: ~1.3%

77% funded after 20 years

Striking how much downgrades affect a credit portfolio’s liability-relative returnImpact of downgrades on excess return vs. Treasuries for Long (10+) Corporate Bond Indices

Five-Year History

Rating Beginning Spread Realized Excess Return “Missing” Return

IG 1.76% 1.20% -0.56%

A or better 1.40% 0.82% -0.58%

AA 1.13% 0.86% -0.27%

A 1.47% 0.79% -0.68%

BBB 2.17% 1.64% -0.53%

Source: Bloomberg Barclays POINT, Schroders. Return period approximately 5 years to June 2018. Exact period in each ratings category chosen so that starting and ending OAS levels are approximately equal. Defaults are generally thought to have detracted 10-20 bps. p.a. from investment grade earned returns. Past performance is no guarantee of future performance. The value of an investment may go down as well as up and is not guaranteed.A or better bonds are used for funding valuations while AA bonds are used for accounting valuations.1Moody’s Investor’s Service.

Treasuries: The Utility Player

Treasure your Treasuries

• Hedge surplus risk via interest rate duration

• Hedge surplus risk “through the back door” –negative correlation with equities

• Alpha potential from active sector allocation

Treasuries help the plan reduce funding volatility…to a point

Minimum Tracking Error portfolio credit allocation

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0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00%Liability Tracking Error

Pre Crisis Post Crisis

100% A+Corporate

100% Treasury

75% A+ Corporate

Efficient frontier with Treasuries and Long Corporates

Pre-crisis 70%

Post-crisis 75%

Source: Barclays POINT, Starting end dates were chosen so that spread levels were at approximately same levels. Starting August 31, 1998 for whole period and pre crisis ending June 30, 2017 and June 30, 2007 respectively. Post crisis January 31, 2010 to July 31, 2016. * Liability cash flows set every six months to those of the Barclays Long Corporate A or better Index and remain static for start of next 5 months. Accounting valuations use Citi pension Discount Rates (AA rated bond universe. Past performance is no guarantee of future performance.

Annualized Underperformance to Liabilities

Treasuries are also a tail risk hedge and can offset steep equity losses

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12-Month Excess Return (Long Treasury vs. Equity) and Equity Returns

Source: Bloomberg, Schroders, Starting October 1998 through October 2018. Equity is S&P Total Return Index, Long Treasury is BofA 15+ US Treasury Index. Gross of fees. Past performance is no guarantee of future performance.

Equity Total Return

12m Excess return (Treas-Equity)

Treasury outperforms

Equity outperforms

Optimal amount of Treasuries to own is inconstant over time, and equity-driven

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3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 9.00% 10.00%Liability Tracking Error

20% Equity 40% Equity 60% Equity

Min T/E:45% Treasury

100% Treasury (% FI)

Source: Barclays POINT, Equities represented by the S&P 500 index, credit by the Long Corporate A+ and liability as follows: *Liability cash flows set every six months to those of the Barclays Long Corporate A or better Index and remain static for start of next 5 months. Accounting valuations use Citi pension Discount Rates (AA rated bond universe. Past performance is no guarantee of future performance.

Greater surplus risk reduction as Treasuries are added. There are opportunity costs in expected return.

Efficient frontier with Equity/Treasury/Long CorporatesLiability Outperformance

Alpha howAlpha where

Alpha what

Four ways managers can drive alpha in multi-manager LDI structures

1. High conviction sector allocation (Gov’tCredit)

2. Broader universe (MunisSecuritizedEMD)

3. Security selection using attractive small(er) credits

4. Alternative techniques

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Fixed 50% Treasury allocation 100% Tactically correct 100% Tactically Wrong

Alpha can be earned by allocating between Corporates and TreasuriesRolling 3-Year Excess Return vs. Long Corp A+ benchmark

Annualized total return since August 1988

Long Corp A+ bmrk 6.13%

Fixed 50% Treasury wtg 6.01%

100% Tactically correct 7.89%

100% Tactically wrong 4.28%

Source: Barclays POINT, Schroders September 30, 1988 to March 31, 2018. Tactically correct-every 6 months allocate 50% to treasuries if subsequent 6 month excess return was negative otherwise keep 100% Long Corporate A+. Fixed 50% rebalances weightings back to 50/50 each month. Past performance is no guarantee of future performance.

Credit selection alpha: Majority of issuers have less than $5 Bn in debtNumber of issuer tickers by outstanding debt Barclays US Long Corporate Index

2 3 10

72 66

118

182

- 20 40 60 80

100 120 140 160 180 200

$40 + $25-$40 $15-$25 $5-$15 $2.5-$5 $1 bn - $2.5 < $181% of the issuers in the index have

less than $5 billion outstandingSource: Barclays US Long Corporate Index as of August 31, 2018.

Top-heavy credit universe exacerbates downgrade risk but also offers alpha

Manager A($50 bn AUM)

Manager B($5 bn AUM)

Issuer XAvg. Top 75 Issuer

($12.7 bn outstanding) 3.94% 0.39%

Issuer YAvg. Bottom 378 Issuer

($1.6 bn outstanding)31.25% 3.13%

Size matters:Calculate the proportion of the average debt issue a manager needs to acquire to build a 100 bps position

Source: Barclays US Long Corporate Index as of August 31, 2018. For illustration only.

Alternative LDI: Treasury futures plus a short duration securitized portfolio

• Replace spread duration with alpha uncorrelated with rates and credit

• Reduces opportunity cost of allocating more to LDI over time

• Makes LDI allocation work harder by getting the rates hedge and pursuing higher returns

Alternative LDI: Securitized market is large, fragmented and inefficient

Secular opportunities

Heavily regulated banks

Capital structure

Supply/demand

Asynchronous cycles

LoansSenior

Junior

Increased protection

Increased sensitivity

Securitization

Alternative LDI: Treasury futures plus securitized debt for alpha

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Total Return Correlation Correlation excess returns vs Long G/C

Avg: 0.88

Avg 0.09Long Treasury

Futures exposure

Enhanced securitized

short duration

Long Gov/Credit exposure

Traditional Alpha levers

See subsequent pages for disclosures on the LDI Manager basket. The Alternative LDI track record combines returns of the Schroder Enhanced Securitized USD LIBOR composite gross of fees going back to April 2008. Past performance is no guarantee of future results.

Benefits checklist

Alpha Diversification

Alpha to “keep up”

Hedge main funding risk

Capital efficient

Rolling 36-Month Correlation Alternative LDI: Enhanced Securitized vs LDI Manager Basket

Multi-manager diversification

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0.00% 1.00% 2.00% 3.00% 4.00% 5.00%Annualized Tracking Error

Low TE Managers High TE Managers

Simple Average

Equal wtd baskets Diversification Benefit

Source: Schroders, eVestment. 15 years of monthly returns ending December 31, 2017. Bloomberg Barclays Long Government Credit benchmark. Past performance is no guarantee of future performance. * Annual rebalancing.

Manager alpha/tracking error vs. Long Government/Credit IndexFor the 15-year period ending December 31, 2017Annualized outperformance

= Simple average = Equal wtd basket

Satellite/satellite: Low correlation of highly active managers delivers real diversification

Source: Schroders, eVestment, Society of Actuaries. 15 years of monthly returns ending December 31, 2017. Performance relative to hypothetical liabilities with same cash flow profile as Bloomberg Barclays Long Government Credit Index valued at FTSE accounting pension discount rates. Past performance is no guarantee of future performance.

Manager alpha/tracking error vs. Accounting LiabilityFor the 15 year period ending December 31, 2017Annualized outperformance

Satellite/satellite: Low correlation of highly active managers delivers real diversification

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0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00%Annualized Tracking Error vs. Liability

Low TE Managers High TE Managers

Equal wtd basketsSimple Average

Diversification Benefit

= Simple average = Equal wtd basket

Wrap-up

• LDI should not be set it and forget it• Sponsors may sharpen and improve their LDI

program to combat liability underperformance– Don’t underestimate utility of Treasuries – Expand the relevant universe– Understand the levers of added value– Exploit real diversification benefit by being active

Important InformationThe views and forecasts contained herein are those of the Schroder Portfolio Solutions and US Multi-Sector Fixed Income teams, respectively, and are subject to change. The information and opinions contained in this document have been obtained from sources we consider to be reliable. No responsibility can be accepted for errors of facts obtained from third parties. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. This document is intended to be 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. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management North America Inc. (SIMNA) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. The opinions stated in this presentation include some forward-looking statements. We believe that we are basing our expectations and beliefs on reasonable assumptions within the bounds of what we currently know. There can be no assurance, however, that events will occur as we expect or believe.

All investments involve risks including the risk of possible loss of principal. The market value of a fund's portfolio may decline as a result of a number of factors, including interest rate risk, credit risk, inflation/deflation risk, mortgage and asset-backed securities risk, US Government securities risk, foreign investment risk and liquidity risk. Frequent trading of the Fund's portfolio may result in relatively high transaction costs and may result in taxable capital gains. Duration is a measure of volatility expressed in years. The higher the number, the greater potential for volatility as interest rates change. No investment strategy or risk management technique can guarantee future returns or eliminate risk in any market environment.

Performance shown is past performance and is no guarantee of future results. The value of an investment can go down as well as up and is not guaranteed. The performance reflects time-weighted total rates of return, which adjust for contributions and withdrawals and include both income and change in market value.

Any index referenced herein is a fully invested, unmanaged index that includes income and does not include any transaction costs, management fees or other costs. Within the investment-grade universe, portfolios managed by the Schroder Value investment team differ substantially from the indices presented, including with respect to the number and type of issuers and issues held, sector allocation and material characteristics. It is not possible to invest directly in an index.

Any hypothetical/simulated results shown must be considered as no more than an approximate representation of the portfolio’s performance, not as indicative of how it would have performed in the past, or will perform in the future. Simulated returns are the result of statistical modeling, with the benefit of hindsight, based on a number of assumptions and there are a number of material limitations on the retrospective reconstruction of any performance results from performance records. For example, it may not take into account any dealing costs or liquidity issues which would have affected the strategy’s performance. In addition, gross returns (as applicable) would be lower if applicable management fees and expenses were factored in to the calculation. There can be no assurance that this performance could actually have been achieved using tools and data available at the time. No representation is made that the particular combination of investments would have been selected at the commencement date, held for the period shown, or the performance achieved. This data is provided to you for information purposes only as of the dates of this material and should not be relied on to predict possible future performance. There can be no guarantee that these or any simulated and/or carve-out results will occur in the future, generate a positive return or protect against loss of principal.

Important InformationSchroder Investment Management North America Inc. (SIMNA Inc.) is registered as an investment adviser with the US Securities and Exchange Commission and as a Portfolio Manager with the securities regulatory authorities in Alberta, British Columbia, Manitoba, Nova Scotia, Ontario, Quebec and Saskatchewan. It provides asset management products and services to clients in the United States and Canada. Schroder Fund Advisors LLC (SFA) markets certain investment vehicles for which SIMNA Inc. is an investment adviser. SFA is a wholly-owned subsidiary of SIMNA Inc. and is registered as a limited purpose broker-dealer with the Financial Industry Regulatory Authority and as an Exempt Market Dealer with the securities regulatory authorities in Alberta, British Columbia, Manitoba, New Brunswick, Nova Scotia, Ontario, Quebec, Saskatchewan, Newfoundland and Labrador. This document does not purport to provide investment advice and the information contained in this material is for informational purposes and not to engage in a trading activities. It does not purport to describe the business or affairs of any issuer and is not being provided for delivery to or review by any prospective purchaser so as to assist the prospective purchaser to make an investment decision in respect of securities being sold in a distribution. SIMNA Inc. and SFA are indirect, wholly-owned subsidiaries of Schroders plc, a UK public company with shares listed on the London Stock Exchange. Further information about Schroders can be found at www.schroders.com/us or www.schroders.com/ca. Schroder Investment Management North America Inc. 7 Bryant Park, New York, NY, 10018-3706, (212) 641-3800.

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PRES-PI-LDI-2018