1. 26th March 2009
The Credit Conundrum
Session 1: Strategic asset allocation

2. Agenda
Strategic Asset Allocation
Agenda
2
Context
Strategic Asset Allocation
• Importance
• History
Current Markets
• Impact
• Strategy vs Tactics
Governance
Why Credit?

3. Strategic Asset Allocation
Trustee Governance
Investment
Strategy
Portfolio
Strategy
Monitoring
ALM Analysis
Set Goals / Objectives
Implementation
Trustee Governance
• Strategic asset allocation form
a key part of the Investment
and Portfolio Strategy
• Setting goals and objectives of
the stakeholders is an absolute
pre-requisite
3

4. Strategic Asset Allocation
Relative Importance
Investment
Strategy
Portfolio Strategy
Monitoring
ALM Analysis
Set Goals / Objectives
Implementation
Relative Importance
• Historically insufficient
focus on goals and
objectives of the key
stakeholders and overall
investment strategy
• Necessary inputs to an
effective Portfolio Strategy
and in particular a Strategic
Asset Allocation
• But what do they really
mean...
4

5. Strategic Asset Allocation
Destination “Fully Funded” – Flight Plan
Minimum Funding Level
Cone of Uncertainty
Cone of Uncertainty
FRS 17/IAS 19
BUYOUT S75
5

6. Strategic Asset Allocation
Understanding the Players
6
Fuel Efficiency
Common Objectives
• Shut down un(der) rewarded
risks
• Optimise portfolio
performance
• Funding level
• Value at Risk
• Contribution volatility
• IAS19 Expected Return
• Solve for risk
• Set risk budget using 3 lenses
• Build consensus
• Implement hedging strategy
• Seek to optimise risk adjusted return
(Fuel Efficiency)
• Be proactive in changing market
conditions
• Apply regular risk monitoring and
risk management
Redington Approach
Risk Return
Virtuous Circle
Trustees Sponsor

7. Strategic Asset Allocation
Trustee Time Spent
Investment
Strategy
Portfolio Strategy
Set Goals / Objectives
Implementation
Trustee Time Spent
• Significant time spent on
manager structures and
selection
• Monitoring focused on
manager performance versus
benchmark
• Until recently not enough
time spent on
• Volatility and impact of
liabilities
• Monitoring funding vs
objectives
• Sponsor covenant
Monitoring
ALM Analysis
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8. Importance of Asset Allocation – Academic Research
Strategic Asset Allocation
Importance of Asset Allocation
Study 1 /2 Study 3 Study 4
Authors
Brinson, Hood & Beebower /
Brinson, Singer & Beebower
Ibbotson & Kaplan Drobetz & Kohler
Publisher and Date
Financial Analyst Journal
(1986/1991)
Financial Analyst Journal
(2000)
Universities of Basel and St
Gallen (2002)
Data Used
91 Large US Balanced Pension
Funds 1974 –1983 / 82 Large US
Balanced Pension Funds 1977-
1987
58 US Balanced Pension
Funds 1993 –1997 and 94
US Balanced Mutual Funds
1987 –199
51 German and Swiss
Balanced Mutual Funds
1995 –2001
Findings
% of the Variability of
Portfolio Return over Time
Explained by Strategic Asset
Allocation
94% / 92%
Pension Funds 88.0% *
Mutual Funds 81.4%
83%
% of the of Total Long-Term
Portfolio Return Explained
by Strategic Asset
Allocation
112% / 101%
Pension Funds 99% *
Mutual Funds 104%
134%
Source: Evercore Pan-Asset Capital Management Limited
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9. A Brief History – Who is Responsible?
Strategic Asset Allocation
A Brief History
9
Balanced Mandates – Delegation to manager
Core Satellite – More active management of satellite
Growth vs Matching Assets
Diversification – Wider range of options
Liability Driven Investment (LDI)
Global Tactical Asset Allocation (GTAA) – Back to delegation?

10. Strategic Asset Allocation
Impact of Recent Market Changes
10

11. Equity Indices rebased – Returns
• Since the beginning of 2008, World Equity
markets have produced very poor performance:
• FTSE ALL Share TR: -40%
• S&P 500: -50%
• Eurostoxx 50: -56%
• Nikkei 225: -53%
• Pacific ex Japan: -39%
Equity Indices rebased - Volatility
• The volatility of world equities has increased to
unprecedented levels.
• FTSE ALL Share TR: +19%
• S&P 500: +27%
• Eurostoxx 50: +24%
• Nikkei 225: +27%
• Pacific ex Japan: +15%
Market Changes
World Equities – High Negative Returns/High Volatility
11
Market Changes – World Equities
Do future expectation of the equity risk premium provide
adequate reward for the higher volatility?
Source: Bloomberg
Source: Bloomberg

12. 12
Market Changes
Historical Credit Spreads
Source: Bloomberg / Barclays Capital Redington
Market Changes – Credit Spread
Is credit spread just reward for corporate risk? What about an illiquidity premium?

13. 13
Market Changes
Asset Performance
Market Changes – 12-Month Rolling Asset Performance
Source: Bloomberg / Barclays Capital Redington
• Most growth assets
correlated?
• Matching-like assets
uncorrelated to growth
assets ?
Is diversification working?

14. 14
Market Changes
Gilts yield vs. Swaps
Swap spreads
• Nominal swap spread widening has been concentrated
in the longer tenors (beyond 10 years)
Index-linked gilts & swaps
• Index-linked gilt yields remain well above rates on
equivalent real rate swaps
Market Changes – Gilts Yield vs. Swaps
Market anomalies persist. Opportunities for real money investors?
Source: Bloomberg Source: Bloomberg

15. Governance Structure
Scheme Governance Structure
Delegates from
Sponsor
Risk/Finance
Delegates from
Investment
Manager
Experienced LDI
Manager
Trustees
Investment Sub-
Committee
/Working Party
Redington
Partners
Redington
Investment
Consultants
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Strategic Asset Allocation
Effective Governance Process
• When do tactics take over?
• Transition – Implementation and execution
• Monitoring – Progress and adapting to changes

16. Where on the Spectrum
Strategic Asset Allocation
Where on the Spectrum
Lower Return,
Lower Risk
Higher Return,
Higher Risk
Matching
Assets
Growth
Assets
Credit Credit
In 2009
• Credit has Growth characteristics.
• ...as well as maintaining its matching characteristics
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