managing liability driven investments within a multi-asset ... · managing liability driven...

Speakers:

Jeff Geller, CIO Multi-Asset Solutions, J.P. Morgan Asset

Management

Alison MacArtney, Client Portfolio Manager, J.P. Morgan Asset

Management

Managing Liability Driven Investments within a Multi-Asset Framework

Optimal asset mix will evolve over time in response to changes in risks and plan circumstances

Managing defined benefit plans through

their lifecycle is a dynamic process

Required Return

Funded Status

Volatility

Contribution Tolerance

Downside Risk

Shown for illustrative purposes only.

2


TRADITIONAL LDI

Traditional LDI has focused on hedging

duration risk

Required Return

Funded Status

Volatility


Downside Risk

Fixed Income Portfolios Structured Derivatives

HedgingPrescriptive, Rules-based

de-risking


3


LIABILITY AWARE INVESTING

TRADITIONAL LDI

Lower risk doesn’t have to mean lower

returns

Required Return

Funded Status

Volatility


Downside Risk

ALTERNATIVE APPROACHES TO PENSION PORTFOLIO MANAGEMENT



de-risking

Dynamic De-RiskingTotal Return vs. Pension

Liability


4

Reaching a funding surplus depends

on a number of factors

Source: J.P. Morgan Asset Management and representative plan cash flows. All liability estimates calculated using 12/31/2015 PPA Full Curve. FOR

ILLUSTRATIVE AND DISCUSSION PURPOSES ONLY. The manager seeks to meet the stated objectives. There can be no assurance this will be met.

Typical Plan Asset Growth Factors

Sponsor Inputs: Starting Funded Ratio: 85.0%

Contribution Policy: assumed no contributions

Goal Funded Ratio: 110.0%

Liability Characteristics: Service Cost: 1.50% (approximate for closed plan)

Benefit Payment Structure and Liability Duration

Market Factors: Interest Cost: 4.35% using 12/31 PPA Full Curve

Duration Impacts due to Change in Interest Rates: assumed static

5

Required returns are the anchor of

strategy design

Source: J.P. Morgan Asset Management and representative plan cash flows. All liability estimates calculated using 12/31/2015 PPA Full Curve. FOR

ILLUSTRATIVE AND DISCUSSION PURPOSES ONLY. The manager seeks to meet the stated objectives. There can be no assurance this will be met.

Required Growth to Reach 110% Funding

5.69%

8.82%

5.20%

7.58%

Liability Growth (annualized) Total Required Asset Growth

10 Years 15 Years

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…But achieving them has become more

difficult

J.P. Morgan Asset Management. For illustrative purposes only. Expected returns are based on J.P. Morgan’s Long-term Capital Market Assumptions (LTCMA).

7.33%

7.10%

7.31%7.41%

7.62%

7.89%

6.97%

6.67% 6.63%

6.24%

6.77%

5.84%

6.45%

5.55%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Expected Compound Return of 60% World Equity + 40% Long Gov’t Credit

7

Many plan sponsors are still focused on

asset volatilityEfficient Frontier – Asset Volatility

J.P. Morgan Asset Management. For illustrative purposes only. Expected risk and returns are based on J.P. Morgan’s 2017 Long-term Capital Market Assumptions

(LTCMA). Efficient frontiers based on portfolio combinations of Developed World Equity and US Aggregate Bonds.

US Cash

AC World Equity

Developed World Equity

US Large Cap

US Small Cap

Emerging Markets Equity

Diversified Hedge Funds

Commodities

US Long Duration Government/Credit

US Aggregate Bonds

US High Yield

EMD

US Direct Real Estate

Private Equity

2017 Asset Volatility Frontier

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 20.0% 22.0% 24.0%

Exp

ecte

d C

om

po

un

d R

etu

rn

Expected Volatility

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…But surplus volatility is more relevantEfficient Frontiers – Surplus vs. Asset Volatility

US Cash

AC World Equity


US Large Cap

US Small Cap



Commodities

US Long Duration Government/Credit

US Aggregate Bonds

US High Yield

EMD US Direct Real Estate

Private Equity

2017 Asset Volatility Frontier2017 Surplus Volatility Frontier

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 20.0% 22.0% 24.0%

Exp

ecte

d C

om

po

un

d R

etu

rn

Expected Volatility


(LTCMA). Efficient frontiers based on portfolio combinations of Developed World Equity and US Long Government/Credit Bonds and Long Corporate Bonds to proxy

liabilities. Surplus volatility is shown as a percentage of assets and assumes 85% funded ratio.

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Balancing risk and return

Asset Allocation

Active Risk

Leverage

Illiquidity Premiums

Opportunistic

investing

Drivers of Returns

Duration mismatch to liability

Level of equity risk

Drivers of Surplus Risk

The manager seeks to achieve the stated objectives. There is no guarantee they can be met.

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60.00% 70.00% 80.00% 90.00% 100.00% 110.00% 120.00%

Building portfolios with better expected

outcomesNormal Distributions of Funded Status Outcomes: 5 Year

Source: J.P. Morgan Asset Management. Normal distributions approximated with expected portfolio and liability returns and calculated surplus volatility as percentage of liability.

All data as of December 31, 2015. FOR ILLUSTRATIVE AND DISCUSSION PURPOSES ONLY. Average Pension based on Russell 3000 filings as of December 31, 2015.

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60.00% 70.00% 80.00% 90.00% 100.00% 110.00% 120.00%

Higher expected returns lead to a better

base caseNormal Distributions of Funded Status Outcomes: 5 Year



Better Base Case

12

60.00% 70.00% 80.00% 90.00% 100.00% 110.00% 120.00%

And much lower left tail riskNormal Distributions of Funded Status Outcomes: 5 Year

Reduced Downside Tail Risk



13

Leverage is a useful tool for managing

surplus volatilityEfficient Frontiers – Surplus volatility with and without leverage


(LTCMA). Efficient frontiers based on portfolio combinations of Developed World Equity and US Long Government/Credit Bonds and Long Corporate Bonds to proxy

liabilities. Surplus volatility is shown as a percentage of assets and assumes 85% funded ratio. Leveraged frontier adds US Long Treasury futures to approximate 70%

hedge ratio given underlying frontier weights.

US Cash

AC World Equity


US Large Cap

US Small Cap



Commodities

US Long Duration Government/Credit US Aggregate Bonds

US High YieldEMD

US Direct Real Estate

Private Equity

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0% 18.0% 20.0% 22.0%

Exp

ecte

d R

etu

rn

Expected Surplus Volatility

Constant hedge ratio with leverage

60/40 portfolio with leverage has 2.75% less surplus volatility

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LIABILITY AWARE INVESTING

TRADITIONAL LDI

Lower risk doesn’t have to mean lower

returns

Required Return

Funded Status

Volatility


Downside Risk

ALTERNATIVE APPROACHES TO PENSION PORTFOLIO MANAGEMENT



de-risking

Dynamic De-RiskingTotal Return vs. Pension

Liability


15

Important disclosures

J.P. Morgan Asset Management Long Term Capital Market Assumptions: Given the complex risk-reward trade-offs involved, we

advise clients to rely on judgment as well as quantitative optimization approaches in setting strategic allocations. Please note

that all information shown is based on qualitative analysis. Exclusive reliance on the above is not advised. This information is not

intended as a recommendation to invest in any particular asset class or strategy or as a promise of future performance. Note that

these asset class and strategy assumptions are passive only—they do not consider the impact of active management.

References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Assumptions,

opinions and estimates are provided for illustrative purposes only. They should not be relied upon as recommendations to buy or

sell securities.

NOT FOR RETAIL DISTRIBUTION: This communication has been prepared exclusively for institutional/wholesale/professional

clients and qualified investors only as defined by local laws and regulations.

Any forecasts, figures, opinions or investment techniques and strategies set out are for information purposes only, based on

certain assumptions and current market conditions and are subject to change without prior notice. All information presented

herein is considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect of any

error or omission is accepted. This material does not contain sufficient information to support an investment decision and it

should not be relied upon by you in evaluating the merits of investing in any securities or products. In addition, users should

make an independent assessment of the legal, regulatory, tax, credit, and accounting implications and determine, together with

their own professional advisers, if any investment mentioned herein is believed to be suitable to their personal goals. Investors

should ensure that they obtain all available relevant information before making any investment. It should be noted that

investment involves risks, the value of investments and the income from them may fluctuate in accordance with market

conditions and taxation agreements and investors may not get back the full amount invested. Both past performance and yield

may not be a reliable guide to future performance.

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