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Optimal Portfolio For Compulsory Pension Funds 18 May 2006 Presented by: Hazel McNeilage Executive Director- International Investments.

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Presentation on theme: "Optimal Portfolio For Compulsory Pension Funds 18 May 2006 Presented by: Hazel McNeilage Executive Director- International Investments."— Presentation transcript:

1 Optimal Portfolio For Compulsory Pension Funds 18 May 2006 Presented by: Hazel McNeilage Executive Director- International Investments

2 2 Overview Factors driving the optimal portfolio decision: –Plan specific –Capital market related Choice or no choice? Compulsory pension portfolio strategies around the world Construction of optimal portfolios Conclusion

3 3 Factors Driving The Optimal Portfolio Decision – Plan Related The role of the plan in the overall retirement system of the particular country: –Magnitude of benefits provided –Extent of coverage of the plan –Extent of other retirement benefits, including any guarantees –Impact of the performance of the plan and the quantum of benefits it delivers on other government programs The design of the plan: –DB, DC or hybrid –The extent to which benefits can be withdrawn prior to retirement –The form of retirement benefits – compulsory annuitization; programmed withdrawals; lump sum, or a combination –Any guarantees provided under the plan Membership demographics: –Plan open/closed to new participants –Age distribution of membership

4 4 Factors Driving the Optimal Portfolio Decision – Capital Market Related The nature of the local bond market: –Range & credit quality of issuers –Size & liquidity –Types of securities available (including particularly the availability of real rate securities) –Range of maturities available The nature of the local listed equities market: –Size & liquidity –Sector composition –Transparency The nature and extent of other local investment opportunities: –Instruments necessary to execute various types of absolute return strategies –Real estate (public and private) –Infrastructure –Private equity, etc. Restrictions on foreign investment, including capital controls.

5 5 Choice or No Choice (of Investment Portfolios)? Choice of investment portfolios combined with guarantees may provide a free option to participants Choice allows for differences among participants in: –risk appetites –time horizons –propensities for investment oversight –overall financial position Choice needs to be accompanied with financial education Choice can be important in attracting voluntary contributions Choices need to be carefully constructed: –A limited number of core choices, each well diversified and differentiated on risk/return grounds works well – life cycle funds are one way of doing this –Construction of an appropriate default option is vital

6 6 Typical Pension Portfolios Around the World Sources: Principal AFORE, MPF Schemes Statistical Digest, APRA Annual Statistics, Principal Chile, Superintendencia AFP

7 7 Key Issues in Constructing Optimal Pension Portfolios Diversification –By geography and currency –By asset class, sector and subsector –By manager style –Include absolute return strategies Efficiency in gaining both alpha and beta Selection of suitable managers Avoiding style drift with selected managers Focus on long-term performance –Avoid costly turnover of managers –Strict due diligence process –Appropriate risk controls

8 8 Past performance is not a reliable indicator of future performance. The indexes are unmanaged and do not take transaction charges into consideration. It is not possible to invest directly in an index. Asset Class Performance FF

9 9 Diversification Case Studies 1 – Preferred Securities Index 10-Year Correlation 10-Year Return Spectrum Preferred Securities Lehman Aggregate Index Lehman Global Aggregate Index Lehman High Yield Index S&P 500 Index MSCI World Offers diversification to equities and fixed income Complement to core bonds Historically, has produced superior returns compared to core fixed income Investment grade quality Figures in USD as at 31 March 2006

10 10 Diversification Case Study 2 – Real Estate NAREIT Lehman Aggregate Lehman Global Aggregate Lehman High Yield S&P MSCI World Index 10-Year Correlation10-Year Return As of 31 March Figures presented in USD Enhanced diversification Values are relatively stable compared to stocks Income component exhibits consistent performance Inflation hedge Lease agreements typically linked to inflation measures

11 11 Diversification Case Study 3 – Absolute Return Currency CISDM* Lehman Aggregate Lehman Global Aggregate Lehman High Yield S&P MSCI World *Center for International Securities and Derivatives Markets As of 31 December Figures presented in USD Index8-Year Correlation 10-Year Return Offers generally uncorrelated returns to other asset classes Provides alpha above cash rates Requires a relatively low amount of capital

12 12 Characteristics of Managers Suitable for Pension Assets Rational Disciplined Fundamental Risk controlled Conflict-free Repeatable process Strong fiduciary culture

13 13 Conclusion The suite of optimal portfolios for compulsory pension plans should: Exploit the full range of investment opportunities available, including hedge funds, structured products etc Be efficient in gaining both alpha and beta Be well diversified Be outcome oriented

14 14 Supplemental Information

15 15 Biography Hazel McNeilage - Executive Director - International Investments, Principal Global Investors Hazel is Executive Director - International Investments for Principal Global Investors. She is responsible for Principal Global Investors support of the investment operations within Principal International's affiliate and joint venture businesses across Asia and Latin America. Hazel is also a member of Principal Global Investors' Operating Committee. Most recently, she was Managing Director for PGI Asia ex Japan. Hazel joined Principal in 2001 as head of strategic business development in Australia. Previously, she spent 14 years with Towers Perrin in a variety of roles, including head of asset consulting for Australia and Asia Pacific and served on Towers Perrin's worldwide board of directors. Prior to that, Hazel spent six years in management roles with Liberty Life Association of Africa and two years with a small U.K. financial institution. She received a first class honors degree in mathematics, economics and operations research from the University of Lancaster, England. Hazel is a Fellow of the Institute of Actuaries (London) and Fellow of the Institute of Actuaries (Australia).

16 16 Use Of This Presentation This material contains general information only on investment matters; it should not be considered as a comprehensive statement on any matter and should not be relied upon as such. The information it contains does not take account of any investor's investment objectives, particular needs or financial situation. This material is given in good faith and has been derived from sources believed to be accurate as of May Subject to any contrary provisions of applicable law, no company in the Principal Financial Group nor any of their employees or directors gives any warranty of reliability or accuracy nor accepts any responsibility arising in any other way (including by reason of negligence) for errors or omissions herein. This presentation is intended for the recipient's benefit and should not be passed on to anyone else This presentation is issued in US, by Principal Global Investors, LLC.

17 17 Benchmark Descriptions 1. Large-cap Growth stocks are represented by the annual total returns of the Russell 1000 Growth Index, which is a market-capitalization weighted index of those firms in the Russell 1000 with higher price-to-book ratios and higher forecasted growth values. 2. Large-cap Value stocks are represented by the annual total returns of the Russell 1000 Index, which is a market-capitalization weighted index of those firms in the Russell 1000 with lower price-to-book ratios and lower forecasted growth values. 3. Mid-cap growth stocks are represented by the annual total returns of the Russell MidCap Growth Index, which is a market-weighted total return index that measure the performance of companies within the Russell MidCap Index having higher price-to-book ratios and higher forecasted growth values. 4. Mid-cap value stocks are represented by the annual total returns of the Russell MidCap Value Index, which is a market-weighted total return index that measures the performance of companies within the Russell MidCap Index having lower price-to-book ratios and lower forecasted growth values. 5. Small-cap growth stocks are represented by the annual total returns of the Russell 2000 Growth Index, which is a market-weighted total return index that measures the performance of companies within the Russell 2000 Index having higher price-to-book ratios and higher forecasted growth values. 6. Small-cap value stocks are represented by the annual total returns of the Russell 2000 Value Index, which is a market-weighted total return index that measures the performance of companies within the Russell 2000 Index having lower price-to-book ratios and lower forecasted growth values. 7. International stocks are represented by the annual total returns of the MSCI EAFE Index, which is listed for foreign stock funds (EAFE refers to Europe, Australia, and Far East) and is widely accepted as a benchmark for international stock performance, the EAFE index is an aggregate of 21 individual company indexes. 8. Emerging Markets stocks are represented by the annual total returns of the MSCI EMF index, which is an index composed of companies representative of the market structure of 25 emerging market countries in Europe, Latin America, and the Pacific Basin. 9. Core Bonds are represented by the annual total returns of the Lehman Aggregate Index, which covers the U.S. investment grade fixed rate bond market, with index components for government and corporate securities, mortgage pass-through securities, and asset-backed securities. 10. High yield bonds are represented by the annual total returns of the Lehman High Yield Index, which is an unmanaged index constructed to mirror the characteristics of the high yield bond market. 11. Real Estate Securities are represented by the annual total returns of the NAREIT index, which is a capitalization-weighted benchmark index of most actively traded Real Estate Investment Trusts (REITs), designed to measure real estate performance. 12. Real Estate Direct Property is represented by the annual total returns of the NCREIF Property index, which consists of U.S. commercial real estate properties that have been acquired, at least in part, in behalf of tax-exempt institutions and are held in a fiduciary environment and includes wholly owned and joint venture investments: operating properties only – no development projects; only investment-grade, no-agricultural, income producing properties:Apartments, Industrial, Office, and Retail.


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