1. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
What to Ask of your
LDI Manager?
Pete Drewienkiewicz
27 September 2012
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2. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Asset/Liability Management: Recap (i)
2
£
Liabilities Assets
LDI
Manager
Asset
Manager 1
Asset
Manager 2
Asset
Manager 3
Asset
Manager 4

3. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Scheme
LDI Manager
Advisor
Asset
Manager 1
Asset
Manager 2
Asset
Manager 3
Asset
Manager 4
Asset/Liability Management: Recap (ii)
3
£
Liabilities Assets

4. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Good Governance: Ability to ACT
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Agility
As markets can be volatile,
pension funds must have the
agility to implement
decisions quickly.
Good Governance
Control Transparency
Swift decisions are only
possible with a solid
framework which sets clear
and reasonable goals.
Setting a strong framework
requires a clear and
transparent understanding
of the fund’s current asset
and liability position.

5. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Control:
The Pensions Risk Management Framework (PRMF)
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Source: Redington.
Objective Performance Indicators Actual Performance
Funding strategy
To reach full funding
by 2020
Funding ratio on IAS19 basis 85%
Funding ratio on Gilts Flat basis 70%
Expected returns in
excess of required
returns
Expected returns from current
investment strategy
Gilts + 300bps
Risk target
1-year 1-in-20
minimum worst-case
loss should not
exceed 15% of
liabilities
1-year 95% Value-at-Risk >[15]%
Aspirational target
To be fully inflation
and interest rate
hedged
Nominal hedge ratio <[80]%
Inflation hedge ratio <[80]%
Scheme constraint
Liquidity & collateral
requirements
Liquidity: cash held sufficient to pay
two months of benefits
£50m
Collateral: available eligible collateral
sufficient to meet potential collateral
calls on derivative positions
>£500m

6. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
The Flight Plan
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7. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Improving LDI Sophistication
Increasing Capacity to ACT
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LDI 1.0
Liability Immunisation
LDI 2.0
The LDI “Manager”
LDI 3.0
Holistic ALM
• Interest rate swaps
• Nominal gilts
• Inflation swaps
• Index-linked gilts
• Gilt repo and TRS
• Swaptions
• Unfunded asset
exposures
• Corporate linkers
• Sophisticated option
overlays
• Flight-plan consistent
assets
• Forward starting CDS?
• Shift to fixed income
• Static liability matching
pools
• Focus on de-risking
• Some active management
• Much wider LDI toolkit
• Evolution of trigger rates
• Delegated opportunistic
trades
• Centralised collateral pools
& credit risk management
• Reinvestment risk?

8. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Agility:
The LDI 3.0 Manager as “Quarterback”
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9. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Control:
Managing Assets Against Liabilities
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10. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
LDI Strategy Case Study:
Agility and Control
Replicate physical equity exposures with
synthetic instruments
The client is a large UK DB scheme (£3bn in liabilities) with an overall objective to reduce its risk.
Purchase funded and unfunded hedging
instruments, including:
• Forward-starting index-linked gilts
• Index-linked gilts on asset swap
• Inflation-linked US treasuries (“TIPS”)
on asset swap
• Zero-coupon inflation swaps
• Index-linked gilt on TRS with nominal
exposure hedged out using a mixture of
swaps and long gilt futures
Review major LDI managers and select
most appropriate manager
Meet weekly with new LDI manager to
refine hedging strategy
Manage transition of assets
Client receives regular monitoring of hedge
ratio, level of collateral held, etc.
PROCESS
Purchase long-dated assets with liability
matching and return-generating attributes:
• Long-lease property
• Social housing
• PFI debt
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11. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
...Transparency?
Agility
?
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12. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
IMA and Risk Limits
Counter-
parties
Leverage
Asset
Allocation
Counterparty diversification constraints
insufficiently robust
IMA provides inadequate risk framework
(e.g. based on simple tracking error limit)
Loose controls often originate from outdated IMAs, agreed when risk limits were less stringently negotiated.
Investment
Risk Limits
Poor sector/issuer diversification across
bond holdings and loose credit rating limits
Leverage limits of repurchase transactions
excessively high
Time
£
Liabilities
Hedging
Concentrating solely on tracking error can
result in a lack of understanding of how
liabilities are hedged over the entire curve (see
graph)
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13. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Gold Standard LDI Risk Limits
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Much greater confidence can be
placed in LDI manager
Risk factor restriction for portfolio
Maximum
Risk Limit
Minimum
Risk Limit
PV01 / IE01
Total PV01 relative to liability BM 100% 80%
Total IE01 relative to liability BM 100% 80%
Differential between total PV01 and
total IE01 20% -20%
LPI
Maximum overweight position in LPI
(0,inf) IE01 relative to liability BM 100% 90%
Maximum overweight position in LPI
(0,5) IE01 relative to liability BM 100% 90%
Z-Spread
Total z-spread PV01 relative to liability
BM 25% -10%
Iota positioning
Total Iota PV01 relative to liability BM 25% -10%
Sonia and basis restrictions
Sonia swap PV01 exposure relative to
liability BM 10% 0%
3 month vs 6 month basis PV01
exposure relative to liability BM 25% 0%
Repo and TRS
Market Exposure 25% 0%
Curve position relative to liability
benchmark
Maximum
Risk Limit
Minimum
Risk Limit
Maximum cumulative nominal PV01
differential between buckets
0 - 10 years vs 10 - 25 years 25% -25%
10 - 25 years vs 25 + years 25% -25%
25+ years vs 0 - 10 years 15% -15%
Maximum cumulative real rate PV01
differential between buckets
0 – 10 years vs 10 - 25 years 25% -25%
10 - 25 years vs 25 + years 25% -25%
25+ years vs 0 - 10 years 15% -15%
1
2
3
Managers to report regularly of their
positions within these limits
Reduces probability of large
unidentified or unintended risks
Source: Redington

14. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Gold Standard Governance Framework
Gold standard
governance
framework
outlined in
consultation
with all three
parties.
The aim is not to impose
artificial restrictions on an
LDI manager or restrict
capacity.
The aim is to enhance
understanding of the risks
an LDI manager is
running.
Is the reporting framework
adequate to monitor
risks?
NO RISK LIMIT = NO REPORT
Scheme
LDI Manager
Advisor
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15. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Conclusion: ACT
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Your LDI manager can enhance your agility to identify and
rapidly take advantage of market opportunities
Use of an LDI manager can allow for more efficient liability
control, using external asset managers and asset classes
Full transparency in the reporting and
monitoring framework ensures that LDI
risk limits are properly set and managed

16. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
13-15 Mallow Street London EC1Y 8RD Telephone : +44 (0) 20 7250 3331 www.redington.co.uk
Contacts
Pete Drewienkiewicz
Director | Head of Manager Research
Direct Line: 020 3326 7138
pete.drewienkiewicz@redington.co.uk
Risk Management Firm
of the Year (2011, 2012)
Pension Consultant of the
Year 2012
http://twitter.com/redingtontweets
Disclaimer
For professional investors only. Not suitable for
private customers.
The information herein was obtained from various
sources. We do not guarantee every aspect of its
accuracy. The information is for your private
information and is for discussion purposes only. A
variety of market factors and assumptions may
affect this analysis, and this analysis does not reflect
all possible loss scenarios. There is no certainty that
the parameters and assumptions used in this
analysis can be duplicated with actual trades. Any
historical exchange rates, interest rates or other
reference rates or prices which appear above are
not necessarily indicative of future exchange rates,
interest rates, or other reference rates or prices.
Neither the information, recommendations or
opinions expressed herein constitutes an offer to buy
or sell any securities, futures, options, or investment
products on your behalf. Unless otherwise stated,
any pricing information in this message is indicative
only, is subject to change and is not an offer to
transact. Where relevant, the price quoted is
exclusive of tax and delivery costs. Any reference to
the terms of executed transactions should be treated
as preliminary and subject to further due diligence .
Please note, the accurate calculation of the liability
profile used as the basis for implementing any
capital markets transactions is the sole responsibility
of the Trustees' actuarial advisors. Redington Ltd will
estimate the liabilities if required but will not be held
responsible for any loss or damage howsoever
sustained as a result of inaccuracies in that
estimation. Additionally, the client recognizes that
Redington Ltd does not owe any party a duty of care
in this respect.
Redington Ltd are investment consultants regulated
by the Financial Services Authority. We do not
advise on all implications of the transactions
described herein. This information is for discussion
purposes and prior to undertaking any trade, you
should also discuss with your professional tax,
accounting and / or other relevant advisers how such
particular trade(s) affect you. All analysis (whether in
respect of tax, accounting, law or of any other
nature), should be treated as illustrative only and not
relied upon as accurate.
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London EC1Y 8RD
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17. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Appendix
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18. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Appendix 1:
Multi-Manager Structures
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Early adopters of LDI
have often built up large
exposures to one
manager
Diversifying
operational risk can
lead to fresh problems:
• Inefficient use of
collateral
• Need for aggregated
reporting
• Managers using
different liability
models
• Managers compete to
execute trades
Scheme
LDI Mgr
2
LDI Mgr
1
Custodian
2
Bank
Counterparties
Custodian
1
Different LDI managers not netting off trades leads to trapped collateral

19. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Appendix 2:
Counterparties and Collateral
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Downgrading of swap counterparties in
June 2012 places counterparty risk on
centre stage
Variety of opinions among LDI
managers regarding counterparty risk
Use of ATE clauses within ISDAs
Require sufficient collateral to meet margin
requirements, but inefficient use will drag on
performance
Impact of central clearing on collateral
requirements
Rehypothecation of collateral
Scheme Counterparty
Collateral
Cashflows

20. P. Drewienkiewicz What to Ask of your LDI Manager? 27 September 2012
Appendix 3:
Credit Spread and Gilt Yield Evolution
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-100
0
100
200
300
400
500
600
bps
Sterling IG 15+ Corporate Spread 20-Year Gilt Real Yield IG Spread + Real Yield