1. 26th March 2009
The Credit Conundrum
Session 5: Warning - Holding credit is not without risk

2. 2
Global Equity
47%
Alternatives
3%
UK Property
4%
Cash
6%Corporate Credit
6%
Gilts
34%
Current Asset Allocation (estimate) Q4 2008 Asset Allocation End 2009?
Warning: Holding credit is not without risk
Asset Allocation
Source: Goldman Sachs Asset Management - 2008 Source: Redington Partners
Note: Includes 50%-70% duration overlay using swaps ,Gilts, and /
or synthetic equity replication using futures over Gilts.
Global Equity
25%
Alternatives
3%
UK Property
4%Cash
6%
Corporate Credit
27%
Gilts
25%
Supranationals
10%

3. 3
However timing is important: Excess return over Libor – 2008
Warning: Holding credit is not without risk
Credit, Fixed Income and Equity Returns for 2008
Source: Redington Partners

4. 4
Credit – A Long term investment
Warning: Holding credit is not without risk
Credit – A long term investment?
Price volatility
• Liquidity worsens
• Risk aversion increases
(market panics on
worsening economic
news)
• Default probabilities seen
as rising
• VaR increases, valuations
decrease, deficits rise
Downgrade risk
• Downgrades to High Yield
• Can you hold them?
• No buyers – prices
falling off a cliff
• Mandate design crucial
• How long can your
Portfolio Manager hold
downgraded bonds?
• Fire sale prices to be
avoided

5. 5
Year on Year European GDP vs. 12-month Trailing Upgrade/Downgrade Ratio
Source: Deutsche Bank
Warning: Holding credit is not without risk
Credit – A long term investment?

6. 6
5 year cumulative implied default rates based on spreads v Govt for IG and HY bonds (£)
Source: Deutsche bank ~Default study 17th March 2009
Warning: Holding credit is not without risk
Default rates – Sterling Corporate Bonds
Spread Implied Default rate Actual Default Rate (since
1970)
Source Sector Average 5 yr
spread (bps)
Average
Recovery
Zero
Recovery
Worst Average
iBoxx Corporate 769 51% 33% 2.4% 0.9%
Non-Financial 397 30% 18% N/A N/A
Financial 986 60% 40% N/A N/A
AA 522 38% 23% 1.8% 0.2%
A 747 48% 31% 2.6% 0.6%
BBB 1,035 58% 39% 5.8% 1.8%
High Yield Euro HY 1,592 69% 53% 31.0% 19.3%

7. 7
Type of RMBS No. of Upgrades/Downgrades Barclays Capital rating outlook
RMBS: UK Prime 13/0 Stable
RMBS: UK NC (Subprime) 90/462 Negative
RMBS: Spanish 16/104 Negative
RMBS: Dutch 31/13 Stable to positive
RMBS: Portuguese 3/8 Stable to negative
RMBS: Irish 4/0 Stable to positive
RMBS: Greek 10/0 Stable to positive
CMBS: UK 10/91 Negative
Auto ABS: German 5/2 Stable
Auto ABS: French 0/0 Stable to positive
Auto ABS: Spanish 1/5 Negative
Auto ABS: Italian 0/0 Negative
Total 183/685
2008: Upgrades/Downgrades European ABS plus outlooks
Source: Barclays Capital 2009 Global Securitisation Annual
“Globally,
given the
negative
fundamental
trends and the
possibility of
rating
methodology
revisions by
the rating
agencies, we
expect even
more
downgrades in
2009”
Global 2009 ABS outlook
- Barclays Capital
Warning: Holding credit is not without risk
Upgrades/Downgrades on European ABS

8. 8
Warning: Holding credit is not without risk
Estimated equities returns 1998 - 2018
Source: Redington Partners
Projected levels required from FTSE All TR based on approx. 3% risk premium over gilts

9. Warning: Holding credit is not without risk
Credit vs. Equities
9
10-year Rolling Rate of Return on FTSE 100 versus 10 yr swaps (10 yr to date)
Source: Redington Partners

10. Warning: Holding credit is not without risk
Credit vs. Equities
10
Annual 20-Year returns for the UK stock market
Source: Global Financial Data, Datastream

11. •Shares plummeted against falling property valuations
•March 16th 2009 Brixton axed final dividend and announced
new rights issue
11
In 2008 Dividends axed or slashed across the board –
Losses of USD 903bn worldwide
Capital raising of USD 906bn worldwide
Property companies
Main stream blue chip corporates
Financials
•General Electric announced a 68% cut in dividend for the first
time since 1938
•Dow Chemicals cut theirs by 64% for the first time since 1912
•L&G slashed final dividend by 50% on 25th March 2009
Equities - Dividends Slashed/Share dilution through Rights Issuance
•S& P predicts that
dividends in US could
fall by 25% in 2009.
•From 1931 – 35
American dividends
fell 45%.
2008
2009
Warning: Holding credit is not without risk
Equities Outlook

12. Capital Structure – Order of Seniority
12
Secured
•Regular coupon
•Bond /Loan redeemed at par on maturity
• Secured against named assets
•Losses only when, in event of default, the value of secured assets drops below initial valuation levels
Senior
unsecured
•Regular coupon
•Redeemed at par
•Losses only in event of default
•Usually some recovery rate (historically 40% for investment grade, 15% for high yield)
Lower Tier 2
Upper Tier 2
Tier 1
•Enhanced fixed rate coupon
•Coupon may be cancelled or suspended at the discretion of the issuer
•Issues are long dated or open-ended. Callable by nature with step-up coupons
•Lower recovery rates, as lower down the capital structure
Equity
•Dividend – not guaranteed in either magnitude or existence
•Price of share – not limited to 100 redemption
•Equities take the first losses
Warning: Holding credit is not without risk
Credit vs. Equities

13. Minimum Funding Level
Cone of Uncertainty
Cone of Uncertainty
FRS 17/IAS 19
BUYOUT S75
13
Warning: Holding credit is not without risk
Credit and the Flight Plan
Using Credit in your Strategic Asset Allocation – Matching, Return or Both?

14. 14
Credit – on the path to Buy-in/Buy-out

15. 15
Buyout - “Preferred” Assets
Bonds
Gilts
Sterling investment
grade bonds
Overseas investment
grade credit
Credit Derivatives
Structured Credit
Cash
Bank
deposits
Swaps
Interest Rate
Inflation
Subject to
counterparty
agreement
Equities
Exchange traded
Private
Warning: Holding credit is not without risk
Credit – preferred assets

16. 16
Buyout – Risk Profile of investment Strategies
60 / 30 / 10 – Traditional Allocation
Interest rate and inflation hedging
Transition Growth Assets to
Matching/Eligible assets
Buy-in hedge portfolio/longevity
swaps
Buy-in/Buyout
High Risk
Medium Risk
Low Risk
Least Risk
Warning: Holding credit is not without risk
Getting your ducks in a row

17. 17
Warning: Holding credit is not without risk