Issued in January 2016 For professional investors only Schroders Portfolio Solutions Monthly December 2015 What’s (maybe) hot in 2016 As we go into 2016, we took a straw poll from Schroders’ Portfolio Solutions Team for the hot topics of 2016: Rates The Fed is leading the way, and others expected to follow. Market reaction may bring volatility, favouring realistically set triggers and potentially swaption strategies. Regulation Clearing, now reality rather than phoney war, may grab the headlines, but Basel III may be bigger. Look for it to drive rising repo funding costs as well as bank preferences for par swaps, cash CSAs and more profitable, diversified trading partners on which to spend their balance sheet. Careful structuring of instruments and choice of trading venue become key as well as non-traditional sources of repo financing and maybe rises in the spread of gilt yields over swaps. Reconsidering alpha Mechanistic spread trading has been caught in an overweight gilt position, losing money and struggling to trade the sizes needed. We see a return to more “traditional” ways of sourcing return, with focus on closely controlled growth strategies, absolute return fixed income and portable alpha as well as more subjective approaches to LDI opportunities. Liquidity If rate rises accelerate, LDI will need capital to support drawdowns. Having an accessible form and the governance to supply it may be essential if we see any shocks. Cash CSAs and clearing will also bring focus on the “liquidity ladder”. Growth assets Liquidity pressures and more hedging may push schemes to switch leverage to growth assets rather than LDI. Increasingly sophisticated approaches allow access to more than just vanilla exposure to equities, so loss of diversification isn’t the sacrifice it once was. We see leveraged risk managed equities as a key opportunity for DB schemes. Good or bad credit? De-risking and low yields, push schemes towards credit. Integrating with LDI for both hedging and liquidity will be key; think duration neutral strategies, buy and hold portfolios or synthetic credit exposures. In 12 months’ time we’ll see if any of these come true (or drop us a line, and tell us why we’re wrong!) Schroders: Portfolio Solutions Monthly Markets dashboard Yield changes (bps): Oct 15 to Nov 15 Risk asset m arket changes 10 year 20 year 50 year Oct 15 to Nov 15 FI Gilt yield -8 -6 -12 MSCI World -0.7% IL Gilt yield -15 -4 -6 FTSE 100 -0.1% RPI sw ap +13 +1 -3 5yr Euro CDS -1 bps FI Gilt/Sw ap spread +1 +6 +4 1 year 90% FTSE 100 put +0.2% Source: Schroders, Bloomberg, Merrill Lynch, Credit Suisse, 30 November 2015. Change in equity put is the outright change in premium. Funding level dashboard 1 year reference funding level progression 1 month attribution of funding level change 110% 98% 97% 100% 96% 90% 95% 80% Nov 14 Feb 15 May 15 Aug 15 Nov 15 94% Oct funding Nominal level: rates: 97% -0.8% Real rates: -0.7% Source: Schroders, Bloomberg, 30 November 2015. Please refer to the supporting notes for further details. 2 Growth assets: -0.6% Nov funding level: 95% Schroders: Portfolio Solutions Monthly Market data: LDI markets One year range • L H• Month end 30 Nov 2015 One Month 31 Oct 2015 Three Months 31 Aug 2015 One Year 30 Nov 2014 5 Year 1.29% 1.32% 1.37% 1.32% 10 Year 1.90% 1.98% 1.99% 2.01% 20 Year 2.65% 2.71% 2.64% 2.71% 30 Year 2.65% 2.76% 2.69% 2.86% 50 Year 2.42% 2.54% 2.46% 2.76% 1 Month change (RHS, Bps): Month end curve (LHS): Nom inal rates – Gilt m arkets 4.0% 20 2.0% 0 0.0% -20 0 10 20 30 40 50 Real rates – Index-linked gilt m arkets 5 Year -1.15% -1.05% -1.02% -1.29% 10 Year -0.85% -0.71% -0.77% -0.89% 20 Year -0.78% -0.74% -0.78% -0.68% 30 Year -0.78% -0.74% -0.82% -0.63% 50 Year -0.94% -0.88% -0.96% -0.61% 5 Year 2.84% 2.64% 2.70% 2.86% 10 Year 3.10% 2.97% 3.03% 3.14% 20 Year 3.40% 3.39% 3.44% 3.47% 30 Year 3.43% 3.45% 3.51% 3.52% 50 Year 3.42% 3.45% 3.51% 3.49% 5 Year -0.12% -0.18% -0.23% -0.18% 10 Year 0.03% 0.02% -0.04% -0.02% 20 Year 0.55% 0.49% 0.37% 0.26% 30 Year 0.61% 0.58% 0.45% 0.35% 50 Year 0.54% 0.50% 0.36% 0.30% 2.0% 20 0.0% 0 -2.0% -20 0 10 20 30 40 50 Inflation rates – RPI sw ap m arket 4.0% 20 2.0% 0 0.0% -20 0 10 20 30 40 50 Nom inal gilt curve vs sw ap curve Global bond m arkets 1.0% 10 0.0% 0 -1.0% -10 0 10 20 30 40 50 Forw ard gilt curves 10 Year Bund 0.47% 0.52% 0.74% 0.70% 4.0% 10 Yr Gilt/Bund Spread 1.35% 1.40% 1.21% 1.22% 3.0% 10 Year US Treasury 2.21% 2.14% 2.18% 2.16% 2.0% 10 Yr Gilt/US Spread -0.37% -0.22% -0.21% -0.23% 5 year IG CDS – Euro 70 71 71 58 5 year IG CDS – US 84 79 80 61 1.0% 0.0% Money m arkets 0 10 Gilt curve 3 yrs fwd Currency rates 20 30 40 1 yr fwd 5 yrs fwd 50 30 Nov 2015 31 Oct 2015 31 Aug 2015 30 Nov 2014 Bank of England base 0.50% 0.50% 0.50% 0.50% GBP/USD 1.50 1.54 1.54 1.56 SONIA 0.46% 0.46% 0.47% 0.44% GBP/EUR 1.42 1.40 1.38 1.26 3m Libor 0.57% 0.58% 0.59% 0.55% GBP/JPY 185.1 186.1 187.4 185.6 Interest rate sw aptions as at m onth end: 1y20y 3y20y 5y20y 3y30y 5y30y ATM* Forw ard Par sw ap rate 2.12% 2.21% 2.23% 2.10% 2.11% ATM* Implied volatility 0.76% 0.78% 0.73% 0.74% 0.70% Source: Schroders, Bloomberg, 30 November 2015. *At the money. All data as at month end allowing for UK trading days. 2 Schroders: Portfolio Solutions Monthly Market data: Risk management strategies One year range • L H• Month end One Month Three Months One Year 30 Nov 2015 31 Oct 2015 31 Aug 2015 30 Nov 2014 MSCI World 1,694 1,706 1,658 1,740 FTSE 100 6,356 6,361 6,248 6,723 S&P 500 2,080 2,079 1,989 2,068 Euro Stoxx 50 3,506 3,418 3,287 3,251 Nikkei 225 19,747 19,083 19,136 17,460 Equity indices MSCI All World Total Return (re-based to 100) 120 100 80 Nov 14 Feb 15 May 15 Aug 15 Nov 15 Aug 15 Nov 15 Equity option m arket indicators (FTSE 100, 1 year) ATM* Implied volatility 16.8% 16.4% 16.2% 14.1% Skew (90 – 110) 5.4% 5.3% 4.8% 5.1% ATM im plied 1 year volatility Skew (90 vol – 110 vol) 20.0% 6.0% 5.0% 15.0% 4.0% 10.0% Nov 14 Feb 15 May 15 Aug 15 Nov 15 3.0% Nov 14 Feb 15 May 15 Equity risk m anagem ent strategy indicators (FTSE 100 total return, spot prices) 90% Put Zero cost collar call strike (90% Put) Zero cost put spread collar call strike (70%/90%) 1 yr 3.6% 106.7% 109.7% 3 yr 6.9% 111.8% 123.5% 95% Put Zero cost collar call strike (95% Put) Zero cost put spread collar call strike (70%/95%) 1 yr 4.9% 104.2% 106.6% 3 yr 9.9% 109.6% 118.9% NB - one year range indicators for equity risk management strategies are based on month end values. Note: one year range indicators for equity risk management strategies are based on month end values. Source: Schroders, Bloomberg, Merrill Lynch, Credit Suisse, 30 November 2015. *At the money. All data as at month end allowing for UK trading days. About us The Schroders Portfolio Solutions Team partners with investors to provide risk management strategies across all major financial markets. The team structures and executes physical and derivative based strategies to manage the exposure to global equity and fixed income markets. These solutions draw on the full opportunity set of exchange traded and Over-The-Counter derivatives. To help manage interest and inflation rate risk, Schroders Portfolio Solutions offers a comprehensive and fully flexible solution utilising segregated solutions (encompassing physical bonds, swaps, swaption and synthetic gilt based strategies), as well as the Schroder Matching Plus pooled fund solution. We also provide funding level and market based trigger monitoring and execution for both pooled and segregated solutions. Clients can access these solutions under directed or discretionary mandates. Please contact us at PortfolioSolutions@schroders.com if you would like further information on how Schroders can help manage your Scheme’s exposure to risk. 3 Schroders: Portfolio Solutions Monthly Notes The funding level dashboard shows the funding level progression and attribution of funding level change of a Reference Pension Scheme. This Reference Pension Scheme has a liability duration of around 20 years and assumes the liability is linked 50% to real interest rates and 50% to nominal rates. The assets are assumed to have a beta of 0.75 to global equity markets. This enables the reader to observe the scale of component changes. No allowance for the impact of the progression of time on liabilities is included in the funding level dashboard. Funding level progression is presented on a rolling 12 month basis, indexed to an initial funding level of 100%. schroders.com/ukpensions Important Information: For professional investors only. The views and opinions contained herein are those of the Portfolio Solutions Team at Schroders, and do not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds. This newsletter is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Limited (SIM) does not warrant its completeness or accuracy. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions. Past performance is not a guide to future performance and may not be repeated. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. The forecasts stated in the newsletter are the result of statistical modelling, based on a number of assumptions. Forecasts are subject to a high level of uncertainty regarding future economic and market factors that may affect actual future performance. The forecasts are provided to you for information purposes as at today's date. Our assumptions may change materially with changes in underlying assumptions that may occur, among other things, as economic and market conditions change. We assume no obligation to provide you with updates or changes to this data as assumptions, economic and market conditions, models or other matters change. For your security, communications may be taped or monitored. Issued in January 2016 by Schroder Investment Management Limited, 31 Gresham Street, London EC2V 7QA. Registration No. 1893220 England. Authorised and regulated by the Financial Conduct Authority. 4