What exactly do you do all day?

March 26, 2015 Categories: Investment Strategy, Liability Hedging

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There’s a running joke in the Rae household about what I actually do at work. My eldest now thinks I play Match Attax (don’t ask), my middle thinks I’m a builder and my youngest wishes I was Sir Topham Hatt (*makes a mental note to go to the gym more).

The reality is perhaps less exciting for young children and actually pretty hard to pin down – it varies a great deal every day. There are, however, two things I do every day. When I wake, I look at the moves in the US Treasury markets and then the S&P Index. As a ready gauge for how markets are affecting funding levels this is a great barometer. The second thing I focus on is funding level volatility.

For all of our fiduciary management clients, there is a daily dashboard that I look at. It provides a wealth of great information to enable the management of the balance sheet risks: funding levels, de-risking triggers, asset allocation, liability hedging information and a multitude of time series data.
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Source: for illustrative purposes only.

Out of all the information, why do I focus on the funding level volatility? Well for me, it best captures the four key factors in one series and is supplemented by my knowledge and understanding of what is going on behind the numbers.

The four factors are the current funding level, the asset volatility, the liability volatility, and the correlation between the assets and liabilities. Across each of these variables, I’m very focused on what I can control and what I can’t control. In terms of controllable factors, they are primarily the risk exposures of the asset portfolio across different asset classes, strategies, currencies and the liability hedge ratio. In terms of the things I can’t control, it’s how the market behaves – the current volatility environment across various asset classes, currencies and long dated interest rates and inflation expectations.

I’ve observed a general trend upwards in funding level volatility since the middle of last year driven primarily by increasing market volatility. Across the controllable factors, we’ve been reducing risk through our portfolio positioning in a number of ways. Increasing allocations to convertible bonds, changing the equity profile through the use of option strategies and more defensive holdings, and adding to less market sensitive strategies have all reduced the risk profile of the asset portfolio.

However, increases in the prevailing market volatility have been pushing up funding level volatility (particularly through the liability volatility) from very low levels in the summer of last year. This is a trend that is unlikely to reverse. Indeed, I fully expect greater variability in 2015 and no return to the low volatility world of early 2014.

Of course, as valuable an insight as historic funding level volatility is, what I really worry about is how that volatility will evolve in the future and we conduct much more in-depth analysis that allows us to frame our forward looking expectations. Looking at the historic measure is just a very useful way of starting the day.

If I still have your attention, then I am doing better than with my kids. By this point, with talk of volatility and correlations, I’ve usually lost them to the iPad or preferably the garden, no wiser about what I do – “You do meetings and phonecalls, don’t you Daddy?”

David Rae, Managing Director, Head of LDI Solutions, EMEA<

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