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Adviser  >  Investment for Advisers  >  Advisory Committee  >  Meeting Summaries  >  Meeting Summary for 25 April 2007

Meeting Summary for 25 April 2007

Present:  Mike Yardley, Andy Carter, Robert Talbut, Ewan Smith, Andrew Barrie

In attendance: Nick Leitch (Scottish Life), Niall Cameron (Barrie & Hibbert), David Carruthers (Barrie & Hibbert), and Nick Jessop (Barrie & Hibbert)

Apologies:  David Rose

The 11th quarterly meeting of the Royal London Investment Advisory Committee (IAC) took place on Wednesday 25th April 2007.

Review of previous minutes

The minutes of the previous IAC meeting (24th January 2007) were reviewed and agreed. 

Ewan Smith advised that new Managed Strategies developments are currently undergoing market testing and a report will be presented to the IAC in due course. All other action points from the previous meeting were picked up under each heading below.

Quarterly review of Barrie and Hibbert (B&H) modelling assumptions

The B&H modelling assumptions are the inputs to a stochastic model that is used to determine the benchmark asset allocations within Managed Strategies.

Review of the transaction cost assumptions

David Carruthers presented a paper on behalf of B&H.  The purpose of the paper was to provide clarity around the implicit cost assumptions for each asset class.  David Carruthers advised that the assumed equity and property turnover rates (rate of buying and selling in the portfolio) and the depreciation/maintenance costs associated to property were the key drivers for the assumed costs.  David Carruthers advised that he had consulted with David Rose, and the conclusion was that the implicit cost assumptions are reasonable, and that no change to the modelling assumptions would therefore be recommended by B&H on account of this analysis.  This was accepted by the IAC.

Review of the appropriateness of the overall assumptions

David Carruthers presented a review of the main assumptions, namely; inflation, the returns on each asset class, changes to returns over time, the volatility of returns for each asset class (a measure of risk), and asset class correlations (the degree to which the returns on one asset class are related to another).  The assumptions were compared to current and recent market experience.

David Carruthers commented that the central B&H assumptions are influenced by historic returns over the past 20 – 40 years, whereas current market rates may be expected to exhibit short-term fluctuations. The IAC reviewed the B&H assumptions and noted that recent market conditions exhibit a few unusual features by historical standards, namely:

• Yields on longer term bonds (index-linked, conventional and corporate bonds) are lower than shorter term bonds, reflecting strong pension fund demand.
  
  
• Yields on long-term index-linked bonds are very low by historical standards and low relative to other asset classes.  In other words, this asset class appears to be relatively unattractive based on current market conditions.
  
  
• Yields on corporate bonds are low by historical standards relative to government bonds.

The IAC discussed whether the index-linked bond assumption required changing, with consequential revision of benchmark allocations. Index-linked bonds currently represent 10% of the balanced and 25% of the cautious Managed Strategies portfolios, and 10% of the benchmark asset allocation for the Managed fund and 25% for the Defensive Managed fund. 

In particular the IAC considered whether the allocation to index-linked bonds within the benchmark allocations for long-term investors is now too high.  It was agreed that further analysis was required before coming to a conclusion. 

For the next meeting of the IAC, Royal London Asset Management (RLAM) were asked to present their informed opinion as to the future returns from index-linked bonds, and B&H likewise based on their experience of the assumptions used by other life offices providers within other modelling work.

B&H were also asked to present a paper outlining the impact on suggested Managed Strategies portfolios of three scenarios for index-linked bond yields, namely that

• The current market rate becomes the B&H index-linked bond yield assumption, and the risk premium for other asset classes  is unchanged (in which case index-linked gilts should remain broadly the same attractiveness relative to other asset classes)
  
  
• The current market rate becomes the B&H index-linked bond yield assumption, and the risk premium for other asset classes increases (in which case index-linked gilts become less attractive relative to other asset classes)
  
  
• The current market rate becomes the initial B&H index-linked bond yield assumption, and the long-term assumption is that the yield reverts back to the status quo.  The risk premium for other asset classes is increases  (in which case index-linked gilts become even less attractive relative to other asset classes)

Analysis of the impact of changing the corporate bond yield assumption will also be carried out.

Notwithstanding this period of analysis, the IAC agreed to retain the current model assumptions during this period and accordingly the IAC will recommend to the Royal London Board that the benchmark allocations are unchanged for Q2 2007. 

Quarterly review of RLAM tactical asset allocation within the Scottish Life Pension Adventurous Managed, Managed and Defensive Managed funds

Robert Talbut advised that as at 31st March 2007, RLAM favoured equities over other asset classes, and that this view was reflected in the general overweight in equities and underweight in the other asset classes within the three funds. 

Within equities, RLAM are most positive on UK, European and Far Eastern markets, and less positive on the US and Japanese markets. 

The fund remains broadly benchmark for UK equity investment versus total overseas equity investment.

Robert Talbut reported that as at 31st March 2007, the asset allocations were as follows:

	Defensive Managed		Managed		Adventurous Managed
Asset	Actual Weighting (%)	Benchmark Weighting (%)	Actual Weighting (%)	Benchmark Weighting (%)	Actual Weighting (%)	Benchmark Weighting (%)
Cash	2.7	0.0	0.5	0.0	1.5	0.0
Equities	31.8	27.5	60.9	55.0	81.4	75.0
Gilts	0.0	0.0	0.0	0.0	0.0	0.0
Corporate Bonds	28.6	30.0	16.1	17.5	4.7	7.5
Index-Linked Bonds	22.6	25.0	7.3	10.0	0.0	0.0
Property	14.4	17.5	15.1	17.5	12.4	17.5
Total	100.0	100.0	100.0	100.0	100.0	100.0

Robert Talbut also advised that equity component for all three funds is currently diversified as follows:

UK Equity	54.7	55.0
	Actual Weighting (%)	Benchmark Weighting (%)
Overseas Equity	45.3	45.0
Total	100.0	100.0

Robert Talbut reported that the funds continue to be managed well within the risk budgets (a measure of the degree of asset and stock selection risk the funds can take). 

The following risk budget data was presented

	Risk Budget
	Actual (%)	Benchmark Maximum (%)
Defensive Managed	1.11	3.75
Managed	1.11	2.50
Adventurous Managed	1.27	5.00

David Carruthers confirmed that the risk budget figures were accurate.

Quarterly review of fund performance

Review of the performance of the Scottish Life Pension Adventurous Managed fund, the Managed fund and the Defensive Managed fund, and the 9 Managed Portfolios

Robert Talbut and Nick Leitch presented two papers analysing performance.

Since October 2004 (the implementation of the IAC governance process), the Managed fund and Defensive Managed fund show above benchmark performance and the Adventurous Managed fund shows below benchmark performance. 

The nine asset portfolios within the Managed Strategies framework are showing below benchmark performance since inception. The primary driver behind relative performance has been above benchmark performance from corporate bonds and below benchmark performance from equity and property funds. 

Andy Carter commented that equity performance had been disappointing but that changes were in progress to improve future performance. In some equity areas we had performed well but underperformance in Japan and the US more than offset the good performance elsewhere.  The American fund would be managed on a passive basis subject to appropriate approval and due process.  Andy Carter explained that that in the large and highly efficient US market, the opportunities to consistently add value to client portfolios through an active approach are limited, and that adopting a passive North American mandate was the preferred approach.

Andy Carter also commented that consideration was being given to managing the UK Equity fund on a core/satellite basis (i.e. part of the fund is managed passively, with the balance being managed on an active basis), again subject to appropriate approval and due process.

Andy Carter commented that the property benchmark may not be consistent with that used by other life offices, and hence performance may be relatively better than suggested.

Review of the performance of the Matrix funds

Nick Leitch presented a paper analysing the tracking error, relative performance and risk adjusted performance of the underlying holdings within the Matrix funds. The paper also included information supplied by Old Broad Street Research (OBSR).  During the last quarter it was noted that OBSR had revised their rating downwards on the JPMorgan Japan fund (from AA to A) and Investec UK Smaller Companies fund (from suspended ‘AA’ to no rating).

It was agreed that this was a useful analysis which should be adopted within the RLAM report for all funds.

Following discussion the IAC concluded that the current holdings remain appropriate, and accordingly the IAC will recommend to the Royal London Board that all Matrix fund holdings are unchanged for Quarter 2 2007.

Review of the performance of the other funds (non-Matrix external funds, Scottish Life pension funds and Scottish Life life funds)

Robert Talbut presented a paper describing the performance of these funds, which was accepted by the IAC. No changes were recommended as a result of this paper.

Other Matters

It was noted that Brian Duffin has resigned from the IAC and that John Deane (Chief Executive, Royal London Intermediary Division) has been invited to attend the next meeting of the IAC.

Next Meeting

The next meeting of the IAC is due to take place on 15th August 2007.