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Investment  >  Advisory Committee  >  Meeting Summaries  >  Meeting Summary for 2 August 2006

Meeting Summary for 2 August 2006

Attended: Mike Yardley (Chairman), Brian Duffin, Ewan Smith, Andrew Barrie, Andy Carter (by conference call), David Rose (by conference call), Ian Kernohan (by conference call).

Apologies: Robert Talbut

Review of Minutes

The minutes of the Investment Advisory Committee (IAC) meeting held on 26 April 2006 were reviewed and agreed.

Review of Benchmarks

The quarterly report from Barrie & Hibbert (B&H) was presented by Andrew Barrie. A sensitivity analysis has been carried out on the shape of real yield curve and the impact this has on the benchmark allocations. The analysis demonstrates that the recommended Benchmark allocations are robust to this stress testing and no further work is required at this stage.

Following the last meeting a note was circulated by Andy Carter explaining the construction of the IPD Index which understates the true underlying volatility of the commercial property market. It was confirmed that the model calibration should continue to use a higher volatility assumption. An issue still remains that it is not clear that the actual risk being taken within the property portfolio is consistent with the model calibration but Andy Carter confirmed that the overall size of the portfolio (in excess of £1bn) is such that the portfolio is well diversified both geographically and across different types of property. Andrew Barrie described the differences between the model calibration and the standard B&H calibration now recommended. The most important element is in the difference between the equity and property risk premia.

Risk Premia*	Original Calibration	Current Calibration	B&H Current Standard
Property	2.0%	2.5%	3.0%
Equities (UK)	3.5%	3.7%	4.0%
Equities (Global)	3.8%	4.0%	4.0%

* Risk Premia is the difference between the return of a portfolio and the risk free rate of return (the return received from an investment that takes no risk).  Effectively it shows the amount of extra return that has been derived from taking extra risk within a portfolio.

There was a concern raised by IAC members that further increases in the risk premia and a reduction in the gap between equities and property could not be agreed without further evidence as to why this was a better medium to long-term assumption. Andrew Barrie agreed to prepare a paper on this for the next IAC meeting (24 Oct 2006). 

A query was raised as to whether the equity and property risk premia are gross or net of all associated transaction, management and stamp duty costs. The original model calibration had been made on the assumption that the premia were net of all such costs. Andrew Barrie agreed to confirm this in the note described above and will discuss the level of costs to be assumed with David Rose. 

The issue of timing continues to overstate the volatility between the actual and benchmark portfolios. It was agreed that for analysis purposes this anomaly needed to be removed (both prospectively and historically). David Rose agreed to take this forward as a matter of urgency.  It was noted that for publication purposes the current approach with the inherent timing anomaly would have to be retained. 

It was noted that the level of active risk in the three Royal London Asset Management (RLAM) managed funds continues to be well within the risk budget. The funds continue to exhibit a relatively high beta consistent with the ongoing bias in favour of equities relative to property and index linked. This has contributed to the underperformance of the three funds over the last quarter.

It was noted that the client specific limits on the Scottish Life Defensive Managed Life fund should be relaxed as an interim measure to prevent changes in the ABI peer group forcing further purchases of Index Linked and destabilising the diversification of the fund. In the medium term the intention is to establish a benchmark methodology in the same way as has been carried out for the pension managed funds.

B&H and RLAM have been discussing the use of an ‘audit filter’ tool to help identify performance and benchmark issues for the wider portfolio of unit linked funds within the Royal London Group. The priority is to gain a better understanding of the 25 discretionary managed funds as these are the funds most likely to have been adversely affected by the influence of peer group benchmarks. Andrew Barrie described how the audit filter tool would work. It was agreed that a good starting point for the next phase of activity would be to understand the risk profile of the peer group benchmarks and the types of investor most suited to these profiles. The results of this work will be presented to the next IAC meeting. 

It was agreed that the current benchmarks for the 9 Managed Strategies should be retained for the next quarter.

Managed Fund Portfolio Weightings for Next Quarter

The regular quarterly report from RLAM was presented by Andy Carter. Despite the turbulence of the last quarter RLAM remain confident of the benign background economic conditions likely to emerge over the next 12 to 18 months with reasonable economic growth and stable inflation. This background is likely to underpin the performance of equity markets even if in the shorter term the recent volatility continues.

Hence equities are favoured relative to other asset classes. Within the equity portfolios UK equities are favoured in relation to Overseas where Europe is the least favoured market. After such a strong sustained performance from Property in recent years it is difficult to anticipate further significant outperformance.

Although index linked valuations have improved from the extreme levels seen in Quarter 1 2006 it remains difficult to anticipate relative value in this asset class and so the underweight position is likely to continue.

The proposed distributions for the third quarter of 2006 are noted below:

Defensive Managed Pension fund

	Benchmark	RLAM	Relative
Equities - UK               - Overseas	15.25 12.25 27.50	17.25 14.25 31.50	+2.00 +2.00 +4.00
Fixed Interest Gilts	Nil	Nil	Nil
Corporate Bonds	30.00	30.75	+0.75
Index Linked Gilts	25.00	22.50	-2.50
Property	17.50	15.25	-2.25
	100.00	100.00

Managed Pension fund

	Benchmark	RLAM	Relative
Equities - UK               - Overseas	30.25 24.75 55.00	32.25 26.75 59.00	+2.00 +2.00 +4.00
Fixed Interest Gilts	Nil	Nil	Nil
Corporate Bonds	17.50	18.50	+1.00
Index Linked Gilts	10.00	7.50	-2.50
Property	17.50	15.00	-2.50
	100.00	100.00

Adventurous Managed Pension fund

	Benchmark	RLAM	Relative
Equities - UK               - Overseas	41.25 33.75 75.00	43.75 36.75 80.50	+2.50 +3.00 +5.50
Fixed Interest Gilts	Nil	Nil	Nil
Corporate Bonds	7.50	4.50	-3.00
Index Linked Gilts	Nil	Nil	Nil
Property	17.50	15.00	-2.50
	100.00	100.00

Old Broad Street Research (OBSR)

The quarterly report from OBSR was presented by Ewan Smith. This report covers the performance of the Scottish Life external fund matrix (the Managed Strategies Fund Matrix) relative to the specified benchmark and risk tolerance levels. Two specific issues have been raised by OBSR.

(i) Scottish Life UK Equity Core Plus Pension fund (Schroder UK Equity) - there has been a change of manager and what appears to be a change of mandate to the fund. OBSR have removed the Forsyth-OBSR AA rating on the underlying fund until greater clarity is obtained in relation to the future prospects of the fund. Of greatest concern to IAC is the increased risk flexibility within the new mandate which is beyond that set down for the ‘core plus’ category within the Managed Strategies Fund Matrix.

Ewan Smith agreed to seek further clarity on this point and report back to IAC but it is recommended that if the risk tolerance is no longer consistent with the ‘core plus’ category then action would be required. 

(ii) Scottish Life UK Small Cap Specialist Pension fund (Investec UK Smaller Companies) - again there has been a change of manager which has triggered a suspension of the Forsyth-OBSR AA rating for the underlying fund. A watching brief will be maintained on this fund until further information is available.

In relation to the proposed restructure of the Fidelity Special Situations Fund it was noted that Royal London had voted in favour of the change. However further consideration needs to be given in relation to the mandate for the Scottish Life unit linked fund which is currently fully invested in the Fidelity Special Situation OEIC (Open Ended Investment Company). Any changes here will need to be communicated to IFAs and customers. A meeting with Fidelity is due to take place shortly.

ABI Guidance for Unit Linked Funds

It was noted that the ABI have issued a good practice guidance note covering the management of unit linked funds. A gap analysis is required between existing Royal London Group procedures and those recommended by the guidance note. This may have implications for IAC. 

The Managed Strategies Fund Matrix – Process and Procedures

A draft note covering the processes and procedures associated with the governance associated with the new Managed Strategies Fund Matrix was discussed. The note requires further change to clarify the responsibilities of the IAC.

It was noted that the two new funds (as well as the associated insurance funds) launched as part of the Riley product launch will fall within the same governance framework as the Managed Strategies Fund Matrix.

Date of Next Meeting

The next meeting of the IAC will take place on 24 October 2006.