Alternative Investments for Capital Accumulation Plans (CAP)
1. Alternative Investments for Capital
Accumulation Plans (CAP)
What Plan Sponsors Should Know
Bradley N. Rowe, CFA
Principal
2. Start with the “Risk Free” Asset
1991
2000
2010
2013
0%
2%
4%
6%
8%
10%
12%
14%
3Months
1Year
3Years
5Years
7Years
10Years
15Years
20Years
25Years
30Years
Government of Canada Bonds and Treasury Bills
(Zero Coupon Yield Curve – Start of Year)
Data Source: Bank of Canada
3. ‘W Y S I W Y G’
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Government of Canada (Mid to Long Term Bond Yield)
Bond Yield: 1982 was 14.3%
Bond Yield: 1998 was 5.5%
Bond Yield: 2012 was 2.3%
Data Source: CIA Report on Canadian Economic Statistics
4. ‘W Y S I W Y G’
-20%
-10%
0%
10%
20%
30%
40%
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Median Pension Fund Return
Average Return 1982-1996 was 13.2%
Average Return 1998-2012 was 6.4%
Data Source: CIA Report on Canadian Economic Statistics
5. ‘W Y S I W Y G’
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
20%
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
Government of Canada (Mid to Long Term Bond Yield) vs.
Median Pension Fund Returns (15 year - plotted at Start of period)
Yield Fund Return
Data Source: CIA Report on Canadian Economic Statistics
Bond Yield: 1982 was 14.3%
Average Return 1982-1996 was 13.2%
Bond Yield: 1998 was 5.5%
Average Return: 1998-2012 was 6.4%
Bond Yield: 2012 was 2.3%
Average Return: 2012-2026 will be ??%
6. Asset Allocation – DB Plans (Canada)
Data Source: PIAC, Asset Mix Composites
Asset Class 2000 2003 2006 2009 2012
Fixed Income 37.5% 35.9% 31.1% 33.0% 30.7%
Equities 54.9% 52.2% 51.9% 43.9% 41.1%
Total “Traditional” 92.4% 88.1% 83.0% 76.9% 71.8%
Private Equity 1.5% 3.6% 3.5% 6.0% 7.5%
Real Estate 5.2% 6.7% 7.3% 8.9% 10.2%
Infrastructure Not Reported Not Reported 2.4% 3.8% 5.0%
Hedge Funds Not Reported Not Reported 2.3% 2.0% 1.7%
Other 0.9% 1.6% 1.5% 2.4% 3.8%
Total “Non-Traditional” 7.6% 11.9% 17.0% 23.1% 28.2%
7. Asset Allocation – DB vs. DC (Canada)
72%
28%
Asset Allocation – DB Plans
December 31, 2012
"Traditional" Assets
"Non-Traditional" Assets
99%
1%
Asset Allocation – DC Plans
December 31, 2012
"Traditional" Assets
"Non-Traditional" Assets
Data Source: PIAC, Asset Mix Composites
Total assets reporting: $ 1,164,506 million Total assets reporting: $ 16,041 million
8. Asset Allocation – DB vs. DC (U.S.)
84%
16%
Asset Allocation – DB Plans
December 31, 2011
"Traditional" Assets
"Non-Traditional" Assets
92%
8%
Asset Allocation – DC Plans
December 31, 2011
"Traditional" Assets
"Non-Traditional" Assets
Data Source: Towers Watson
9. Does it Really Matter? (U.S.)
-6%
-4%
-2%
0%
2%
4%
6%
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Net Investment Performance Difference (DB less DC)
Asset-Weighted Median Returns
DC Plans Outperform
DB Plans Outperform
Data Source: Towers Watson
10. Does it Really Matter?
• From 1995-2011, DB Plans outperformed DC Plans by
an average of 0.76%
• From 2000 – 2011, DB Plans outperformed DC Plans by
an average of 1.10%
• From 2007 – 2011, DB Plans outperformed DC Plans by
an average of 0.39%
– DB Plan volatility was 1.5% lower
• Fees also play a role!
11. Key DB and CAP Differences
1. Investment Strategy
– Managing uncertainty
– Behavioural constraints
2. Structure and Resources
– Professional oversight
– Scale
– Flexibility
12. 1. Investment Strategy
• DB Plan Sponsor
– Single Fund
– Relatively predictable
liabilities and cash flow
– Potential for additional
funding
– Liability immunization
– Dedicated staff and/or
consultants to assist with
investment choices
• CAP Sponsor
– Uncertain length of
retirement and expense
amounts
– Limited potential for
additional funding
– Likely a need to continue
to grow assets in
retirement
– Investment choices left to
the member – limited
knowledge and/or interest
13. Spectrum of CAP Participants
• Investment offering must consider needs of all participants
– Defaulter: offer a suitable default option
– Passive Selector: offer structure and limited choice
– Active Selector: offer suitable range of options
Unwilling or
unable to
make
investment
choices
Defaulter
Able to make
investment
choices but
choose not to
Passive
Selector
Make their
own
investment
choices
Active
Selector
14. 2. Structure and Resources
• DB Plan Sponsor
– Dedicated staff and/or
external consultants to
assist with oversight
– Centralized control
– Single investment policy
with established objectives
and goals
– Economies of scale
• Broad opportunity set
– Flexibility in making
changes to asset classes
• CAP Sponsor
– Expectation of full liquidity
– Recordkeeping is
predicated on the ability
for participants to view
daily account values
– Different objectives
– Daily pricing requirement
– Limited flexibility for
changing investment
options
• Participant notice required
15. Characteristics of Alternatives
• Relative to traditional fixed income, alternatives
are expected to generate higher cash yields and
deliver higher capital appreciation
• Relative to traditional equities, alternatives can
serve two distinct roles:
– Return enhancement
– Risk diversification
• The choice of alternative as well as the source of
the funding will depend on investor goals
16. Some Common Alternatives
Asset Class
Role Relative
to Equities
Liquidity
Need for
Specialized
Resources
Expected
Returns vs.
Equities
Expected
Volatility vs.
Equities
Expected
Correlation
to Equities
Private Equity
Return
Enhancer
Low - None Medium - High Higher Higher High
Real Estate Risk Diversifier Depends Low - Medium Slightly Lower Lower Low
Infrastructure Risk Diversifier Low - None Medium Similar Lower Low - None
Hedge Funds Risk Diversifier Lower Medium - High Depends
Lower – Much
Lower
Depends
17. Gaining Access to Alternatives
Asset Class DB Plans DC Plans
Private Equity Private Equity Limited Partnership
Invest in public companies involved in
Private Equity deals
Real Estate
Private Equity Limited Partnership
Real Estate Investment Trusts (REITS)
Direct Investments
Comingled
Real Estate Investment Trusts (REITS)
Pooled funds
Infrastructure
Private Equity Limited Partnership
Direct Investments
Comingled
Invest in public companies involved in
Infrastructure
Hedge Funds Hedge Fund Limited Partnerships
Mutual Funds using hedge fund-like
strategies
18. Typical Private Equity Cash Flow
1 2 3 4 5 6 7 8 9 10
InvestorCashFlows
Time
The “J” Curve
Distributions
Capital Calls
Cumulative Cash Flows
Investment Period
Harvest Period
19. Example: Infrastructure
• Refers to facilities and services essential for the
economic productivity of society.
• Typically involve the movement of goods, people,
water and energy.
20. Example: Infrastructure
Investment Characteristics
• Backbone of the global economyEssential Services
• High capital costs, regulation, advantageous locations, economies of
scaleBarriers to Entry
• Regulatory framework provides indexation mechanismInflation Protection
• Demand has low sensitivity to price changesLow Demand Elasticity
• Long duration. Low reinvestment risk. Matches long duration obligationsLong Life
• Long term contracts. Low maintenance requirements. “Take or Pay”
commitments from customersPredictable Cash Flows
• Relative long term independence from financial marketsLow Correlation to Other Assets
21. Issues for CAP Sponsors
• Investment Liquidity
– The need for daily liquidity
• Member Education
– Placing complex choices in the hands of
participants who may lack understanding
• Governance and oversight
– Complex investments
22. Is There a Solution?
• Publically traded / listed options
– REIT’s
• Companies that invest in direct real estate
– Listed infrastructure
• Public companies that have exposure to infrastructure
– Private equity
• Listed companies that invest in private equity deals
• Offers indirect exposure to the “direct”
investment, with higher volatility (i.e. the price of
liquidity)
23. Is There a Solution?
• Pre-built asset allocation funds
– Target Date funds
– Target Risk funds
• Member selects the “target” fund option and opts for
an automatic rebalancing along the glide path through
time
– Member choice limited / restricted
– Gain reasonable certainty around liquidity needs
– Liquidity managed by Plan sponsor
• Combination of liquid and illiquid options
24. Is There a Solution?
• Unallocated CAP Plan
– No participant investment choice
– Single fund
– Like a DB Plan without benefit guarantees
– Liquidity managed by Plan sponsor
• Joint employee / employer sponsorship
– All participants earn the same total fund rate of return
– Ease of administration and communication
– Build “guarantees” around participants approaching
retirement
• Risk sharing
– Legal implications?