Innovation in the face of uncertainty

27 November 2012

Sean Henaghan

Investment Director, Multi-manager and Investment

Solutions

The new investor reality

• The Global Financial Crisis highlighted many client portfolios contained too much equity market related risk

• Investors are now highly sensitive to volatility and downside risk

• Investors have adopted a couple of approaches:

– have increased allocations to more defensive asset classes such as cash and fixed income

– sought funds that targets growth for the future whilst actively managing risk (with an eye on preserving wealth)

Investors are now more aware

Decumulation*

Acco

un

t b

ala

nce $

Accumulation and decumulation account balance (real terms)

(+ / –) 2% difference in

returns from base case

Base

case

Better returns by 2% significantly extends asset life

* Assumptions vary to previous slides, as this chart is demonstrating sensitivity, not the level. Draws down on capital and income

at 6% of initial balance, indexed at CPI of 3% pa. Source: AMP Capital.

They understand the impact over-exposure to equities can have on their

portfolio, especially near retirement

Accumulation AGE

GFC type event

Dissatisfaction with current approach…. so members are doing it themselves

2

Peer Group Balanced Funds vs Assumed Objective

Source: AMP Capital, ATO, APRA, Chant West Multi-Manager September Quarter report 2012.

Volatility is here to stay (for the foreseeable future)

0

2

4

6

8

10

12

US

Australia

Rolling 10 year standard deviation of annual GDP growth

Source: Global Financial Database, AMP Capital, as at June 2012.

1900 1920 1940 1960 1980 2000

High levels of public debt, more fragile

household balance sheets and big

swings

in monetary policy mean more

volatile asset markets

Real returns focus, with a proactive attitude to managing risk

We aim to give investors greater confidence by:

•Seeking stable, risk-adjusted returns

•Targeting lower volatility (between 4% to 8%) than equity markets

•Where possible - attempts to capture the highs whilst minimising the lows in the market

•Agnostic to peer risk

•Taking an active approach to managing risk through:

– Three types of diversification

– Risk mitigation strategies

– Dynamic asset allocation

// 7

Diversified return Sources

Div

ers

ific

atio

n

Risk/tail overlay

Alternative markets

(beta)

Australian

equities Equity long/short Private equity

Developed

market equities

Equity market

neutral Distressed debt

Emerging

market equities Event driven Infrastructure

REITS Volatility

arbitrage Agriculture

IG credit Macro Timber

High yield credit Trading Aircraft leasing

Commodities Stock selection Ship leasing

ILBs Multi strategy Micro cap

Sovereign debt Distressed debt Catastrophe

insurance

Cash Emerging

markets

Life

settlements

Traditional

markets

(beta)

Manager

returns

(alpha)

Alternative

markets

(beta)

Improved diversification of risk

Australian

equities 48.4%

Emerging market

equities 13.6%

Developed market

equities 23.8%

Absolute return

– growth 5.0%

Absolute return – growth 1.4%

Absolute return – defensive 0.9%

Sub investment grade credit 0.7%

Investment grade credit 0.6%

Direct infrastructure 0.8%

Diversified alternatives 1.2%

Direct property 0.9%

Private equity 2.2%

Inflation linked bonds 0.4%

Sovereign bonds 0.2%

REITs 2.2%

Significantly less concentration in equity risk

Australian

equities 19.4% Emerging market

equities 4.9%

Developed market

equities 35.2%

Diversified alternatives 2.3%

Private equity 1.7%

Inflation linked bonds 3.4%

Sovereign bonds 1.4%

REITs 5.1%

Absolute return

– defensive 5.9%

Sub investment

grade credit 10.5%

Investment

grade credit 10.5%

Indicative portfolio allocations:

Traditional diversified fund

risk contributions

Indicative portfolio allocations:

AMP Capital Extended Multi-Asset Fund

risk contributions

Dynamic asset allocation (DAA) in action The AMP Capital Multi-Asset capability can respond dynamically

in short timeframes to better position for expected change

Fund allocations

Source: AMP Capital as at July 2011 , January 2012 and July 2012. Allocations represent the AMP Capital Multi-Asset Fund.

Risk management philosophy • We take an active approach to risk by:

1. Considering the expected asset class performance and risk in different parts of the investment cycle

2. Scrutinising risk across the entire portfolio - asset class, manager, sector, country

3. Actively managing the impact of ''event risk'' through tactical hedging strategies

4. Managing liquidity risk (illiquid assets no greater than 20% of portfolio )

• Our approach to risk management is proactive and forward looking

Our approach to tail hedging • Dynamic Asset Allocation

• Diversification (long volatility investments)

— Duration, CTA, CB, Quality

• Direct hedges (50 basis point budget)

—Put options

—CDS (if available)

• Risk trades

— Relative value e.g. small cap / large cap spread

— Contingent trades e.g. oil sands

• Volatility

— VIX, variance swaps, inflation swaps

// 12

Key risk and possible response: US stimulus withdrawal

• Smaller capitalisation (small caps) stocks generally have lower earnings quality and are less liquid than the ‘higher quality’ larger stocks

• Small caps generally outperform large caps during periods of rising growth and can underperform sharply in a downturn or ‘stress event’

• In mid 2011:

– Small caps were trading at a 30% valuation premium to large cap

– The US QE2 stimulus program was nearing its end

– World growth numbers were deteriorating post the Japan earthquakes

Possible strategy

Trade: Sell Russell 2000 futures/ Buy SP 500 Futures

Close position: When QE3 discussion emerges

RISK MANAGEMENT EXAMPLE

Diversification, DAA and tail hedging has enabled our fund to provide downside resilience against equity indices

Returns for the Multi Asset Fund are after fees and before tax. Past performance is not a reliable indicator of future performance.

A new approach that may suit all stages of the investor life-cycle

Acco

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Accumulation Phases Retirement Phases

*Multi-Asset Fund

Source: AMP Capital

Decumulation*

Accumulation AGE

25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100

Income Investments

Income

Real Return MAF*

Growth

investments

Growth

investments

Real Return

Multi-Asset

Fund

Real Return

Multi-Asset

Fund

Real Return

Multi-Asset Fund

Practical retail implementation issues • The usual overarching factors such as ratings, team resourcing etc. – these

are more pertinent in getting onto the platform i.e. having opportunity to hunt and gather

• Model Portfolio (MP) inclusion is tricky and a harder nut to crack – most are based on meeting planner assessment of clients risk appetite – which is interpreted through a traditional SAA paradigm (Conservative, Balanced etc).

• Real Return funds are turning this paradigm on its head and therefore dealer groups and planners will find it difficult to allocate within the SAA model.

– For example within a constrained and range bound SAA, Real Return Funds create potential compliance issues if ranges are breached. MP’s may limit their use to reduce this risk.

• MP’s are based on the mantra diversification of strategy and manager.

– challenge of understanding manager versus market risk

• Difficult to categorise the sector ie alternatives; alternative balanced