institutional investment perspectives - towers watson

© 2011 Towers Watson. All rights reserved.

Institutional Investment PerspectivesTowers Watson Investment Services, Inc.

December 8, 2011

© 2011 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.towerswatson.com 2

Today’s presenters

Chris DeMeoHead of Investment, Americas

Carl HessGlobal Head of Investment

Marko KomarynskyDirector of U.S. Investment Manager Research


Towers Watson Investment Services (TWIS)

Who We Are Our Client BaseMore than 200 U.S. clients with $650 billion in assets160 defined benefit plans 120 defined contribution plansCorporate retirement plans are our focus

Our Resources Our Services Investment Policy Consulting Portfolio Construction

Manager Searchand Selection

Asset/liability modelingAsset allocation studiesInvestment manager structureDC line-up structureInvestment option structureInvestment product analysisRisk managementInvestment policy statement developmentSpending policy development

Dynamic strategic asset allocationOpportunistic exposure to asset classes and strategiesActive vs. passive managementSuitability assessment

Qualitative manager reviewsDetermination of number of managers and mixture of stylesTraditional asset class searchesAlternative asset class searches

“End State” Support Plan Operations Other Services

Annuity market conditions monitoringBuy-in vs. Buy-out analysisCoordination with plan administrator and insurance providers

Liquidity managementPlan rebalancingCustodial interfaceManager contract execution on behalf of Trust

DC provider searchesTrustee/custodian selectionTopical researchQuarterly fund monitoring reports

Investment consultants since 1961SEC registered investment advisorMore than 1,000 global investment consulting relationships675 worldwide associates

Global Investment Review

Resources8 global consultants3 dedicated full-time professionals

FocusEconomic and market viewsAsset class researchCoordinate alpha and beta specialists

Investment Strategy

Resources143 global consultants88 dedicated full-time professionals

ActivityMore than 475 ALM & Risk Budgeting studies in 2009 with a volume of $951 billionMore than 200 structured product transactions to date totaling more than $100 billion

Manager Research

Resources150 global consultants, 90 full-time108 full-time equivalent consultants

Coverage697 global selection exercises in 200994 selections for alternatives in 2009More than 3,500 manager meetings in 2010

Thinking Ahead

Resources9 consultants7 dedicated consultants

Recent ThemesDiversityCombined risk frameworkPension fund governance


The next three years

FY11 FY14700+ associates worldwide More associates

More specialistsStronger brand

>1,000 worldwide clients>40 delegated relationships

More delegated responsibilityIncreasingly diverse client base especially Insurance, E&F

60% Core consulting 20% Strategy20% Other

More asset based feesFiduciary outsourcing and structured products contribute an increasing share of revenue and profits

FY11 revenue >$200m Ongoing revenue growthMaintain financial momentum through stronger business model, research and innovation leadership and global brand


Commitment to research and education —Recent examples

Research/Papers

Global Investment Matters

Survey of Investment and Economic Expectations

Extreme Risks – 2011 Update

Do Not Hire Managers for Past Performance

2011 Insurance Asset Management Survey

Stable Value Strategies

Asset Allocation Considerations for Nonprofits

Global Alternatives 2011

Opportunities to Build Governance

Webcasts

Emerging Markets Debt

Managing Financial Volatility in Non-Qualified Deferred Compensation Plans

Risk Management within the Investment Portfolio

Implementing Structured Solution Strategies

Best Practices for Developing and Implementing Portfolio Strategies

Client Events

IdeasExchange (iX) conference (New York)


Sources of growth

Delegated Investment Services

AlternativesHedge FundsReal EstatePrivate markets

Structured products

Defined contribution plans

Foundations

Endowments

Sovereign funds

Insurers


Our current views — November 2011 (Three-year horizon relative to U.S. cash)

Asset Class Returns Risk Overall Rating

Developed equities Moderately attractive Elevated Moderately attractive

Emerging market equities Moderately attractive Elevated Moderately attractive

Investment grade credit Moderately attractive Slightly elevated Moderately attractive

Emerging market debt Moderately attractive Slightly elevated Moderately attractive

Emerging market currency Highly attractive Slightly elevated Highly attractive

Real developed govt bonds Moderately unattractive Slightly elevated Moderately unattractive

Nominal developed govt bonds Moderately unattractive Slightly elevated Moderately unattractive


Return Driver Framework

The following return drivers are available to investors:

Risk Premium Investors are Rewarded for Bearing the Risk of:

Equity Being lower down the capital structure in the event of corporate default

Credit Corporate bond issuers defaulting on their bond obligations

Illiquidity Holding an asset that cannot be quickly or cheaply sold

Insurance Providing protection against extreme losses

Term The uncertain return and mark-to-market volatility of an index-linked bond compared to holding cash

Inflation Inflation being higher than anticipated and therefore reducing real returns on fixed-interest bonds

Currency The risk that the purchasing power of the currency falls due to a currency crisis

Skill A manager, previously considered skilful, underperforming its benchmark

We note that:The term, inflation and currency premia can easily be accessed and have a high capacity

The term and inflation premia have a low to negative relationship to equities (a “flight to quality”)


Return Driver Framework — Mapping different asset classes onto the return drivers

The above table outlines our view on the risk premia associated with certain asset classesFor actively managed investments, the size of the skill risk premium exposure will depend on the conviction in the manager and the alpha they are expected to provideHedge funds are primarily a skill-based asset class, and different managers will have exposure to various different risk premia

Risk Premia

Inflation linked government bonds (AAA)

Nominal government bonds (AAA)

Corporate bonds

Hedge funds

Emerging market currency

Emerging Market Debt

Emerging market equities

Emerging wealth

Volatility arbitrage

Commodities

Reinsurance

Alternative betas

Alternative credit

Bonds

Private market funds

Core infrastructure

Core global property

Illiquid assets

InsuranceIlliquidityCreditEquity InflationTerm CurrencyDeveloped market equity

SkillAsset Classes


Manager research locations1 September 2011

Our philosophy Our process Our resultsWho are we?

European Research Team73 researchers

Americas Research Team33 researchers

Asia Pacific Research Team33 researchers

Global Research Team139 researchers

(97 full-time equivalents)

Small decision-making groups with an asset-class focus: Area of Specialist Knowledge (‘ASK’) teams


Research group structure1 September 2011


Strong commitment to research with more than 150 researchers globally

Asset ResearchIdentifying attractive asset classes now

and going forward

Manager ResearchFinding value added investment

opportunities net of fees

Thinking AheadChallenging the status quo and solving

future problems

Research

7 researchersAverage investment experience of 6 years



Administrative support15 people

Quantitative support19 people

Systems team15 people


Research leadership structure1 September 2011


Significant challenge from leadership and Manager Research Review Committee

Asset ResearchDavid Hoile

Manager ResearchCraig Baker

Thinking AheadTim Hodgson

ResearchCraig Baker

Research OperationsAndrew Funnell

BondsEd Britton

EquitiesMartin Knowles

ProcessJane Welsh

Hedge FundsDamien Loveday

Private MarketsLuba Nikulina

CanadaZainul Ali

U.S.Marko Komarynsky

EMEAPaul Jayasingha

AsiaMark Brugner

AustraliaHugh Dougherty


Manager research stream information1 September 2011

Stream Number of People Full-time Equivalent (FTE) Average Experience (Years)

Bonds 31 16 11

Equities 48 29 10

Hedge Funds 21 15 12

Private Markets 36 21 12


Breakdown by FTE


Areas of Specialist Knowledge (ASK)

Manager Research resources are organized into a series of ASK teams. There are ASK teams for all of the major asset classes and specialist activities in the investment industry. Each ASK team is responsible for researching all managers within its asset class, and providing recommendations of suitable managers. Teams are also responsible for staying current and providing white paper research on trends in their respective investment areas

EquitiesAustralianCanadianEAFEEmerging MarketsEuropeanGlobalHong KongJapanesePacific BasinSingaporeU.K.U.S.

BondsAsianAustralianCanadianEmerging MarketsEuropeanGlobalHigh YieldHong KongJapaneseSingaporeSwissU.K.U.S.

AlternativesCommoditiesCurrency/TAA/ Target Return Multi AssetHedge Funds — DirectHedge Funds — Fund of FundsInfrastructurePrivate Equity — DirectPrivate Equity — Fund of fundsReal Estate — EuropeReal Estate — North AmericaReal Estate — Asia Pacific

SpecialistCustodyIndexationMulti-managerStructured productsSustainable Investment and Corporate GovernanceQuantitative analysis inputTarget date fundsTransition


Key differentiators

Key differentiators of Towers Watson’s Manager Research team and process:

Global reach and access

• Hold 3,000+ research meetings per year and have met 2,500+ managers• More than 150 researchers in major financial centres around the world ensures

strong coverage• Prestigious client base opens doors to managers and assists in fee negotiations

and new product ideas• Input and support from other teams including asset class research and thinking

ahead groups

Qualitative focus

• Strong focus on qualitative research to identify superior asset managers• Focus on the traits of the ‘great investors’• Past performance is better for providing questions than answers• In-depth quantitative analysis carried out using proprietary tools to inform and

allow more probing questions

Innovation and track record

• Work with managers to develop strategies that meet the needs of our clients• Have demonstrated our ability to add value through manager selections and

structure with our model portfolios



TW manager research coverage (as at November 2011)

We carry out 3,000+ research meetings per yearand have met 2,500+ managers

Managers

6,107

2,399

673

Products

25,509

7,920

2,322


Manager searches

Towers Watson does not use a pre-approved manager list from which we conduct searches

Process is structured/disciplined, but customized for each client’s performance objectives and related selection criteria

Overview of our search process:

Client/consultant/research staff actively involved

Determine desired characteristics/criteria

Set timetable

Focus on “efficacy” (quality), led by manager research staff, and “suitability” (fit), led by consulting staff

Determined by the relevant ASK team (manager research staff)

Usually three to six candidates best suited to meet the client’s specific need

PlanningStage

PreliminaryCandidate

Identification

FinalCandidate

Recommendation


US Total Search Activity Through November 2011


Philosophy — Manager selection



Combining qualitative and quantitative

How we do this:


Formal research meetings

Managers' internal meetings

Background checks

Operational due diligence

Qualitative Input View

Performance analysis

Portfolio analysis

Trading analysis

Capacity analysis

Fees analysis

Quantitative Input

Fact-based opinions

Output

Define the factors that you believe dictate success;Look for those factors with rigorous research


Philosophy — Success factors

Competitive Advantage


Investment professionals

Philosophy and insight generation

Portfolio management

Sustainability of Competitive Advantage

Firm and team stability

Opportunity set

Alignment


People are key

Understanding of behavioural psychology and its effects

Ability to separate information from market noise

A guiding philosophy, steeped in common sense

A natural understanding of risk

Competencies

Passionate about investment

A desire to succeed and a constant thirst for learning more

Have learned from their experiences and mistakes

Commitment

Bounce ideas off people for challenge not confirmation

Recognise the limits to their understanding

Have the strength of character to wait for opportunities

Willing to go against the crowd and able to act amid uncertainty

Character

What we look for:



Typical process for rating products


ASKsigns off

Skill 1 considerations

Devil’s advocate

Engagement

Follow-up meetings

Follow-up desk-based research and conf calls

Initial research meetings

Desk-based research

Universe of managers

Head of stream signs off

Experience/stability of team, fees, process/philosophy, quant analysis

Market knowledge, contacts, publications, databases

Meet key people, detail on process, independent thoughts emails

Review manager’s research and quant output, further quant analysis

Sit in on internal meetings and investment discussions, meet more people

Fees, capacity framework, vehicles

One ASK member makes case against rating manager highly

Key points to cover before moving to a FREX 1 skill rating

ASK debates all key issues and decides whether to assign a FREX 1 skill rating


Manager fee negotiation examples

Product type Original fee TW-negotiated fee Comment

Global equities 75bps 50bps The fees were not uncompetitive, however by engaging with the manager throughout the due diligence process, we were able to reduce the fees exclusively for Towers Watson clients.

Emerging market debt

1.75% + 20%6% hurdle

95bps In 2010 we proposed manager to a client. The manager agreed to provide the product for a lower management fee with no performance fee.

Direct hedge fund 2% + 25% 1.5% + 20%2 year lock in

As the result of our continued discussions, the manager created a new share class that will be subject to lowers fees with a two-year lock-in period. This is a significant reduction from the original fee. The lock-in period will be subject to key main clauses and clients will be able to redeem if the fund experiences a drawdown of more than 15% over a one-year period.

Private equity fund 2% + 20%8% preferred return100% general partner catch up

1.25% + 20%9% preferred return60% general partnercatch up

Fees in Private Market portfolios are typically the same for all investors in a fund; this presents both opportunities and challenges to ensure the fee terms are acceptable to us. We were able to engage fully with the manager on the subject of its fees and change the fee structure of the fund. The original terms were significantly improved upon.

Real Estate fund 85bps From 60bps to 20bps

Fee reduction specific to Towers Watson‘s global client base. Specific fee reduction depends on Towers Watson advised assets in the fund.

RAFI Index fund From 22.5bps to 12.5bps

From 8bps to 4bps depending on TW assets

Fee reduction specific to Towers Watson‘s global client base. Specific fee reduction depends on Towers Watson advised assets in the fund.



Conclusion

Key advantages of working with Towers Watson

Proven ability to add value and innovation

• Global access, experienced team and disciplined process have led to superior results

• Leverage prestigious client base to gain access to capacity constrained strategies, develop new products offering key advantages to clients and negotiate attractive fees and terms

Broad coverage and access to other sources of research

• Large global team enables us to cover both mainstream and alternative asset classes

• Cross-fertilization of ideas across teams within manager research and with our asset class and thinking ahead research groups leads to innovative solutions being sought

Flexibility in the way we work with you

• We aim to offer a tailored service to our clients to meet their needs• We are equally happy acting as a traditional advisor as we are offering a

more delegated approach


Contact details

Chris DeMeo335 Madison Avenue, New York, NY 10017-4605212 309 3845 [email protected]

Carl Hess335 Madison Avenue, New York, NY 10017-4605212 309 3800 [email protected]

Marko Komarynsky191 North Wacker Drive, Suite 2100, Chicago, IL 60606-1615312 525 2362 [email protected]


Disclaimer

The information included in this presentation is general information only and should not be relied upon without further review by the appropriate professional advisors. Towers Watson is not a law firm or accounting firm, and we are not providing legal, accounting or tax services or advice. Additionally, material developments may occur subsequent to thispresentation rendering it incomplete and inaccurate. Towers Watson assumes no obligation to advise you of any such developments or to update the presentation to reflect such developments.

This document may not be reproduced or distributed to any other party, whether in whole or in part, without Towers Watson’s prior written permission, except as may be required by law.

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