tuvalu trust fund€¦ · ex-post volatility 3.7 3.1 ex-ante volatility both in target 5.5 4.5...

ERIKSEN & ASSOCIATES LTD Actuaries & Investment Strategists

Auckland Wellington

Eriksen & Associates Ltd Eriksen & Associates Ltd

443 Lake Rd, Takapuna Level 9, 111 The Terrace

Box 33 1318, Auckland, New Zealand Box 10 105, Wellington, New Zealand

Ph +64 9 486 3144 Fax +64 9 486 4413 Ph +64 4 470 6144 Fax +64 4 470 6145

[email protected] [email protected]

TUVALU TRUST FUND

INVESTMENT REVIEW FOR THE YEAR ENDING 30 JUNE 2017

ERIKSEN & ASSOCIATES LIMITED

18 AUGUST 2017

Eriksen & Associates Ltd 2 Tuvalu Trust Fund August 2017 Investment Report Ending 30 June 2017

CONTENTS

Executive Summary ............................................................................................................................................. 3

Introduction ......................................................................................................................................................... 6

Performance of the Fund as a Whole .................................................................................................................. 7

Peer Group Performance ..................................................................................................................................... 7

Market Value versus Maintained Value of the Fund ......................................................................................... 10

Asset Allocations for the Fund as a Whole ........................................................................................................ 12

Performance of Individual Managers ................................................................................................................ 15

AMP Analysis ..................................................................................................................................................... 16

Schroders Analysis ............................................................................................................................................. 19

Attribution Analysis ........................................................................................................................................... 22

Eriksens House-view/Economic Commentary................................................................................................... 24

Economic and Risk Indicators ............................................................................................................................ 28

Appendix 1: Quantitative Rankings ................................................................................................................... 34

Appendix 2: Reserve Fund Managers ................................................................................................................ 38


EXECUTIVE SUMMARY

This is the quarterly investment monitoring report for the Tuvalu Trust Fund (TTF) as at 30 June 2017. All performance numbers are

shown net of investment fees. Longer term bond yields increased sharply at the end of June, affecting share markets. The increased

volatility may lead to a broader market correction. We recommend maintaining the current managers who are well placed to

navigate such events.

ASSETS

TTF’s market value as at 30 June 2017 was AU$170.6 million while the maintained value was AU$163.9 million. The investment gains

over the quarter were approximately $1.5 million.

At the end of June 2017 Australia contributed $1.7 million and New Zealand $476,000.

The Fund is split 50.6% in AMP vs. 48.1% in Schroders and 1.3% in cash.

The following table shows the current total TTF market value, funds under management split by manager, and their percentage of

TTF versus the long term target percentage of 50/50.

Table 1: Fund Manager Asset Mix

Manager Fund value

$(AUD) Actual Allocation

% Target Allocation

%

AMP Capital Extended Multi-Asset Fund 86,342,513 50.6 50.0

Schroders Real-Return Fund 82,078,448 48.1 50.0

Cash Contributions 2,176,425 1.3

Total Fund Assets 170,597,386 100.0 100.0

Chart 1: TTF Value


PERFORMANCE

The Australian CPI All Groups (“AG”) result for the quarter to 30 June was 0.2% which increased the overall Fund objective. The total

Fund has outperformed its objective over five years by 1.0% per annum.

Table 2: TTF Post-Fee Performance

1 Year

% 3 Year (p.a.)

% 5 Year (p.a.)

% 1 April 2012

(p.a.) %

Total Fund 8.4 6.2 7.5 7.2

Benchmark CPI (AG) plus 4.5% p.a. 6.5 6.0 6.5 6.5

Value Add 1.9 0.2 1.0 0.7 Note: Table 6 in this report includes returns over shorter time periods.

The return of the Fund over the quarter was strong for April and May but was down in June. Following comments by ECB President

Mario Draghi about tapering the ECB’s asset purchase program, yields rose across the globe. This caused a bout of volatility at the

end of June, producing losses for stocks across the major European markets. However, the Fund’s returns across the longer time

horizons are pleasing, with the objective being met across each period analysed. The main objective over a five year time horizon

was met comfortably, outperforming by 1.0%.

The performances of the TTF’s underlying investment managers are shown against two benchmark managed funds below. These

funds adopt similar investment strategies and have similar objectives to AMP and Schroders. They provide a comparative indicator

to the two TTF underlying funds’ performance. We also report the Schroders Balanced Fund as the reference portfolio. This

represents a typical actively managed balanced fund. It demonstrates the potential opportunity cost of using the OBAA strategy.

The Morningstar Balanced Fund index provides a broader market comparison.

Chart 2: TTF Performance Comparison


TRAFFIC LIGHT ASSESSMENT

Exceed Target/no business change

Meet Target/minor business change

Below Target/major business change

Tuvalu Trust Fund

Tuvalu Trust Fund: Achieve CPI AG + 4.5% over 5 years = 6.5% 7.5

Downside risk objective: likelihood of achieving negative return over a 12-month period of less than 20%

3.3*

Target distribution 4% per annum: percentage of market value above maintained value at quarter end

4.1

Performance AMP Schroders RRF Schroders Balanced

AMP: Achieve CPI TM plus 5.75% over 5 years (8.0%) Schroders: Achieve CPI TM plus 5.00% over 3 years (7.0%)

8.3 5.1 7.0

Ex-post volatility

3.7 3.1

Ex-ante volatility Both in target

5.5 4.5

Probability of Loss AMP < 10% = green, Schroders > 12% = red

9.8 18.9 22.4

Risk AMP Schroders

Investment process change Nil Nil

Key investment personnel change Nil Nil

Organisational structure change Nil Nil

Investment constraints observed Yes Yes

Sufficient liquidity for the Trust Fund’s purpose Yes Yes

* The 3.3% reflects the historical probability of loss over the last five years. During that period the markets have generally been

benign with interest rates falling and stock markets rising.

The investment constraints refer to the manager:

keeping each asset class within its ranges

not leveraging the funds

maintaining a consistent ESG policy.

AMP

AMP achieved its performance objective over 5 years with low expected volatility and < 10% probability of loss.

FUM for this strategy is approximately $1.2 billion.

SCHRODERS

Schroders did not achieve its performance objective for the three years to 30 June and so has an amber rating. To achieve

the objective in the medium term the manager believes an important source of return will not just come from the market

level but also at a sub-asset level, specifically through the realignment of currencies and interest rates.

The probability of loss is above 12% and so has been rated red. This is due to the low expected returns Schroders have

applied in their forecast for each major asset class return. The result is a small margin above zero for the overall expected

return of the fund and therefore a higher probability of loss. An extra point to note is that the probability of loss figure

does not take into account overlay positions which aim to mitigate downside risks (e.g. FX exposure, S&P 500 put options,

short duration overlays, curve flatteners); thus the true portfolio probability of loss is lower.



INTRODUCTION

This is a quarterly investment monitoring report for the Tuvalu Trust Fund (TTF) by Eriksen & Associates

Limited.

TTF invested its holdings during the quarter in:

The AMP Capital Extended Multi-Asset Fund (AMP);

Schroder Investment Management Australia’s Real-Return Fund (Schroders); and

Cash in the Westpac Corporate Cheque Account (in-house cash).

The returns shown are based on information provided by AMP Capital and Schroders Investment

Management Australia.

The SIOP approved by the Board in May 2016 gives the desired asset mix and ranges as shown in the tables

below.

Table 3: Fund Manager Asset Mix and Range

Asset Class Target Allocation %

Allowable Range %

AMP Capital Extended Multi-Asset Fund 50 45 - 55

Schroders Real-Return Fund 50 45 - 55

Absolute Return Assets 100 100

Total Assets 100 100

Table 4: Fund Manager Benchmarks

Manager

Benchmark

AMP Capital Australian CPI (Trimmed Mean*) plus 5.75% over five year periods

Schroders Australian CPI (Trimmed Mean*) plus 5.00% over three year periods

* CPI (TM)

Table 5: Benchmark Definition

Sector

Benchmark

Absolute Return Assets Australian CPI All Groups plus 4.5% over five year periods


PERFORMANCE OF THE FUND AS A WHOLE

All performance returns are analysed post-fee in this report.

Table 6: TTF Post-Fee Fund Performance

Quarter %

YTD %

1 Year %

3 Year (p.a.) %

5 Year (p.a.) %

1 April 2012 (p.a.) %

Total Fund 0.9 5.3 8.4 6.2 7.5 7.2

Benchmark CPI (AG) plus 4.5% p.a. 1.3 4.6 6.5 6.0 6.5 6.5

Value Add -0.4 0.7 1.9 0.2 1.0 0.7

Chart 3: TTF Post-Fee Fund Performance

PEER GROUP PERFORMANCE

We track the TTF against a number of funds1:

Perpetual’s Diversified Real Return Fund;

Standard Life’s Global Absolute Return Strategies Fund;

Schroders Balanced Fund (reference portfolio); and

Morningstar Multi-Sector Balanced Fund Index (for market comparison).

We have chosen a range of alternative sound well established multi-asset products available in the

Australian market to provide the Board with a better understanding of the depth of product now available.

The funds chosen are based on both global and Australian best of breed products available in the

Australasian marketplace. The selection criteria were based on organisational strength, past and expected

performance, size of fund and ability to meet the objectives. 1 All sourced from Morningstar Direct


The Perpetual product has been the reserve manager for the current investments in AMP and Schroders for

several years. The Standard Life fund is a global product available in Australia. It has a similar investment

strategy style to the AMP and Schroders products (OBAA).

Following sovereign wealth fund best practice we compare a reference portfolio as part of the analysis which

in this case is the Schroders Balanced Fund.

Longer term bond yields increased sharply at the end of June, affecting share markets. The increased

volatility may lead to a broader market correction. We recommend maintaining the current managers who

are well placed to navigate such events.

Table 7: TTF Post-Fee Comparison with Peers

1 Year %

3 Years (p.a.) %

5 Years (p.a.) %

1 April 2012 (p.a.) %

Total TTF Performance 8.4 6.2 7.5 7.2

AMP Extended Multi-Asset Fund 9.7 7.4 8.3 7.7

Schroders Real Return Fund 7.1 5.1 6.7 6.6

Perpetual Diversified Real Return Fund 6.2 4.7 7.7 7.2

SLI Global Absolute Return Strategies 5.2 3.8 6.2 5.6

Schroders Balanced Fund 12.4 7.0 10.3 9.4

Morningstar Multi-Sector Balanced Fund Index 6.5 7.1 9.6 9.1

Chart 4: TTF Post-Fee Comparison with Peers


The performance of the TTF since it moved to an OBAA (“Objective Based Asset Allocation”) strategy is

compared to the performance of its peers in the following chart. Over the longer term the comparison will

provide an objective measure of the success of the OBAA strategy. The OBAA strategy has thus far been

successful in that it has protected capital and provided distributions to the Tuvalu Government. Over the

long term it is expected that this will continue to provide consistent returns with less downside volatility,

while still benefiting from much of the upside performance in markets.

Chart 5: TTF Managers Post-Fee Comparison with Peers Rolling Three Month Returns

Chart 6: TTF Managers Post-Fee Comparison with Peers Cumulative Returns Since 1 April 2012


MARKET VALUE VERSUS MAINTAINED VALUE OF THE FUND

The chart below shows the TTF Market Value versus the Maintained Value since March 2007.

Chart 7: TTF Market Value vs. Maintained Value

The value of the fund has gradually increased since March 2009 with the exception being a drop in value in

September 2011. Prior to this, the Fund had significantly decreased in value throughout 2008 and early 2009

following the global financial crisis. The capital donations, distributions and reinvestments since the new

OBAA strategy was implemented in 2012, along with recent major changes in market value are set out

below.

Table 8: Capital Donations, Distributions and Reinvestments

Date Donor Contributions

$ million Distributions to GoT

$ million Reinvestment of Distributions

by GoT $ million

Dec-2013 6.5 -

2013 Australia 3.17 - -

Jul-2014 Australia 0.88 - -

2014 Turkey 0.03 - -

Dec-2014 8.7 -

Oct-2015 GoT 3.0 - -

Dec-2015 - 4.78

Jun-2016 Australia 1.43 - -

Jun-2016 New Zealand 0.48 - -

Nov-2016 - 5.0

Jan-2017 1.7 -

Jun-2017 Australia 1.7

Jun-2017 New Zealand 0.48


TTF’s market value at 30 June 2017 was AU$170.6 million, which includes an overall increase in value from

investment returns of approximately $1.5 million during the quarter.

At 30 June 2017, the maintained value was $163.9 million. The CPI was up by 0.2% for the quarter, bringing

the one year CPI figure to 1.9%. The TTF market value currently exceeds the maintained value by $6.7

million, or 4.1%.

The following table shows the projected growth of the Fund towards the target of $200 million by 2020.

Annualised growth rates of 2.5%, 3.5% and 4.5% have been used with the CPI assumed to be 2% per annum.

Distributions are assumed to be reinvested. The projection excludes additional contributions by the

Government of Tuvalu or donors.

Table 9: 2020 Growth Projections

Date

CPI + 2.5% $ million



Sep-2017 172.5 172.9 173.3

Sep-2018 180.2 182.4 184.6

Sep-2019 188.4 192.4 196.6

Sep-2020 196.8 203.0 209.3


ASSET ALLOCATIONS FOR THE FUND AS A WHOLE

The Fund’s asset split between managers at 30 June 2017 is shown in the following table and chart.

Table 10: Fund Manager Allocations

Manager Fund value $(AUD)

Actual Allocation %

Target Allocation %

AMP Capital Extended Multi-Asset Fund 86,342,513 50.6 50.0

Schroders Real Return Fund 82,078,448 48.1 50.0

Cash Contributions 2,176,425 1.3

Total Fund Assets 170,597,386 100.0 100.0

Chart 8: Manager Allocations as a Percentage vs. Target

Chart 9: AMP and Schroders Fund Allocation Movements from 1 July 2012 to Date

The Fund allocations for both AMP and Schroders have remained fairly constant since 1 July 2012. Both

funds are well within their target ranges of between 45% and 55%.


ASSET ALLOCATIONS OF INDIVIDUAL MANAGERS

The asset allocations of each of the current Fund’s managers, AMP and Schroders, are analysed below. The

assets are grouped into three main categories:

Table 11: Asset Category Explanations

Asset Category

Purpose Example

Defensive Reduce risk Cash Bonds Fixed interest instruments

Diversified Diversify risk Alternatives Low correlation to defensive and growth assets

Growth Add risk and return Equities Increase capital growth Property

Table 12: TTF Asset Category Allocations as at 31 March 2017

Asset Category Allocations AMP %

Schroders %

Total Fund %

Defensive Assets 11.3 62.5 36.9

Diversified Assets 42.5 11.4 27.0

Growth Assets 46.2 26.1 36.1

Total Fund Assets 100.0 100.0 100.0

Chart 10: Movement of TTF Asset Category Allocations Since April 2012

Since 1 April 2012 when TTF first invested with these managers, the proportion of defensive assets has

decreased by 10.1%, while diversified assets have increased by 7.4% and growth assets increased by 2.7%.

Over the quarter there was a decrease in growth assets (-3.8%) and an increase in diversified assets (+3.6%)

and defensive assets (+0.2%).


COMPARISON OF AMP AND SCHRODERS ALLOCATIONS

Chart 11: Comparison of Asset Allocations

The asset allocations of AMP and Schroders are compared in the chart above which demonstrates the

diversity of the managers’ investment styles which are clearly complementary.

Chart 12: Comparison of Cash Weightings

AMP has reduced its cash weighting from a peak in May 2014 of 24.6%. Currently AMP’s weighting sits at

10.9% which is a decrease over the quarter. Schroders has kept its cash weighting relatively high which

currently sits at 31.9%.

11.3

62.5

42.5

11.4

46.2

26.1

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

AMP Schroders

Defensive Assets % Diversified Assets % Growth Assets %


PERFORMANCE OF INDIVIDUAL MANAGERS

The CPI Trimmed Mean (TM) and All Groups (AG) numbers which are the basis for the performance

objectives for the underlying funds and the TTF are set out below.

Table 13: CPI Performance

Quarter %

YTD %

1 Year %

3 Year (p.a.) %

5 Year (p.a.) %

1 April 2012 (p.a.) %

CPI (Trimmed Mean) 0.5 1.5 1.8 1.9 2.2 2.2

CPI (All Groups) 0.2 1.2 1.9 1.5 2.0 2.0

The chart below shows the quarterly CPI results over time. The trimmed mean CPI results are more stable because they omit the outlier changes both up and down. Chart 13: Rolling Three Month CPI Results


AMP ANALYSIS

AMP ASSET CATEGORY ALLOCATIONS

Table 14: AMP Asset Category Allocations

Asset Category Allocations

Market Value $(AUD)

Actual Allocation %

Target Range %

Target Midpoint %

Difference %

Defensive Assets 9,739,466 11.3 10 - 100 40.0 -28.7

Diversified Assets 36,716,280 42.5 0 - 75 30.0 12.5

Growth Assets 39,886,767 46.2 0 - 75 30.0 16.2

Total 86,342,513 100.0 100.0 100.0 0.0

Chart 14: AMP Asset Category Allocations

AMP continue to have an overweighting to growth and diversified assets, while remaining underweight in

defensive assets relative to the target midpoints of their ranges. The broad ranges mean that all of the

allocations are well within their parameters.

Chart 15: Movement of AMP EMAF/MAF Asset Category Allocations Since 1 January 2010


Table 15: AMP Capital EMAF/MAF Movement of Asset Category Allocations

Movement of Asset Category Allocations Quarter %

Since 1 April 2012 %

Defensive Assets -5.3 -32.7

Diversified Assets 5.1 23.6

Growth Assets 0.3 9.1

AMP EXTENDED MULTI-ASSET FUND NET PERFORMANCE

The AMP Extended Multi-Asset Fund was seeded in February 2012 by TTF. Returns prior to this are taken

from the existing wholesale AMP Multi-Asset Fund (a retail market product), which was established on 1

January 2010.

Table 16: AMP Capital EMAF/MAF Post-Fee Performance

Quarter %

YTD %

1 Year %

3 Year (p.a.) %

5 Year (p.a.) %

1 April 2012 (p.a.) %

AMP Extended Multi-Asset Fund 1.0 6.3 9.7 7.4 8.3 7.7

Benchmark CPI (TM) plus 5.75% p.a. 1.9 5.8 7.7 7.7 8.0 8.0

Value Add -0.9 0.5 2.0 -0.3 0.3 -0.3

Chart 16: AMP EMAF Post-Fee Performance


Chart 17: AMP Rolling Three Year Sharpe Ratio

The chart above shows AMP’s rolling three year Sharpe Ratio. This ratio measures the performance of an

investment after adjusting for its risk. Essentially it shows how well the return of an asset compensates the

investor for the risk taken. A ratio of 1 through to 1.99 is considered good, 2 to 2.99 is very good and 3 and

above is excellent. AMP’s Sharpe Ratio is currently 1.38 which is good under these market conditions.

Chart 18: AMP and ASX200 Rolling Three Year Portfolio Volatility

The volatility of AMP’s returns and that of the ASX200 over a rolling three year period is shown in the chart

above. The volatility of AMP’s EMAF and the ASX200 increased slightly since last quarter.


SCHRODERS ANALYSIS

SCHRODERS ASSET CATEGORY ALLOCATIONS

Table 17: Schroders Asset Category Allocations

Asset Category Allocations

Market Value $(AUD)

Actual Allocation %

Target Range %

Target Midpoint %

Difference %

Defensive Assets 51,299,030 62.5 10 - 100 40.0 22.5

Diversified Assets 9,356,943 11.4 0 - 75 30.0 -18.6

Growth Assets 21,422,475 26.1 0 - 75 30.0 -3.9

Total 82,078,448 100.0 100.0 100.0 0.0

Chart 19: Schroders Asset Category Allocations

Schroders are overweight in defensive assets and underweight in diversified and growth assets compared to

their target range midpoints.

Chart 20: Movement of Schroders RRF Asset Category Allocations Since 1 January 2010


Table 18: Schroders RRF Movement of Asset Category Allocations

Movement of Asset Category Allocations Quarter %

Since 1 April 2012 %

Defensive Assets -2.2 12.5

Diversified Assets 2.1 -8.7

Growth Assets 0.1 -3.7

SCHRODERS REAL RETURN FUND NET PERFORMANCE

Table 19: Schroders RRF Post-Fee Performance

Quarter %

YTD %

1 Year %

3 Year (p.a.) %

5 Year (p.a.) %

1 April 2012 (p.a.) %

Schroders Real Return Fund 0.8 4.4 7.1 5.1 6.7 6.6

Benchmark CPI (TM) plus 5% p.a. 1.7 5.2 6.9 7.0 7.3 7.3

Value Add -0.9 -0.8 0.2 -1.9 -0.6 -0.7

Chart 21: Schroders RRF Post-Fee Performance


Chart 22: Schroders Rolling Three Year Sharpe Ratio

Schroders’ rolling three year Sharpe Ratio decreased to 0.98 over the quarter.

Chart 23: Schroders and ASX200 Rolling Three Year Portfolio Volatility

Schroders RRF volatility over rolling three year periods is slightly higher than the previous quarter at 3.17%.


ATTRIBUTION ANALYSIS

Exceed Target/no business change

Meet Target/minor business change

Below Target/major business change

Tuvalu Trust Fund

Tuvalu Trust Fund: Achieve CPI AG + 4.5% over 5 years = 6.5% 7.5

Downside risk objective: likelihood of achieving negative return over a 12-month period of less than 20%

3.3

Target distribution 4% per annum: percentage of market value above maintained value at quarter end

4.1

Performance AMP Schroders RRF Schroders Balanced

AMP: Achieve CPI TM plus 5.75% over 5 years (8.0%) Schroders: Achieve CPI TM plus 5.00% over 3 years (7.0%)

8.3 5.1 7.0

Ex-post volatility

3.7 3.1

Ex-ante volatility Both in target

5.5 4.5

Probability of Loss AMP < 10% = green, Schroders > 12% = red

9.8 18.9 22.4

Risk AMP Schroders

Investment process change Nil Nil

Key investment personnel change Nil Nil

Organisational structure change Nil Nil

Investment constraints observed Yes Yes

Sufficient liquidity for the Trust Fund’s purpose Yes Yes

* The 3.3% reflects the historical probability of loss over the last five years. During that period the markets

have generally been benign with interest rates falling and stock markets rising.

The investment constraints refer to the manager:

keeping each asset class within its ranges

not leveraging the funds

maintaining a consistent ESG policy.

AMP

AMP achieved its performance objective over 5 years with low expected volatility and < 10% probability

of loss.



SCHRODERS

Schroders did not achieve its performance objective for the three years to 30 June and so has an amber

rating. To achieve the objective in the medium term the manager believes an important source of return

will not just come at the market level but also at a sub-asset level, specifically through the realignment

of currencies and interest rates.

The probability of loss is above 12% and so has been rated red. This is due to the low expected returns

Schroders have applied in their forecast for each major asset class return. The result is a small margin

above zero for the overall expected return of the fund and therefore a higher probability of loss. An

extra point to note is that the probability of loss figure does not take into account overlay positions

which aim to mitigate downside risks (e.g. FX exposure, S&P 500 put options, short duration overlays,

curve flatteners); thus the true portfolio probability of loss is lower.



ERIKSENS ECONOMIC COMMENTARY

Hawkish comments by European Central Bank President, Mario Draghi, at the end of June caused a global

bond sell-off. Draghi’s comments indicated that the ECB may start to look at tapering their asset purchase

program due to reflationary forces in the economy. In a nutshell, tapering means interest rates would rise.

As a result the US, Canadian, UK and German 10-year bond yields all increased. Most significant was the

change in the yield of the German bund which doubled in a week (from 0.23% to 0.47%).

The following graph shows Capital Economics’ forecast for 10-year German government bond yield over the

next two and a half years - an increase of 1.75%. If the yield of the German bund increases by just 1%, the

result will be almost a 10% mark-to-market capital loss.

Source: dailyshotletter, Wall Street Journal, Capital Economics

The table below gives you an idea of just how significant a change in yield can be on the market value of your

fixed interest investments. For example, the price of a 6% coupon bond with 10 years to maturity would fall

by 7.1% (highlighted) if interest rates increased by just 1%.

Change in bond price (%) from a 1% change in interest rates – for a 6% coupon bond

Years to Maturity Rates Increase Rates Decrease

1 -0.9 0.9

5 -4.1 4.3

10 -7.1 7.7

30 -12.4 15.4


US yields also increased earlier in June due to an anticipated hike in the Fed rate, up to 1.25%. This was on

the back of continued gains in the labour market, but despite softer inflation figures which Yellen attributed

to one off reductions in certain categories within the core inflation measure.

The following graph illustrates the divergence in monetary policy from central banks around the globe, and

what part of the economic cycle each of these economies are at. However, it seems likely Europe will follow

Canada, China and the US, and potentially the UK in tightening as their next move. Hence the market

movements which increase investor uncertainty.

Source: dailyshotletter, Wall Street Journal, Moodys Investor Service

Another possible reason for tightening is the inflationary outlook. China’s working population is at peak

capacity so they are experiencing wage pressure. This should raise the prices of Chinese exports which

would be inflationary. We do not expect deflation to be a concern going forward despite the fall in oil prices.

Aside from rising yields, passive investing is another major concern within financial markets. The following

graph shows how significant the growth has been in passive investing. It shows just one fund manager,

Vanguard, and their share of ownership of S&P 500 companies. Vanguard now have at least a 5% holding in

468 companies within the index.


No longer are stocks being chosen based on underlying fundamentals, what has become more important is

whether or not a stock is listed within an index. Stocks markets continue to move upwards on momentum

and the risk of a correction is growing.

Simon Doyle, Head of Fixed Income and Multi-Asset at Schroders, sums up the challenges investors are

currently facing:

“In a cyclical context the global economy is in reasonable shape. The major economic blocks (US, Europe,

Japan, China and Asia) are expanding and while growth risks remain visible, recession on a 1- 2 year window

seems a low probability outcome (barring of course a shock).

None of this though changes the structural challenge faced by the global economy which effectively

guarantees low growth (in both nominal and real terms) over the longer term. These factors have been well

documented but as a refresher include:

Historically high leverage limiting the potential for credit expansion to fuel sustained growth;

Structurally low rates and ballooning central bank balance sheets (which together with high public

sector leverage limit the ability of policy makers to reflate in the face of a growth / deflationary

shock);

The demographic constraints of aging populations in key parts of the global economy (China, Europe

and Japan especially);

Moderate trend growth in productivity (barring a technological induced productivity shock);

Specific debt and overcapacity problems in China (the world’s most recent structural growth engine);

Rising income / wealth inequality and the rise of the political economy;

Source: mauldineconomics.com


In Australia’s case specifically, pressures on national income brought about by the unwinding of the

Terms of Trade boom.

The structural valuation backdrop for both bonds and equities remains problematic.

In the case of equities, structural valuations have deteriorated over the last 12 months as equity prices have

risen without a commensurate improvement in earnings prospects. This is evident across a range of

structural valuation metrics. While importantly the situation is more acute for US equities than other major

markets, the structural valuation risk from all major markets is to the downside.

While bond yields are higher than they were a year ago, the rise in bond yields over the last year though

needs to be put into context. Around 21% of the global bond market is still trading on negative yields, while

in Japan and Europe 52% and 46% respectively were issued with negative yields. The bottom-line is that the

rise in yields is modest in an historical context meaning no material change in the prospects for bonds over

the medium term – low returns seem assured.

So where does this leave us?

Firstly, the task has not gotten any easier. Narrower credit spreads and more demanding equity valuations

mean we are starting behind the "8 ball”. Beta derived from mainstream assets is unlikely to provide us with

the boost we’ve enjoyed in recent years. However, markets rarely move in straight lines and current narrow

risk premiums are unlikely to be permanent, particularly if central banks start the long path back to policy

normalization (whatever that is). Managing this adjustment will be an important contributor to returns over

the medium term. The two critical objectives to avoid as much of the repricing as possible and to re-enter

markets when risk premiums have rebuilt and prospective returns rebuild;

Secondly, broad market beta is not our only tool. At the sub-asset class level there is considerable

opportunity to both add incremental return and manage risk. We expect the realignment of currencies and

interest rates to be an important source of return. For example, opportunities in GBP and the AUD as well as

in European and US yield curves are being exploited for this purpose. In fact we currently see the

management of these types of strategies to be almost as important in achieving our objectives (particularly

in the short run) as our broad market beta exposure.

In short, the environment is unlikely to do us any favours. We expect that the above in combination will be

what gets us to where we need to be, but we also need to bear in mind we are very mindful of risk –

particularly the minimisation of downside risk. One implication of narrow risk premium is that there is little

room for error and downside risk is elevated. Avoiding this will be just as important as capturing return on

the upside.

The bottom-line is that we need to be realistic. Achieving CPI+5% from here even over a 3 year timeframe

will be tough, but as we have seen over the last 12 months it remains an appropriate objective, so too do our

risk targets.”


ECONOMIC AND RISK INDICATORS

Table 20: Economic Indicators

Indicator Quarter %

YTD %

1 Year %

3 Year (p.a.) %

5 Year (p.a.) %

1 April 2012 (p.a.) %

CPI (AG) AUD 0.2 1.2 1.9 1.5 2.0 2.0

Australian GDP* 0.4 0.9 1.6 2.2 2.4 2.4

Equities (ASX200) -1.6 8.5 14.1 6.1 11.8 10.2

Oil W-Texas (USD) -9.0 -4.6 -4.7 -23.5 -11.5 -14.2

Gold (USD) -0.6 -5.6 -5.7 -0.2 -4.9 -5.5 *Trend figure

Chart 24: Australian Dollars vs. Other Currencies on Bid Basis

Table 21: Currency Rates and Five Year Averages, Lows and Highs

AUD/NZD AUD/EUR AUD/GBP AUD/USD

Period End 1.0476 0.6725 0.5905 0.7670

Period Average 1.1080 0.6988 0.5644 0.8502

Period Low 1.0184 0.6292 0.6429 0.7023

Period High 1.2584 0.8122 0.6849 1.0415

Over the quarter the Australian dollar weakened against each currency in the table above except the USD.


RISK INDICATOR INDICES

The indices set out below measure various indicators of “risk”. These definitions of risk include:

1. The VIX Index. This measures the volatility of the S&P 500 Index Options and is an indication of

market sentiment. Values of greater than 30 generally indicate excessive volatility and suggest

investor uncertainty. Values less than 20 indicate investors are much less concerned.

2. The Purchasing Managers Index (PMI). This measures the headline PMI number, designed to provide

a snapshot of the health of the economy as well as insight into key economic drivers such as

inflation, exports, employment and inventories etc.

3. Credit Growth measures the amount of new credit allocation by lenders to borrowers. It is one of

the key drivers of inflation, growth and asset prices and when rising is a leading indicator of

economic expansion. Excessive credit growth is considered to be a warning sign of an overheating

economy.

At the beginning of the quarter the VIX index was 12.4 and at the end it was 11.5. The VIX index sits at 10.4

as at 31 July 2017. Note the graph shows end of day values of the index, so intraday values could be higher

or lower.

Chart 25: VIX Index Over Five Years as at 31 July 2017

The VIX index had been under the 30% threshold for over three years until August 2015. The 30% threshold

is considered to be the point at which volatility becomes high. This steep increase was largely due to the

plunge in the Chinese stock market which significantly disrupted markets worldwide.

Since August 2015 the threshold has been threatened on a number of occasions. The index was above 20%

for the best part of January and February 2016, and also for a period in June following Brexit and in

November after Trump’s election. The VIX has been near historical lows over the June quarter.

The following chart shows a one year view of the VIX rather than the five years above.


Chart 26: VIX Index Over One Year as at 31 July 2017

Chart 27: PMI Indices Over Five Years

The PMI indices for each region increased over the quarter and year, except China over the quarter. Each

region/country was at or above the threshold of 50 which indicates there were a higher number of survey

answers that reported an improvement.


Chart 28: Credit Growth Indices Over Five Years

Credit growth is often used as an indicator of economic growth. Generally, expanding credit growth signals

an expanding economy. Excessive credit growth can be considered as a warning sign of an overheating

economy. Only the US declined for the quarter. Over the year both the US and China contracted.

Chart 29: Australian GDP Growth; Annualised on a Percentage Basis

The chart shows annual GDP growth for the last five years. GDP increased 1.7% for the year to March (the

latest data available). The average annual GDP growth rate in Australia from 1960 until 2016 was 3.5%. The

all-time high was recorded in 1967 at 9.0% and the all-time low was in 1983 at -3.4%.


Chart 30: Australian Consumer Confidence

Consumer sentiment decreased over the quarter. Consumer Confidence in Australia has averaged 101.3

from 1974 until 2016, reaching an all-time high of 127.7 in January of 2005 and a record low of 64.6 in

November of 1990.

Chart 31: Australia Business Confidence

Business confidence is measured from a monthly survey of 350 Australian companies. It measures the

expectations of business conditions for the upcoming month and is a simple average of trading, profitability

and employment indices. Business confidence in Australia was 9 in March, up from 7 in May and but down

from 13 in April. The average since 1997 is 5.8.


Chart 32: Australia Leading Economic Index

The chart above combines a selection of economic variables into a single measure that provides a reliable

cyclical indicator of the Australian economy. It includes the following:

S&P/ASX200 Aggregate monthly hours worked

Dwelling approvals CSI expectations index

US industrial production

Unemployment expectations index

RBA commodity prices index

Yield spread (10yr bond - 90 day bill)

The index went down or stayed the same month-on-month for the June quarter. It averaged -0.01% from

1960 to 2017. It reached a record low of -1.07% in December 2008.


APPENDIX 1: QUANTITATIVE RANKINGS

RISK VS RETURN SNAPSHOT

Chart 1: Risk vs Return

A plot of rolling three year (post-fee) returns vs. rolling three year standard deviation shows that AMP and

Schroders (and therefore the TTF) have returned circa 6.2% per annum over the past three years with

relatively little volatility – around 3.4% per annum. In comparison, Perpetual and Standard Life have

returned 4.7% and 4.3% annualised respectively. Standard Life had higher volatility (4.3%), while Perpetual

was slightly lower (2.9%). The chart below shows the difference in three year volatility where the TTF has

less risk than Standard Life and the Schroders Balanced Fund, but slightly more than Perpetual.

Chart 2: TTF vs Peers Rolling Three Year Volatility


THREE YEAR TRAILING STATISTICS

Table 1: Three Year Trailing Statistics

Standard Deviation %

Return %

Sharpe Ratio

Sortino Ratio

TTF 3.4 6.9 1.3 1.3

AMP Extended Multi-Asset Fund 3.9 8.2 1.4 1.5

Schroders Real Return Fund 3.1 5.6 1.0 1.0

Perpetual Diversified Real Return Fund 2.9 4.7 0.9 0.9

SLI Global Absolute Return Strategies 4.3 3.8 0.4 0.4

Schroders Balanced Fund 5.5 7.0 0.8 0.8

The volatility measurements in the table above are explained as follows:

STANDARD DEVIATION

Standard deviation is defined as a measure of the dispersion of a set of data from its mean. The more

spread apart the data, the higher the deviation. Standard deviation is calculated as the square root of

variance. Standard deviation is applied to the annual rate of return of an investment to measure the

investment's volatility. Standard deviation is also known as historical volatility and is used by investors as a

gauge for the amount of expected volatility. For example, a volatile stock or high risk fund will have a high

standard deviation while the deviation of a stable blue chip stock or defensive fund will be lower. A large

dispersion indicates how much the return on the fund is deviating from the expected normal returns.

The table above shows the TTF standard deviation is much lower than Standard Life and Schroders Balanced,

but slightly higher than Perpetual.

SHARPE RATIO

This volatility statistic was developed to measure risk-adjusted performance. The Sharpe Ratio is calculated

by subtracting the risk-free rate - such as that of the 10-year Government Bond or 90 Day Bank Bill rate -

from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio

returns.

The Sharpe Ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of

excess risk. This measurement is very useful because although one portfolio or fund can yield higher returns

than its peers, it is only a better investment if those higher returns do not come with too much additional

risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been. A negative

Sharpe ratio indicates that the risk-free asset would perform better than the fund being analysed.

A ratio of 1 though to 1.99 is considered good, 2 to 2.99 is very good and 3 and above is excellent.


SORTINO RATIO

A variation of the Sharpe ratio is the Sortino ratio, which removes the effects of upward price movements on

standard deviation to measure only return against downward price volatility. In effect this differentiates

between good and bad volatility present in the Sharpe ratio. This differentiation of upwards and downwards

volatility allows the calculation to provide a risk-adjusted measure of a security or fund's performance

without penalizing it for upward price changes. The higher the Sortino ratio the better.

CONDITIONAL VALUE AT RISK

Conditional Value at Risk (CVaR) refers to the expected shortfall of a portfolio given the lowest x% of cases.

The percentage we have used in the calculation is 10%. i.e. the table below shows the average return of the

lowest 10% of monthly returns for each fund.

Table 2: Conditional Value at Risk

CVaR Since Jan 2010 %

CVaR Since April 2012 %

TTF -1.2 -1.2

AMP Extended Multi-Asset Fund -1.5 -1.6

Schroders Real Return Fund -1.1 -1.0

Perpetual Diversified Real Return Fund -1.2 -1.0

SLI Global Absolute Return Strategies -1.6 -1.6

Schroders Balanced Fund -2.6 -2.4

UPSIDE/DOWNSIDE CAPTURE

Upside and Downside Capture Ratio are defined as follows:

Upside Capture is defined as a statistical measure of an investment manager's overall performance in up-

markets. The up-market capture ratio is used to evaluate how well an investment manager performed

relative to an index during periods when that index has risen. The ratio is calculated by dividing the

manager's returns by the returns of the index during the up-market, and multiplying that factor by 100.

An investment manager who has an up-market ratio greater than 100 has outperformed the index during

the up-market. For example, a manager with an up-market capture ratio of 120 indicates that the manager

outperformed the market by 20% during the specified period. Many analysts use this simple calculation in

their broader assessments of individual investment managers.

Downside Capture is the opposite of Upside Capture. An investment manager who has a Downside Capture

ratio of less than 100 has outperformed the index during the down-market. For example, a manager with a

down-market capture ratio of 80 indicates that the manager's portfolio declined only 80% as much as the

index during the period in question.


Table 3: Upside/Downside Capture Ratio vs Morningstar Balanced

1 Year 3 Years 5 Years

AMP Multi-Asset Fund 84.88 ↑ 74.50 ↑ 77.43 ↑

-6.18 ↓ 40.32 ↓ 51.89 ↓

Schroders Real Return Fund 62.53 ↑ 60.31 ↑ 63.69 ↑

-12.51 ↓ 45.38 ↓ 44.53 ↓

Over the one, three and five year periods AMP and Schroders have underperformed against the benchmark

on the upside. AMP and Schroders have performed well on the downside, falling less than the benchmark in

periods of decline. Over the one year time horizon both AMP and Schroders have actually performed

positively when the benchmark has declined.

THREE YEAR CORRELATION MATRIX

Table 4: Correlations

1

2 3 4 5

1 AMP Extended Multi-Asset Fund

2 Schroders Real Return Fund 0.93

3 Perpetual Diversified Real Return Fund 0.84 0.85

4 SLI Global Absolute Return Strategies 0.85 0.72 0.67

5 Schroders Balanced Fund 0.93 0.95 0.84 0.69

The correlations between the two underlying funds, AMP and Schroders, and the two reserve funds are

shown in the table above. The correlations are calculated from rolling three year returns.

Correlation refers to any of a broad class of statistical relationships involving dependence. In turn,

dependence refers to any statistical relationship between two random variables or two sets of data.

Correlation is obtained by dividing the covariance of the two variables by the product of their standard

deviations.

AMP and Schroders RRF are quite highly correlated at 0.93 which is to be expected given their similar

objectives. Although their investment strategies differ, the friendly markets also increase the appearance of

being highly correlated. Standard Life has a relatively low correlation with both Schroders funds and

Perpetual but is highly correlated to AMP at 0.85. Perpetual is more closely correlated to Schroders than it is

to AMP. Schroders Balanced Fund is highly correlated to AMP and Schroders RRF. Because the Schroders

team uses the same pools of assets and same strategies you would expect the two Schroders products to be

highly correlated. Only their asset class ranges differ.


APPENDIX 2: RESERVE FUND MANAGERS

PERPETUAL DIVERSIFIED REAL RETURN FUND

The Perpetual Diversified Real Return Fund seeks to achieve a return of inflation plus 5% per annum

(CPI +5% p.a.) over rolling 5-year periods. The Fund also seeks to achieve this return target at low levels of

volatility over the long term, while still benefiting from capital growth in rising markets by taking a whole-

portfolio approach to managing risk.

The Fund invests in a diversified portfolio of investments across a range of geographies, sectors, strategies

and sources of returns that can be difficult for investors to access directly. This can range from more

‘traditional’ domestic and global equities, Australian and global bonds, and cash; to ‘real’ assets, such as

unlisted property and infrastructure; to more unconventional opportunities, such as infrastructure debt,

frontier markets and commodity strategies.

SLI GLOBAL ABSOLUTE RETURN STRATEGIES FUND

The Australian product, in AUD, is the Standard Life Investments Global Absolute Return Strategies Trust

which is invested primarily in the Standard Life Investments Global SICAV2 Global Absolute Return Strategies

Fund (the Underlying Fund) based in Luxembourg. The Underlying Fund utilises a combination of equities

and bonds and investment strategies based on advanced derivative techniques which results in a well-

diversified portfolio.

The primary objective of the Fund is to deliver a positive absolute return over the medium to long term in all

market conditions. The Fund’s benchmark is the Bloomberg AusBond Bank Bill index and its performance

target is to outperform the benchmark by 5% per annum gross of fees, on a rolling three year basis.

2 société d'investissement à capital variable, translated as 'investment company with variable capital'

tuvalu trust fund€¦ · ex-post volatility 3.7 3.1 ex-ante volatility both in target 5.5 4.5...

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