10 JULY 2013

LGPS investment strategiesInvestments for the new “normal”

Crispin Lace

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Austerity can be about success!

Survive or thrive

Identify and seize the opportunities› Strong cost benefit discipline

› Tilt the odds in your favour

Live to fight another day› Hedge, insure, reduce probability and impact

of tail events

The practicalities of ‘thriving’

› Beware diversifying for the sake of diversification

› Seek growth wherever you can

› Have conviction in your views and ensure they are expressed in your portfolio

› Look after the pennies

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Understanding diversification

Diversification by another name

Lothian to reduce 'sub-optimal' market cap exposure

“The Lothian Pension Fund is to reduce its reliance on market capitalisation-based equity indices and increase

investment in global portfolios, in order to boost performance and reduce volatility for members.”

Source: Pensions Insight

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Principal risk components of asset returns

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Risk components reflect the premia that drive returns

Skill

Economic

Credit

Inflation

Real Interest Rates

Liquidity

Political

Source: Russell Investments. For illustrative purposes only

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We need a different lens to judge diversity

Risk Components

Illiquidity 4%Skill 6%

Political 2%Economic 53%

Credit 18%Inflation 4%

Real Rates 13%

30% UK Equity17% US Equities 7% European Equities 4% Pacific Equities 4% Emerging Markets30% Corporate Debt 8% Property

Asset Allocation

In pursuit of growth

Austerity means less growth

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...at least in the developed marketsSource: Bloomberg

Eurozone GDP growth %

US GDP growth %

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Source: OECD, Stat Extracts, http://stats.oecd.org

World GDP Growth

…and contribute more to global GDP growth

Emerging markets have faster growth

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Governance and transparency concerns at both the market and company level

High volatility, low liquidity

Worry about the longevity and stability of local companies

Currency risk

Political risk for investors in the public eye

Tabloid headline: “Taxpayer funds invested

in cruel dictatorship”

But direct investment can be a problem

How do we access emerging economic growth without investing in emerging market stocks?

› Access the economic engine through companies on developed stock markets

› Two ways to approach the problem

› Market exposure – % of company revenue derived from EM

› Allows the investor to mimic short-term market movements

› Economic exposure – Combination of revenue and free-float market cap

› Direct link to the long-term economic growth of emerging countries

› Example: Eldorado Gold Corp

› 98% of total revenue derived from EM but only $770 million

› Stock price sensitive to short-term emerging market price volatility

› Example: Tesco

› £19 billion revenue from emerging markets but only 29% of total revenue

› Stock price has limited sensitivity to emerging market price volatility

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Smart beta…A transparent, rules-based investment strategy, designed to provide a specific exposure to market segments or factors

Capture both forms in a single methodology

› Combine both economic and market exposure into a single, robust methodology

› Accurately represents companies with both shorter term stock market and long-term growth exposure to emerging markets

› Maximize beta to emerging markets while being mindful of volatility and size biases

› Provides an emerging market exposure factor representing both economic and market exposures

› Allows for index to remain rules-based and transparent

› Easily understand emerging market influence on a company in context of free-float market capitalisation

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Source: Russell. Indexes are unmanaged and cannot be invested in directly.1 July, 2008 through 31 December, 2012

15.0 17.0 19.0 21.0 23.0 25.0 27.0 29.01.90

1.95

2.00

2.05

2.10

2.15

2.20

2.25

2.30

2.35

2.40

Russell Developed LC EM GeoExposure

Russell Developed LC Index

Russell Emerging Markets LC Index

Annualized Standard Deviation (%)

An

nu

aliz

ed

Re

turn

(%

)Using GeoExposure indices to capture emerging growth

Expressing conviction

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Removing unwanted factor exposures

Equity manager type AllocationGrowth2 managers, active fundamental

25%

Value2 managers, active fundamental

25%

Core 1 manager, active quantitative

10%

Small Cap1 manager, active fundamental

7%

PassiveRussell 3000® Index

33%

Total 100%

Stylized example for illustrative purposes only. This is not meant to constitute investment advice.

› Stock market returns are explained by factors such as Size, Momentum and Value as well as idiosyncratic factors.

Va

lue

Le

vera

ge

Gro

wth

Siz

e

Ma

rke

t S

en

sitiv

ity

Liq

uid

ity

Sh

ort

-Te

rmM

om

en

tum

Lo

ng

-Te

rmM

om

en

tum

Exc

ha

ng

e R

ate

Se

nsi

tivity

Vo

latil

ity

-0.6

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

0.0 0.10.0

-0.1

0.3

0.00.1 0.1

-0.3

0.4

Ris

k fa

cto

r im

pa

ct %

(bp

s im

pa

ct o

f a

on

e s

td d

ev

fact

or

eve

nt)

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Source: Russell & Axioma Russell Roadmap Risk Analysis for a hypothetical portfolio as of December 31, 2011 Analysis is based on historical data for the hypothetical portfolio and is not meant to represent any actual results. The above analysis was run versus the Russell 3000 Index.  The hypothetical portfolio consists of 6 randomly chosen Russell “buy” ranked managers from the Russell Manager Research Database. Managers were chosen from across the style spectrum to create a portfolio with equal value/growth exposure in addition to small cap, core active and core passive exposure. This allocation is similar in nature to many of our consulting clients’ portfolios.  Managers chosen are not necessarily in current client portfolios or funds and results could vary widely with the use of additional/other managers.

Fund level volatility adjusted style exposuresImpact on excess returns of a 1 standard deviation move in factor return

Volatility is the largest risk exposure

U.S. Equity manager type AllocationGrowth2 managers, active fundamental

25%

Value2 managers, active fundamental

25%

Core 1 manager, active quantitative

10%

Small Cap1 manager, active fundamental

7%

PassiveRussell 1000

® Index

16.5%

Smart BetaRussell 1000

® Defensive Index™

16.5%

Total 100%

Hypothetical example shown for illustrative purposes only.

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Create precision tools to manage risk

VOL(+)

HRL(+)

MKT(+)

CHEM(+)

CFN(+)

HSE(+)

ENGY(+)

EXCH(-)

BANK(+)

DIVFSV(+)

0% 5% 10% 15% 20% 25%

20.2%

15.6%

14.2%

12.8%

11.1%

11.1%

10.1%

8.7%

7.4%

7.2%

Sum of top 10 common factor contrib. to risk = 118.4%

Top 10 common factor contribution to active risk

Current Proposed

HRL(+)

PHAR(+)

CHEM(+)

HSE(+)

CFN(+)

VOL(+)

ENGY(+)

MKT(+)

HEA(+)

INTSFT(+)

0% 5% 10% 15% 20% 25%

13.2%

11.5%

8.4%

8.2%

7.9%

7.7%

5.9%

5.3%

4.9%

4.6%

�Sum of top 10 common factor contrib. to risk = 77.5%

�

Hypothetical example, shown for illustrative purposes only.

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Better balance of risks & more focus on alpha

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36 monthforecasts

10 yearforecasts

Market 6.3% 5.5%

Volatility -0.3% -1.0%

Value -0.1% 1.1%

Size 0.0% -0.4%

Momentum 0.6% 0.9%

Liquidity 0.0% 0.8%

Leverage -0.1% -0.3%

Growth -0.1% 0.5%

Source: Russell (end March 2013 assumptions)

Expressing views through precision tools

› Develop your views with short and long-term forecasts

› Express these views in your portfolio using smart beta tools such as the Russell-Axioma Factor Indices

Looking after the pennies

Industry issues

“The alignment of incentives along the chain is, at best, patchy, particularly around transactional

services such as currency trading or managing portfolio transitions.”

Professor John Kay

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”The Bloomberg report claims major investment banks have been routinely rigging the primary currency

benchmark rate, WM/Reuters 4pm London fix, to profit off clients. Lawsuits in the United States and media

attention have identified hidden FX costs when currency trades were executed on a principal basis”

Pensions Insight

Saving money with agency FX

› By using an agency broker local government schemes can save money

› Based on Russell’s experience, schemes can typically save around 70% of their current transaction costs through our agency FX capability

› This equates to around £400k per annum for a£3 billion scheme

Source: Russell Research Paper – Still overpaying for FX.The savings assume that the £3 billion scheme has a 40% allocation to segregated global equities

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GeoExposure

Fundamental

Defensive

Risk Factors

DefensiveMeets the needs of investors looking to manage risk by lowering volatility

FundamentalRules-based investment

strategy which looks to avoid valuation errors through a market-price independent

weighting approach

Geographic Exposure

Allows investors to gain access to emerging

markets exposure through developed market companies

Risk FactorsHelp investors express their conviction ideas within portfolios

A precision toolkit to help you thrive in the new normal

Important informationThe Russell Geographic Exposure Indexes are based on the geographic exposure screening data provided by Revere Data, LLC. Revere Data, LLC is not a registered adviser or broker/dealer, and it does not have any affiliated entities or subsidiaries that are registered adviser or broker dealer. Revere Data is primarily a provider of financial data and analytics to institutional investors, index developers and corporations. Revere Data is the owner of the trademarks, service marks and copyrights related Revere GeoRev. Revere Data, LLC is a Delaware Limited Liability Corporation located in 1 California St. CA 94111.

Russell Investments and Axioma, Inc. have entered into a strategic alliance with respect to the Russell-Axioma Factor Indexes. Russell and Axioma are the source and joint owners of the trademarks, services marks and copyrights related to the Russell-Axioma Factor Indexes. Russell is a trademark of Russell Investments. Axioma is the owner of Axioma trademarks, service marks and copyrights related to Axioma's optimization solutions.

Russell Investments and Research Affiliates LLC have entered into a strategic alliance with respect to the Russell Fundamental Indexes. Subject to Research Affiliate’s intellectual property rights in certain content, Russell Investments is the owner of all copyrights related to the Russell Fundamental Indexes. Russell Investments and Research Affiliates jointly own all trademark and service mark rights in and to the Russell Fundamental Indexes. Research Affiliates is the owner of the trademarks, service marks, patents and copyrights related to the Fundamental Index and the Fundamental Index methodology.

The trade names Fundamental Index®, RAFIR, the RAFI logo, and the Research Affiliates corporate name and logo are registered trademarks and are the exclusive intellectual property of Research Affiliates, LLC. Any use of these trade names and logos without the prior written permission of Research Affiliates, LLC is expressly prohibited. Research Affiliates, LLC reserves the right to take any and all necessary action to preserve all of its rights, title and interest in and to these marks.

Fundamental Index®, the non-capitalization method for creating and weighting of an index of securities, is patented and patent-pending proprietary intellectual property of Research Affiliates, LLC (US Patent No. 7,620,577; 7,747,502; 7,778,905; 7,792,719; Patent Pending Publ. Nos. US-2007-0055598-A1, US-2008-0288416-A1, US-2010-0063942-A1,WO 2005/076812,WO 2007/078399 A2, WO 2008/118372, EPN 1733352, and HK1099110).

Russell Investments is the owner of the trademarks, service marks, and copyrights related to its respective indexes. The Russell logo is a trademark and service mark of Russell Investments.

Indexes are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Unless otherwise noted, source for the data in this presentation is Russell Investments. Index benchmark return information is provided by vendors and although deemed reliable, is not guaranteed by Russell Investments or its affiliates.

This material is proprietary and may not be reproduced, transferred, or distributed in any form without the prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.

The information, analyses and opinions set forth herein are intended to serve as general information only and should not be relied upon by any individual or entity as advice or recommendations specific to that individual or entity. Anyone using this material should consult with their own attorney, accountant, financial or tax adviser or consultants on whom they rely for investment advice specific to their own circumstances.

This material is not an offer, solicitation or recommendation to purchase any security.

Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional.

This document has been issued by Russell Investment Group and Russell Investments Limited. Russell Investment Group is a Washington, USA corporation and is a subsidiary of The Northwestern Mutual Life Insurance Company, which operates through subsidiaries worldwide, including, but not limited to, Russell Investments Limited, Russell Implementation Services Limited, Russell Investments France, , Russell Investment Group Private Limited (Registration No. 199901513K) in Singapore; Russell Investments Korea Limited (ID number 110111‑4653047) in Korea; Russell Investment Management Ltd (ABN 53 068 338 974, AFS License 247185) in Australia; Russell Investment Group Pty Limited ABN 90 003 066 859, AFS License 247172, in Australia (this company has a registered representative office in Beijing, People’s Republic of China (BAIC registration number 110000450166680)); and Russell Investment Group Ltd (Company number 667910) in New Zealand.

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Copyright © Russell Investments 2013. All rights reserved.

First used July 2013.

CORP-8544

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