Rachna de Koning, FCIA, FSA,

Vice President & Director

Michael Augustine, CFA, FCIA, FSA,

Vice President & Director

TD Asset Management

Liability Driven Investing

(LDI) in Canada:

A distinct approach

A question of risk

Are LDI and de-risking becoming synonymous?

2

The unique Canadian LDI landscape

Success comes from smart and pragmatic implementation

• Unique actuarial standards

• Supply and demand: size and composition

3

LDI benchmark challenges

• Discount rates: insufficient tools

• Subjective and theoretical

• No market for liabilities

4

Another challenge: Multiple measures

• Solvency funding and accounting

Two different measures, based on different methodologies, that do not move in tandem. To the extent you veer in one direction, you introduce risk in another… and that risk needs to be budgeted for

5

More to LDI than just extending duration

6

Assumption: Liability cash flows of duration 16.7 years, valued on an economic basis (government of Canada curve) at December 31, 2013.

Source: Canadian Institute of Actuaries, TDAM Portfolio Analytics

Credit spread driver is significant

7

Credit is 30% of discount rate

Credit is 16% of discount rate

• Your LDI benchmark includes a proxy credit component• Credit weight persists in a lower-for-longer environment

Assumption: Liability cash flows of duration 16.7 years, valued on an economic basis (government of Canada curve) at December 31, 2013.

Source: PC-Bond Analytics, TDAM Portfolio Analytics. PC-Bond, a business unit of TSX Inc. Copyright © TSX Inc. All rights reserved. The information contained herein

may not be redistributed, sold or modified or used to create any derivative work without the prior written consent of TSX Inc.

How many times do you think actuarial standards, guidance and educational notes have changed in the last 5 years?

1. Less than 5

2. 5-15

3. 15-25

4. 25-35

8

Source: Canadian Institute of Actuaries

Adjust LDI strategy to fit changing guidance

Liabilities change along the way: • New membership data

• Market realities lead to new guidance

• Better models

Mortality table change:• Good news — Canadians are living longer

9

An imprecise combination of art and science

LDI benchmark:

• Precision is a fallacy

• Removing all risks is impossible

10

Canadian fixed income landscape

• LDI benchmarks are fixed income based

• Unique supply characteristics

• Market segmentation and demand

11

Is fifty the new thirty?

On May 16, 2014…5 year Canadian bond yields were 1.55%10 year Canadian bond yields were 2.26%30 year Canadian bond yields were 2.81%

How much did a 50 year Canadian bond yield?1. 2.75%2. 2.80%3. 2.91%4. 3.09%

12

Source: Bloomberg Finance L.P.

Federal government bond market

• Term of debt is increasing

• Currently Canada's federal bonds are 40% of Universe and 25% of Long Universe but improving fiscal position is projected to decrease bond supply

13

Canada BudgetAverage term to maturity

Source: Public Accounts of Canada: Department of Finance

In Canada, what is a donut?

1. Sugary treat found at your local Tim Horton’s

2. A perpetual bond issued by the provinces

3. Innovative debt structure issued by provinces to meet unique Canadian market needs

4. A floating rate provincial bond reset quarterly

14

Provincial government bond market

Provincial government bonds are uniquely Canadian: 30% of Universe, 50% of Long Universe, and primary issuer of ultra-long bonds; Long duration used for innovative Asset Liability Management/LDI solutions

15

10 years 25 years

Retail Investors Life Insurers / Pension Funds

Moderate liquidity Extremely illiquid Most liquid

Provincial strip bond market

How many long AA-rated corporate bonds are there in Canada?

1. 126

2. 49

3. 14

4. 5

16

As per S&P ratings

Long corporate bond market

Long Corporate Bond Universe(by credit rating)

17

Long Corporate BondIssuance 2013

Long Corporate Bond Universe(by industry)

• Record high water mark of new bond issuance in 2013

• 25% of Long Universe; but limited “high quality” long corporate bonds

Energy26%

Infrastructure

42%

AA3%

A64%

BBB33%

As of December 31, 2013.

Source: PC-Bond Analytics . PC-Bond, a business unit of TSX Inc. Copyright © TSX Inc. All rights reserved. The information contained herein

may not be redistributed, sold or modified or used to create any derivative work without the prior written consent of TSX Inc.

As of December 31, 2013.

Source: TD Securities Inc.

Market segmentation affects valuation

18

“Double Coincidence of Needs: Pension Funds and Financial Stability” Bank of Canada, speech, May 2014

Investor term preference can affect relative value in the marketplace

Corporate and provincial bond spreads

0

40

80

120

160

0 5 10 15 20 25 30 35 40 45 50

Term to Maturity

Cre

dit

Sp

rea

d (

bp

s)

Province of Ontario Bond

Corporate Issuer

As of December 31, 2013. Source: PC-Bond Analytics

PC-Bond, a business unit of TSX Inc. Copyright © TSX Inc. All rights reserved.

The information contained herein may not be redistributed, sold or modified or

used to create any derivative work without the prior written consent of TSX Inc.

A holistic view of LDI in Canada

Must be smart and pragmatic• Use balance and flexibility

• Move beyond the basics

• Widen the opportunity set

• Be active

19

Be balanced

20

• Set objectives and budget for risk

• Allow for trade-offs

• Consider all asset classes

• Bonds; domestic and global

• Equities

• Real estate

• Infrastructure

Move beyond the basics

• LDI 2.0 recognizes the value of corporate bonds

• In low interest rate environment credit is more important

21

What does your LDI benchmark require?

Basis Credit as % of discount

rate

Credit Spread (bps)

Liability ($mm)

Economic 0 0 100

Solvency (AP) 16% 58 91

Solvency (LS) 16% 61 90

Accounting 30% 134 81

What can the market give you?

Bond Portfolio Credit Spread (bps)

Assets Required

($mm)

Long Canada Bonds 0 100

Long Bond Universe 82 88

Long Corporate A 152 80

Long Corporate BBB 199 75

For illustrative purposes only.

22

• Bond returns can be highly correlated

• Be flexible and diversify using entire universe

• Must be thoughtful about credit markets

Bond Portfolio Correlation to Accounting Liability

Long AA Corporate Bonds High by definition

Long A Corporate Bonds 94%

Long BBB Corporate Bonds 88%

Think beyond AA-rated bonds

Widen the opportunity set

23

• Most portfolios are only 40% to 60% bonds

• Bond overlays can increase the liability duration match and can also provide a good source of additional income

• Equities, real estate and infrastructure can increase the liability inflation and credit match and can also provide a good source of income

Actively manage your risk

• As fixed income becomes a larger part of the asset mix, consider active management, taking advantage of:• Independent credit research

• Industry diversification

• Yield and credit curve analysis

• Security selection

24

LDI in Canada: Opportunities abound

• Turn challenges into opportunities through smart thinking and pragmatic implementation

25

Disclaimer

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