Redington and Societe Generale CIB - Equity Hedging for UK Pension Funds - March 2014

EQUITY HEDGING FOR UK PENSION FUNDS

MARCH 2014

2

SUMMARYIN THIS PAPER WE: Show that equity risk is likely to be one of the major risks faced

by a UK DB pension fund this year.

Provide a framework for defining what extreme equity risk means, and describe why this might be a problem for pension funds.

Define and describe a number of equity hedging strategies approaches, some of which involve trading in options and volatility derivatives.

Articulate the possible objectives of an equity hedging strategy, and provide a framework for defining the properties of any strategy. The framework is based around three possibly competing objectives:

— The Hard Floor objective; — The Volatility Smoothing objective; and — The Tail Risk Hedging objective.

Show that if the Hard Floor objective is chosen, it can only be achieved over a single time period, and approaches that offer this sort of protection often do not necessarily statisfy the other objectives.

Show that the objectives of the strategy heavily influence the strategy chosen, and that if Tail Risk or a Volatility Smoothing is the overriding objective, an approach involving volatility derivatives is likely to be the best. Volatility Smoothing can be also achieved with approaches that trade only in underlying equities or linear derivatives.

Illustrate the properties of a comprehensive range of equity tail risk hedging strategies compared to our framework.

Show that equity risk hedging strategies have some element of carry cost, but that there do exist ways in which to reduce or minimize such costs. Whether an individual pension fund chooses to bear this cost depends on individual risk preferences.

Carry out a detailed analysis on two particular strategies: — Volatility Control, which satisfies the Volatility Smoothing

objective; — Enhanced Collars, which satisfy the Tail Risk objective.

This paper is the result of cooperation between Redington and Societe Generale’ Cross-Asset Solutions teams. We would like to seize this opportunity to thank SG’s Cross-Asset Solutions Engineering team for its valuable input on all comparative simulations carried in the paper.

ABOUT THE AUTHORS

We would welcome the opportunity to discuss further. Please do get in touch to find out more.

Dan MikulskisRedington: Director, ALM & Investment Strategy

Dan joined Redington in June 2012

Prior to this, Dan worked at Deutsche Bank in their Cross Asset Trading Group where he focused on their equity volatility trading business and in-house systems development.

Developed and tested quantitative tools to support portfolio management at Macquarie Funds Group.

Started his career as an Investment Consultant at Mercer.

Fellow of the Institute of Actuaries.

Contact: +44 (0) 20 3326 7129 [email protected]

Karim TraoreSociété Générale: Director, Pension Fund and Investment Management Solutions

Karim joined Société Générale in March 2005.

At Société Générale, Karim works within the Cross-Asset Solutions division and is in charge of relations with Pension Funds.

Prior to that, Karim held a sales role in Fixed Income at another investment bank.

SG Cross-Asset Solutions division provides investment and hedging solutions for a wide range of institutional clients.

Pension Funds and related Investment Management companies constitute a core client base of Société Générale.

Contact: +44 (0) 20 7676 7445

[email protected]

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CONTENTS1. Introduction

2. Framework for hedging objectives

3. Description and quantitative analysis of strategies

4. Evaluation of strategies against objectives framework

5. In-Detail analysis of two strategies a. Volatility control b. Enhanced Collar

6. Comments on execution

7. Detailed description of strategies

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1. INTRODUCTION

Historically, the largest investment risk faced by UK Defined Benefit pension schemes has been real interest rates, or equivalently, interest rates and inflation. This basic idea was first established in 1997 by John Exley, Amit Mehta and Andrew Smith (The Financial Theory of Defined Benefit Pension Schemes BAJ 1997 4:835:966).

It has since become virtually ubiquitously accepted that these risks are unrewarded in a mean-variance portfolio construction sense, and hence they have been increasingly eliminated through the use of interest rate and inflation hedges. As of early 2013, we estimate that between 25 and 40% of these risks have been hedged from UK defined benefit liabilities. Current low levels of long term yields in the UK have reduced appetite to hedge somewhat, but many pension funds retain an aspirational objective to be fully hedged against these risks.

At the same time, though, UK pension fund exposure to equities has decreased. According to the PPF’s Purple Book study of 7800 schemes in the PPF universe, the allocation to equities fell from 61.1% in 2006 to 44% in 2012 (source: PPF website).

SO WHAT MAIN INVESTMENT RISKS DOES AN AVERAGE UK DB PENSION FUND NOW FACE?

Figure 1: Risk Attribution of a hypothetical pension fund constructed from the average asset allocations as detailed in the PPF Purple book 2012 95% 1-year Value-at Risk estimated on a Monte-Carlo basis expressed as a percentage of liabilities

40%

35%

30%

25%

20%

15%

10%

5%

0% 0.0%

0.5%

CommodityRisk

EquityRisk

AlternativesRisk

CreditRisk

Perc

enta

ge o

f Tot

al L

iabi

litie

s

InterestRate Risk

InflationRisk

DiversificationBenefit

Total

Risk Attribution by Risk Type

19.7%

17.0%

9.0%

13.6%

2.5%

11.1%

Source: PPF Purple Book, Redington

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Asset Allocation

Equity 44%

Gilts 18%

Corporate Bonds 18%

Hedge Funds 4%

Property 4%

Cash & Other 13%

Total 100%

Liability duration 15 years

Liability hedge ratio 40%

Funding ratio 83%

Source: PPF Purple book 2012, other than liability hedge ratio which is estimated by the authors

Shown in figure 1 is the evidence that, despite decreasing market exposure to equities, the removal of the other large risks that DB pension funds previously faced means that equity risk is likely to still be a very large component of the total risk facing a typical UK DB a pension fund. This trait is particularly emphasised in downside scenarios where other assets held such as credit have an increasing correlation to equities.

A substantial body of academic evidence supports the reasons for an equity risk premium and its existence through time. For example Dimson, Marsh and Staunton, in “Triumph of the Optimists, 101 years of Global Investment Returns”, present data from 1900 that supports equity risk premia in different markets of around 4-5%p.a. Indeed, most pension funds retain equity risks in the belief that they are rewarded in the long term, and because they have the ability to tolerate some volatility in market values in the short term.

However, while pension funds may be able to tolerate some month-to-month volatility in their portfolios, regulation changes have led to a greater aversion to, and lower ability to tolerate, large downward moves in equity markets.

WHY TAIL RISKS AFFECT PENSION FUNDS

Most pension funds in the UK are in a situation where their target is either: Full-funding on a conservative valuation basis (often known as “self-sufficiency”, consistent with a terminal investment portfolio involving low levels of investment risk. Meaning that the pension scheme can then be run off with minimal dependence on the sponsoring employer

Full-funding on a buyout basis

Some schemes with particular demographics or with sponsors in special situations may adopt a different target.

Given the two targets described above, at the time of writing most pension schemes are in a position where they are underfunded relative to these targets. This means schemes are pursuing an investment strategy which is expected to deliver returns in excess of their liabilities, in order to meet their funding goal over a defined time horizon (often referred to as a “flight plan”).

Sharp falls in the value of assets can increase this required return, and given there is an upper limit on the returns one can hope to generate from an asset portfolio, too steep a decline in a pension scheme’s assets can jeopardise the chances of the scheme meeting its objectives.

Extreme downside asset shocks can knock a pension scheme off its flight plan.

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DEFINING EXTREME EQUITY RISK

Existing literature suggests several possible definitions of extreme equity risk:

1. AN EVENT OUTSIDE 3 STANDARD DEVIATIONS AS PREDICTED BY THE NORMAL DISTRIBUTION

This definition is time-period independent. So, for example, a 20% fall over a month and a 50% fall over a year would both come under this definition. The probability of a 3 standard deviation event occurring under the normal distribution is approximately 0.4%, meaning such an event should happen less than one in 200 time period. The following table summarises the events that would count as a tail risk under this definition, under a normal distribution, with a 16% annualized standard deviation (equal to the long term standard deviation of the FTSE 100 index).

Time period Downside return for 3 Standard Deviations

Month -14%

Quarter -24%

Year -48%

2. AN EVENT THAT OCCURS MORE OFTEN THAN ITS FORECAST UNDER THE NORMAL DISTRIBUTION

Under this definition, smaller moves (such as 2% daily moves) would be classed as extreme events if they occur more often than forecast under the normal distribution. The chart in figure 2 illustrates some of the returns that would count as extreme events under this definition.

Figure 2: Distribution of the daily returns of the FTSE 100 compared to a normal distribution 1987 - 2013

0,0%

2,0%

4,0%

6,0%

8,0%

10,0%

12,0%

-6,8% -5,8% -4,8% -3,8% -2,8% -1,8% -0,8% 0,2% 1,2% 2,2% 3,2% 4,2% 5,2% 6,2% 7,2%

FTSE 100 daily Return Distribution Equivalent normal distribution

Source: Bloomberg, Redington

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3. AN EVENT THAT IS OUTSIDE THE PROBABILITY LEVEL AND TIME PERIOD OF THE INSTITUTION’S VALUE AT RISK MODEL

Pension funds, like insurance companies, typically use a 1-Year VaR calculation. Banks and hedge funds might use a shorter time period such as a month or single day.

The table below shows the moves associated with various probability levels over 1 year and 1 month, based on a normal distribution with a 16% standard deviation (equal to the long term standard annualized standard deviation of the FTSE100 index).

Significance level Associated 1 year move 1 month move

95% -42% -12%

98% -49% -14%

99% -53% -15%

99.5% -57% -16%

The definition chosen will have some impact on which historical periods count as an extreme event; however, the extreme moves seen in 2008, 2002-2003 and August 2011 probably qualify under all definitions.

WHY HEDGE EXTREME EQUITY RISK

Many pension funds take significant equity risk in the expectation that it will be rewarded, and that these investment returns will contribute to closing any deficit present in the scheme, in the place of or as well as sponsor contributions. While the precise situation of each fund and sponsoring employer varies, it is generally true to say that, while capital losses on an equity portfolio that are recovered within a few months or a year can be tolerated, those that leave the fund in a materially worse capital position at the following valuation point cannot. These types of losses can result in a higher contribution level being imposed on the employer, and can impact negatively the disclosed balance sheet of the employer, potentially threatening its financial.

Hence, it is logical that both pension funds and sponsoring employers may be prepared to give up some of the upside associated with an equity investment in return for a high confidence (ideally, certainty) that such a negative event will not be realised.

The presence of and increasing aversion to equity tail risk events presents the question of if and how these risks can be effectively hedged. It also raises the subsequent question of the costs of this hedging, and how that cost compares to the non-hedging alternative risks outlined above.

The rapid growth of VIX futures and related strategies is testament to the increasing awareness of and appetite to hedge these risks. As shown below, the daily traded volumes of VIX futures contracts have surged hugely in recent years, with a record average daily volume of over 130,000 contracts traded in January 2013 being more than three times the volume a year earlier. In a 2012 paper, Guobuzaite and Martellini of Edhec- Risk Institute (“Edhec”)1 demonstrate that volatility derivatives have a high negative correlation to the underlying equity index, and therefore represent a good choice of instrument to hedge extreme equity risk. We therefore associate the increased trading volumes in the VIX with an increasing desire on behalf of all types of investors to hedge extreme equity risk. It is worth noting that the VIX index relates to the volatility of options on the S&P 500 index, however it has been widely adopted as a more universal measure of volatility.

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Figure 3: Traded volume of VIX futures 2005 - 2013

Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13

VIX Futures Volume

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

Source: Bloomberg

A number of products and strategies exist with a similar or related objective – to mitigate the downside of an equity portfolio. The question we ask and attempt to answer in this paper is: what are the characteristics of these strategies and how can we characterize their properties, and inherent “carry” costs?

The Edhec paper1 analyses the tail risk hedging properties of VSTOXX futures and options, and conclude that adding a small allocation to the futures or call options on the VSTOXX index can improve equity portfolio downside outcomes, and risk adjusted returns.

Here we extend that analysis to cover a wider variety of derivative approaches to the problem, as well as considering two approaches that do not involve volatility derivatives.

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2. FRAMEWORK FOR HEDGING OBJECTIVES

Before we describe the strategies we have considered we first set out the framework through which we evaluate the strategies.

The framework sets out likely considerations for a pension fund when choosing an equity risk hedging strategy. A common starting point is what we call the Hard Floor Objective (HFO), where a fund would seek to insure that the equity portfolio cannot lose more than a certain % over a certain time period. Clearly, this objective can be very closely satisfied by buying a European Vanilla put option with an appropriate strike price and maturity date on the whole equity portfolio (we assume here that it is possible to trade this option, for most equity portfolios this should – at least in theory – be the case). Let us call this strategy 1.

One way to calculate the carry cost of this strategy is to consider the premium paid for the option, which is explicit. Although on day 1 of the strategy the option sits as an asset rather than a cost, the central expectation will likely be that the option expires worthless and hence the premium will be a drag on performance.

An alternative way of calculating the carry cost of this strategy is to determine the average of the payoffs of the option under the historical return distribution (by definition, the discounted average of the payoffs under the risk neutral distribution is the premium of the option).

One downside to this strategy is that, unless there is a concrete reason why the protection level and maturity date are chosen, they are often chosen somewhat arbitrarily and they strongly affect the properties of the strategy. For example, if a 3 year option is chosen, the protection ends completely after 3 years and a 50% fall on the first day of the fourth year may be unprotected. Similarly, even if the position is “rolled” to a new option contract on expiry, which is not guaranteed to be possible at the same price, the portfolio is not protected against two or more consecutive downward moves that just fail to breach the strike. Finally, unless additional features are added to the vanilla option such as a lookback or upward ratchet, any investment gains achieved over the early part of the protection period will not be protected, as the floor will be with reference to the starting level.

This sensitivity of strategy 1 to the maturity date and strike chosen often leads to the exploration of a new strategy (2), in which a selection of strikes and maturities are chosen. However, strategy 2 no longer satisfies the HFO in its original form.

Two further possible objectives now present themselves, which leads to our three investment approaches:

1. HARD FLOOR OBJECTIVE (HFO) Purpose: ensure that the portfolio cannot lose more than x% from the starting position over a certain time period.

2. VOLATILITY SMOOTHING OBJECTIVE (VSO) Purpose: reduce the fluctuations in value of the portfolio over time.

3. TAIL RISK HEDGE (BSP) Purpose: provide a large positive payoff in the event of a “Black Swan”.

All the strategies we look at in this paper relate to one or more of the objectives cited above: HFO, VSO or BSP.

Secondary objective: minimize carry cost.

Figure 4: Objectives framework for evaluating equity risk hedging strategies

HARD FLOOR

VOLATILITYSMOOTHING

TAIL RISKHEDGE

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3. HIGH LEVEL DESCRIPTION OF STRATEGIES AND SUB-STRATEGIES

We separate those approaches that use options and other volatility derivatives (1-7) from those that are employed just using underlying equity or linear derivatives such as futures, strategies 8 and 9.

Given the increased complexity and costs associated with employing volatility derivatives, we argue that there must be a clear reason for doing so in terms of their properties compared with the simpler approaches.

STRATEGY # NAME DESCRIPTION OTHER VARIANTS

Strategies employing Options and Volatility derivatives

1 Single Static Put Usually OTM Strikes, Maturities, American expiry, Lookback, Ratchet

2 Multiple Static Put

Layer strikes and expiries, typically 3-5 different contracts

3 Dynamic Option AS per static option but with rules/ framework for taking profit and/or rolling option position, some discretion involved

4 VIX & related strategies

Implemented with VIX futures VXX, UVX, various roll related strategies

5 Systematic Option

Systematic buying/selling of options according to a pre defined strategy

Calendar collar

6 Variance Swaps & related strategies

Variance swap: pay fixed receive variance (volatility squared)

Variants include cheapening by selling front end VIX futures or options

7 Volatility Control + put option

Equity portfolio managed in a volatility control manner associated with roll of 1y put options on this equity portfolio

Strategies not employing Options and Volatility derivatives

8 Volatility Control

Rebalancing mechanism between equity index and cash

Is easy/cost effective to buy options on a volatility controlled portfolio, hence vol control + put option is another variant

9 Low volatility stock portfolios

Equity manager selects a portfolio of stocks with low realised volatility. Indices exist which track the performance of such portfolios.

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4. QUANTITATIVE RESULTS

Strategies from 2001

to October 2013FTSE TR 1. Single

Static Put2. Multiple Static Put 4. VIX

4a. VIX related strategy

5. Systematic Option

6. Variance Swap

7. Roll of Puts + Volatility

Control

8. Volatility Control

9. Low Volatility Stocks

Mean 1Y Excess Return

0.00% -2.26% -2.06% 4.45% 6.16% 0.61% 4.50% -0.55% 0.06% 9.26%

VaR 95% 1Y -31.28% -15.18% -21.03% -23.42% -23.12% -4.25% -26.95% -12.63% -13.14% -23.01%

Return during the year 2008

-30.47% -18.62% -27.39% -22.63% -21.00% -1.27% -25.59% -11.79% -11.82% -29.51%

Return in July 10 - Oct. 2013

10.48% 6.30% 6.27% 6.45% 8.64% 1.78% 12.25% 4.12% 4.08% 6.68%

Average 1Y Rolling Volatility

18.93% 9.79% 11.41% 18.72% 20.67% 6.45% 18.31% 9.35% 10.36% 11.44%

Source: SG Engineering.

Data Track Dates Data Track Dates

FTSE Total Return 02/01/2001 to 11/10/2013 Systematic Option 02/01/2001 to 11/10/2013

Single Static Put 02/01/2001 to 11/10/2013 Variance Swap 02/01/2001 to 22/10/2013

Multiple Static Put 02/01/2001 to 11/10/2013 Volatility Control 02/01/2001 to 11/10/2013

VIX 20/12/2005 to 11/10/2013 Low Volatility Stocks 09/04/2002 to 05/02/2014

VIX related strategy 19/12/2006 to 11/10/2013

DISCLAIMERTHE FIGURES RELATING TO PAST PERFORMANCES AND/OR SIMULATED PAST PERFORMANCES REFER OR RELATE TO PAST PERIODS AND ARE NOT A RELIABLE INDICATOR OF FUTURE RESULTS. THIS ALSO APPLIES TO HISTORICAL MARKET DATA.

Notes:

a. Excess Returns are measured relative to the FTSE 100 Total Return Index.

b. All Returns are calculated as Log Returns.

c. Availability of data is always an issue when trying to backtest these kind of strategies. We have illustrated against the FTSE 100 for the purposes of convenience from a data perspective rather than because this represents the equity allocation of UK pension funds

d. Some of the periods of data (particularly for the VIX where we have data since 2005) are dominated by the post-Lehman period which was exceptional in terms of equity volatility. Therefore it is possible to draw only very limited conclusions, particularly in regard to the returns of the VIX related strategies.

Details of the strategies shown

1. Single static put is a 5 year put struck at 90% of the starting index value.

2. Multiple static put is a combination of 4 year and 5 year options struck at 85% and 95% of the starting index value.

3. A dynamic option strategy is not shown.

4. VIX strategy consists of a 5% rolled allocation to the short term futures contract.

4a. VIX related strategy is a 5% allocation to a program of allocating to the VIX contract with the lowest implied cost of carry at the point of execution, this depends on the shape of the VIX futures term structure at the point of execution.

5. Systematic option strategy is monthly buying of 90% 1 year puts and daily selling of 2 week 102% calls.

6. Variance swap strategy is a 5% allocation to a long position in a 1 month variance swap on a rolling basis.

7. Roll of Puts with Volatility Control is an annual roll of 1Y Puts struck at 90% on a virtual index consisting of FTSE 100 Total Return Index and a volatility control mechanism aiming at setting volatility at 10% (see details below).

8. Volatility Control is implemented with a 10% volatility target using a 50 day volatility measure, rebalanced daily.

9. Low volatility stocks approach is a monthly rebalancing of all the stocks in the index according to the inverse of their volatility measured on a 50 day basis.

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Illustration of strategies relative to framework

Figure 5: Equity risk hedging strategies illustrated relative to the objectives framework

Qualitative Observations

Single and multiple static put strategies do not maintain hard floor protection over shorter time periods when the options used are of longer term (4 or 5 years).

The downside mitigation (as measured by the VaR95%) offered by static long-term and roll optionstrategies is not more effective than a volatility control approach.

Also, the volatility reduction effects of a 4 or 5-year and roll option approaches is no more effective at reducing volatility than a volatility control approach.

The static and roll option approaches also come with significant carry costs that affect the returns over time.

When put options are employed in conjunction with a volatility controlled portfolio the carry costs through time are significantly less than a situation which uses conventional index options.

However, partly due to the effectiveness of the volatility control method, the put options in the backtest do not become in-the-money to a significant extent.

This means that the performance of the volatility control + put options strategy appears similar to the volatility control by itself, with a small drag due to the option premium.

The VIX-related strategies, systematic options and variance swaps are all effective at reducing the 1 year 95% VaR – satisfying the Tail Risk Objective.

However, although the extreme tails are removed, the volatility is not reduced and the VIX and variance swap strategies all have similar volatilities to the underlying equity. The Volatility Smoothing Objective is not satisfied.

It should be noted that the ultimate underlying of the VIX contract are options on the S&P500, so there is a clear basis risk between this and the FTSE100 portfolio against which it is analyzed in this example.

However over the period of time illustrated, developed equity markets have tended to behave similarly in periods of extreme stress, hence the VIX index has some tail hedging properties even when illustrated against a FTSE 100 portfolio. It is likely but not certain that this would be the case in the future.

The systematic option strategy analyzed reduces both tail risk and the portfolio volatility. In practice it is hard to characterize this very broad subset of approaches and strategies could be set up to satisfy different combinations of the objectives.

One particular subset of those strategies has been developped by Societe Generale for Pension Funds and consists in purchasing a Put option and selling a series of short-dated Call options. This strategy - referred to as the Enhanced Collar or the Calendar Collar - can offer a material reduction of volatility and tail risk while protecting long-term expected returns of the equity portfolio.

The Volatility Control and Low Volatility Stocks approaches both reduce the volatility. In addition, the Volatility Control approach shows a lesser downside in the more extreme market scenarios. On this basis, out of the two approaches that do not use volatility-based derivatives, we believe the Volatility Control approach best satisfies the Volatility Smoothing Objective.

Employing a more sensible strategy with respect to the roll down of VIX futures (4a compared to 4) can reduce the carry cost of this strategy, albeit that the returns shown here are distorted a little by the sample period.

HARD FLOOR

KEY

Single Static Put Option Strategy

Multiple Static Put Option Strategy

Dynamic Option Strategy

Systematic Option Strategy

VIX

Variance

Volatility Control

Low Volatility Stocks

Volatility Control + Annual Put OptionVOLATILITYSMOOTHING

TAIL RISK HEDGE

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5. STRATEGIES IN-DETAIL

A. IN DETAIL: VOLATILITY CONTROLVolatility Control as a concept is the management of assets through continual rebalancing between an equity holding and cash. The rebalancing attempts to achieve a target level of volatility in the equity + cash portfolio. For example, if the target volatility level is 12%, and the realized volatility on the agreed measure is 18%, the overall portfolio would be 66% allocated to the equity index.

Volatility Control involves use of linear instruments only, such as equities, futures or ETFs.

Because there are so many possible measures of an asset’s volatility, the pros and cons of each particular approach to measuring volatility are well beyond the scope of this paper. However, we believe that the broad properties of a Volatility Control strategy are robust to the precise method chosen.

The charts below illustrate the backtested performance of a volatility controlled approach applied to the FTSE 100 back to 1984.

Figure 6: Daily Return Distribution of Volatility Control on FTSE 100 index compared to the FTSE 100 index and a Normal distribution 02/01/2001 - 11/10/2013

0%

2%

4%

6%

8%

10%

12%

14%

FTSE Total Return Distribution

Volatility Control Index Return Distribution

Normal Distribution

Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10

-6,8% -5,6% -4,4% -3,2% -2,0% -0,8% 0,4% 1,6% 2,8% 4,0% 5,2% 6,4% 7,6%

Frequency

Daily Return (%)

Source: Bloomberg, SG Engineering

Figure 7: 1-Year Rolling Volatility of Volatility Control on FTSE 100 index compared to the FTSE 100 index 02/01/2001 - 11/10/2013

0

0,05

0,10

0,15

0,20

0,25

0,30

0,35

0,40Volatility Control Index Volatility FTSE Index Volatility

Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13

Annualised 1-Year Rolling Volatility (%)


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Figure 8: Daily Return Distribution of Volatility Control on FTSE 100 index compared to underlying FTSE 100 index and a Normal distribution

0%

5%

10%

15%

20%

25%

FTSE Index Return Distribution Volatility Control Index Return Distribution

-50% -45% -40% -35% -30% -25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

Frequency

Daily Return (%)


Volatility Control FTSE 100

Av. 1Y Rolling Return 4.56% 3.67%

Excess Return vs. FTSE TR 0.88% -

Av. 1Y Rolling Volatility 9.70% 19.30%

Max Draw down -23.10% -44.80%


Max 1Y Rolling Volatility 11.30% 39.00%

Min 1Y Rolling Volatility 8.30% 7.90%

Max leverage 100.00% 100.00%

Min lev 0.00% 100.00%



We can draw the following conclusions about Volatility Control as a strategy:

The volatility experienced at the portfolio level is indeed smoothed compared to a static investment in the FTSE 100, illustrated by a much smaller range for the realized volatility around the target level.

Large drawdowns are partially mitigated by a de-levering out of equities as the market begins to fall and becomes more volatile. We can see that the worst drawdown of the volatility controlled strategy was a 23% peak to trough fall compared to 45% for the uncontrolled strategy.

There is an improvement in the Information Ratio of 0.09.

In any given year the volatility controlled portfolio can underperform a conventional portfolio, particularly in years when the underlying index oscillates in both directions.

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Over the period shown, Volatility Control outperformed the uncontrolled strategy; however, do not always expect this to be the case. It is more likely that the volatility controlled strategy will have a high risk adjusted return (as demonstrated by the higher Sharpe ratio) but in some cases may have a lower return.

Volatility Control also offers little protection against sudden market drops not preceeded by an increase in volatility, such as March 2010.

Volatility control can be combined in practice quite effectively with a single static option, as having the volatility control mechanism in place means that the cost of put options is reduced compared to a static allocation.

Volatility Control in conjunction with options

One characteristic of volatility control is that the premium of put options on a portfolio which is managed with volatility control is lower, and more stable through time than options on a conventional portfolio whose risk varies substantially through time.

For example, in our quantitative backtest the 1 year 90% option on the 10% volatility control index carries an average premium of 0.68%. This compares at the time of writing to a premium of 4% for a 90% 1-year put option on the FTSE 100 index.

The price of the option on the volatility control index is lower for two reasons: — The volatility of the volatility control index is lower (10% vs an average of 18% for the FTSE 100), — The volatility control index experiences less sharp increases in its volatility than the FTSE 100

index, meaning that the skew is smaller also.

Furthermore, the premium of the options on the volatility control index does not depend on the level of implied volatility in the options market. This can fluctuate substantially, for example in March of 2009 the premium for a 1 year 90% put option on the FTSE 100 was in excess of 6%.

The result is a portfolio that meets both the Volatility Control and Hard Floor objectives, with an annual carry cost sufficiently low that it is viable as a long-term strategy.

Over the period of time tested the option on the volatility controlled index did not generate a significant payout, hence almost all of the 0.68% annual premium appears as a drag on returns.

B. IN DETAIL: SYSTEMATIC OPTION STRATEGIESHere we detail the properties of one particular systematic option strategy, the Enhanced Collar. In practice many different strategies can be implemented with a very wide range of properties, so it is by nature hard to characterize these together. The motivation for structuring the Enhanced Collar strategy is to come up with an approach that offers some downside protection, while also trying to mitigate the carry costs.

Enhanced Collar as a concept is the financing of a long-dated Put protection strategy by the continual sale of short-dated Call options on the same underlying index. The strategy aims to provide downside protection against equity market falls, but also allow participation in rising markets.

The Enhanced Collar involves the use of equity index options: Call options and Put options on the underlying benchmark of the equity portfolio.

There are many possible ways to set the maturities and the strike levels for the Enhanced Collar, which depends on the hedging horizon of the pension fund, its desired downside protection level, as well as the positive return it wishes to lock-in. Specific studies could be conducted for that purpose.

SG has been at the forefront of the development of the applications of this strategy for pension funds.

The charts below illustrate the backtested performance of the Enhanced Collar applied to the FTSE 100 back to 2001.

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Figure 9: Daily Return Distribution of Enhanced Collar Strategy on FTSE 100 index compared to the FTSE 100 index and a Normal distribution 02/01/2001 - 11/10/2013

0%

5%

10%

15%

20%

25%

30%

FTSE Total Return Distribution

FTSE Total Return + Enhanced Collar Return Distribution

Normal Distribution

-6,8% -5,6% -4,4% -3,2% -2,0% -0,8% 0,4% 1,6% 2,8% 4,0% 5,2% 6,4% 7,6%

Frequency

Daily Return (%)


Figure 10: 1 Year Rolling Volatility of Enhanced Collar Strategy on FTSE 100 index compared to the FTSE 100 index 02/01/2001 - 11/10/2013

0

0,05

0,10

0,15

0,20

0,25

0,30

0,35

0,40FTSE Index + Enhanced Collar: Volatility FTSE Index Volatility


Annualised 1-Year Rolling Volatility (%)


Figure 11: 1 Year Rolling Return of Enhanced Collar Strategy FTSE 100 index compared to the FTSE 100 index 02/01/2001 - 11/10/2013

-0,6

-0,4

-0,2

0

0,2

0,4

0,6FTSE Index + Enhanced Collar: Return FTSE Index Return


1-Year Rolling Return (%)


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Figure 12: Annual Return distribution of Enhanced Collar Strategy on the FTSE 100 index compared to the FTSE 100 index on a Total Return basis

FTSE Total Return Distribution FTSE Total Return + Enhanced Collar Return Distribution

-50% -45% -40% -35% -30% -25% -20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

Annual Return (%)

Frequency

0%

5%

10%

15%

20%

25%

30%


Enhanced Collar FTSE TR

Av. 1Y Rolling Return 5.78% 3.67%

Excess Return vs. FTSE TR 2.11% -


Max Draw down -11.00% -44.80%


Max 1Y Rolling Volatility 9.20% 39.00%

Min 1Y Rolling Volatility 4.40% 7.90%

Max leverage 100.00%

Min lev 100.00%



We can draw the following conclusions about the Enhanced Collar as a strategy: Volatility is indeed smoothed, illustrated by a much smaller range for the realized volatility compared to FTSE100.

Large drawdowns are partially mitigated by the Put option protection as the market begins to fall and becomes more volatile. We can see that the worst drawdown of the Enhanced Collar strategy was a 11% peak to trough fall compared to 45% for the plain FTSE100.

There is an improvement in the Information Ratio of 0.34 compared to investing in the FTSE 100 alone.

In any given year the Enhanced Collar portfolio can underperform a conventional portfolio, particularly in years when the underlying index is sharply rising.

Over the period shown, the Enhanced Collar outperformed the FTSE 100, however we would not always expect this to be the case. It is more likely that the Enhanced Collar strategy will have a high risk adjusted return (as demonstrated by the higher Sharpe ratio) but in some cases may have a lower return.

An adverse scenario for the enhanced collar strategy is one where there is a sudden market rise not followed by an increase in volatility. In this scenario the short call options the investor has sold will be exercised and hence the investor will not participate in this upside. If implied volatility does not rise then the premium generated by selling subsequent call options will also not increase.

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Execution of the hedging strategy could be undertaken in various ways depending on a number of parameters including:

— Size

— Bespoke character of the transaction

— Pricing Transparency

— Time constraint

— Level of confidentiality required

Size matters as large transactions would not have the same impact on the markets than small ones. Therefore, in order to insure a cost-efficient execution, large transactions in size would need to be dealt with a particular care.

If the hedging transaction is bespoke – meaning it has been designed with unique features for the pension fund – there may be a need for the hedging counterparty to transact specific contracts subject to liquidity constraints. Again, particular care would be needed not to communicate the specifics of the transaction to too wide a group of potential counterparties in advance of finalizing the trade.

There are various ways to insure pricing transparency of a given hedging transaction. The need for best price needs to be balanced with the liquidity provided by the hedging counterparty. Also, for large hedging transactions, informing multiple counterparties on the matter might have a negative impact on the effective price upon execution.

Time constraint is important: establishing a clear execution schedule with the hedging counterparty with a target date, market level or hedging budget. The more clarity on the execution timetable and the more effective could be the hedging counterparty in providing cost-effective pricing.

In some cases (large transactions, market sensitivity) the Pension Fund could require the transaction to be kept private. In this case, execution needs to take that element into account.

6. COMMENTS ON EXECUTION

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7. DESCRIPTIONS OF STRATEGIES

STATIC PUT OPTION (1)

DESCRIPTIONPension fund will typically purchase an out of the money put option, struck anywhere between 60-90% of the current market level. The maturity could vary anywhere between 1 and 10 years.The option will be held to maturity by an asset manager.Typically the notional value of the option will be set equal to the notional value of the equity portfolio the option is protecting, therefore initially the delta of the option will be considerably less than this.

ADVANTAGESAssuming no basis risk between the index underlying the option and the clients actual portfolio, then this will provide a hard floor on the amount by which the portfolio can fall in value over the time horizon of the option.Single decision point for pension fund, minimal ongoing governance.Vanilla instruments, and – if struck on one of the major large cap indices such as S&P500, FTSE100, DAX, ESTOXX, KOSPI, Nikkei or HSI and with a maturity of less than 3 years there will be some “screen” market availability for pricing transparency. The liquidity within this will vary depend on the strike, contract and maturity.Transaction costs should be relatively small and transparent.Ongoing cost should be minimal.

DISADVANTAGESIn practice, may be hard to ensure no basis risk between option and portfolio.Introduce high degree of dependence on the precise strike and maturity chosen – eg if a 2 year option, then no protection at all beyond 2 years. Strategy can be rolled but at unknown cost.Listed market outside the specific contracts mentioned above may not be helpful. Typically the premium on such options is optically “high” and typically either all or most of the premium will be written off as a drag against returns of the portfolio from a returns perspective.Introduces mark-to-market risk relating to the implied volatility of the option, at all times before the expiry of the option

CARRY COST CONSIDERATIONSGenerally entire premium of option will be considered carry cost over the term of the option.The premium can be reduced by first employing a volatility-control mechanism on the underlying equity portfolio.

MULTIPLE STATIC PUT OPTION (2)

DESCRIPTIONThe idea of this approach is to mitigate some of the strike-specific and maturity risk inherent in (1).The pension scheme will buy either (I) a variety of different maturities with the same strike, (II) a variety of strikes with the same maturity or a combination of (I) and (II).The overall notional exposure of this structure will likely be kept equal to the equity portfolio that it is designed to protect, therefore protecting different portions of the portfolio over different time periods and to different levels.

ADVANTAGESCompared to (1) mitigates the exposure to the individual strike and maturity.

DISADVANTAGESProtects different portions of the portfolio over various time periods and to different levels, but there is no one single level and time period that 100% of the portfolio is protected.Exposed to market pricing at entry point.Exposed to changing market pricing (implied volatility) through time.

CARRY COST CONSIDERATIONSGenerally entire premium of options will be considered carry cost over the term of the option.

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DYNAMIC OPTION STRATEGY (3)

DESCRIPTIONThis approach will generally be an evolution of the above described static option approaches but allowing for some degree of profit taking in the case of large increases in an option’s value before maturity, and associated trading of volatility.It could be extended to allow relative value volatility trades, for example selling of calls or put spreads to capture differences in implied volatility at different strikes and maturities.

ADVANTAGESThe primary reason for doing this will be to capture more of the upside if option values increase before the maturity of the option, and taking advantage of relative value pricings in the volatility surface at different strikes and maturities. The motivation for this is likely to be to mitigate the carry costs associated with a static strategy.

DISADVANTAGESThe disadvantages are increased complexity and importantly governance required to implement and monitor the decision rules chosen. An agile implementation method will also have to be considered so that opportunities can be exploited as they arise. Further, any given set of trading rules that may have performed in the past will be subject to criticisms and there is no guarantee that it will be have in a similar way in the future.

CARRY COST CONSIDERATIONSAim will be to reduce carry costs associated with static option strategies, in practice will depend on the ex-post realised performance of the rules chosen.

VIX (4)

DESCRIPTIONThe VIX is now a well-known index based on the volatility of short term options on the S&P 500 index. Similar indices exist for other equity markets (such as the VDAX on the DAX and VSTOXX on the EuroStoxx, although the liquidity in both of these is substantially lower than the VIX).Futures contracts exist on the VIX index varying in maturity from 1 month to 1 year. It has been shown that the price of these futures contracts has a substantially negative correlation to most equity markets, therefore appropriately sized positions in VIX futures can act as a tail risk protection for an equity portfolio.

ADVANTAGESThe VIX contacts are widely known and liquid, they are more standardised than individual option contracts and involve less complexity. As they are a futures contract their price behaviour is a little more easily understandable than that of options. As they are a futures contract, a position in the VIX does not have the time decay associated in a position in an option with a fixed maturity date.

DISADVANTAGESThe VIX futures curve is in contango the vast majority of the time which means that in practice, if one enters a VIX futures position and nothing changes, there is a negative PnL associated with the position. Hence in practice there can be very significant time decay of a VIX position which will depend on the shape of the futures curve at the time. Various systematic strategies exist to attempt to minimize the roll costs by varying the particular futures contract that is used depending on the steepness of the futures curve, and possibly taking long and short positions along the curve. At certain points in the past the upward sloping term structure of the VIX has been quite extreme, meaning that strategies which always invested in the first futures contract and rolled down the curve can perform quite badly. One example of this is the period of time between June and December 2011.The VIX index relates to the implied volatility of options on the S&P 500 index. This means that there is a basis risk if it is used as a hedge for other equity indices such as the FTSE 100. It has been the case historically that in extreme events equity markets have tended to move broadly in line and so the VIX has acted as a tail risk hedge compared to other equity indices. It is likely but not certain that this will be the case in the future. For small movements in the underlying indices it is possible there will be a weaker relationship between the VIX and the FTSE 100 or other equity indices.Volatility indices relating to other equity markets such as the DAX, Eurostoxx and FTSE have been launched in recent years although the tradable sizes in these markets are substantially lower than that of the VIX.

CARRY COST CONSIDERATIONSAs above. Also, it is possible to construct strategies which attempt to minimize the VIX roll down carry implications by trading in and out of longer dated VIX futures. The success of these strategies in mitigating carry costs depends on the future shape of the VIX futures curve. Generally they will be based on what has performed well in the past so their future effectiveness depends to some extent on the VIX futures curve behaving in the same way it has previously.

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SYSTEMATIC OPTION STRATEGY (5)

DESCRIPTIONSystematic option strategies extend the idea of static options but attempt to reduce the dependence on market pricing at exact time of entry, and on the market level at exact time of maturity. To do this a portfolio of expiries and strikes are held with a regular (eg monthly) rotation out of a slice of the option portfolio and rolling into a new contract. By doing this any peaks or dips in the market pricing of options are smoothed over. In addition a programme of selling call options in a similar manner can be employed to attempt to reduce carry costs.

ADVANTAGESLess dependence on the market level at entry of an option position, less dependence on the market level at maturity.In practice there is a large variety of potential variations to this implementation, which make it hard to generalize too much but it can be tailored to accommodate a variety of possible objectives.

DISADVANTAGESAs this approach holds of a portfolio of options of different strikes and expiries, it will not guarantee a hard floor on the portfolio over any given period of time.

CARRY COST CONSIDERATIONSA systematic approach to put options only is likely to have similar carry costs to static option strategies, employing call option selling as well can significantly reduce cost of carry.

VARIANCE SWAP (6)

DESCRIPTIONA variance swap is a volatility derivative where parties agree to exchange a fixed cashflow for the future realised variance (volatility squared) of a reference equity index. A strategy which uses this as a tail risk hedge would take a small exposure to a variance swap such as a 1 month swap, and roll this position through time.

ADVANTAGESAs variance is the square of volatility, this has the advantage that the payoff in a downside scenario should be proportionally large, meaning that potentially a smaller allocation would be needed to generate a desired downside payoff.

DISADVANTAGESVariance in itself is quite variable and in practice we find that this strategy can result in big mark-to-market gains which can disappear just as rapidly before the maturity of a given swap arrangement.

CARRY COST CONSIDERATIONSIt is difficult to put an explicit value on the carry cost of a variance swap position, and any analysis will be sensitive to the exact time period chosen. It is possible that a variance swap position can give rise to a drag on portfolio returns at least as great as a static option position.

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VOLATILITY CONTROL + PUT OPTIONS (7)

DESCRIPTIONThe equity portfolio will be managed in a volatility control manner aiming at setting volatility at 10%.Pension fund will roll 1Y put options struck at 90% on the equity portfolio managed in a volatility control manner, as described above.Typically the notional value of the option will be equal to the notional value of the equity portfolio the option is protecting.Please see section “volatility Control” for more specific details on the mechanism.

ADVANTAGESSingle decision point for pension fund, minimal ongoing governance.By employing volatility control and put options the pension fund achieves both volatility smoothing and a hard floor.Cheaper than Vanilla options given that the volatility of the underlying is lower, and more constant.Transaction costs should be relatively small and transparent (the bank making the price is not taking on risk exposure to the level of implied volatility in equity markets, which can itself be quite variable).Ongoing cost should be minimal.

DISADVANTAGESBacktests show that the cost of carry is higher than the payoffs over the period tested, meaning that a large part of the option premium is a carry cost.Compared to a pure allocation to the underlying equity, the de-gearing mechanism present in Volatility Control will mean that it will lag equity markets in periods of fast recovery as it will take time to re expose itself.

CARRY COST CONSIDERATIONSGenerally a large part of the option premium will be considered carry cost over the term of the option. In some years the option will generate a positive payout and this will partly offset the years where there option expires worthless.The carry cost of the option strategy will depend on the strike and maturity chosen for the options, but is materially less than for an option strategy employed on a conventional equity index such as the FTSE 100.

VOLATILITY CONTROL (8)

DESCRIPTIONVolatility control rebalances between and equity index exposure and a cash exposure according to the trailing volatility of the equity index compared to a target. If the volatility of the index rises above the target exposure to the index will be reduced below 100%. In practice it is usually best implemented through the most liquid underlying instruments such as futures. Volatility Control does not involve any trading in volatility based derivatives such as options or VIX.

ADVANTAGESIt is simple to understand and implement., as it is simply a rebalancing mechanism between a liquid underlying (such as equity index futures) and a cash asset.Employing a volatility control mechanism is also a very effective way of reducing the premium paid for static put options on the portfolio (see below).

DISADVANTAGESCompared to an approach that trades in volatility derivatives Volatility Control will not offer as much protection against extreme instantaneous downside moves, although this can be provided by employing a put option strategy in conjunction with the volatility control (see below).Compared to a pure allocation to the underlying equity, the de-gearing mechanism present in Volatility Control will mean that it will lag equity markets in periods of fast recovery as it will take time to re-expose itself.

CARRY COST CONSIDERATIONSAnalysis over long time periods and across markets shows that Volatility Control has a higher Sharpe ratio than an allocation to the underlying market index, this is supported by several academic studies2.

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BIBLIOGRAPHY

1 The Benefit of Volatility Derivatives in Equity Portfolio Management, Edhec (May 2012) http://faculty-research.edhec.com/_medias/fichier/edhec-publication-the-benefits-of-volatility_1346228228600.pdf

2 Journal of Index Investing September/October 2012 “The Optimal Design of Risk Control Strategies” Guido Geese http://www.indexuniverse.com/publications/journalofindexes/joi-articles/12932-optimal-design-of-risk-control-strategy-indexes.html

3 RedViews “Taming the Beast: The Hedgehog and the Fox” December 2012 http://www.redington.co.uk/getattachment/eea3dd74-37c8-446e-afa9-fd8d1973f295/Taming%20The%20Beast.aspx

LOW VOLATILITY STOCK PORTFOLIO (9)

DESCRIPTIONOne way to construct a portfolio that reduces volatility is to either select the lowest volatility stocks in the index, or alternatively to weight stocks according to the inverse of their volatility. Volatility is usually measured on a trailing basis on a medium term measure such as one year. The stocks will be rebalanced usually monthly or annually.

ADVANTAGESIf it is the case that stocks with a low historical volatility continue to do so going forward, this approach will build a portfolio that should have a lower volatility than the market portfolio through time.

DISADVANTAGESLow volatility stocks tend to be concentrated in certain sectors such as Healthcare and Utilities, this approach can lead to large concentrations of the portfolio in particular stocks and sectors.Depending on the calculation methodology and rebalancing frequency this approach can result in quite material levels of portfolio turnover, given it involves trading at an individual stock level this can introduce significant transaction costs.If portfolio rebalancing takes place at less frequent intervals such as annually, the returns can be sensitive to the exact choice of the rebalancing month.Historical analysis suggests that low volatility stocks can still suffer substantial drawdowns in market crashes and this is bourne out by our analysis.The performance of low volatility stocks can differ quite considerably from the overall index, and while recent performance has been exceptionally good it is possible that a low volatility stocks portfolio might not fully participate in market rallies to the same extent as the overall index.

CARRY COST CONSIDERATIONSThere will be no explicit carry costs associated with this strategy however over time the returns will clearly differ from a standard market capitalization weighted benchmark. The extent that they do so is not predictable in advance with any degree of confidence and there are bound to be periods where the returns are substantially above and below that of a market capitalization benchmark. For further work on the subject see Redviews: “Taming the beast, the hedgehog and the fox”3.

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4 Members

Investment Consulting

7

5

7

Manager Research

ALM & Investment Strategy

Technology Operations Education &

Communication

54 AMAZING EMPLOYEES

W E W E R E T H E F I R S T C O N S U LTA N C Y T O B R I N G R I S K M A N A G E M E N T

Named after the visionary actuary Frank Redington, the developer of Immunisation Theory, Redington was founded in May 2006 by Dawid Konotey-Ahulu and Robert Gardner.

OCT 2006 DEC 2006

DEC 2007

JULY 2008JUN 2008

SEPT 2008

OCT 2009JAN 2010

SEPT 2011OCT 2011

NOV 2011

SEPT 2009

Authorisation granted

Gets its client

Redington staff: 5

E u r o p e a n P e n s i o n s A w a r d s: Winner of European Breakthrough Firm of the Year

Financial News Awards:Specialist Investment Consultancy of the Year

Global Life & Pension Awards:#1 In ALM/LDI #2 in Manager Selection #3 in Strategic Advice #3 Overall Consultant

Assets under consulting of £150,000,000,000

Financial News Awards

European Pensions Awards

Best Consulting Firm of the Year

JUL 2011 Launched

Assets under consulting

Redington staff: 21

Assets under consulting: £30,000,000,000Redington moves to Mallow Street offices

Redington staff: 36Assets under consulting: £80,000,000,000

Redington expands team to 45

Best Consulting Firm (non-asset allocation issues)

Risk Management Firm of the YearLife & Pensions Risk Awards

(£200,000,000,000)

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JUN 2012 European Pensions AwardsRisk Management Firm of the Year 2012

Pension Consultancy of the Year 2012

MAY 2012 RedBlog was listed as one of the Guardian’s 2012 must-read finance resources.

NOV 2012 Redington implements seven step framework

N

In 2012 we also launched RedSTART, a financial literacy programme

tackling young people’s failure to save. Our consultants provide free

educational training days to students at local schools to help them prepare for

September 2012 Redingtons Co-CEO Robert Gardner abseils down the tallest

building in Europe, “The Shard” to raise 25k in support of Commando Spirit

Sean (Age-13) -Lister Community School

69 years experience as actuaries 257 years capital markets experience

OUR STAFF HAVE A WEALTH OF COMBINED EXPERIENCE INCLUDING

MAY 2013

JUN 2013

JUL 2013Assets under consulting in excess of (£270,000,000,000)

PENSION WEEK’S PENSION AND INVESTMENT PROVIDER AWARDS (PIPA)

Best Investment Consultant 2013

Global Investor / ISF

1st

A L M Development

European Pensions European Consultancy of the Year

European Risk Management Firm of the Year

Global Investor/ISF Awards

Pension Consultancy

of the year 2013

TECHNIQUES FROM INVESTMENT BANKING INTO THE WORLD OF PENSIONS.

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ABOUT SOCIETE GENERALE:

Societe Generale is one of the largest European financial services groups. Based on a diversified universal banking model, the Group combines financial solidity with a strategy of sustainable growth, and aims to be the reference for relationship banking, recognised on its markets, close to clients, chosen for the quality and commitment of its teams.

Societe Generale has been playing a vital role in the economy for 150 years. With more than 154,000 employees, based in 76 countries, we accompany 32 million clients throughout the world on a daily basis. Societe Generale’s teams offer advice and services to individual, corporate and institutional customers in three core businesses:- Retail banking in France with the Societe Generale branch network, Credit du Nord and Boursorama, offering a comprehensive range

of multichannel financial services on the leading edge of digital innovation;- International retail banking, financial services and insurance with a presence in emerging economies and leading specialised businesses;- Corporate and investment banking, private banking, asset management and securities services, with recognised expertise,

top international rankings and integrated solutions.

Societe Generale is included in the main socially responsible investment indices: Dow Jones Sustainability Index (Europe), FSTE4Good (Global and Europe), Euronext Vigeo (Global, Europe, Eurozone and France) and 5 of the STOXX ESG Leaders indices.

For more information, you can follow us on twitter @societegenerale or visit our website www.societegenerale.com.

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The contents of this document are given for purely indicative purposes and have no contractual value.

No offer to contract: This document does not constitute an offer, or an invitation to make an offer, from Societe Generale or Redington to purchase or sell a product. Prior to investing in a product, investors should seek independent financial, tax, accounting and legal advice.

Market information: The market information displayed in this document is based on data at a given moment and may change from time to time.

Information on past performances and/or simulated past performances: The value of an investment may fluctuate. The figures relating to past performances and/or simulated past performances refer or relate to past periods and are not a reliable indicator of future results. This also applies to historical market data.

Information on future performance: The value of an investment may fluctuate. The figures relating to future performance are a forecast and are not a reliable indicator of future results.

The simulations presented in this document result from estimations of Societe Generale and Redington at a given time, on the basis of parameters selected by Societe Generale and Redington, the market conditions at such time and historical data which can in no way be considered as a guarantee of future performance. Therefore, the prices or figures indicated in this document only have an indicative value and do not constitute in any manner a firm price offer from Societe Generale and Redington.

This document is co-issued in the U.K. by Redington and the London Branch of Societe Generale. Societe Generale is a French credit institution (bank) authorised by the Autorité de Contrôle Prudentiel et de Résolution (the French Prudential Control and Resolution Authority)and the Prudential Regulation Authority and subject to limited regulation by the Financial Conduct Authority and Prudential Regulation Authority. Details about the extent of our authorisation and regulation by the Prudential Regulation Authority, and regulation by the Financial Conduct Authority are available from us on request.

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Redington and Societe Generale CIB - Equity Hedging for UK Pension Funds - March 2014

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Transcript of Redington and Societe Generale CIB - Equity Hedging for UK Pension Funds - March 2014