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36 State Street Global Advisors | Investment Options

RETHINKING FIXEDINCOME

W ith a wider range of options soon to be available for those heading into retirement, the days of steering DC members' investments into a mixture of UK long bonds and cash are numbered. So, in this brave new world, what should those tasked with providing more fl exible retirement choices for members be thinking about? The debate in the industry, so far, has focused on how the end asset allocation of the investment glidepath should be designed to accommodate the three options retiring members will have at their disposal: to buy an annuity, take cash or stay invested and drawdown their assets over time. Whichever approach a pension scheme undertakes to facilitate the new choices available, now is an opportune time to review the fi xed income allocation within that strategy. After all, in a global fi xed income market worth over $28 trillion, the opportunities are immense and it seems far too limiting to restrict a strategy to only the 6% portion of the market that sterling bonds comprise.Currency (£ Trillions)

Market valueBondsIssuers

Euro

7.13,421685

Sterling1.8968349

US Dollar12.88,5131517

Other currencies7.28,513605

Total28.916,3152260

Source: Barclays, as of 31 Jan 2015

Bond market size (GBP)

“ Accessing fi xed income passively

has traditionally dominated the DC market, but alternative methods warrant consideration."

Sahil Sethi

DC Strategist, SSGA

“ The world of investing in fi xed

income is a more multifaceted place today than it was a few years ago."Maiyuresh Rajah DC Senior Relationship Manager, SSGA

Emerging Market Debt

traditional developed bond issuers and the low yields exposures available to investors, and how they relate

Advanced Beta

As with other asset classes, a variety of approaches indices. They feature the transparency, consistency,

Contribute | Rethinking Fixed Income 37

08

Strategy 1

ANNUITY MATCH

Historically a combination of long dated gilts and UK corporate bonds has been used to create strategies that aim to match the movements in annuity prices. With the sale of annuities halving since last April1 , there may be repercussions for annuity pricing. It may be prudent, for example, to monitor and manage the duration of the bonds backing annuities since this is likely to alter in line with the changing demographics of annuity-buying retirees. Importantly, with members likely to use the new fl exibility to delay annuity purchases, the duration of bonds backing an annuity bought at 65 can be di? erent to that of an annuity bought when the member is 70 or older.

Strategy 2

CASH-BASED

Whilst there is a broader debate about the merits of an investment strategy that targets 100% cash at the point of retirement, at its most basic level it has the potential to reduce members' real purchasing power due to current record low interest rates. Retirees may also lose out in nominal terms if their pension fund fails to keep up with record-keeping and investment charges. This is especially the case for members who may delay retirement and end up ‘stranded" in cash for longer than expected. Strategies that invest in short-duration bonds with maturities of up to a year can help here by adding up to 40-50 basis points to the annual yield. Schemes that also seek to keep track with infl ation could also consider adding an allocation of top-rated, shorter-duration bonds that yield in line with infl ation. Strategy 3

DRAWDOWN

In the drawdown phase, bond investments typically aim to balance a requirement to generate su? cient return to fund a desired retirement lifestyle with the need to control risk. This wider objective poses some interesting questions and throws up equally interesting opportunities: Local versus global: There are more than 2000 bond issuers globally compared to just over 300 for sterling- denominated bonds 2 . Given the return-seeking objective, it may make sense to cast a wider net and consider incorporating emerging market debt too.

The rating spectrum:

Selecting only top-rated issuers

means omitting the opportunity of a range of potentially high yielding bonds. The trade-o? between risk and reward needs to be considered carefully, however for some strategies, it may make sense to expand the universe from top-rated

issuers to include those in the high yield territory.The world of investing in fi xed income is a more multifaceted place today than it was a few years ago.

Pension schemes have a variety of fi xed income options to choose from to help in their mission for better investment outcomes for members. The forthcoming pension changes make for a timely opportunity for pension schemes to review their approach to this asset class. 1 2

Source: Barclays January 31, 2015

$28 TRILLION

Global fi xed

income market 6%

Portion comprised by

Sterling fi xed income

Source: Barclays January 31, 2015

36 State Street Global Advisors | Investment Options

RETHINKING FIXEDINCOME

W ith a wider range of options soon to be available for those heading into retirement, the days of steering DC members' investments into a mixture of UK long bonds and cash are numbered. So, in this brave new world, what should those tasked with providing more fl exible retirement choices for members be thinking about? The debate in the industry, so far, has focused on how the end asset allocation of the investment glidepath should be designed to accommodate the three options retiring members will have at their disposal: to buy an annuity, take cash or stay invested and drawdown their assets over time. Whichever approach a pension scheme undertakes to facilitate the new choices available, now is an opportune time to review the fi xed income allocation within that strategy. After all, in a global fi xed income market worth over $28 trillion, the opportunities are immense and it seems far too limiting to restrict a strategy to only the 6% portion of the market that sterling bonds comprise.

Currency

(£ Trillions)

Market valueBondsIssuers

Euro

7.13,421685

Sterling1.8968349

US Dollar12.88,5131517

Other currencies7.28,513605

Total28.916,3152260

Source: Barclays, as of 31 Jan 2015

Bond market size (GBP)

“ Accessing fi xed income passively

has traditionally dominated the DC market, but alternative methods warrant consideration."

Sahil Sethi

DC Strategist, SSGA

“ The world of investing in fi xed

income is a more multifaceted place today than it was a few years ago."

Maiyuresh Rajah

DC Senior Relationship

Manager, SSGA

Emerging Market Debt

traditional developed bond issuers and the low yields exposures available to investors, and how they relate

Advanced Beta

As with other asset classes, a variety of approaches indices. They feature the transparency, consistency,

Contribute | Rethinking Fixed Income 37

08

Strategy 1

ANNUITY MATCH

Historically a combination of long dated gilts and UK corporate bonds has been used to create strategies that aim to match the movements in annuity prices. With the sale of annuities halving since last April 1 , there may be repercussions for annuity pricing. It may be prudent, for example, to monitor and manage the duration of the bonds backing annuities since this is likely to alter in line with the changing demographics of annuity-buying retirees. Importantly, with members likely to use the new fl exibility to delay annuity purchases, the duration of bonds backing an annuity bought at 65 can be di? erent to that of an annuity bought when the member is 70 or older.

Strategy 2

CASH-BASED

Whilst there is a broader debate about the merits of an investment strategy that targets 100% cash at the point of retirement, at its most basic level it has the potential to reduce members' real purchasing power due to current record low interest rates. Retirees may also lose out in nominal terms if their pension fund fails to keep up with record-keeping and investment charges. This is especially the case for members who may delay retirement and end up ‘stranded" in cash for longer than expected. Strategies that invest in short-duration bonds with maturities of up to a year can help here by adding up to 40-50 basis points to the annual yield. Schemes that also seek to keep track with infl ation could also consider adding an allocation of top-rated, shorter-duration bonds that yield in line with infl ation.

Strategy 3

DRAWDOWN

In the drawdown phase, bond investments typically aim to balance a requirement to generate su? cient return to fund a desired retirement lifestyle with the need to control risk. This wider objective poses some interesting questions and throws up equally interesting opportunities: Local versus global: There are more than 2000 bond issuers globally compared to just over 300 for sterling- denominated bonds 2 . Given the return-seeking objective, it may make sense to cast a wider net and consider incorporating emerging market debt too.

The rating spectrum:

Selecting only top-rated issuers

means omitting the opportunity of a range of potentially high yielding bonds. The trade-o? between risk and reward needs to be considered carefully, however for some strategies, it may make sense to expand the universe from top-rated issuers to include those in the high yield territory.

The world of investing in fi xed income is a more

multifaceted place today than it was a few years ago. Pension schemes have a variety of fi xed income options to choose from to help in their mission for better investment outcomes for members. The forthcoming pension changes make for a timely opportunity for pension schemes to review their approach to this asset class. 1 2

Source: Barclays January 31, 2015

$28 TRILLION

Global fi xed

income market 6%

Portion comprised by

Sterling fi xed income

Source: Barclays January 31, 2015

CONTRIBUTE

express written consent. instability in other nations. and other conditions. express written consent. instability in other nations. should not be relied on as such. to be reliable. There is no representation or warranty as to the accuracy of the services to institutional investors.

For subscriptions, email us at ukdc@ssga.com

or visit ssga.com/ukdc Your feedback and participation in Contribute surveys is welcome.

Send your suggestions to ukdc@ssga.com

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