Kitty Maccoll

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(No Transcript)
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Asset Allocation and Stochastic Modelling

• Effective use in financial planning

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Introduction

• Decline in guaranteed products changes the
  emphasis of advice
• Clients need good investment advice
• And they need it explained to them
• Asset allocation is the most important investment
  decision
• Decisions on long term asset allocation are
  always based on some sort of model
• Investments are uncertain
• So mathematical models are stochastic

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Individual investors with institutional problems

• As defined benefit products disappear, investment
  risk becomes more important for retirement
  planning
• Responsibility falls to advisers
• That means
• Making good decisions
• Making sure investors understand
• Fortunately faster computers, the internet and
  the market allow
• Institutional solutions for individual investors

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Decisions and explanations

• Advice process typically involves
• Needs analysis
• Risk profile (ATR)
• Product selection (Asset allocation)
• In moving from needs to product solutions, we
  need to
• Explain risk to investor
• Compare alternative strategies
• Decide on a course of action
• Monitor and update
• We can help do this

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For long term investors high equity exposure
doesnt mean high risk
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Fund Profile Modelling and portfolio efficiency
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But in the short term cash can be king
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With income drawdown you can be too cautious
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With profits vs. unit linked
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Where do these comparisons come from?

• A model!
• What does a model need to do
• Forecast outcomes need sensible returns
• Range of outcomes need a stochastic model
• Range of assets need a multi asset model
• Global markets need currency and global model
• Retirement planning need annuity prices and
  interest rates
• Real understanding real terms results need
  inflation forecast
• Its a complex world thats being modelled

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Many models are available

• Our tools arent tied to a particular model
• But, any model that meets the requirements from
  the previous slides will be complex
• Our stochastic model Global CAPLink meets these
  requirements and more.
• Actually built for a greater list of requirements
• In development for over 15 years
• Originally used for institutional asset and
  liability management
• Cheaper computers mean it can now be used for
  retail investors

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Global CAPLink main relationships
Short Long Interest Rates and Full Treasury
Yield Curve
Real GDP
Price Inflation
Equity Earnings Yield
Equity Earnings Growth Rate
Currency Strength
Cash Treasury Bond Income and Total Return
Equity Income and Total Return
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Global CAPLink relationships extended
Core
Wage Inflation
Additional Inflation
Aa Corporate Yield Curve
Index-Linked Yield Curve
Additional GDP
B Corporate Yield Curve
Additional Economic Variables
Additional Yield Curves
Derived Asset Classes, e.g. property, small cap
equities, etc
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And made global

• Key Links Are
• Currencies
• Bond yields
• Earnings yields

U.S.A
Other Countries
UK Europe
Japan
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Global CAPLink how is it built?

• Start with the relationships it needs to model
• Write down equations which capture those
  relationships
• drt f1(ru - rt)dt f2(rt, pt,)dt f3(rt)dZ1
• Calibrate parameters to match
• Historical data
• Current market conditions
• Test the calibration and its implications for the
  required purposes

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Obtaining results from the model theory

• Model determines a distribution of future
  outcomes for the economy and the market
• There is no simple formula for the distribution
• But an equation is what is needed for a Monte
  Carlo calculation
• A set of scenarios can be generated that matches
  the equation and calculates outcomes for an
  investment product or strategy
• From these outcomes, a range, average, maximum,
  as appropriate, can be determined

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CAPLink in practice

• Calibration updated quarterly
• Agreed with
• Historical record
• Current market
• Regulators (FSA etc.)
• Scenarios generated off-line in advance
• Number of scenarios and modelled assets are
  produced as required for each deployment
• Holistic product range taking account of assets,
  contributions, income, fees/charges, tax and
  guarantees

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New challenges for any model

• Side by side comparison of variable annuities to
  help decide between products
• Range of funds is a key consideration so need to
  capture fine distinctions between funds in a
  systematic way
• Also need links to
• Inflation
• Guarantee terms
• Fee structures
• We can do this with CAPLink

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Thanks to all our sponsors