Kylie Minogue Asset Models & Who cares anyway Martyn Dorey Consultant 2 December 2003 Important Notice This document has been approved for issue in the UK by PSolve, a division of io investors Ltd., regulated by the FSA. Information contained in this document has been derived from sources that we consider to be reasonable and appropriate. While this information is believed to be reliable, no representations or warranties are made as to the accuracy of information presented, and no responsibility or liability can be accepted for any error, omission or inaccuracy in this document or related materials. This document may also include our views and expectations, which cannot be taken as fact. This information is supplied to you in confidence and you may not pass it on to any other party without PSolve’s prior written consent. Past performance is not necessarily a guide to future returns. The value of investments can go down as well as up as a result of market and currency fluctuations. Due to the above factors, an investor may get back less than was originally invested.

2 Objectives Split presentation into three parts Epistemology –Influence of internal culture on modelling –Reflections on debate earlier Technical –Pay attention here comes the science bit –Behavioural aspects of optimisation –How do you put a price on the downside Do we care? –What are the big issues we need to be thinking about over the year –Plan for next year

3 Step back in time Whats the Kylie link? This is an accessible conference Fancied doing something different from neighbours & went into competitive pop business Early success was short lived Culture changed Found herself out of a job What was wrong?

4 Wouldn’t change a thing - Kylie ultimate consultant: Reinvent approach every decade using latest technology Responded to changing cultural environment Measurable feedback on approach Did not specialise but got better at everything Anything goes Above all took risk Got involved in the creative process

5 Kylie Vs. actuarial risk modelling Creative thinking? –Is culture is stagnant Press - do we take it too seriously? –Competitive approach in press and talks Competitors in the top 40 –Breadth and depth of product philosophies/styles –Similar models used –4 advisors 65% of FTSE 100 Change of direction interpreted –weakness not creative strength Bitchy? –Use competitors good ideas –Finish other peoples ideas Integrated vs. segregated –Get involved in creative process –Seek contemporary creativity Trying to be ‘hard’ –You can still be normal

6 Getting ideas out. Express risk as –Potential funding level –Potential contribution rate rises Analysis examines different outcomes based on a simple bell curve Most people concerned with poor experience Also consider better than expected 100% funded Average in the middle 90% of time X funded or better Poor experience Gray area = 90% Better than average experience 1/3 of time Y funded or better Gray area =33%

7 Mini case study (1) Client likes bonds With very little information from actuary basis for discussion

8 Shocked

9 I should be so lucky

10 Je Ne Sais Pourquoi? 100% Equities –MFR low risk –FRS17 high risk 100% Bonds –MFR high risk –FRS17 low risk 50:50 lowest risk against all benchmarks

11 Obsession: Behavioural finance Myopic risk aversion Hope for out-performance Need risk to outperform in long term Too much risk under-perform in short term Probability of achieving objective Risk against benchmark Prob where IR = 0.36

12 Obsession: Behavioural finance Myopic risk aversion Hope for out-performance Need risk to outperform in long term Too much risk under-perform in short term Skill Increasing skill Probability of achieving objectives Active risk Increasing risk

13 Obsession: Behavioural finance Myopic risk aversion Hope for out-performance Need risk to outperform in long term Too much risk under-perform in short term Skill Increasing skill Probability of achieving objectives Optimum risk

14 Obsession: Behavioural finance Probability of achieving objectives manager information ratio active risk

15 Word is out: Cost to risk It’s not ‘hard’ Behavioural method? If things go wrong how much do you have to pay? Looks only at downside Works with any distribution you like – here we will use stochastic Could be thought of as an option You will exercise option if your assets don’t deliver the goods

16 Cost to risk: What do I have to do? Calculate the option: PV(Min(x-obj),0) Determine a benchmark Determine an objective Calculate distribution around this Work out the mass function Then calculate the expected value of downside

17 Output (1)

18 Output (2)

19 Who cares: What is the biggest issue for the younger members Generate something you would like to hear someone talk about Something that you would like to talk about Opportunity to practice Try out some ideas