1. Asset management
STRICTLY CONFIDENTIAL
New ways to think about Inflation Protection and Retirement Income in DC Plans
Drew Carrington, CFA, CAIA Head of Defined Contribution and Retirement Solutions Group
November 15, 2011
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2. Glide path management: Managing to the right risks
Building to retirement
Transitioning to retirement
Enjoying retirement
Not saving enough: Shortfall risk
Volatility in market prices: Market risk
Risk (NOT Equity) Allocation
Cost of living outpacing returns: Inflation risk
If the current way to look at the glide path is sub-optimal, then how should we be looking at it?
Again, it’s about addressing and managing the four retirement risks and how they change during participants’ life stage.
By doing so, we can adjust allocation to our investments …
Outliving savings: Longevity risk
Source: UBS Global Asset Management For illustrative purposes only.
Before retirement
Retirement
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3. Glide path management: Managing to the right risks
Building to retirement
Transitioning to retirement
Enjoying retirement
Not saving enough: Shortfall risk
Volatility in market prices: Market risk
Risk (NOT Equity) Allocation
Cost of living outpacing returns: Inflation risk
If the current way to look at the glide path is sub-optimal, then how should we be looking at it?
Again, it’s about addressing and managing the four retirement risks and how they change during participants’ life stage.
By doing so, we can adjust allocation to our investments …
Outliving savings: Longevity risk
Source: UBS Global Asset Management For illustrative purposes only.
Before retirement
Retirement
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4. Inflation risk: the erosion of purchasing power
Managing inflation risk is critical near and through retirement
$100,000 today will only purchase $60,269 worth of goods in 20 years—almost a 40% decrease in purchasing power.
… 20 years later, at 2.5% inflation, he/she will need this much
$164,000
$100,000
Participant has this much at retirement…
Age 60
Age 80
Steadily rising inflation (or an inflation spike) makes the basket of goods and services that a participant is accustomed to consuming, permanently more expensive—eroding savings purchasing power
For illustrative purposes only. (In 2007 the median account balance at ages was $100,000 according to EBRI)
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5. Inflation impact: Purchase less of what you need in the future
60 years old Monthly income: $1500
80 years old Monthly income: $1500
Purchasing power has declined 40%
TIPS—inflation linked bonds—protect against inflation because they grow at the rate of CPI, tracking changes in the price of the basket of goods of the average urban consumer
For illustrative purposes only. (In 2007 the median account balance at ages was $100,000 according to EBRI)
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6. The benefits of using TIPS
Designed to protect the purchasing power of investments, especially for near retirees
TIPS offer inflation protection that conventional nominal bond investments do not
Nominal bonds are negatively correlated to inflation
Nominal bond coupon may be too low to compensate for loss of purchasing power due to inflation
Erosion of purchasing power may be permanent
TIPS are better correlated to inflation
Coupons and income grow at a rate closely matching Headline CPI (adjusted monthly with a two- month lag)
Protect standard of living by preserving retirement savings purchasing power
Principal is also adjusted by CPI, so TIP matures at “real” or inflation-adjusted value
TIPS are a proven, reliable inflation hedge
Short-term (1yr) TIPS and intermediate term (10yr) TIPS have a track record as reliable hedges against inflation
Reliability factor exceeds that of commodity stocks (such as natural resource companies), commodity futures, and REITs
TIPS are cost effective
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7. Correlation of TIPS to CPI
Historically, the correlation of TIPS to CPI is approximately 0.34, which means its inflation beta or sensitivity closely mirrors CPI.
Nominal bond correlation, in contrast, is negative.
Source: UBS Global Asset Management research, and various index providers.
All data is September 30, 1997 – June 30, Correlations and standard deviations are based on rolling 12 quarter periods.
Asset classes represented by: US nominal bonds: Barclays Capital US Aggregate Bond Index; Equity: S&P 500 Index; CPI; TIPS: Citigroup US Inflation Linked Securities Index. Past performance is no guarantee of future results.
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8. Reducing risk… really? 3 - Year 5 - Year 10 - Year Max Return Risk
Drawdown -
TIPS
8.3%
4.4%
7.2%
5.3%
6.1%
Inflation
1.2
2.9
2.3
2.6
2.4
3.9
S&P 500
25.2
20.7
2.8
18.2
45.8 -
REITS
2.0
43.2
2.4
34.2
9.2
26.4
65.4
NCREIF
1.5
9.5
3.4
8.1
7.8
6.3
23.9
Commodities -
15.9
35.1
5.3
34.1
3.5
28.4
66.2
Energy
1.2
29.0
3.4
27.8
10.3
23.2
47.1
Materials
0.6
34.4
1.1
29.2
6.9
24.8
47.4
Source: UBS Global Asset Management; data as of 9/30/11

9. Active TIPS offer compelling advantages
Market size (USD600 billion) – there is room in the playing field
Index construction – only 31 issues
Supply and demand skews – as new issues enter the benchmarks and change the weights for passive index investors
Behavior of TIPS – particularly on-the-run vs. off-the-run TIPS
Cost differential between active TIPS and passive managers is relatively low ≈ 15 bp
Ability to make active decisions
Duration
Curve
Security selection
Break-even inflation bet vs. nominal Treasuries
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10. Behavior of TIPS in various inflation scenarios
Annualized expected rates of return of TIPS
Rates of return on TIPS under various annual inflation/deflation scenarios if held to maturity MINUS that of similar nominal Treasuries
Rates of return on TIPS under various annual inflation/deflation scenarios if held to maturity
High inflation
Moderate
No inflation
Deflation
Severe deflation
For illustrative purposes only.
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11. Ways to incorporate TIPS in DC plans
Participant’s menu
TIPS embedded in target date funds as the core inflation protecting strategy
TIPS as a designated hedging sleeve within a custom target date fund
TIPS as a component within an inflation hedging bundle (a real asset bundle)
TIPS as a strategy within a retirement income solution
Primary; automatic
P articularly if potential investment returns are anticipated to provide for future consumption - as is often the case when investing up to retirement.
TIPS positioned as investment option to protect against inflation
Do-it-yourself
For illustrative purposes only.
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12. Glide path management: Managing to the right risks
Building to retirement
Transitioning to retirement
Enjoying retirement
Not saving enough: Shortfall risk
Volatility in market prices: Market risk
Risk (NOT Equity) Allocation
Cost of living outpacing returns: Inflation risk
If the current way to look at the glide path is sub-optimal, then how should we be looking at it?
Again, it’s about addressing and managing the four retirement risks and how they change during participants’ life stage.
By doing so, we can adjust allocation to our investments …
Outliving savings: Longevity risk
Source: UBS Global Asset Management For illustrative purposes only.
Before retirement
Retirement
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13. What was supposed to be fun, isn’t fun any more
“I’m worried that I am going to run out of food.”
“I’ve actually run out of food.”
“My best friend is a volleyball.”

14. One of these things is not like the other…

15. Principles follow us as adults
Stocks
Bonds
Annuities
Cash

16. Historical perspective on investment vs. annuities
Asset classes are made up of investments.
Annuities are insurance, not investments.
 Annuities aren’t an asset class.

17. We take asset classes and build into efficient frontier
US Bonds
US Equity
Cash
Return
Risk (Volatility)
Source: UBS Global Asset Management; For illustrative purposes only.

18. Annuities as an asset class+
Unique economic drivers
1. Mortality-contingent payments
Investment expectations
Streams of payments in the future that can be discounted
Functions enough like a bond that by discounting, an expected return can be derived
The change (or volatility) in expected return can be estimated and modeled
Annuities

19. Annuities can be added to efficient frontier
US Bonds
US Equity
Cash
Return
Fixed Deferred Annuity
Fixed Deferred Annuity
Fixed Deferred Annuity
Risk (Volatility)
Source: UBS Global Asset Management; For illustrative purposes only.

20. But what if we redefine the risk and return parameters…?
Amount of income
Risk of running out of money in retirement
Return
Risk (Volatility)
Source: UBS Global Asset Management; For illustrative purposes only.

21. Annuities become an even more important asset class
Cash
US Bonds
US Equity
Fixed Deferred Annuity
Amount of income
Amount of income
Fixed Deferred Annuity
Fixed Deferred Annuity
Fixed Deferred Annuity
Risk of running out of money in retirement
Source: UBS Global Asset Management; For illustrative purposes only.

22. Conclusion: All risks need to be considered in DC plans
Building to retirement
Transitioning to retirement
Enjoying retirement
Not saving enough: Shortfall risk
Volatility in market prices: Market risk
Risk (NOT Equity) Allocation
Cost of living outpacing returns: Inflation risk
If the current way to look at the glide path is sub-optimal, then how should we be looking at it?
Again, it’s about addressing and managing the four retirement risks and how they change during participants’ life stage.
By doing so, we can adjust allocation to our investments …
Outliving savings: Longevity risk
Source: UBS Global Asset Management For illustrative purposes only.
Before retirement
Retirement
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23. Leaving you with this quiz…
You are given a safety mechanism that will likely save your life.
It will certainly be more expensive than not having it.
It involves an explosion that may injure you.
It may affect the look or design.
Would you choose the option or not…?
Do we even provide the option to include…?

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