Implementing Long

Duration Strategies
WWW.WATSONWYATT.COM
Watson Wyatt Investment
Consulting Web
Conference
March 7, 2006
 Today’s Presenters

Howard Crane
– Practice Director, Investment Consulting, North
America

Marko Komarynsky
– Senior Manager Research Consultant

2 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Conference Logistics

Only the presenters can be heard during the presentation.

At any time during the conference, you may submit a written
question over the web. If you would like ask multiple
questions, you must delete your first question out of the
queue. We will have a record of the questions. We will
provide spoken answers to as many of these questions as
possible during the Q&A portion of the conference.

If you experience technical difficulties, press *0 on your touch
tone phone and an operator will help you offline.

This conference is being recorded.

The presentation and a replay will be posted on
http://www.watsonwyatt.com/wic on March 8, 2006.

3 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Watson Wyatt Investment Consulting
Web Conferences

First in a series

For investment professionals and plan sponsors

Topics driven by current market environment,
increasing opportunities to better manage risk
and to seek greater returns

Suggestions are welcome

4 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Why Long Bonds? Why Now?

Current environment
– Continuing funding shortfalls despite recovering
asset values
– Plan freezes

Prospective changes to legislation and
regulation

Improving the balance of risk-taking in plan and
fund management

5 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Implementing Long Duration

Long duration strategies

Timing

Manager highlights

6 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Derivatives Overlay

Alpha and Beta
engines considered
separately

Alpha: typically
current core/core
plus portfolio

Beta: various Current Alpha Engineered
derivatives overlay Generating Target Duration
possibilities Portfolio Alpha + Overlay

7 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Physical Long Bonds and Derivatives

Liquidate current
portfolio

Purchase longer
duration bonds
and derivatives

Current Alpha Engineered

Generating Long Duration
Portfolio Target Mandate

8 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Benefits of Derivatives Overlay

Separates Alpha and Beta exposure

Wider opportunity set to generate Alpha

Already familiar with the manager

Variety of ways to obtain Beta exposure: swaps,
futures and other derivatives

Implementation is easy to understand

9 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Drawbacks of Derivatives Overlay

Requires a sophisticated
Basis risk and negative

manager convexity

Potentially higher yield
OTC derivatives require
curve risk than physical manager to be a QPAM
and derivatives strategy

Capital requirements

Overlay strategy may be associated with derivatives
considered leverage

Counterparty risk/Credit

Significant use of risk
derivatives

10 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Benefits of Physical Long Bonds and
Derivatives

Superior cash flow matching and immunization

Securities tend to have positive convexity

Faster implementation

Easier to benchmark against a
standard

Can be accomplished without
using derivatives

11 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Drawbacks of Physical Long Bonds
and Derivatives

Limited opportunity set to generate Alpha

Limited supply of cash bonds

Credit analysis is more difficult

Concentration risk: security, issuer and rating

Exchange traded derivatives have limited duration

May require a different investment manager

12 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Combination Strategy

Use overlay in the beginning then switch to
physical and derivative portfolio

Allows for Alpha generation when client still
might need it and immunization when it is
more critical

13 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Timing Options

Make the change immediately

Phase in using a defined time period

Phase in over a period of time using conditional
market signals as triggers

14 Copyright © Watson Wyatt Worldwide. All rights reserved.

 Manager Highlights

Agincourt Capital Management

Atlantic Asset Management

Barclays Global Investors, N.A.

BlackRock, Inc.

C. S. McKee

Delaware Investments

Denver Investment Advisors LLC

Fischer Francis Trees & Watts

Goldman Sachs Asset Management

Hartford Investment Management

Hillswick Asset Management

Income Research and Management

Jennison Associates LLC

JPMorgan Asset Management
15 Copyright © Watson Wyatt Worldwide. All rights reserved.

Loomis, Sayles & Company

Mercantile-Safe Deposit

Morgan Stanley Investment Management

NISA Investment Advisors

Pacific Investment Management

Prudential Investment Management

Reams Asset Management Company

Ryan Labs, Inc.

Standish Mellon Asset Management

STW Fixed Income Management

Vanguard

Wellington Management Company

Western Asset Management Company
 How to Evaluate These Options

The key to choosing the implementation strategy is
“regret risk” and your forecasts
– “Regret” varies with stakeholders
– Confidence in forecasts varies

If near-term events will not create regret, policy
implementation may be immediate

If regret is likely to be significant, phased implementation
is most appropriate

If forecasts of interest rate and sector behavior are
important, phased implementation with “triggers” may
work best

16 Copyright © Watson Wyatt Worldwide. All rights reserved.

Implementing Long
Duration Strategies
WWW.WATSONWYATT.COM
Questions
 Disclaimer
The information included in this web conference is general information
only and should not be relied upon without further review by the
appropriate professional advisors. Watson Wyatt is not a law firm or
accounting firm, and we are not providing legal, accounting or tax
services or advice. Some of the information included in this web
conference might involve the application of law; accordingly, we
strongly recommend that participants consult with and involve its legal
counsel and other professional advisors as appropriate to ensure
that they are fully advised concerning such matters. Additionally,
material developments may occur subsequent to this web conference
rendering the presentation incomplete and inaccurate. Watson Wyatt
assumes no obligation to advise you of any such developments or to
update the web conference to reflect such developments.

18 Copyright © Watson Wyatt Worldwide. All rights reserved.