deep and experienced team
cutwater offers customized strategies for:
strategy development process
It is critically important for investment professionals to truly understand the unique circumstances of the pension plan, and the plan sponsor itself, prior to recommending any investment strategy. As such, employing a comprehensive process to quantify and evaluate the current strategy is equally important. We believe our four phase strategy development process can serve as an effective framework to accomplish these goals.
initial plan assessment
The first phase in the Strategy Development Process is the Plan Assessment. The goal of this phase is to gain an in-depth knowledge of the key characteristics of the plan as well as other important variables, such as future plan scenarios and risk tolerance. This is accomplished through an information gathering process and, more importantly, a comprehensive client interview.
deterministic and stochastic modeling
Cutwater utilizes both deterministic "what if" scenarios and stochastic simulations to frame the risk
of an investment strategy against a stream of liabilities.
The deterministic view is designed to highlight plan risks
through several scenario analyses, including (but not limited to):
We then apply stochastic modeling to assess if the current allocation is aligned with the client's stated risk tolerance, utilizing our proprietary stochastic model, the Risk Analysis Manager, "RAM". RAM is an asset allocation and portfolio construction tool that seeks to quantify risk and volatility while meeting a client's investment objectives. The model is unified with Cutwater's investment philosophy as it follows a forward-looking, counter-cyclical capital allocation framework and covers fixed income, equity, and alternative asset classes. The output is a distribution of returns calculated by running the portfolio through a series of Monte Carlo simulation (typically 10,000 paths), each of which incorporates the following:
The stochastic simulations quantify volatility over both short-term and long-term time horizons. Short-term volatility is assessed by quntifying the downside funded ratio volatility over a one year time period (excluding contributions). We quantify long-term volatility by simulating the present value of contributions that would be needed to meet funding requirements over the life of the plan.
constructing a milestone plan
Once the current and target optimized hedge ratios have been determined, the plan sponsor can start to
construct a de-risking path to get from the starting point to the end game. This path, called a Milestone
Plan, seeks to quantify the optimized hedge ratio at each funded ratio milestone given the plan sponsor's
stated risk tolerance, expressed in terms of a downside funded ratio volatility target, which declines as funded
ratio milestones are achieved. It is also important to note that this path is both time and interest rate
irrelevant because it is the funded ratio that determines the volatility target, which in turn drives the investment
allocation. In this framework, the path is a controlled
journey to de-risking. Once the sponsor has aligned the current portfolio with the current stated risk tolerance
which put the plan "on the path," the funded ratio will drive the hedge ratio, regardless of the level of interest
rates. In the event of a drop in the funded ratio, the Milestone Plan can allow for re-risking by providing
a guide to rebalancing the portfolio to the previous volatility target.
Additionally, the Milestone Plan can use discrete funded ratio milestones to trigger rebalancing, or as an alternative for plans seeking a bit more flexibility and discretion within their de-risking path, the Milestone Plan can also be designed with funded ratio bands as the trigger to rebalancing.
selecting a starting point
For plans seeking to further reduce volatility beyond what a traditional long government/credit or long credit strategy offers, we often recommend moving the hedging assets into a customized portfolio that could include the use of derivatives in order to achieve a more precise hedge.
Since 1994, Cutwater has utilized and managed derivatives as a risk management and credit management
tool on behalf of its clients. Cutwater was also an early participant in the credit default swap market and has
been an active end user for its LDI clients since 1999. Credit derivatives have been an integral component
for our credit replication strategies, overlays, and as a means to hedge risk. During the course of its history,
Cutwater has executed over $100 billion (notional) of derivative transactions covering a broad spectrum of
As a manager with a strong understanding of both the cash and derivatives markets, we will take exposure in the most efficient way possible to gain the desired exposure. The decision between the different markets will incorporate a thorough liquidity and collateral analysis of any derivative trades which will factor into the decision tree. Furthermore, trades will be analyzed within an overall portfolio context to ensure that the portfolio has proper market liquidity in times of stress. We recognize the importance of market cycles and liquidity within the markets and will maintain a proper balance between cash and derivatives. As a consistent transactor in the derivative markets for over a decade, we have ISDA / CSAs in place with virtually all of the major derivative providers. We pay strict attention to counterparty exposure on an ongoing basis and manage it accordingly by maintaining relationships with virtually all of the major derivative providers around the world, enabling us to achieve a high degree of counterparty diversification for our clients and can measure counterparty exposure based on a number of metrics, including, net DV01, mark-tomarket, notional or rating.