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ALM and Asset Allocation Solutions

The Rothschild & Cie "The Case for Inflation-Linked Corporate Bonds: Issuers’ and Investors’ Perspectives" Research Chair

Inflation-linked securities are a relatively recent innovation in the debt markets that began with the introduction of Treasury Inflation-Protected Securities (TIPS), first for sovereign states and then for corporations, with the first inflation-linked corporate notes offered in 2003 in the US. While a dominant fraction of inflation-linked debt is issued by sovereign states, there has been a recent interest amongst various state-owned agencies, municipalities but also corporations, in particular utility or financial-services companies, to issue inflation-linked bonds.

On the supply side, it is perhaps surprising that some large corporations and municipalities are still sitting on the sidelines, since the intuition suggests that if a firm's or a municipality’s revenues tend to grow with inflation, then having some inflation-linked issuance can be a natural hedge. On the demand side, a strong interest is also expected as inflation hedging has become a concern of critical importance for pension funds with inflation-linked liabilities, but also for private investors, who consider inflation as a direct threat with respect to the protection of their purchasing power.

The purpose of the Rothschild & Cie "The Case for Inflation-Linked Corporate Bonds: Issuers’ and Investors’ Perspectives" Research Chair, under the leadership of Lionel Martellini, scientific director, of EDHEC-Risk Institute, is to support research undertaken at EDHEC-Risk on the benefits of inflation-linked corporate bonds from the issuers’ perspective as well as from the investors’ perspective. The research chair also focuses on comparing and contrasting issuers’ and investors’ perceptions of inflation-linked corporate bonds.

The chair will be overseen by a joint Rothschild & Cie/EDHEC-Risk Institute steering committee.

The first project undertaken as part of the chair will be to examine the role of inflation-linked corporate bonds in optimal liability management decisions.

[Press release announcing the launch of the research chair: 03/06/10]

Research output:

Analysing and Decomposing the Sources of Added-Value of Corporate Bonds Within Institutional Investors’ Portfolios
August 2013
Lionel Martellini, Vincent Milhau
This paper provides a formal analysis of the benefits of corporate bonds in investors’ portfolios, distinguishing between the impact of introducing them in performance-seeking portfolios and the impact of introducing them in liability-hedging portfolios. It shows that investor welfare can be improved by the design of performance-seeking portfolios with improved liability-hedging properties, or conversely by the design of liability-hedging portfolios with improved performance properties. [Press release announcing the publication of the research: 24/09/13]

The Benefits of Sovereign, Municipal and Corporate Inflation-Linked Bonds in Long-Term Investment Decisions
April 2013
Romain Deguest, Lionel Martellini, Vincent Milhau
This paper proposes an empirical analysis of the opportunity gains involved in investing in inflation-linked bonds for long-term investors facing inflation-linked liabilities. Using formal intertemporal spanning tests, it finds that substantial welfare gains are obtained, especially over long-horizons. Introducing inflation-linked bonds allows investors to improve investor welfare because of their hedging and performance benefits; hence investors may attain the same welfare (risk-return trade-off) with a lower initial investment when inflation-linked bonds are available compared to investing in stocks and nominal bonds only. Even more substantial utility gains are obtained in situations where the regulatory value for investors’ liabilities contains a credit risk adjustment.

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks”
May 2012
Noël Amenc, Felix Goltz, Vincent Milhau, Masayoshi Mukai
EDHEC-Risk Institute has conducted extensive research into advanced debt management practices, including a study on the possibility of increasing firm value through the issuance of an optimal level of inflation-linked bonds, which would allow for a reduction in the variability of cash flows, net of debt costs. Supplementing the research documented in the EDHEC-Risk publication “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks”, a call for reaction was issued seeking assessment of the study’s key conclusions. A bifurcated survey, with two separate sets of questionnaires, was issued to institutional investors and members of corporate finance departments – the two parties most qualified to provide professional insight. The results indicate that the topic is perceived as highly relevant to current investor concerns and issuers of corporate debt; moreover, they suggest that the issuance of inflation-linked bonds may provide a solution to both parties’ exposure to inflation risk.

[Press release announcing the publication of the research: 26/06/12]

Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks
March 2011
Lionel Martellini, Vincent Milhau
This paper provides a joint quantitative analysis of capital structure decisions and debt structure decisions within a standard continuous-time capital-structure model. In the presence of interest rate and inflation risks, we are able to obtain quasi-closed form expressions for the price of various forms of indexed- and non-indexed bonds issued by the firm, which allows us to generate computationally efficient estimates for the optimal debt structure. Our analysis shows that debt-structure decisions have a strong impact on capital structure decisions. It also suggests that substantial increases in firm value can be generated by optimal debt structures.

[Press release announcing the publication of the research: 11/05/11]

Related articles:

Inflation-linked debt offers useful inflation hedge
August 2011
Lionel Martellini, Vincent Milhau
"(...) In a recent paper supported by Rothschild & Cie, we propose a formal analysis of a company’s debt management decisions. We take it that the company is subject to default risk and can employ various debt instruments, including fixed-rate, floating-rate, and inflation-linked debt. We argue the main motive behind debt management is not to reduce the cost of debt financing, but instead to hedge interest rate and inflation risk exposures. This approach, which is based on matching the company’s financing with the exposure of its activities to interest rate and inflation risk, constitutes a transposition of the well-known technique in institutional financial management called asset-liability management. (...)"

Related events:

How to Improve Corporate Debt Programmes with Inflation Linked Corporate Bonds
Paris – 3 May, 2011

Recent research carried out as part of the Rothschild & Cie ‘‘The Case for Inflation-Linked Corporate Bonds: Issuers’ and Investors’ Perspectives’’ research chair at EDHEC-Risk Institute introduces a general framework with which a corporation subject to default risk may make optimal debt-management decisions. It attempts to answer the following question: given an exogenous revenue process for a corporation, what is the optimal liability structure when the issuer faces such instruments as fixed-rate debt, floating-rate debt, and inflation-linked debt?

At a special presentation in Paris on May 3 and in London on May 4, Lionel Martellini, PhD, Scientific Director at EDHEC-Risk Institute, will detail the recent EDHEC-Risk research on this matter. The main contribution of this research is to provide a joint quantitative analysis of capital-structure decisions and debt structure decisions within a standard continuous-time model in the presence of interest-rate and inflation risks.

The main findings are that debt management has an impact on capital structure and that an optimal debt structure can facilitate substantial increases in firm value. The research finds that a number of corporations would benefit from issuing inflation-linked bonds, bonds usually associated with sovereign states.

The Paris seminar programme is available here.

For further information, please contact severine.anjubault@edhec-risk.com.

About Rothschild & Cie

Rothschild has been involved in investment banking since its beginning over two hundred years ago when Rothschild businesses were established in the principal cities of Europe at the end of the 18th century. Today, the Rothschild Group is one of the world’s leading financial advisory and asset management organisations which is family controlled and independent. It has an established network of offices around the world with more than 2000 people in over 40 countries (including the USA, UK, France, Switzerland, Singapore, China,…).

Rothschild Global Financial Advisory is involved in providing impartial and expert M&A and strategic advice as well as financing and restructuring advice across the range of equity and debt capital markets. Rothschild & Cie Gestion is the asset management arm of the Rothschild Group in France.

Rothschild & Cie Gestion manages EUR 22bn in assets and offers a diversified product range, with expertises in equities (focusing on European equities), bonds (including govies, Euro credit and European convertibles), balanced management, and long-only as well as alternative multi-management.


Website: www.rothschild.com/IAM/