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Institutional Investment - June 25, 2008

New investor solutions are coming - interview with NoŽl Amenc

This month's interview with NoŽl Amenc, PhD, Professor of Finance at EDHEC Business School and Director of the EDHEC Risk and Asset Management Research Centre, is featured in a special supplement that was drawn up by the French financial daily AGEFI on the occasion of the EDHEC Institutional Days in Paris.


NoŽl Amenc

The full report (in French), with additional details on the topics discussed here, can be found online on the AGEFI website here.

In the interview, NoŽl Amenc, PhD, Professor of Finance at EDHEC Business School and Director of the EDHEC Risk and Asset Management Research Centre, discusses EDHEC's recent research results in the areas of Liability-Driven Investment, core-satellite allocation and ETFs.

Have LDI (liability-driven investment) strategies been expanding in the European institutional world?

NoŽl Amenc: This approach, which involves offering ďexternalisedĒ solutions to hedging liabilities, is gaining in popularity.† It developed initially within small institutions in the U.K. and northern Europe dealing with bond funds, enabling them to deal with the duration of liabilities of less sophisticated investors lacking internal actuarial expertise. More sophisticated uses of LDI, based on the separation theorem formalised by Prof. Martellini, proposed to separate liability-hedging from performance-seeking by relying on derivatives for the former. Also in this context, investment banks set up engineering units to compete with asset managers in this market. However, over recent months and as a result of the financial crisis, institutional investors have become more hesitant about OTC derivatives for such long periods. It is thus likely that LDI solutions based on ďcashĒ instruments will return, in force, to the market.

What are the latest LDI research findings?

NoŽl Amenc: We will see a second-generation of LDI productsóreferred to as dynamic LDI, because they are based on a contingent allocation between the liability-hedging portfolio and the performance-seeking portfolio. In another innovation, liabilities will no longer be hedged systematically through instruments that correlate perfectly with them but are expensive due to their low returns. They will be replaced by imperfect hedging portfolios composed of more profitable real assets (e.g., equities, property and infrastructure) that offer attractive statistical properties on a longer-term horizon, and whose combination is seen to offer a satisfactory hedge.

Given the context, how is a core-satellite strategy developed?

NoŽl Amenc: It is in the interest of both clients and managers for their portfolios to separate management of absolute risk (core) from that of relative risk and the risk of outperformance. This organisation should also structure the operations of management companies. It makes little sense to still see extensive product ranges accompanied by messages from management companies claiming to have specialists in every asset class, management style and geographic area. It is impossible to be successful at everything, so it is often better to create many ďpassive investment coreĒ portfolios that communicate the choice of risk for the funds offered to investors and, on the other hand,† focus managers on a small number of satellite portfolios in which they†excel and then carry the alpha created over to all funds.

Is the ETF market developing appropriately?

NoŽl Amenc: ETFs (exchange-traded funds) are now as likely to be index funds, or even structured products, as actively-managed funds. The business potential in these various market segments is enormous. For index funds, whose goal is to deliver inexpensive betas (market performance) on increasing numbers of asset classes, the challenge in the coming years will be to choose betas for replication. This choice already structures ETF providersí offerings. For example, investors know that cap-weighted stock indices are inefficient and do not offer the best representation of the market risk premium. Some alternatives, like indices based on financial analysis, represent progress, but it is still possible to improve by relying on more than 50 years of portfolio construction research. The ETF market is very competitive and its participants must find new ideas and new kinds of indices and renew their offerings. The question is also relevant to index suppliers, who cannot simply rely on their brand to guarantee the quality of their indices.



About NoŽl Amenc

NoŽl Amenc is professor of finance and director of research and development at EDHEC Business School, where he heads the Risk and Asset Management Research Centre. He has a masters degree in economics and a PhD in finance and has conducted active research in the fields of quantitative equity management, portfolio performance analysis, and active asset allocation, resulting in numerous academic and practitioner articles and books. He is associate editor of the Journal of Alternative Investments and a member of the scientific advisory council of the AMF (French financial regulatory authority).