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Investment Management - September 22, 2010

It is imperative to look into new theories that take into account changes in the economic and financial environment - an interview with Xavier Lépine

In this month's interview, Xavier Lépine, chairman of UFG, discusses the recent publication, "From Deterministic to Stochastic Life-Cycle Investing - Implications for the Design of Enhanced Forms of Target Date Funds", drawn from the UFG-LFP research chair at EDHEC-Risk Institute. He also comments on the current environment for both target-date funds and the full range of UFG-LFP's activities.

Xavier Lépine

One of the main conclusions of the recent publication, "From Deterministic to Stochastic Life-Cycle Investing - Implications for the Design of Enhanced Forms of Target Date Funds", drawn from the UFG-LFP research chair at EDHEC-Risk Institute, is that more financial innovation is needed to design improved target-date funds that truly take into account the stochastic nature of the investment opportunity set. Is this a conclusion that you agree with?

Xavier Lépine: Of course. Most target-date funds rely on theories that were formulated in the nineteen-fifties and have these main postulates:

  1. that the time horizon is the essential parameter for such an investment;
  2. that the risky assets (stocks) outperform less risky or risk-free assets (bonds or cash-equivalents) over time;
  3. that the share invested in stocks should be inversely proportional to the investor’s age.

The products designed on this basis and thus on theories of the phenomenon of mean reversion and of the distribution of risk and return following a normal law have been called into question for several years by profound changes in the economic and financial world.

Financial markets have become, at one and the same time, more sophisticated and more global: they are grounded on the same regulations and behavioural rules worldwide, they benefit from fast and heavy flows of information, and so on. All this accentuates their pro-cyclical behaviour, as well as the phenomenon of ever-larger bubbles.

Academic theories formulated in a context of more closed, more autonomous, less highly correlated markets are clearly no longer applicable to the current environment. So that is the goal of the EDHEC-Risk chair: to create more efficient target-date funds, it is imperative to look into new theories that take into account changes in the economic and financial environment and thus a different use of stochastics and the possibility of more numerous assumptions.

Do you think that target-date funds will continue to experience growth as individuals take on increasing responsibility for their own retirement investments, or do you think that some of the recent poor performance will dampen enthusiasm for these funds?

Xavier Lépine: It’s undeniable: in developed countries, in the provision of pensions, above all, governments are acting less and less as “insurers,” simply because they no longer have the means to do so and because globalisation implies “revisited” social competition (see Adam Smith in The Wealth of Nations).

Individuals have no choice but to find a new organisation, sometimes a collective one, to take over from the State in that role. Long-term savings is a major issue for our economies. So the acute need for savings and investment products that make it possible to preserve or maintain purchasing power is clear.

The paper published as part of the first year of the research chair shows that one can, given a reasonable number of cases, and therefore of funds, correctly take into account not only the investment horizon and objective but also the evolution of asset prices and the investors’ risk aversion. Do you think that, both for employee savings and private wealth management, this tailor-made industrial approach could have strong sales potential?

Xavier Lépine: It is true, sadly, that in the last ten years stocks in developed economies have not performed. Nor have target date funds. But that only heightens the relevance of products that make allowances for both assets and liabilities and, more simply, of theoretical asset allocation conceived in keeping with a better definition of the liability.

Manager risk and model risk should take the place of market risk. Models, as it happens, must make allowances for what happens over time, no longer just for time itself, to make progress in asset allocation and to make it through swings in the markets more effectively. In view of the importance of long-term savings to all of our economies, the commercial potential is clearly great.

What is your analysis of the current economic environment for UFG-LFP, notably as far as the property markets are concerned? Do you think that the effects of the financial crisis will continue to be felt for some time?

Xavier Lépine: The effects of the crisis are still being felt. This is so because it is not a mere financial crisis but a crisis of the very structure of the global economy, a crisis of demand linked to changes in the means of production and consumption in a globalised world and to the imbalances that result from it. Although it would be wrong to say that it has been spared these troubles—the real estate market is recovering, but in a way that’s very different from one country to the next, from one region to the next, even from one property to the next!—property is still a real asset that offers highly legible cash flows. These characteristics make real estate an essential component of what target date funds should be: it could easily take the place of a part of the allocation to bonds.

UFG-LFP is a long-standing partner of EDHEC-Risk Institute and has supported its research for several years. What has motivated this corporate patronage?

Xavier Lépine: There is a paradox in finance: those involved, most of whom are highly educated, rely but little on the fruits of their education when it comes to reflecting on their professions as managers. As a result, there is a great need for disinterested and objective academic research. That is certainly the stance of EDHEC-Risk Institute, which does research with an international dimension and manages to strike the proper balance between fundamental and applied research. As the Institute is close to the reality of business as a result of its contacts with asset managers and investors, it always has relevant links to and perspectives on its fields of research. UFG-LFP is delighted to be a part of it.

About Xavier Lépine

Xavier Lépine, Chairman of UFG, has 25 years of experience in the alternative investment field. Prior to joining UFG Group in 1999, he began his career with Société Générale and Banque de l'Union Européenne. He later created FP Consult, an asset management company specialized in emerging markets, and became Chairman of the Board of Fortis Investment Management France. Appointed Vice Chairman and Managing Director of UFG Group in June 2006, he became Chairman of the Group in December 2006. Mr. Lépine holds a DEA in monetary economics and international finance from Dauphine University, Paris.