EDHEC-PRINCETON Institutional Money Management Conference
By Lionel Martellini, Professor of Finance, EDHEC Business School and Scientific Director, EDHEC-Risk Institute
Lionel Martellini
The inaugural EDHEC-PRINCETON Institutional Money Management Conference was held on April 27, 2012, at the Princeton Club in New York. In the face of a number of key changes of paradigms that are currently affecting the investment industry, this one-day conference was intended to provide a selected number of invited investment professionals with the latest academic insights related to new frontiers in institutional money management. The format of the conference was designed to facilitate the exchanges of views between academics and practitioners; it involved presentations by members of the faculty of Princeton University and EDHEC-Risk Institute, followed by a discussion with the audience.
At the outset, in describing EDHEC-Risk Institute’s philosophy, we stressed the importance of shifting from the provision of investment products and towards the provision of investment solutions. The focus of the investment industry should not be on generating investment products based on alpha, but on serving investors’ needs by helping them find solutions to the problems they face, more often than not through access to beta. In this context, the conference focused in the morning on the design of improved building blocks (also known as investment benchmarks) for some popular asset classes (namely, stocks, bonds and commodities) and in the afternoon on the design of improved asset allocation strategies.
In the first presentation of the day, Professor Raman Uppal of EDHEC-Risk Institute presented his research on developing a general framework for equity portfolio construction while showing how to calibrate norm-constrained portfolios and comparing their performance with different strategies and datasets. Turning to fixed-income markets, Professor Frank Fabozzi of EDHEC-Risk Institute looked in the following presentation at four research areas dealing with bond indices: investor duration target and stability of bond indices in relation to investor objectives; the concentration risk problem in bond indices; the stability issue for the average credit riskiness of a bond index and developing a useful measure of credit riskiness for index construction; and liquidity issues in bond index construction. In the last morning presentation, Professor John Mulvey of Princeton University examined the question of long-only and long-short commodity investments in an asset allocation context, and more specifically the role of managed futures and commodity funds and how to protect wealth during turbulent periods. Professor Mulvey discussed the advantages of highly liquid investments – such as in the managed futures domain – for protecting capital and for dynamic asset allocation.
In the opening session of the afternoon, I analysed the challenge of long-term investing with short-term constraints, a question that we have been examining closely in recent years, notably within the “Asset-Liability Management and Institutional Investment Management” research chair at EDHEC-Risk Institute supported by BNP Paribas Investment Partners. We argue that new forms of investment solutions should rely on the use of improved performance-seeking and liability-hedging building-block portfolios, as well as on the use of improved dynamic allocation strategies that explicitly take short-term risk budgets as inputs. It is only by putting the pieces of the puzzle together, and by combining the underlying sources of expertise and added value that the asset management industry will satisfactorily address investors' needs.
Professor René Garcia of EDHEC-Risk Institute then looked at asset allocation decisions in the presence of regime switches. His research results show that regime-switching models are able to characterise well the joint distribution of financial asset returns and that the presence of regimes to capture the distribution of asset returns has important consequences for asset allocation. Effects vary according to the regime and the investment horizon. The share invested in stocks may decrease with the horizon contrary to a linear model with predictability and mean reversion. Predictability changes asset allocation even with regimes, especially at long horizons.
Professor Jakub Jurek of Princeton University addressed the question of downside risk and alternative investments. His three key conclusions were that hedge fund returns exhibit downside risk exposure, passive downside risk exposure dominates active risk exposure, and endowments have barely covered their cost of capital. In other words, hurdle rates for investments with downside risk are significantly higher than suggested by linear models and are highly sensitive to portfolio composition and market volatility.
Finally, Professor Yacine Aït-Sahalia of Princeton University gave a presentation on asset allocation and risk management in a world where all asset classes can fail together. His conclusion was that jumps are needed to properly account for the risk in portfolio management, but that among jumps, one cannot stick to the simplest ones (Poisson) – self-exciting jumps are needed to provide a realistic description of turbulent times and consequently optimise a portfolio and conduct risk management.
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Lionel Martellini, Professor of Finance, EDHEC-Risk Institute, and Visiting Fellow, ORFE Department, Princeton University
Yacine Aït-Sahalia, Professor of Economics and Finance, Department of Economics, Princeton University, Director of the Bendheim Center for Finance, Princeton University
Morning session: Advances in investment benchmarks
New frontiers in equity investments: Equity portfolio construction using better constraints
Raman Uppal, Professor of Finance, EDHEC-Risk Institute
Related research papers
Optimal Versus Naive Diversification: How Inefficient is the 1/N Portfolio Strategy?
Frank J. Fabozzi, Professor of Finance, EDHEC-Risk Institute and Visiting Fellow, ORFE Department, Princeton University
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EDHEC-Risk European Index Survey 2011
John Mulvey, Professor of Operations Research and Financial Engineering, ORFE Department, Princeton University
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The Role of Managed Futures and Commodity Funds: Protecting Wealth during Turbulent Periods
Afternoon session: Advances in asset allocation strategies
Long-term investing in the presence of short-term constraints
Lionel Martellini, Professor of Finance, EDHEC-Risk Institute, and Visiting Fellow, ORFE Department, Princeton University
Related research paper
Dynamic Allocation Decisions in the Presence of Funding Ratio Constraints
Asset allocation decisions in the presence of regime switches
René Garcia, Professor of Finance, EDHEC-Risk Institute
Downside risk and alternative investments
Jakub Jurek, Assistant Professor of Economics and Finance, Department of Economics and Bendheim Center for Finance, Princeton University
Related research paper
The Cost of Capital for Alternative Investments
Asset allocation and risk management in a world where all asset classes can fail together
Yacine Aït-Sahalia, Professor of Economics and Finance, Department of Economics, Princeton University, Director of the Bendheim Center for Finance, Princeton University
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