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Academic Research - February 23, 2011

EDHEC-Risk Institute Research Insights - IPE Supplement

By Noël Amenc, Professor of Finance, EDHEC Business School, and Director, EDHEC-Risk Institute

EDHEC-Risk Institute was pleased to be able to produce a special supplement for Investment & Pensions Europe (IPE) on the occasion of the EDHEC-Risk Institutional Days 2010, which were being held for the first time in Monaco. The event represented a milestone for EDHEC-Risk Institute because it was also the first time that our flagship institutional conference had been organised in conjunction with the IPE Pension Fund Awards, thus providing an exceptional opportunity for the awards ceremony attendees to take advantage of their visit to Monaco in order to bring themselves up-to-date with the latest developments in institutional investment research.

This supplement complements the Global Institutional Investment Conference at the EDHEC-Risk Institutional Days 2010 and aims to provide research-based solutions to some of the key challenges facing institutional investors today.

On of the most prominent of these challenges is to find an appropriate benchmark for institutional investments. As Lionel Martellini points out in his article on alternatives to cap-weighted indices, the latter have become an integral part of the investment process of long-term investors such as pension funds, endowments, and insurance companies, even though convincing empirical evidence from academic research shows that cap-weighted indices provide an inefficient risk/return trade-off. Another key question is whether currently available bond indices are optimal for investors. In their article, Carlos Campani and Felix Goltz review some of the problems with existing corporate bond indices, outline some alternatives that have been proposed and conclude that for investors to embrace indexing of their corporate bond investments, improved index construction solutions need to become a priority for index providers.

In order to be able to bridge the gap between the results of academic research and the practices in the financial industry, it is of course essential to have a clear idea of what exactly the professional practices are. For many years EDHEC-Risk Institute has been conducting industry surveys that lead to publications which include both the results of the survey and the academic background to the survey topic. In his article on a recent survey of European pension funds, advisers, regulators, and fund managers, taken as part of the AXA Investment Managers research chair on “Regulation and Institutional Investment” at EDHEC-Risk Institute, Samuel Sender explains that there are biases that prevent many pension funds from managing their assets optimally. In theory, rule-based risk-controlled investing and discretionary economic capital should lead to the same insurance of risks, but the reliance on discretionary investment policies involves the risk of delays and of behavioural biases that distort the theoretical strategy. We thus recommend more reliance on rule-based strategies even for the management of economic capital and prudential risk-based regulations. Very simple and intuitive methods that require little or no mathematical background can prove to be efficient means of insuring risks.

In their article on integrated asset-liability management, which is based on research carried out as part of the "Asset-Liability Management and Institutional Investment Management" research chair at EDHEC Risk Institute, supported by BNP Paribas Investment Partners, Lionel Martellini and Vincent Milhau look at the impact of pension fund allocation decisions on the wealth of shareholders, bondholders and pensioners. Their model has important policy implications in that it provides a first step towards a much needed methodological framework for the design of firm-specific regulatory constraints and accounting valuation principles. It also has a number of implications in terms of investment decisions at the pension fund level, and funding decisions at the sponsor company level.

In a separate article, Bernd Scherer examines the optimal asset allocation for sovereign wealth funds. Our research in this area is drawn from the research chair on “Asset-Liability Management Techniques for Sovereign Wealth Fund Management” in partnership with Deutsche Bank, which is managed by EDHEC Risk Institute—Asia in Singapore. While outlining the benefits of the asset-liability management approach, Professor Scherer refers to themes that will be of crucial importance in years to come, such as the impact on sovereign funds of resource uncertainty, governance costs, and the macroeconomic leverage of an economy.

Our final contribution focuses on the question of whether private wealth managers will adopt institutional investors’ risk management techniques. A survey conducted with the support of Ortec Finance as part of the “Private ALM” research chair at EDHEC-Risk Institute shows the relevance of customised risk management and asset-liability management techniques to professionals but reveals that while the concepts are useful, there is a lack of well-adapted practical tools available today that would allow the managers to move towards integrating such techniques in their investment process.

We wish you an enjoyable read of the supplement and extend our warmest thanks to IPE for this editorial partnership. As EDHEC-Risk Institute celebrates its 10th anniversary in 2011 we hope to continue to provide academic insights that will genuinely contribute to improving institutional investment practices.