Asset Allocation and Asset Liability Management

As part of the MSCI Research series on global equity implementation, this paper reviews the active management opportunity in different market segments, and discusses the role of very active mandates across segments in a core-satellite portfolio structure.

Our research based on manager performance data over the last 10 years indicates that there is little evidence that average emerging markets or small cap managers have produced higher or more persistent risk-adjusted returns relative to their developed markets large cap peers. Therefore institutional investors may consider active and passive management as complementary strategies across these different equity segments.

Due to the outperformance of high active risk mandates over the analyzed period, a simulated core-satellite structure across different equity segments achieved a higher information ratio than a combination of low active risk managers. The outperformance of high active risk mandates may reflect links between higher manager skill, higher investment conviction, and/or fewer constraints. Depending on investment beliefs, institutional investors might explore such a core-satellite structure to implement the global equity allocation.

 

Publication: MSCI Research Insight
Authors: NIELSEN Frank, KANG Xiaowei, Fachinotti Giacomo

Defined Contribution (DC) plans are rapidly becoming the primary retirement investment vehicle for a majority of employees across the US and other markets around the globe. Asset allocation for DC plans has to strike a balance between growth and protection assets over the savings lifecycle while protecting the long-term purchasing power of the nest egg. Due to the long duration of retirement investing and various risks associated with it, implementing the right asset allocation has become critical and challenging for DC plans.

The unique Risk Focused methodology presented in this paper aims to address the shortcomings of conventional Target Date Funds experienced during the 2008 financial crisis. The proposed approach addresses the cumulative impact of shortfall, sequence of returns, longevity, and market risks in determining asset allocation at different time horizons. This is accomplished by combining the term structure of risk, return, and covariance of asset classes with an explicit risk budget. The Risk Focused glide path potentially delivers comparable retirement wealth outcomes with enhanced downside protection, lower journey volatility, and attempts to facilitate a smoother journey on the road to retirement. Hence, the caption of the paper, “ Road to Retirement – Bumpy or Smooth, Depends on your Route”.

Publication: MSCI Research Insight
Authors: MSCI Applied Research

The recent financial crisis led many institutional investors to review their asset allocation policies and explore alternative approaches to implementation. MSCI recently held discussions around the world with major pension plans, asset managers, and investment consultants to understand different approaches to implementing equity allocation. Following these consultations, we provide a framework for the implementation of global equity allocation. Our research suggest that global equity mandates, together with dedicated emerging market mandates and small cap mandates, may be emerging as the "new classic" structure for implementing equity allocation.

Publication: MSCI Research Insight
Authors: Fachinotti Giacomo, KANG Xiaowei, NIELSEN Frank

The analysis of a possible positive relationship between economic growth and stock market returns is interesting both theoretically and practically. Investors often wonder if they should assign higher weight to countries with higher economic performance, hoping that economic growth will eventually show up in equity returns. Although this relationship seems quite intuitive, historically long-run stock price growth has fallen short of GDP growth in many countries. In this bulletin, we use long-term equity data to analyze the steps leading from GDP to stock prices, and point out several factors that could explain why GDP growth is diluted before it can reach shareholders.

Publication: MSCI Barra Research Insight
Authors: BENDER Jennifer, LEE Jyh-Huei

This research bulletin is the first in a series covering various aspects of stress testing and scenario analysis. In this paper, we compare and contrast two historical scenarios that may be of current interest given the increasing uncertainty regarding the returns on sovereign fixed income investments. The scenarios we consider here are the 1998 Russian debt crisis and the 1994 US rate hike that followed the savings and loan (S&L) crisis. We put a stylized US pension plan through the stress tests using BarraOne, a risk platform that provides more than 60 preloaded historical scenarios from the 1970s to the present. Each scenario that we consider applies shocks to global market factors for equities, interest rates, credit spreads, FX rates, and commodities. We review the effect of the scenarios on the pension plan, and we discuss possible hedges.

Publication: MSCI Barra Research Bulletin
Authors: BRIAND Remy, MSCI Barra Applied Research , VANNEREM Philippe

In this bulletin, we examine the effects of an alternative global index weighting scheme that weights countries in a regional index by their GDP. This strategy has led  to a superior performance of the MSCI All Country World, MSCI World, and MSCI Emerging Markets GDP Weighted Indices in the past 40 years, when compared to their market capitalization weighted counterparts. We also list possible reasons that could explain this historical outperformance.

Publication: MSCI Barra Research Bulletin
Authors: NAGY Zoltan

Globalization has brought about a major rethinking of the equity investment. Thought leaders in the industry are questioning the merit of the existing equity allocation practices and are increasingly looking towards an integrated global equity investment process. The partitioned domestic/non-domestic approach to equity investing may have been built on the grounds of segmented economies, high levels of foreign investment restrictions, and heavily domestically-focused companies but its validity is being challenged by a changing and more integrated global equity landscape. Traditional arguments supporting a home bias equity allocation are less defensible and certain leading institutional investors are realizing that the segmentation between domestic and international equities at a strategic level is a legacy that may come with important market timing risks and opportunity costs. A more integrated approach to equity investing may be the next stage in the evolution of investment processes and a natural consequence of globalization. A broad and investable global equity benchmark is an integral part of such a process.

Publication: MSCI Barra Research Insight
Authors: Aylur Subramanian Raman, Fachinotti Giacomo, NIELSEN Frank

The relationship between stocks and bonds has important implications for asset allocation and risk diversification. This Research Bulletin examines the recent history of this relationship in the G5 economies. It also uses the multi-asset class platform of the Barra Integrated Model (BIM) to consider some of the possible drivers behind the evolution of this relationship. In addition, it is shown that scenario testing is useful in determining the impact on the stock-bond correlation from possible future scenarios. An inflation surprise accompanied by quicker-than-expected Fed hikes, for instance, would likely imply an increase in the optimal allocation to global equities at the expense of global bonds.

Publication: MSCI Barra Research Bulletin
Authors: MSCI Barra Applied Research

This case study provides an introduction to modeling assets and liabilities for asset owners within BarraOne. We show how to use BarraOne to analyze both assets and liabilities in a shared framework for understanding risk and return. Our example uses zero coupon bond instruments to proxy for liabilities although other proxies may be easily substituted. We illustrate how to analyze the surplus risk of the portfolio focusing on market risk specifically. Other sources of risk—nonmarket or biometric risk—are not addressed here but are discussed.

Publication: MSCI Barra Model Insights
Authors: MSCI Barra

This case study focuses on some of the features that make BarraOne an innovation in risk management technology. We will demonstrate that, with the power of BarraOne, traditional (Barra) risk reporting and flexible reporting can be combined to ensure that sources of portfolio risk are completely consistent with the investment strategy, effectively allocating the risk budget.

Publication:
Authors: THILGES Brad

The challenging aspect of the framework outlined above is the development of reasonable expectations for the results of active management. Active risks appear to be quite stable. Therefore, we have consistently assumed that active risk in each active category equals the median returns-based active risk for the corresponding RogersCasey peer group over the five years ending December 31, 1996. We chose to use this approach in order to generalize by style of management, rather than focusing on specific managers. In practice, when conducting a similar analysis for a specific investment program, it would be more appropriate to use a holdings based plan-wide risk analysis to estimate the portfolio risks. For expected active returns we have conducted three separate analyzes using differing sets of information ratio assumptions described below. Each of these is a reasonable approach although there are other alternatives. One cautionary note would be to avoid using information ratio measures for individual managers based on their historical experience because of the weak evidence of persistence for active managers.

Publication:
Authors: DEMAKIS Drew W.

Publication:
Authors: JENSEN Mathew R., McHALE-FOSSE Tracy, RAMACHANDRAN Narayan

Publication:
Authors: Source: Barra Newsletter

The concept of a normal portfolio is a simple one on the surface. A normal portfolio is simply a portfolio that represents an investment manager's style. However, in practice one  quickly uncovers a number of difficult and subtle issues that make the development of normals a task requiring great care and thought. Many of these issues are a result of the complex, and sometimes contentious, relationship between the owner of funds (the sponsor) and the manager of the funds. This note will examine normal portfolios in the                            context of the sponsor/manager relationship.

Publication:
Authors: MUNRO Joanna

The whole is not the sum of its parts as far as investment risk is concerned. The same diversification of risk that makes portfolio management interesting at the individual manager's level also applies at the aggregate level and makes the management of managers a game that calls for skill and perspective. The message of this paper is that sponsors should look at portfolio risk in the aggregate. An aggregate view makes the cost of aggressiveness for active managers far smaller when viewed in the aggregate than when each manager is viewed in isolation. Multiple managers offer sponsors great diversification benefits; but sponsors need to adapt policy to take advantage of those diversification benefits.

Publication:
Authors: Source: Barra Newsletter