Institute. Yale School of Management EDHEC-Risk Institute Strategic Asset Allocation and Investment Solutions Seminar

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1 Institute Yale School of Management EDHEC-Risk Institute Strategic Asset Allocation and Investment Solutions Seminar November 12-13, 2013, Yale Campus (New Haven, CT) - USA

2 Yale SOM EDHEC-Risk Strategic Asset Allocation and Investment Solutions Seminar Seminar Description The focus of this two-day seminar is to equip participants with practical tools to improve asset allocation and risk management processes, implement novel investment management approaches, and develop new products and solutions. The seminar provides an overview of the main techniques used in the context of strategic and tactical asset allocation decisions, and presents a new paradigm based on framing these decisions in terms of uncorrelated risk factors, as opposed to correlated asset returns. It also discusses how the presence of liability constraints impacts asset allocation decisions, and introduces state-of-the-art asset-liability management (ALM) and liability-driven investment (LDI) techniques. It finally explains how to develop improved forms of dynamic asset allocation strategies such as target-date funds that extend beyond simple deterministic schemes and exploit changes in market conditions, as well as the presence of short-term risk budgets. Key Learning Objectives > Review the state-of-the-art tools for improving strategic, tactical, and dynamic asset allocation decisions. > Learn how to reframe asset allocation decisions as risk-parity factor allocation decisions. > Explore how to harness the latest investment technologies to develop customized products/solutions for clients. > Understand the wide range of strategies for asset-liability management and liability-driven strategies. Detailed Outline Day 1 Morning Session: Roger G. Ibbotson Fundamentals of Asset Allocation It has been shown that asset allocation policy is a key factor in determining portfolio performance, even though the relative impact of the long-term asset allocation policy mix relative to the impact of active performance from timing, security selection or fees has often been grossly over-estimated in the literature. In this context, it is of critical importance for all investors to understand the fundamentals of sound asset allocation decisions. These fundamentals relate to some of the most profound questions in investment such as the exact nature of the riskreturn relationship, the influence of risk factors on security returns, the empirical long-term analysis of risk premia across asset classes, as well as the relative importance of strategic versus tactical asset allocation decisions. This morning session is designed to familiarize investors with strategic asset allocation for both institution and individual portfolios. We develop the risk and return relationships, valuation, diversification, multiple betas, optimization, and portfolio construction. > Calculating present value and returns, valuation and discount rates, compounding and creating historical indexes of stocks, bonds, bills and inflation. Applying risk premiums to estimate discount rates and the cost of capital. > Understanding diversification, alphas and betas. Estimating expected returns and explaining realized returns. Constructing portfolios and using optimization techniques to maximize return while minimizing risk. > Explaining long term returns in stock and bond markets. Comparing the returns from asset allocation policy (strategic asset allocation or smart beta) with the returns from active management (timing and security selection, less fees). What portion of portfolio returns come from asset allocation policy? Why does your portfolio return differ from mine? 2

3 > Risk and Return across the asset classes. Risk and Return payoffs within the stock market. What works best? Can we achieve higher return and lower risk? Should we invest in the more or less popular stocks? Afternoon Session: Lionel Martellini Measuring and Managing Diversification for Policy Portfolios The first-order challenge for most investors is to design a strategic asset allocation benchmark, or policy portfolio, which will allow them to obtain the most diversified, and hence the best rewarded, access to risk premia across various asset classes. In principle, the prescription is straightforward: investors should generate meaningful estimates for risk and return parameters, and maximize risk-adjusted performance. In practice, the situation is made complex by the lack of availability of reliable expected return estimates, so the focus shifts from the goal (max Sharpe ratio) to the mean (well-diversified portfolio). Recent research has highlighted that allocation decisions could be best expressed in terms of rewarded risk factors, as opposed to standard asset class decompositions. Looking through the asset class decomposition level to focus on the underlying factor decomposition level appears to be a perfectly legitimate approach; such ideas can be traced back to standard asset pricing models. The practical implications of this perspective in terms of the design of well-diversified asset allocation decisions are starting to emerge. While the benefits of diversification are intuitively clear, what exactly a well-diversified portfolio is remains a bit ambiguous. This afternoon session will equip participants with an in-depth understanding of the challenges involved in implementing robust asset allocation decisions in the context of the design of a well-diversified portfolio of risky assets. > From asset allocation to risk allocation: asset allocation decisions across asset classes versus portfolio construction decisions within asset classes; allocating to risk factors versus allocating to asset classes; from measurement of factor exposures to passive replication of, and optimal allocation to, factor exposures; consequences for institutional management of this change of paradigm. > Measuring diversification: weight-based versus risk-based measures of diversification; measuring the number of independent bets in asset allocation decisions; turning correlated asset returns into uncorrelated factor returns; pros and cons of using principal component analysis versus minimum linear torsion. > Managing diversification: from naive diversification to scientific diversification; assessing the out-of-sample performance of global minimum asset allocation variance benchmarks, maximum Sharpe ratio asset allocation benchmarks, equal risk contribution asset allocation benchmarks and diversified risk parity asset allocation benchmarks. Day 2 Lionel Martellini Morning Session: Incorporating Long-Term Liability Objectives While diversification is a methodology well-suited to allow investors to efficiently extract risk premia out of performance-seeking assets, it is not the appropriate tool when it comes to protecting long-term liability needs, a challenge which is best addressed by hedging, which is another form of risk management. Asset-liability management is characterized by a dual focus on performance generation through optimal exposure to rewarded risk factors so as to alleviate the burden on contributions versus hedging against unexpected shocks that impact current value of liabilities. The liability-driven investment (LDI) paradigm stipulates that risk and performance are two conflicting objectives that are best managed when managed separately. This approach calls for the design of two separate asset allocation benchmarks, a well-diversified performance-seeking portfolio (PSP) on the one hand, and a liability-hedging portfolio (LHP) that best tracks the liabilities on the other hand. While the LDI paradigm suggests that investor welfare should depend on how good each building block is at delivering what it has been designed for, namely risk-adjusted performance benefits for the PSP, and hedging benefits for LHP, the interaction between performance and hedging motives is also expected to play an important role. 3

4 This morning session will introduce participants to a detailed analysis of the challenges involved in the design of LDI solutions, with a focus not only on matching the interest rate and inflation exposure on the asset and liability sides, but also on aligning the performance-seeking and liability-hedging portfolios for enhanced assetliability management benefits. > A brief history of ALM: cash flow matching, immunization, surplus optimization; fund separation theorem and LDI strategies; performance-seeking portfolio vs. liability-matching portfolio; using derivatives to implement the liability-matching portfolio. > Liability-hedging in the short-run and in the long-run: the trade-off between the short-term perspective, where interest rate risk dominates, and the long-term perspective, where inflation risk dominates; realized versus expected inflation risk; hedging inflation-linked liabilities without inflation-linked bonds; designing long/ short nominal bond portfolio strategies to neutralize the exposure to unexpected changes in expected inflation. > Beyond LDI: from fund separation theorems to fund interaction theorems; performance-seeking portfolios with attractive liability-hedging properties and liability-hedging portfolios with attractive performance properties; increasing the allocation to the performance-seeking portfolio without increases in risk budgets by enhancing its liability-hedging properties; trading-off diversification benefits versus hedging benefits. Afternoon Session: Incorporating Short-Term Risk Constraints Investors preferences include (regulatory or self-imposed) short-term risk constraints in addition to longterm objectives. This is a serious concern which requires the use of a new form of risk management given that managing such risk constraints with diversification is impractical (one can only diversify away specific risk, not systematic risk) and managing them with hedging is prohibitively costly. While lower than those of deterministic strategies, downside risk levels can remain substantial for investment solutions designed to focus on achieving long-term objectives. Introducing a control over downside risk can be done through suitably-designed risk-controlled mechanisms that are specifically engineered so as to reduce the opportunity cost associated with downside protection. Risk insurance is the form of risk management that is suited to allow investors to achieve long-term investment objectives while respecting short-term risk budgets and constraints. This afternoon session will equip participants with an in-depth understanding of the various forms of insurance strategies, and how they can be implemented in an asset allocation context with or without the use of derivatives. > From risk diversification to risk hedging: introducing risk management constraints into asset allocation; defining margin for error as a function of risk aversion; implementing time- and state-dependent asset allocation strategies for risk management; reviewing portfolio insurance strategies: constant proportion portfolio insurance vs. option-based portfolio insurance; understanding risk management techniques based on replication and on derivatives; introducing exotic structures. > Using risk budgets as ingredients in the design of the optimal portfolio strategy; implementing martingale techniques in optimization; taking into account mean reversion in equity returns within the context of a riskcontrolled strategy; incorporating maximum drawdown constraints in product design; minimizing the costs of downside protection and maximizing access to the upside potential. > Designing improved forms of long-term investment strategies for institutional or individual investors: capturing the benefits of mean-reversion in equity returns; including maximum drawdown constraints; introducing goal-oriented strategies; reducing the opportunity cost of downside risk hedging; using improved asset class benchmarks within long-term investment strategies. 4

5 Seminar Instructors Lionel Martellini Professor of Finance, EDHEC Business School, Scientific Director, EDHEC-Risk Institute PhD U.C. Berkeley Lionel Martellini is a specialist in asset allocation, derivatives, fixed income modelling, and alternative investment. He was previously on the faculty of the University of Southern California. He has also held a visiting position at Princeton University. He has served as a consultant to various institutional investors, investment banks, and asset management firms on questions related to risk management, alternative investment strategies, and asset allocation decisions. His research on asset management, portfolio theory, derivatives valuation, fixed income products, and alternative investment has appeared in leading journals, including among many others Financial Analysts Journal, Journal of Derivatives, Journal of Economic Dynamics and Control, Journal of Financial and Quantitative Analysis, Journal of Mathematical Economics, Journal of Portfolio Management, Management Science, and Review of Financial Studies. He was awarded the Inquire Europe First Prize in 2009/2010 for his work. He sits on the editorial boards of various journals including the Journal of Alternative Investments and the Journal of Portfolio Management. Roger G. Ibbotson Professor in the Practice of Finance, Yale SOM PhD University of Chicago Roger G. Ibbotson is Chairman and CIO of Zebra Capital Management, LLC, an equity investment and hedge fund manager. He is founder, advisor and former chairman of Ibbotson Associates, now a Morningstar Company. He has written numerous books and articles including Stocks Bonds Bills and Inflation with Rex Sinquefield (updated annually) which serves as a standard reference for information and capital market returns. Professor Ibbotson conducts research on a broad range of financial topics, including liquidity, investment returns, mutual funds, international markets, portfolio management, and valuation. He has recently published The Equity Risk Premium and Lifetime Financial Advice. He has also co-authored two books with Gary Brinson, Global Investing and Investment Markets. He is a regular contributor and editorial board member to both trade and academic journals. Yale SOM EDHEC-Risk Certificate in Risk and Investment Management Institute Attendance at the Strategic Asset Allocation and Investment Solutions seminar is mandatory to obtain the certificate. For further information on the Yale SOM EDHEC-Risk Certificate in Risk and Investment Management please refer to the certificate brochure. 5

6 Fee and Billing Information Fees Standard rate: USD3,000 CFA Institute Member rate: USD2,250 Early birds available before September 1 st. Fees include instruction, documentation, refreshments at breaks, and lunch. Accommodation is not included. Billing and payment The fee is billed upon registration and must be settled before the seminar begins. Payment can be made by credit card or wire transfer. Transfer or cancellation Transfer of registration to a colleague, upon written notice, is allowed and free of charge. Transfer of registration fees to another Yale SOM - EDHEC-Risk programme must be requested in writing and is subject to the following charges: 45 to 30 days notice: 15% of the tuition fee; 29 to 11 days notice: 30% of the tuition fee; 10 days notice or less: 50% of the tuition fee. Cancellations of confirmed seats must be received in writing and are subject to the following charges: 45 to 30 days notice: 25% of the tuition fee; 29 to 11 days notice: 50% of the tuition fee; 10 days notice or less: 100% of the tuition fee. Schedule A typical programme day lasts from 8:30 am to 5:30 pm and is usually divided into lectures and application cases. The two class sessions in each half-day period are separated by 30-minute refreshment breaks. Lunch is included. Venue Maurice R. Greenberg Conference Center (Yale SOM campus) 391 Prospect Street New Haven, CT Continuing Professional Education Credits EDHEC-Risk Institute is registered with CFA Institute as an Approved Provider of continuing education programs EDHEC-Risk Institute is registered with GARP as an Approved Provider of continuing professional education credits for FRMs and ERPs. Further Information and Registration For further information, please contact Mélanie Ruiz at: yalesom-eri@edhec-risk.com or on: To register, please visit: YaleSOM-ERI_november_2013 6

7 Yale School of Management 135 Prospect Street New Haven, CT Tel.: Institute EDHEC-Risk Institute 393 promenade des Anglais BP Nice Cedex 3 France Tel: +33 (0) EDHEC Risk Institute Europe 10 Fleet Place, Ludgate London EC4M 7RB United Kingdom Tel: EDHEC Risk Institute Asia 1 George Street #07-02 Singapore Tel: EDHEC Risk Institute North America 1230 Avenue of the Americas Rockefeller Center - 7th Floor New York City - NY USA Tel: EDHEC Risk Institute France rue du 4 septembre Paris France Tel: +33 (0)