Reactions to the EDHEC Study Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks

Transcription

1 An EDHEC-Risk Institute Publication Reactions to the EDHEC Study Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks May 2012 with the support of Institute

2 2 Printed in France, May Copyright EDHEC The opinions expressed in this study are those of the author and do not necessarily reflect those of EDHEC Business School. The author can be contacted at

3 Table of Contents 1. Introduction Background and Methodology Survey Results Conclusion...21 References...23 About Rothschild & Cie...27 About EDHEC-Risk Institute...29 EDHEC-Risk Institute Publications and Position Papers ( )...33 An EDHEC-Risk Institute Publication 3

4 About the Authors Noël Amenc is Professor of Finance and Director of EDHEC-Risk Institute. He has a master's degree in economics and a PhD in finance and has conducted active research in the fields of quantitative equity management, portfolio performance analysis, and active asset allocation, resulting in numerous academic and practitioner articles and books. He is a member of the editorial board of the Journal of Portfolio Management, associate editor of the Journal of Alternative Investments and a member of the scientific advisory council of the AMF (the French financial regulatory authority). Felix Goltz is Head of applied research at EDHEC-Risk Institute. He carries out research in empirical finance and asset allocation, with a focus on alternative investments and indexing strategies. His work has appeared in various international academic and practitioner journals and handbooks. He obtained a PhD in finance from the University of Nice Sophia-Antipolis after studying economics and business administration at the University of Bayreuth and EDHEC Business School. Vincent Milhau holds master's degrees in statistics (ENSAE) and financial mathematics (Université Paris VII), as well as a PhD in finance (Université de Nice-Sophia Antipolis). In 2006, he joined EDHEC-Risk Institute, where he is deputy scientific director. His research focus is on portfolio selection problems and continuous-time asset-pricing models. Masayoshi Mukai is an analyst at EDHEC-Risk Indices and Benchmarks. He attended college at the University of California at Berkeley, where he graduated with high honors and was a Regents and Chancellor s scholar. He also holds an MPhil in Management from the University of Cambridge, Judge Business School and is a member of Girton College. His research interests are in the area of equity and fixed income indexing innovation. 4 An EDHEC-Risk Institute Publication

5 Introduction An EDHEC-Risk Institute Publication 5

6 Introduction EDHEC-Risk Institute has conducted extensive research into advanced debt management practices, including a study on the possibility of increasing firm value through the issuance of an optimal level of inflation-linked bonds, which would allow for a reduction in the variability of cash flows, net of debt costs. Supplementing the research documented in the EDHEC- Risk publication Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks, a call for reaction was issued seeking assessment of the study s key conclusions. A bifurcated survey, with two separate sets of questionnaires, was issued to institutional investors and members of corporate finance departments the two parties most qualified to provide professional insight. The results indicate that the topic is perceived as highly relevant to current investor concerns and issuers of corporate debt; moreover, they suggest that the issuance of inflationlinked bonds may provide a solution to both parties exposure to inflation risk. 6 An EDHEC-Risk Institute Publication

7 2. Background and Methodology An EDHEC-Risk Institute Publication 7

8 2. Background and Methodology 1 - Each of these methods has unique risks and drawbacks, and there is generally a trade-off between accuracy and cost. For example, inflation swaps (ignoring counterparty risk) are a direct hedge, however, they may be prohibitively costly. TIPS similarly have low returns. Ang et al. (2011) have studied the relationship between specific stocks and inflation, while others have found that, generally, equities are negatively correlated with inflation in the short-term, but positively correlated over longer horizons. Thus, equities, as well as real estate and commodities have been identified as inflation hedges, albeit imperfect ones (see e.g. Amenc et al. 2009). 2 - For example, in March 2012, US TIPS were sold with record negative yields (see e.g. Eddings 2012). 3 - Strong investor demand for inflation-linked corporate bonds is reflected in the sell-out of Tesco s recently issued (Dec. 2011) inflationlinked bond offering (see Hyde 2011). 4 - See e.g. Inderst (2010) who finds that infrastructure companies, as well as utilities (which sometimes have regulated price increases tied to inflation indices) have inflation-linked cash flows. 5 - As mentioned, utility and infrastructure companies have been known to have revenues strongly correlated to inflation, while, for example, others have noted a negative correlation between inflation and the revenues of banking companies (which hold high amounts of financial assets; see Boyd et al. 2001) Background: The case for inflation-linked corporate bonds Inflation risk has been a growing concern for all investors while for some, such as pension funds which have liabilities directly tied to an inflation index, inflation hedging has always been of critical importance. The assets used by investors to hedge inflation risk typically include sovereign inflation-linked bonds, such as U.S. Treasury Inflation Protected Securities (TIPS), inflation swaps, equities, and commodities. 1 Sovereign bonds tied to an inflation index, however, have lost some of their appeal to investors. In particular, the low returns of these bonds 2 coupled with rising uncertainty of sovereign issuers credit-worthiness have contributed to an environment where inflation-linked bonds issued by corporations may emerge as an appropriate substitute for sovereign inflation-linked bonds. 3 Many institutional investors, while they often have fixed liabilities, are free to choose in terms of defining their asset allocation. Conversely, the assets of corporations which issue bonds for financing are relatively fixed, while they have the opportunity to adjust their liabilities through various forms of debt-issuances, including inflationlinked bonds which are typically tied to an inflation index such as the CPI, and floating rate bonds which are tied to the evolving level of interest rates. Firms with high correlation between their cash flows and inflation can effectively hedge the inflation risk inherent in their cash flows by issuing inflation-linked debt. For example, it is often argued that firms in the utility sector 4 have revenues which increase with inflation, thus offering natural compensation for an obligation to pay inflation-linked coupons on bonds issued. This same type of debt can be used by investors to hedge inflationbased liabilities. Furthermore, corporate bonds share a credit risk component with corporate liabilities (particularly pension liabilities), making them a more natural liability hedge than sovereign bonds (Scherer 2006). Thus inflation-linked corporate bonds potentially provide a means to reduce the risk of certain issuers while simultaneously reducing the risk of investors. Despite the fact that levels of correlation of corporate cash flows with inflation vary widely across companies, 5 corporate debt issuances are nearly uniform in their treatment of inflation risk with most of them refraining from issuing inflationlinked debt. As a consequence, the market for inflation-linked corporate debt is not well developed. For the UK, Leaviss (2010) estimates the outstanding amount of inflation-linked corporate debt at $11 billion, compared to a total market of $342 billion for corporate bonds. Another illustration of the scarcity of inflationlinked corporate bonds is that amongst the 94 corporate bonds available from the retail bonds outlet of the London Stock Exchange, there are only two inflationlinked bonds. The lack of development of the corporate inflation-linked debt market in practice, has a parallel in the academic literature which has relatively little to say on how to optimally choose as an issuer between different types of debt (e.g. inflation-linked versus nominal debt). The academic literature on debt-management 8 An EDHEC-Risk Institute Publication

9 2. Background and Methodology 6 - Leland (1994), Leland and Toft (1996) and Ju and Ou-Yang (2006) all examined capital structure theory assuming fixed-rate debt. 7 - For some extreme parameter values we found that an optimal level required a negative position (which could be obtained through derivative-based tools). and capital structure has studied the idea of an optimal capital structure (i.e. the decision of how to split the firm s sources of financing between equity and debt), however, these models of optimal capital structure typically assume fixedrate bonds, 6 and thus ignore the possible choices among different types of debt. In particular, such a narrow focus on debt-versus-equity financing ignores the impact of hedgeable risk factors originating from firm assets and how they could be mitigated through an optimal use of different types of debt. A recent EDHEC-Risk Institute paper titled Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks has examined optimal debt structures of corporate issuers who have the option to issue different types of debt. Rather than focusing solely on the decision to use debt-versus-equity for financing, the paper studies the optimal choice among different types of debt, looking at floating-rate and inflation-linked bonds in particular. The study considers how such elements of the debt structure would help to hedge inflation and interest rate risks that are present on the asset side. As a premise, the paper assumed that the objective pursued by optimising debt structure is to maximise firm value, as opposed to decreasing the average cost of debt servicing or to make it less volatile. A prominent finding was that hedging the risk factors that impact the asset (even partially), led to lower variability of cash flows, net of debt costs, thus decreasing the chance of default and consequently maximising firm value. Moreover, the leverage ratio that is attained with an optimal mix of fixed-rate debt, floatingrate and possibly inflation-indexed bonds is shown to be higher than that attained with nominal bonds only. In other words, optimising debt structure enables the firm to take on more debt, which shows that optimal capital structure depends on the chosen debt structure. The study clearly shows that the correlation between asset values and interest rates, and the correlation between asset values and inflation, will influence the optimal mix of fixed-rate debt, floating-rate debt and inflationlinked debt. 7 In particular, higher levels of correlation of asset value with inflation should incite the issuer to offer less fixed-rate debt and more inflation-linked debt. Different levels of correlation also produced different levels of increases to firm value, with higher absolute values of correlation resulting in a larger increase, and higher positive correlation resulting in the largest increase, as depicted in the following table taken from the study. Table 1. Depicts the benefit of adopting an optimal debt structure which includes inflation-linked bonds across firms with different levels of correlation between firm risk and inflation risk Correlation between firm's risk and inflation risk Relative increase in firm value from optimising debt structure % 10.8% 45.4% Proper interpretation of these results requires analysing firm risk within the context of firm-wide cash flows and firm-wide uncertainty. Traditional debt management strategy has established the clear goal of liability minimisation. Employing such a narrow focus on the cost of debt has led to the standard conclusion that variable rate bonds are An EDHEC-Risk Institute Publication 9

10 2. Background and Methodology simply a tool to pursue active views on future inflation or interest rates. If a firm focuses on liabilities in isolation, issuing debt which increases variability of debt costs is naturally contrary to the goal of minimising and stabilising liabilities. The overall goal of a corporate issuer, however, is to maximise total firm value, while evaluating liabilities within its own confined framework ignores the impact of factors affecting the entire firm. Particularly for firms with revenue highly sensitive to interest rates or inflation (e.g. as depicted in Table 1), evaluating debt with the goal of simple cost reduction can have substantial effects on total firm value, as these tractable risk factors impact cash flows from assets and liabilities. Thus, a clear distinction can be made between a pure liability strategy which segregates liabilities from firm-wide risk factors, and one which integrates assets and liabilities into a single coordinated framework. Parallel to a corporate issuer s integrated asset-liability management strategy is an investor s framework which evaluates asset allocation within the context of its liabilities. With regard to both issuers and investors, employing a strategy constrained strictly to either assets or liabilities limits the ability to hedge firmwide risks. The adoption of inflation-linked bonds as either an investment or a form of issued debt has distinct effects on investors and issuers, as described in the following table. The EDHEC-Risk study produces a strong theoretical argument that issuance of inflation-linked bonds could be of mutual benefit to both corporations and investors. Current practices, however, are in disaccord with this finding, with relatively few firms issuing inflationlinked bonds. Thus, it was important to isolate the perspective of key stakeholders on our conclusions and to identify any practical barriers to the development of the corporate bond market. Our analysis of the professional perspective was meant to be comprehensive and precise; accordingly, two separate questionnaires were issued to corporate finance departments and institutional investors, with questions tailored to their unique concerns. Table 2 Issuer Investor Pure Liability (or Asset) Focus-Use of fixed-rate debt - Fixed-rate debt allows for reduced risk from a pure debt-management perspective (i.e. it minimises uncertainty/variability of debt-servicing cost). - If the investor s focus is on nominal return, standard fixed debt has a certain cost (ignoring credit risk). Integrated Asset-Liability Focus-Use of inflation-linked debt - Reduces risk from an asset-liability management perspective; reduces variability of firm-wide cash flows, net of debt payments, thus reducing chance of default and as a result, maximising firm value - Allows for inflation risk matching of assets and liabilities - Perfect inflation hedge; possibility of directly matching liabilities tied to same inflation index. - If liabilities are linked to inflation, then inflationlinked corporate bonds are a way to create a safe asset liability-hedging portfolio (LHP). - In particular corporate bonds may be more reasonable than sovereign bonds when hedging corporate pension fund liabilities (Scherer 2006). 10 An EDHEC-Risk Institute Publication

11 2. Background and Methodology 8 - No single company classification received more than one response, other than Energy Company, with two respondents identified Methodology As our paper examined an issue that is relevant to both issuers and investors of debt instruments, it was important to identify the nuances of the views held by the two parties. Our questionnaire was designed to gain thorough insight on matters distinct to each group, as well as contrast their assessment of issues relevant to both. Widespread agreement with the fundamental propositions made by this research would warrant a re-examination of standard debt-management practices. Additionally, we wanted to envision how inflation-linked bonds would be received by those closest to the topic in practice. For questions assessing agreement with key propositions, a numerical scale was employed to help produce a more meaningful analysis of the magnitude of agreement. Beginning in May 2011, we sent out online questionnaires to parties classified as either institutional investors or members of corporate finance departments. We received responses from 25 issuers and 21 investors, the large majority of which (82.6%) were from Western Europe. Our paper discusses theoretical propositions which have yet to reach the realm of practice; therefore, the primary goal of our survey was to gain qualitative and exploratory insight, as opposed to establishing representative views. Thus, our survey does not reflect the fair and true opinions of the average professional. Furthermore, our survey, as it queried specialised issues, was likely exposed to self-selection bias, and may have attracted responses from those with above average interest and knowledge on the topic. Investors Close to 40% of the respondents to the investor survey were members of pension funds, while the remaining respondents were investment professionals in a variety of other capacities. Figure 1. Investors company type Issuers Nearly half (48%) of the respondents from corporate finance departments were from France, while 36% of respondents were from Northern or Western European countries. Respondents came from a wide variety of corporations. 8 Figure 2. Issuers company type An EDHEC-Risk Institute Publication 11

12 2. Background and Methodology 12 An EDHEC-Risk Institute Publication

13 3. Survey Results An EDHEC-Risk Institute Publication 13

14 3. Survey Results 3.1 Initial question about relevance and timeliness of topic Both parties nearly uniformly confirm that the topic is timely and relevant. 87% of all respondents and 100% of issuers responded positively to the first question. Such an overwhelmingly positive response indicates that the topic is not only of theoretical interest, but also fills an apparent void of research that is applicable in practice. Figure 3. Do you think that the optimal design of corporate market debt programmes in the presence of interest rates and inflation risks is a relevant topic for research at the present time? may in fact lead to a high correlation between a firm s liabilities and its asset values, thus reducing the variability of net cash flows and, as a result, the probability of default. These questions, therefore, prompt a re-examination of the definition of risk within the context of debt-management and they assess recognition of the natural hedging ability of inflation-linked debt. Figure 4. The study affirms that issuing floating-rate bonds or inflation-linked bonds may increase risk from the perspective of pure debt management, but may decrease risk from the perspective of integrated asset/liability management. Does this affirmation seem reasonable? (Issuers) Figure 5. The study states that a number of corporations would benefit from issuing inflation-linked bonds and that if a firm's revenues grow with inflation, issuing some inflation-linked debt can be a natural hedge. Do you agree? (One of three questions asked to both parties) 3.2 Key Issues We then questioned respondents with regard to our conclusion that the issuance of inflation-linked bonds may increase risk from a pure liability perspective, but decrease risk from an integrated assetliability management perspective; and whether inflation-linked debt would perform as a natural hedge. Given an identifiable level of correlation between a firm s asset values and inflation, a riskier debt structure (one which increases uncertainty of debt payments) We received very strong responses affirming that inflation-linked bonds had risk-decreasing attributes in the relevant context, while both issuers and investors 14 An EDHEC-Risk Institute Publication

15 3. Survey Results 9 - Pimco s Bill Gross noted in 2010 that some corporate debt is now looking safer than some sovereigns. According to the Mergent FISD database there are at least nine European private issuers with bonds rated AAA or aaa. As of March 2012, Standard and Poor s rates only 10 European countries sovereign debt as AAA, including low-volume issuers Lichtenstein and Luxembourg (data taken from www. standardandpoors.com). expressed substantial agreement about the natural hedging properties of inflationlinked debt, indicating that there is consensus across relevant parties. We then questioned issuers assessment of our conclusion that inflation-linked debt can decrease the probability of bankruptcy and consequently increase firm value. Corporate debt has taken on a newfound prominence in light of the sovereign debt crisis 9 and inflation and interest rate risk are key risk factors. However, there is a remarkable absence of a viable framework for a corporation to determine an optimal liability structure. Our proposed framework relies on a state-of-the-art continuous-time model; this question seeks assessment of our application of the model and the assumptions which facilitate it. Figure 6. Do you agree that issuing inflation-linked bonds substantially increases firm value through a better hedging of inflation risk exposure within the firm's revenues, which in turn decreases the probability of bankruptcy, one of the major conclusions of EDHEC-Risk's research? (Issuers) Again, there was substantial agreement, with a full quarter of respondents strongly agreeing and no respondents in disagreement of what is arguably the key conclusion of our research on the topic. 3.3 Perceived prospects of a liquid market We posed a straightforward query to both parties about whether the theoretical paper by EDHEC-Risk has the potential to enable the development of a highly liquid market for inflation-linked corporate bonds. Figure 7. Do you think that the results of this type of research could enable a liquid market for very long-term corporate debt to be created as a result of interest from institutional investors in the emergence of new inflation-hedging instruments? There were remarkably similar responses from both parties. Over half of respondents acknowledge the prospects for the development of a liquid market resulting from interest generated from institutional investors. While there was a lower level of agreement than with previous questions regarding fundamental issues, the prospects of liquidity involve many complex factors including market microstructure effects, possibly explaining the quarter of respondents having no opinion. 3.4 Issuers Interest in Offering Inflation-Linked bonds Our final question to issuers asked whether or not they thought inflation-linked debt could be of interest to their company. This question served the purpose of a straightforward query to the most relevant parties of whether or not their firms would An EDHEC-Risk Institute Publication 15

16 3. Survey Results 10 - It is important to note that some regions and currencies where inflation is rampant may have the strongest need for inflationlinked debt programs. be likely to issue inflation-linked bonds. It would also be very important to contrast the responses with the rest of the issuer questionnaire to highlight any unapparent issues or sources of hesitation (e.g. if the respondents otherwise recognised the benefits of inflation-linked debt, but noted that their firm was unlikely to issue any, it would indicate that there were other issues that need to be addressed). Figure 8. Do you think that issuance of this kind of debt could be of interest to your own company? (Issuers) Viewing the results within the context of current practices in contrast to the very small proportion of corporations that issue inflation-linked bonds nearly a third of respondents state that this type of debt could be of interest, indicating that there may be an increase in the issuance of corporate inflation-linked bonds in the future Qualitative insight from respondent comments: The 40% of respondents who answered No is in sharp contrast to the strong responses in agreement with the theoretical basis for inflation-linked bonds (e.g. 84% of respondents who agreed that issuing inflation-linked bonds may decrease risk from an ALM perspective, and 75% of respondents who agreed or strongly agreed that issuing inflationlinked bonds would substantially increase firm value). As the discrepancy may be attributed to respondent-specific issues such as internal bureaucratic barriers or a unique negative correlation between revenues and inflation, a comment section was included to provide respondents an opportunity to express any individualised concerns. Of the 10 respondents who stated that their company would be unlikely to issue inflation-linked debt, four provided explanations. Two respondents stated that their business activities were uniquely inappropriate for inflation-linked bonds; one of these two firms had revenues negatively correlated with inflation and a prohibitively small debt-program, while the other had an optimal structure which included no debt. One respondent notably stated that they had revenues in multiple currencies, making it too difficult to predict their net inflation risk. 10 The remaining respondent who provided comments stated that inflation risk was not a major risk A Short Note on Diversification and Hedging Diversification is seen by many as the fundamental tenet of finance and risk management. The application of diversification (i.e. methods employed to achieve diversification) have evolved over the years, from the cardinal proposition that two stocks are more desirable than one, to the recognition that some nominally diversified portfolios lack genuine diversification of risk, in that they are concentrated in a small number of highly correlated stocks. Even adequate diversification, however, is merely a necessary attribute, and far from sufficient to achieve the goals of proper risk management. While 16 An EDHEC-Risk Institute Publication

17 3. Survey Results diversification is a fundamental building block, it is not the ultimate aim, and is instead a tool used to pursue one specified objective that is subordinate to the investor s overall goal. Properly contextualising diversification requires identification of all sources of risk, and a coordination of all the means employed to manage them. Thus, the scope of the pursuit of diversification can be segregated into a performance seeking portfolio (PSP), which has the clearly defined goal of extracting available risk premia A recent Goldman Sachs research report identified low levels of correlation between the Barclays US TIPS Index and several equity indices, broad bond indices, and a commodity index (the absence of an inflation-linked corporate bond index makes direct comparison infeasible). It is further important to recognise the limits of diversification. Diversification is commonly misperceived as an ubiquitous tool for risk minimisation. As the market downturn in 2008 made evident, diversification fails to protect against a convergence of correlation. Similarly, in the asset-liability context, diversification is inappropriate to hedge or immunise risk originating from liabilities. In accordance with an application of the fund-separation theorem, a liability-hedging portfolio (LHP), which abstains from seeking returns or diversification, is the appropriate means to employ a dedicated method to hedging liabilities. factor affecting company cash flows. 3.5 Questions Tailored to Investors The appropriate framework to analyse the applicability of inflation-linked bonds as hedges is one that eschews an assetonly perspective, and instead adopts an integrated asset-liability management perspective. While the primary focus of our study was how corporate issuers could improve practices by adopting a broader analysis, similar considerations may also precipitate a modification of an investor s firm structure. For investors, delineating a portfolio dedicated to hedging liabilities which, for many, may be a significant departure from standard practices can be essential to immunising a difficult-to-manage risk factor such as inflation. a distinct objective compared to that of a liability-hedging portfolio. Inflation-linked bonds have historically low correlation with other asset classes and could thus contribute to a portfolio s improved risk-reward profile. 11 To address asset-allocation considerations we included a question seeking recognition of the diversification potential of inflation-linked corporate bonds. It would be helpful to identify all attractive attributes of this type of debt instrument, and whether it would be sought out for its contribution to risk-adjusted return generation, or for controlled risk matching, or both. Figure 9. Would you consider inflation-linked corporate bonds to be a useful addition to the strategic mix of asset classes? While inflation is clearly and measurably tied to many investors liabilities, it is also a prominent risk factor within the performance-seeking portfolio, which has An EDHEC-Risk Institute Publication 17

18 3. Survey Results Figure 10. If so, would you see them as being more useful for diversifying equity risk within performance-seeking portfolios, or for inflation risk matching in liability-hedging portfolios? 81% of respondents consider inflationlinked corporate bonds as a useful addition to the strategic mix of asset classes. This indicates that the market for inflationlinked corporate debt would not be limited to those seeking liability hedges. Of the 81% who responded affirmatively, over 40% recognised that inflation-linked bonds have equity-diversifying potential, while over 94% recognised the risk matching potential Final Question to Investors As we recognise that inflation-linked corporate bonds are a relatively novel addition to the debt market, we wanted to gain a thorough understanding of the perceived benefits and shortcomings of inflation-linked corporate debt, as well as their potential applications and usefulness in different contexts. We therefore asked respondents to hypothetically identify specific characteristics and uses that they would find favourable and unfavourable. This allowed us to not only identify the important issues, but to assess their perceived importance relative to each other. The questions pertained to a variety of issues including general investment concerns such as the need for diversification and lower costs, as well as investorspecific or organisational matters such as relevant rules or programs and policies. We also examined key issues specifically related to the nature of the issuer for instance, we contrasted inflationlinked corporate debt with its sovereign counterpart in regard to liquidity, quality of credit-ratings, and credit-worthiness in the event of a spike in inflation. In accordance with the strong recognition of the hedging properties of inflationlinked bonds, 61% of respondents cited the diversification and liability-hedging potential as a favourable attribute. It is also notable that only 14% of respondents felt that corporate debt is less Figure 11. As far as investing in the liability-hedging portfolio is concerned, what would be your arguments for investing or not investing in inflation-linked corporate bonds? I am favourable because: 18 An EDHEC-Risk Institute Publication

19 3. Survey Results Figure 12. As far as investing in the liability-hedging portfolio is concerned, what would be your arguments for investing or not investing in inflation-linked corporate bonds? I am not favourable because: risky with regard to risk documentation, forecastability and stability, and availability of reliable ratings. It is worth noting that the least favourable attribute is recognised by 33% of respondents, compared to the most favourable attribute which is recognised by 61%. Our responses further reveal that credit-worthiness within the context of an inflation-linked corporate bond might be one of the more prominent concerns held by investors. As we provided an other option to capture possible issues which were left out, we can be fairly certain that these two broad questions captured the essence of the most favourable and unfavourable characteristics perceived by our respondents. An EDHEC-Risk Institute Publication 19

20 3. Survey Results 20 An EDHEC-Risk Institute Publication

21 4. Conclusion An EDHEC-Risk Institute Publication 21

22 4. Conclusion Our study examined the relevant academic theory and proposed a functional model to evaluate a corporation s optimal debt structure. The breadth and practical nature of the paper resulted in several key issues emerging with clarity. To present a thorough analysis of the abstract concepts, current practices and future progression, we thought it would be best to supplement our study with practitioner insight through a formal call for reaction the results of which confirm many of the conclusions of our research. the central tenet of the paper: that for many firms, current debt-management practices can be improved through the issuance of inflation-linked debt. Three questions which pertained to general concerns were asked to both groups of respondents. As depicted in the following graphs, the perspectives were remarkably similar across both investors and issuers. Potential issuers exhibited substantial agreement with the positive attributes of inflation-linked debt, while over half of respondents recognised the prospects for the development of a highly liquid market as a result of this type of research. Overall, the responses reflect strong agreement with many of our key propositions, and Figure 13. Contrast of responses of questions asked to both parties 22 An EDHEC-Risk Institute Publication

23 References An EDHEC-Risk Institute Publication 23

24 References Amenc, N., Martellini, L. and Ziemann, V Inflation-Hedging Properties of Real Assets and Implications for Asset-Liability Management Decisions. The Journal of Portfolio Management, Summer, Ang., A., Briere, M., and Signori, O Inflation and Individual Equities. Working Paper. Bao, J., Pan, J. and Wang, J. 2011, The Illiquidity of Corporate Bonds. The Journal of Finance, 66: Boyd, J., Levine R., and Bruce D. 2001, The Impact of Inflation on Financial Sector Performance. University of Minnesota, Journal of Monetary Economics. Chen, L., Lesmond, D., and Wei, J. 2007, Coporate Yield Spreads and Bond Liquidity. Journal of Finance 62, De Jong, F. and Driessen, J. 2005, Liquidity Risk Premia In Corporate Bond Markets, Working Paper, University of Amsterdam. Eddings, C. 2012, Treasury Sells Inflation Notes at Record Low Negative Yield. Bloomberg News: Edwards, A. K., L. E. Harris, and M. S. Piwowar Corporate bond market transaction costs and transparency. Journal of Finance 62, Goldman Sachs Asset Management, A Reference Guide to Inflation-Linked Bonds. reference_guide_to_inflation-linked_bonds.pdf Gross, B Interview. PIMCO's Bill Gross On Corporate Versus Sovereign Bonds: March Commentary. Hyde, D Tesco Bank ends inflation-linked bond after ten days of huge interest sees it sell out and more. This is Money. article /tesco-inflation-linked-corporate-bond-ends-sell-out.html Inderst, G. Infrastructure as an Asset Class. EIB Papers, Vol. 15, No. 1, pp , Ju, N., and H. Ou-Yang (2006). A model of optimal capital structure with stochastic interest rates. Journal of Business 79 (5), Leaviss, J Index-linked corporate bonds could combat inflation fears, says M&G. index-linked-corporate-bonds-could-combatinflation-fears-says-mandg/a Leland, H Corporate debt value, bond covenants, and optimal capital structure. Journal of Finance 49 (4), Leland, H., and Toft, K Optimal capital structure, endogenous bankruptcy, and the term structure of credit spreads. Journal of Finance 51 (3), Longstaff, F., 2002, The Flight-to-Liquidity Premium in US Treasury Bond Prices. Journal of Business 77, An EDHEC-Risk Institute Publication

25 References Martellini, L. and Milhau, V Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks. EDHEC-Risk Institute Publication. Scherer, B The case for liability driven investment. Deutsch Bank Asset Management. The City UK, Bond Markets. Financial Market Series. An EDHEC-Risk Institute Publication 25

26 References 26 An EDHEC-Risk Institute Publication

27 About Rothschild & Cie An EDHEC-Risk Institute Publication 27

28 About Rothschild & Cie Rothschild has been involved in investment banking since its beginning over two hundred years ago when Rothschild businesses were established in the principal cities of Europe at the end of the 18th century. Today, the Rothschild Group is one of the world s leading financial advisory and asset management organisations which is family controlled and independent. It has an established network of offices around the world with more than 2000 people in over 40 countries (including the USA, UK, France, Switzerland, Singapore, China, ). Rothschild Global Financial Advisory is involved in providing impartial and expert M&A and strategic advice as well as financing and restructuring advice across the range of equity and debt capital markets. Rothschild & Cie Gestion is the asset management arm of the Rothschild Group in France. Rothschild & Cie Gestion manages EUR 22bn in assets and offers a diversified product range, with expertises in equities (focusing on European equities), bonds (including govies, Euro credit and European convertibles), balanced management, and long-only as well as alternative multi-management. 28 An EDHEC-Risk Institute Publication

29 About EDHEC-Risk Institute An EDHEC-Risk Institute Publication 29

30 About EDHEC-Risk Institute Founded in 1906, EDHEC is one of the foremost international business schools. Accredited by the three main international academic organisations, EQUIS, AACSB, and Association of MBAs, EDHEC has for a number of years been pursuing a strategy of international excellence that led it to set up EDHEC-Risk in With eighty professors, research engineers, and research associates, EDHEC-Risk has the largest asset management research team in Europe. The Choice of Asset Allocation and Risk Management EDHEC-Risk structures all of its research work around asset allocation and risk management. This issue corresponds to a genuine expectation from the market. On the one hand, the prevailing stock market situation in recent years has shown the limitations of diversification alone as a risk management technique and the usefulness of approaches based on dynamic portfolio allocation. On the other, the appearance of new asset classes (hedge funds, private equity, real assets), with risk profiles that are very different from those of the traditional investment universe, constitutes a new opportunity and challenge for the implementation of allocation in an asset management or assetliability management context. This strategic choice is applied to all of the Institute's research programmes, whether they involve proposing new methods of strategic allocation, which integrate the alternative class; taking extreme risks into account in portfolio construction; studying the usefulness of derivatives in implementing asset-liability management approaches; or orienting the concept of dynamic core-satellite investment management in the framework of absolute return or targetdate funds. Academic Excellence and Industry Relevance In an attempt to ensure that the research it carries out is truly applicable, EDHEC has implemented a dual validation system for the work of EDHEC-Risk. All research work must be part of a research programme, the relevance and goals of which have been validated from both an academic and a business viewpoint by the Institute's advisory board. This board is made up of internationally recognised researchers, the Institute's business partners, and representatives of major international institutional investors. Management of the research programmes respects a rigorous validation process, which guarantees the scientific quality and the operational usefulness of the programmes. Six research programmes have been conducted by the centre to date: Asset allocation and alternative diversification Style and performance analysis Indices and benchmarking Operational risks and performance Asset allocation and derivative instruments ALM and asset management These programmes receive the support of a large number of financial companies. The results of the research programmes are disseminated through the EDHEC- Risk locations in Singapore, which was established at the invitation of the Monetary Authority of Singapore (MAS), the City of London in the United Kingdom, and Nice, France. In addition, it has a research team located in the United States. EDHEC-Risk has developed a close partnership with a small number of sponsors within the framework of research chairs or major research projects: Core-Satellite and ETF Investment, in partnership with Amundi ETF Regulation and Institutional Investment, in partnership with AXA Investment Managers 30 An EDHEC-Risk Institute Publication

31 About EDHEC-Risk Institute Asset-Liability Management and Institutional Investment Management, in partnership with BNP Paribas Investment Partners Risk and Regulation in the European Fund Management Industry, in partnership with CACEIS Exploring the Commodity Futures Risk Premium: Implications for Asset Allocation and Regulation, in partnership with CME Group Asset-Liability Management Techniques for Sovereign Wealth Fund Management, in partnership with Deutsche Bank The Benefits of Volatility Derivatives in Equity Portfolio Management, in partnership with Eurex Structured Products and Derivative Instruments, sponsored by the French Banking Federation (FBF) Advanced Modelling for Alternative Investments, in partnership with Newedge Prime Brokerage Advanced Investment Solutions for Liability Hedging for Inflation Risk, in partnership with Ontario Teachers Pension Plan The Case for Inflation-Linked Corporate Bonds: Issuers and Investors Perspectives, in partnership with Rothschild & Cie Solvency II Benchmarks, in partnership with Russell Investments Structured Equity Investment Strategies for Long-Term Asian Investors, in partnership with Société Générale Corporate & Investment Banking The philosophy of the Institute is to validate its work by publication in international academic journals, as well as to make it available to the sector through its position papers, published studies, and conferences. Each year, EDHEC-Risk organises two conferences for professionals in order to present the results of its research, one in London (EDHEC-Risk Days Europe) and one in Singapore (EDHEC-Risk Days Asia), attracting more than 2,000 professional delegates. EDHEC also provides professionals with access to its website, which is entirely devoted to international asset management research. The website, which has more than 50,000 regular visitors, is aimed at professionals who wish to benefit from EDHEC s analysis and expertise in the area of applied portfolio management research. Its monthly newsletter is distributed to more than 1,000,000 readers. EDHEC-Risk Institute: Key Figures, Nbr of permanent staff 80 Nbr of research associates 18 Nbr of affiliate professors 6 Overall budget 11,200,000 External financing 6,215,000 Nbr of conference delegates 1,850 Nbr of participants at EDHEC-Risk Indices & Benchmarks seminars 391 Nbr of participants at EDHEC-Risk Institute Risk Management seminars 419 Nbr of participants at EDHEC-Risk Institute Executive Education seminars 356 An EDHEC-Risk Institute Publication 31

32 About EDHEC-Risk Institute The EDHEC-Risk Institute PhD in Finance The EDHEC-Risk Institute PhD in Finance is designed for professionals who aspire to higher intellectual levels and aim to redefine the investment banking and asset management industries. It is offered in two tracks: a residential track for high-potential graduate students, who hold part-time positions at EDHEC, and an executive track for practitioners who keep their full-time jobs. Drawing its faculty from the world s best universities and enjoying the support of the research centre with the greatest impact on the financial industry, the EDHEC- Risk Institute PhD in Finance creates an extraordinary platform for professional development and industry innovation. indices and benchmarks that provide more efficient or more academic-based solutions to investors needs than current offers available on the market. Research for Business The Institute s activities have also given rise to executive education and research service offshoots. EDHEC-Risk's executive education programmes help investment professionals to upgrade their skills with advanced risk and asset management training across traditional and alternative classes. In partnership with CFA Institute, it has developed advanced seminars based on its research which are available to CFA charterholders and have been taking place since 2008 in New York, Singapore and London. While EDHEC-Risk makes important public contributions to the advancement of applied financial research and the improvement of industry practices, the insights drawn from EDHEC-Risk s Indices & Benchmarking, ALM and Asset Management and Derivatives and Asset Management research programmes over the past several years have led to a series of 32 An EDHEC-Risk Institute Publication

33 EDHEC-Risk Institute Publications and Position Papers ( ) An EDHEC-Risk Institute Publication 33

34 EDHEC-Risk Institute Publications ( ) 2012 Amenc, N., F. Goltz, M. Masayoshi, P. Narasimhan and L. Tang. EDHEC-Risk Asian Index Survey 2011 (May). Guobuzaite, R., and L. Martellini. The Benefits of Volatility Derivatives in Equity Portfolio Management (April). Amenc, N., F. Goltz, L. Tang, and V. Vaidyanathan. EDHEC-Risk North American Index Survey 2011 (March). Amenc, N., F. Cocquemas, R. Deguest, P. Foulquier, L. Martellini, and S. Sender. Introducing the EDHEC-Risk Solvency II Benchmarks maximising the benefits of equity investments for insurance companies facing Solvency II constraints - Summary - (March). Schoeffler, P. Optimal market estimates of French office property performance (March). Le Sourd, V. Performance of socially responsible investment funds against an efficient SRI Index: The impact of benchmark choice when evaluating active managers an update (March). Martellini, L., V. Milhau, and A.Tarelli. Dynamic investment strategies for corporate pension funds in the presence of sponsor risk (March). Goltz, F., and L. Tang. The EDHEC European ETF survey 2011 (March). Sender, S. Shifting towards hybrid pension systems: A European perspective (March). Blanc-Brude, F. Pension fund investment in social infrastructure (February). Ducoulombier, F., Lixia, L., and S. Stoyanov. What asset-liability management strategy for sovereign wealth funds? (February). Amenc, N., Cocquemas, F., and S. Sender. Shedding light on non-financial risks a European survey (January). Amenc, N., F. Cocquemas, R. Deguest, P. Foulquier, Martellini, L., and S. Sender. Ground Rules for the EDHEC-Risk Solvency II Benchmarks. (January). Amenc, N., F. Cocquemas, R. Deguest, P. Foulquier, Martellini, L., and S. Sender. Introducing the EDHEC-Risk Solvency Benchmarks Maximising the Benefits of Equity Investments for Insurance Companies facing Solvency II Constraints - Synthesis -. (January). Amenc, N., F. Cocquemas, R. Deguest, P. Foulquier, Martellini, L., and S. Sender. Introducing the EDHEC-Risk Solvency Benchmarks Maximising the Benefits of Equity Investments for Insurance Companies facing Solvency II Constraints (January). Schoeffler.P. Les estimateurs de marché optimaux de la performance de l immobilier de bureaux en France (January) Amenc, N., F. Goltz, Martellini, L., and D. Sahoo. A Long Horizon Perspective on the Cross-Sectional Risk-Return Relationship in Equity Markets (December 2011). Amenc, N., F. Goltz, and L. Tang. EDHEC-Risk European Index Survey 2011 (October). 34 An EDHEC-Risk Institute Publication

35 EDHEC-Risk Institute Publications ( ) Deguest,R., Martellini, L., and V. Milhau. Life-Cycle Investing in Private Wealth Management (October). Amenc, N., F. Goltz, Martellini, L., and L. Tang. Improved Beta? A Comparison of Index- Weighting Schemes (September). Le Sourd, V. Performance of Socially Responsible Investment Funds against an Efficient SRI Index: The Impact of Benchmark Choice when Evaluating Active Managers (September). Charbit, E., Giraud J. R., Goltz. F. and L.Tang Capturing the Market, Value, or Momentum Premium with Downside Risk Control: Dynamic Allocation Strategies with Exchange-Traded Funds (July). Scherrer, B. An Integrated Approach to Sovereign Wealth Risk Management (June). Campani, C.H. and F. Goltz. A Review of corporate bond indices: Construction principles, return heterogeneity, and fluctuations in risk exposures (June). Martellini, L., and V. Milhau. Capital structure choices, pension fund allocation decisions, and the rational pricing of liability streams (June). Amenc, N., F. Goltz, and S. Stoyanov. A post-crisis perspective on diversification for risk management (May). Amenc, N., F. Goltz, Martellini, L., and L. Tang. Improved beta? A comparison of indexweighting schemes (April). Amenc, N., F. Goltz, Martellini, L., and D. Sahoo. Is there a risk/return tradeoff across stocks? An answer from a long-horizon perspective (April). Sender, S. The elephant in the room: Accounting and sponsor risks in corporate pension plans (March). Martellini, L., and V. Milhau. Optimal design of corporate market debt programmes in the presence of interest-rate and inflation risks (February) Amenc, N., and S. Sender. The European fund management industry needs a better grasp of non-financial risks (December). Amenc, N., S, Focardi, F. Goltz, D. Schröder, and L. Tang. EDHEC-Risk European private wealth management survey (November). Amenc, N., F. Goltz, and L. Tang. Adoption of green investing by institutional investors: A European survey (November). Martellini, L., and V. Milhau. An integrated approach to asset-liability management: Capital structure choices, pension fund allocation decisions and the rational pricing of liability streams (November). Hitaj, A., L. Martellini, and G. Zambruno. Optimal hedge fund allocation with improved estimates for coskewness and cokurtosis parameters (October). An EDHEC-Risk Institute Publication 35