Insights into Individual Investment Solutions - IMR Special Edition

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Individual Investment Solutions And Other Research - IMR Special Edition Autumn 2017

Arjuna Sittampalam

In the special edition of Investment Management Review (IMR) some recent EDHEC insights into important topics are outlined. A large proportion of this edition is devoted to two papers on individuals’ retirement investing. If adopted by the industry, they should have a radical impact on individual investment management.

The two papers on the goals-based framework and mass customisation together are applicable to the entire wealth spectrum of individuals with the former covering the mass affluent upwards and the latter addressing the needs of the investor closer to the average. They will provide tailor-made solutions currently not available except to the wealthiest.

The first five related articles in this edition cover individual investments, one of them outlining the principles underlying the goals-based framework and the challenges of mass customisation. A new bond retirement index series is also explained here.

A non-academic resume of the paper ‘Introducing a comprehensive investment framework for goals-based wealth management’ is an in-depth review of the goals-based framework aimed at providing a comprehensive understanding for everybody interested in the implementation of practical solutions.

Another non-academic resume covering the paper ‘Mass customisation versus mass production in retirement investment management: Addressing a tough engineering problem’ explains an innovative way forward for meeting the challenge of mass customisation that allows large numbers of individuals to invest in just two types of portfolios.

While the way forward is clearly indicated by the two papers, it is the industry that needs to implement the new ideas in practice. The fourth article points to the industry’s serious difficulties in doing so, though rapidly changing conditions should encourage the radical transformation that is required. 

The last of the five puts the need for individual retirement solutions in the context of some of the latest thinking in Modern Portfolio Theory and approaches already used by institutional investors. 

Academic research has come up with a remarkable result of considerable importance to pension funds, using liability-driven approaches. Portfolio Theory advocates that pension plans should invest in two portfolios, a liability-hedging portfolio consisting of fixed income securities and a performance-seeking

portfolio exposed to riskier assets. However, the finding is that selecting certain types of equity in the risky portfolio can not only enhance the liability-hedging benefits, but can also increase the overall performance. Alternatively, a higher allocation to equities becomes possible with commensurate extra performance with the same liability-hedging benefits.

Another group of four articles concerns the relatively new and related paradigms of factor investing and smart beta that are rapidly growing in acceptance and importance. The first two cover bond investing, while the other two pertain to the use of factors across and within assets classes and in equities.

The concepts of factor investing and smart beta are much less developed in bonds as compared with equites. In the identification of factors, various difficulties arise. Existing bond indices have serious deficiencies which are partly related to factor exposures being unstable. A broad overview of current first generation smart beta approaches also shows up various weaknesses. 

The second related article refers to difficulties of measuring and identifying factors. A review is carried out of the most consistently identified fixed income factors and it is pointed out that more research is required before bond risk factors can be reliably used in efficiently extracting risk premia. 

Asset allocation decisions have for years been based on weightings attached to different asset classes. In a new approach that is increasingly adopted, these decisions are based on exposure to risk factors cutting across asset classes. The theme of the third article is the methodology used to implement this approach including the use of efficient factor indices as building blocks for each risk factor in the allocation process.

In the last of the four, the problems with equity factor methodologies used by some providers, when they depart from academically accepted practices, are analysed. These include the same provider using different definitions of the value factor at various times. Excessively concentrated bets without adequate diversification are also identified.

When portfolios are constructed on the basis of long-term weights, rebalancing is often carried out to restore the initial weights. The penultimate article of the edition investigates the conjecture that this rebalancing can be a source of extra investment performance. The results show that this is true for suitably selected categories of stocks.

In general, the variation of bond yields along the yield curve reflects either expected future interest rates or the risk premium. Assessing the risk premium impact on the steepness of the yield curve is, thus, important to bond managers. The final article describes the EDHEC Bond Risk Premia Monitor launched by EDHEC-Risk Institute as a tool to derive a state-of-the-art estimation of the risk premia in bond markets using market and monetary policy information.



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Table of Content 

  • Retirement Goal-Based Investing
  • A Path-Breaking Solution For Individual Investors’ Problems
  • Tailor-Made Funds With Economies Of Scale
  • Individual Investment Processes For The 21st Century
  • Multi-Asset Products And Solutions
  • Equity Portfolios With Liabilityhedging Benefits
  • Bond Risk Premia: The New Frontier In Factor Investing And Smart Beta
  • Factor-Based Approaches To The Design Of Smart Bond Portfolios
  • Factor Investing: Efficient Harvesting Of Risk Premia Across And Within Asset Classes
  • Be Serious With Equity Factor Investing
  • Measuring Volatility Pumping Benefits In Equity Markets
  • Predicting Risk Premia For Treasury Bonds: The EDHEC Bond Risk Premium Monitor