A new research publication from the EDHEC Risk and Asset Management Research Centre finds that novel liability-hedging investment applications can decrease the cost of inflation insurance and the probability of severe deficits for long-horizon investors versus a solution solely based on Treasury Inflation Protected Securities (TIPS) or inflation swaps. Liability-hedging investment technologies include commodities and real estate in addition to inflation-linked securities.
The research, entitled Alternative Investments for Institutional Investors: Risk Budgeting Techniques in Asset Management and Asset-Liability Management, was drawn from the EDHEC/Morgan Stanley Investment Management ‘Financial Engineering and Global Alternative Portfolios for Institutional Investors’ research chair.
In the case of a 20-year investment horizon adding:
•5% of alternatives (real estate and commodities) to a liability-hedging portfolio led to a 19% reduction in shortfall probability, and a 42% drop in severe shortfall probability•10% of alternatives led to a 39% reduction in shortfall probability, and 78% in severe shortfall probability
While investing in real estate leads to higher shortfall probabilities in the short and medium term, the figures show that significantly lower probabilities are obtained in the very long run (greater than 30 years). The increased expected return generated through the introduction of commodities and real estate in addition to TIPS in a liability-hedging portfolio allows a reduced global allocation to a performance-seeking portfolio while meeting overall performance expectations, which in turn allows better risk management.
Overall, EDHEC’s results suggest that alternative asset classes are very useful ingredients for institutional investors facing inflation-related liability constraints.
A copy of the survey can be downloaded here.
D.C.