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Asset-Liability Management Decisions for Sovereign Wealth Funds

Authors :
Lionel Martellini
Professor of finance at EDHEC Business School and
scientific director of EDHEC-Risk Institute.

Vincent Milhau
Senior Resarch Engineer

This publication contains the results of the first-year research work conducted at EDHEC-Risk Institute within the EDHECDeutsche Bank research chair on assetliability management (ALM) techniques for sovereign wealth fund management.

EDHEC Publication

EDHEC Publication

Under the responsibility of Lionel Martellini, the scientific director of EDHEC-Risk Institute, this chair examines optimal allocation policies for sovereign wealth funds (SWFs).
This paper proposes a quantitative dynamic asset allocation framework for sovereign wealth funds, modelled as large long-term investors that manage fluctuating revenues typically emanating from budget or trade surpluses in the presence of stochastic investment opportunity sets. The optimal asset allocation strategy takes into account the stochastic features of the sovereign fund endowment process (where is the money coming from), the stochastic features of the sovereign fund's expected liability value (what the money is going to be used for), and the stochastic features of the assets held in its portfolio. Our results suggest that the investment strategy for an SWF should involve a state-dependent allocation to three building blocks, a performance-seeking portfolio (PSP, typically heavily invested in equities), an endowment-hedging portfolio (EHP, customised to meet the risk exposure in the sovereign wealth fund endowment streams), and a liability-hedging portfolio (LHP, heavily invested in bonds for interest rate hedging motives, and in assets exhibiting attractive inflationhedging properties,  when the implicit or explicit liabilities of the sovereign wealth funds exhibit inflation indexation), as well as separate hedging demands for risk factors impacting the investment opportunity set, most notably interest rate risk and equity expected return risk.
Type :
EDHEC Publication
Dates :
Created on October 21, 2010
Further information :
For more information, please contact Joanne Finlay, EDHEC Research and Development Department [ joanne.finlay@edhec.edu ]

The contents of this paper do not necessarily reflect the opinions of EDHEC Business School.

Finance

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