Asset Management – Current Trends and Challenges

Mladen LatkovićRisk Manager

Raiffeisen Mandatory Pension Fund Mgmt Co.

Croatian Quants DayDepartment of Mathematics, Faculty of Science, Zagreb,

22 February 2008

Summary

• Pension funds investment goals

• Applying MVO in practice

• Black-Litterman model

• Global diversification

• New investment styles and products

Pension funds investment goals• Croatian pension system:

– 1st pillar: Pay-As-You-Go (defined benefit)– 2nd pillar:

• pension funds (defined contribution) – accumulation phase• pension insurance company – retirement phase

• Mandatory pension funds:– long-term savings vehicles (bear investment risk)– AuM (as of Dec/07): € 2.9 bn

• Investment goals:– positive real return (long term)– towards absolute return strategy (avoid drawdowns)

Modern Portfolio Theory in practice

• Markowitz MVO:– unknown values of asset returns and covariances

• estimation risk – MVO is “error maximizer”– diversification diminishes with increasing risk

tolerance– instability to small changes in parameters

• possible solutions:– resampling procedure (Michaud, 1998)– robust optimization (El Ghaoui & Lebret, 1997; Ben-

Tal & Nemirovski, 1998)

Constrained MVO• constraints reduce estimation risk:

– simple constraints (min/max exposure, cardinality constraints)– Equivalent Number of Assets (Bouchaud et al., 1997; Rouvinez

2003):

i iw2

1ENA

Black-Litterman model• provides mechanism for calculating an implied

expected returns of assets• optimal portfolio should be close to the market• Bayesian approach:

market equilibrium returns

+investors subjective views on expected returns of a

(sub)portfolio (with given level of confidence)

mixed estimate of expected returns

BL extensions

• multi-factor models, recession risk (Krishnan & Mains, 2005)

• non-normal markets (Giacometti et al., 2005; Meucii, 2006)

• hedge funds (Martellini & Ziemann, 2008)

Global diversification• Asset classes (traditional view):

– equity– fixed income– real estate– commodities– private equity– hedge funds

• Multi-asset funds examples – university endowment funds– double digit returns, low risk, moderate drawdowns– stable allocations

New investment styles and products• financial innovation• exposure to alternative betas – different risk premiums

than traditional (equity, interest rates, credit)– style factors in equity markets (e.g., small cap vs. large cap)– volatility, liquidity, spread

• new products:– structured products (capital guaranteed, structured risk profile)– hybrid securities

• commoditisation of hedge fund type strategies• UCITS III directive

– expanding universe of appropriate investments– derivatives not just for hedging

• hedge funds replicators• 130/30 strategy (130 long, 30 short)

Thank you!

Mladen LatkovićRisk ManagerRaiffeisen Mandatory Pension Fund Management CompanyMagazinska 69, ZagrebE-mail: mladen.latkovic@rmf.hrPhone: +385-1-6003-938Web: www.rmf.hr