Improved Risk Reporting with Factor-Based Diversification Measures

Improved Risk Reporting with Factor-Based Diversification Measures — February 2014

4. Empirical Analysis for Pension Funds

Inflation-linked bond: Concerning the inflation-linked bond asset class, we choose the Bank of America Merrill Lynch US Inflation-linked Treasury Index (G0QI). It tracks inflationlinked sovereign debt that are denominated in US dollars and issued by the US government in its domestic market. We chose this index among the US market indices for the same reasons as for the high-yield bond index. This index excludes STRIPS but takes into account the originally-issued zero-coupon bonds; Domestic equity: We choose the S&P500 composite index to track the domestic equity asset class as it a broad and popular index; International equity: We choose the FTSE World Ex-US as a benchmark for the international equity asset class; Global equity: We choose the FTSE All World as a benchmark for the global equity asset class; Private equity: For the private equity asset class, we choose the S&P 600 small-cap benchmark; Real-estate: For the real estate asset class, we choose the MSCI REIT as a benchmark. This index mostly includes equity REITs from the MSCI US Investable Market 2500 Index; Commodity: For the commodity asset class, we choose the S&P GSCI commodity; Mortgage: For the mortgage asset class, we choose the Bank of America Merrill Lynch US Mortgage Backed Securities Index (M0A0); Cash: We choose the three-month US Treasury-Bill as a benchmark to track the cash asset class. We collect weekly returns for each benchmark (with reinvested dividends) for the period ranging from 30 September, 1997 to 30 September 2012 and display their descriptive

allocated to the asset classes when the pension funds filled the original forms. As a consequence, we had totals amounting 100.1% or 99.9% for several pension funds. Hence we have rescaled the weights in order to guarantee that they all sum up to 100%. Once the partition is completed, we choose appropriate benchmarks for each asset class. We make the following selection: Domestic fixed income: For the domestic fixed income asset class, we choose the Bank of America Merrill Lynch US Corporate & Government Index (B0A0). This index includes US Treasury, US agency, foreign government, supranational and corporate securities. Inflation-linked debts are excluded from this index; I nternational/Global fixed income: For the international/global fixed income asset class, we choose the JP Morgan Global Aggregate Bond Index (JPM GABI). We deliberately choose a global fixed income market index for this asset class in order to stick to the assumption made by the P&I Research Center when building its databases; High-yield bond: For the high-yield bond asset class, we choose the Bank of America Merrill Lynch US High-yield Index (H0A0). This index tracks the corporate bonds publicly issued in the US domestic market that have a rating below investment grades and that is based on an average Moody’s, S&P and Fitch. We chose a US market index for this asset class according to the assumption we have done when modifying the P&I databases. As we assumed that the high-yield corporate bonds (and the inflation-linked bonds) were belonging to the total domestic fixed income asset class, we made the same assumption here and chose a US domestic market index tracker;

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An EDHEC-Risk Institute Publication