An EDHEC-Risk Institute Publication

Reactions to an EDHEC Study

on the Impact of Regulatory
Constraints on the ALM of
Pension Funds
October 2009

Institute
2 Printed in France, October 2009. Copyright© EDHEC 2009.
The opinions expressed in this study are those of the author and do not necessarily reflect those of EDHEC Business School.
Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

Table of Contents

1. Introduction: EDHEC Study and Organisation of the Call for Reaction............... 7

2. Panel of Respondents.................................................................................................... 11

3. Aggregate Results: Broad Agreement with the Conclusions of the Study........13

4. Results by Theme............................................................................................................15
4.1 Stricter Prudential and Accounting Regulations are Feared....................16
4.2 ALM Techniques are Considered Efficient but Derivatives
are Preferred to Dynamic Asset Allocation...................................................18
4.3 Why the Underfunding?...................................................................................20
4.4 Regulators Should Encourage Long-Term Approaches
to Investing but Set Minimum Funding Constraints.................................20
4.5 Internal Models are of Utmost Importance to Pension Funds and
Regulations Should Provide Incentives to Build Them..............................22

5. Conclusion........................................................................................................................25

6. Appendices.......................................................................................................................27
6.1 Statistical Methodology....................................................................................28
6.2 Respondents Raise the Issue of Corporate Failures
and Corporate Risk.............................................................................................29

7. Bibliography.....................................................................................................................33

About the EDHEC-Risk Institute......................................................................................35

An EDHEC-Risk Institute Publication 3

 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

About the Author

Samuel Sender has participated in the activities of the EDHEC-Risk Institute

since 2006, first as a research associate—at the same time he was a consultant
to financial institutions on ALM, capital and solvency management, hedging
strategies, and the design of associated tools and methods. He is now a full-time
applied research manager at the EDHEC-Risk Institute. He has a degree in
Statistics and Economics from ENSAE (Ecole Nationale de la Statistique et de
l'Administration Economique) in Paris.

4 An EDHEC-Risk Institute Publication

Executive Summary

An EDHEC-Risk Institute Publication 5

 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

Executive Summary

EDHEC surveyed pension funds, their

advisers, their regulators, their fiduciary
managers, and their asset managers for their
reactions to an EDHEC study entitled “Impact
of regulations on the ALM of European
pension funds”.

The call for reaction elicited 142 non-blank

responses and is the first international survey
in which both regulatory constraints and the
means of managing them—modern ALM
techniques—are assessed jointly. 93.7% of
respondents (95.3% of those from pension
funds) report that they are somewhat
or very familiar with accounting and/or
prudential constraints for pension funds;
the results of the call for reaction are very
much aligned with EDHEC’s views that
modern ALM techniques are instrumental in
managing minimum funding constraints and
that short-termism is counterproductive for
pension funds.

In addition, the respondents believe that

risk management is more instrumental in
protecting minimum funding ratios than
high initial funding ratios; the implications
are that regulations should provide
incentives to build internal models.

6 An EDHEC-Risk Institute Publication

1. Introduction: EDHEC Study
and Organisation of the Call
for Reaction

An EDHEC-Risk Institute Publication 7

 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009
1 - Amenc et al. (2009) 65:
“Pension funds have a unique
ability to behave as very
long-term investors. This
ability stems in part from the
very long pension liabilities
in their books, but more than
that, from the long-term
ties that bind employers and
employees. Pension funds
are a sub-product of the
employment contract, not a
competitive financial service.
This prevents the risk of
client runs commonly faced
by insurance companies and
banking corporations, a risk
that brings the investment
horizon nearer. In pension
funds, deficits do not make
employees resign, as we have
seen with General Motors”.
2 - By real assets and
liabilities, we mean items that
are at least partly indexed to
inflation or to the economy.
Real liabilities, for instance,
are indexed to inflation and
wages; for us, inflation-linked
bonds, equities, real estate,
and other alternative asset
classes are real assets.
3 - Prudential regulations
set minimum funding ratios
to protect plan members.
These ratios are either fixed
minimums or they depend
on risk throughout a simple
formula then called the
standard model. Internal
models usually make it
possible to enjoy reduced
funding requirements,
provided they help improve
risk management (and reduce
risk).
8 An EDHEC-Risk Institute Publication
I. Introduction: EDHEC Study and
Organisation of the Call for Reaction
In early 2009, the EDHEC-Risk
Institute published an extensive
review (Impact of regulation on the
ALM of European pension funds)
of prudential and accounting regulations
and of how they should be embedded in
the ALM of pension funds, with a particular
focus on the Netherlands, the United
Kingdom, Switzerland, and Germany. The
Centre has published an additional study
that attempts to evaluate the reasons for
current pension fund underfunding (The
European pension fund industry again
beset by deficits).
The main conclusions were that:
• Regulations have tightened, making it
important for the ALM of pension funds to
take them into account. This tightening of
regulations has sometimes had the perverse
effect of leading to the closure of defined-
benefit pension funds.
• Modern ALM techniques, such as
dynamic liability-driven investments,
are instrumental in preserving minimum
funding ratios. When these techniques are
burdensome, either because management
agreement is needed to rebalance a
portfolio or because smaller schemes make
continuous monitoring difficult, derivatives
can be used.
• Overall, current funding shortfalls reflect
mainly the reluctance of pension funds
and their sponsors to use modern ALM
techniques and take regulatory constraints
into account.
• Pension funds have a unique ability to
behave as very long-term investors, as
pension liabilities are a byproduct of the
employment contract, and no client-run is
possible.1 As a result, they can benefit from
investment opportunities that require a long
horizon, whether for illiquid investments
or for assets whose term structure of risk
slopes downward (that is, in which time
reduces risk).
• The increased short-termism of
regulations, with the proposed IAS 19
reform implying full recognition of the
volatility of the profit and loss (P&L) of
pension funds in the P&L of the sponsor,
adds to the excessive focus of investors
on the P&L and makes the long-term
replication of liabilities difficult, in
particular for real liabilities.2 After all,
matching these liabilities requires real
assets, assets that imply short-term
volatility in the accounts.
• After the crisis, which has left many
pension funds underfunded, regulators
have been tempted to require higher
funding ratios as a means of mitigating
the effects of downturns. In our view,
however, risk management is more likely
than high funding ratios to ensure that
liabilities are covered, so it should be
favoured. “The idea that risk management
is best reflected in an internal model is
especially relevant for pension funds; after
all, no standard formula can capture the
diversity of the pension landscape and
the variety of protection mechanisms”
(Amenc et al. 2009, 151). In general,
we argue that regulations should give
pension funds incentives to build internal
models3 that are full risk management
systems rather than risk measurement
tools: risk management is always useful.
The call for reaction was meant to allow
the respondent to express an opinion on
Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

I. Introduction: EDHEC Study and

Organisation of the Call for Reaction

these crucial themes. The questions were

posed in a neutral manner to allow EDHEC
to analyse the use and perceived efficiency
of ALM tools and concepts, rather than
merely to elucidate the degree to which
practitioners agree with the conclusions
of our research.

The opinion of respondents was very much

in line with that of EDHEC. The themes of
the responses are:
• Stricter prudential and accounting
regulations are feared.
• ALM techniques are considered efficient
but derivatives are preferred to dynamic
asset allocation.
• Regulators should encourage long-term
approaches to investing but set minimum
funding constraints.
• Internal models are of utmost importance
to pension funds and regulations should
provide incentives to build them.

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 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

I. Introduction: EDHEC Study and

Organisation of the Call for Reaction

10 An EDHEC-Risk Institute Publication

2. Panel of Respondents

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 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

2. Panel of Respondents

The call for reaction elicited 142 non-

blank responses. 45% of respondents
are direct stakeholders in pension
funds—pension funds, sponsors, and
participants. Advisors and actuaries
account for 35% of respondents. Finally,
providers of products to pension funds
(asset managers, investment banks, and
fiduciary managers) account for 16% of
respondents.

Figure 1: Respondent’s employer type

No. %
Pension fund 43 30.3%
Regulator/supervisor 4 2.8%
Sponsor (or association of sponsors) 14 9.9%
Participant (or association of participants, including labour unions) 7 4.9%
Fiduciary manager 7 4.9%
Asset management firm 12 8.5%
Investment bank 4 2.8%
Advisor/actuary 51 35.9%

Approximately 63% of respondents are

from continental Europe. Nearly a third
are from the United Kingdom; less than
8% are from outside the European Union.
Figure 2: Countries of respondents
No. %
Belgium 13 9.2%
Finland 4 2.8%
France 10 7.0%
Germany 9 6.3%
Netherlands 12 8.5%
Sweden 2 1.4%
Switzerland 15 10.6%
UK 41 28.9%
Other EU 25 17.6%
USA 2 1.4%
Other non-EU 9 6.3%

12 An EDHEC-Risk Institute Publication

 3. Aggregate Results:
Broad Agreement with the
Conclusions of the Study

A n E D H E C R i s k a n d A s s e t M a n a g e m e n t R e s e a rc h C e n tre Pub l i ca ti on 13
 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

3. Aggregate Results: Broad Agreement

with the Conclusions of the Study

The first two questions were a direct test
of the relevance of the subject and of the
main conclusions of the EDHEC study.
EDHEC argued that prudential and
accounting regulations must be taken into
account in the ALM of the pension fund
and of its sponsor; 95% of respondents
agreed that these constraints were either
somewhat important or very important and
needed to be taken into account.
In the main conclusions of the study, the
only point of disagreement seems to be
that respondents do not, in general, agree
that current deficits reflect the reluctance
of pension funds to adopt modern ALM
techniques (figure 9). Instead, they
attribute these deficits to longevity (65.3%
of the respondents think that longevity
risk is the main risk faced by the pension
system, a risk not addressed by modern
ALM techniques).

Figure 3
By contrast, there is unexpectedly strong
%
0 - not at all 0.0% support for the notion that pension fund
1 - not very 6.3% regulation should encourage the use of
2 - somewhat 51.4%
3 - very 42.3% internal models—more than 80% agree
with this view.
EDHEC argues that the use of modern ALM
techniques and internal models can mitigate
the impact of tightening (prudential
and accounting) regulations. 85%, as it
happens, of the respondents agreed
that modern ALM techniques are either
somewhat useful or very useful means of
mitigating the impact of regulations.

Table 1: General agreement and statistical significance

Main conclusion of the study Non- P-value and
Question Agree Disagree
response significance
(1) Regulations (…) sometimes led to the closure of **
Figure 4 60% 19% 21%
defined-benefit pension funds (p=4.8e-8)
(2) Modern ALM techniques (…) are instrumental in **
Figure 7 64.7% 28.1% 7.2%
protecting minimum funding ratios (p=8.3e-6)
(3) Current funding ratios reflect the reluctance (…)
-
to use modern ALM techniques and embed regulatory Figure 7 41.4% 54.3% 4.3%
(p=0.1004)
constraints
(4) Pension funds are long-term investors **
Figure 8 82.4% 14.1% 3.5%
(p=7.2e-18)
(5) The increased short-termism visible in the proposed **
Figure 8 66.9% 30.3% 2.8%
IAS 19 reform is detrimental to pension funds (p=1.1e-5)
(6) Regulations should give pension funds incentives to **
Figure 9 80.9% 12% 7.1%
build internal models (p=8.1e-19)
Total responses **
71.5% 28.5%
(p=3e-34)
**=significant at the 1% level; * = significant at the 5% level

14 An EDHEC-Risk Institute Publication

4. Results by Theme

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 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

4. Results by Theme

4.1 Stricter Prudential and Accounting The EDHEC study argued that there is a
Regulations are Feared difference between stricter minimum
The first section of the call for reaction deals funding constraints that can be managed
with the impact of stricter prudential and with modern ALM techniques and higher
accounting regulations. funding requirements that “involve an
immediate increase in funding ratios and
60.6% of the respondents believe that thus require additional contributions. The risk
stricter regulations force sponsors to close is that these contributions will be perceived
defined-benefit funds; they report that as a direct and unwelcome cost and result in
increased costs and greater administrative knee-jerk closures of DB schemes” (Amenc
burdens are the two main immediate causes et al. 2009, 9).
of these closures. Results are significant
at the 1% level (p-value of 4.84e-8). In Respondents agree that there is such a
the analysis below, for the full sample, an difference and in the majority are against
opinion with response rates higher than 60% an increase in funding requirements. In
is generally considered significant without particular, 78.6% of the sponsors (93.8%
further comment. of UK sponsors and pension funds) express
the concern that “stricter regulations, when
Figure 4 - Do prudential and accounting regulation directly or
indirectly force sponsors to close DB funds?
they increase funding requirements, lead
80 to closures of DB funds” (see figures 6a,
70 6b, and 6c). As table 2 shows, sponsors as
60.6% well as UK sponsors and pension funds
60
50
express significantly more concern about
40
stricter regulations’ leading to the closure of
30
defined benefit pension funds than do other
19.7% 19.7% respondents (non-sponsors and non-UK
20
pension professionals).
10
0 Table 2: Statistical significance of the difference in group
No Yes I don't know
responses.
Sample Agree Disagree Fisher’s ANOVA
Figure 5 - (if answer to figure 1 is Yes)
Groups exact test
Please specify
60 54.7% UK sponsors 15 1 ** **
+ PF
50 EX (UK 71 55 (p=0.005) (p=0.0016)
sponsors + PF)
40
Sponsors 12 2 * *
30 Non-sponsors 74 54 (p=0.0477) (p=0.0242)

19.8%
20
9.3% 10.5%
10

0
Because DB provision Because of the greater
becomes too costly administrative
burden involved
Because expertise to Other
address regulation is missing

16 An EDHEC-Risk Institute Publication

Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

4. Results by Theme

Figure 6a - Impact of stricter regulations on the ALM of PFs: Do Figure 6c (UK) - Impact of stricter regulations on the ALM of PFs:
stricter regulations… Do stricter regulations…
80 100 93.8%
70 81.3%
60.6% 80
60 56.3%
52.1% 62.5%
50 47.9% 60
50%
40
40
30
20
20
10
0 0
…foster risk …require higher contributions …foster risk …require higher contributions
management during economic downturns, management during economic downturns,
and prudent precisely when firms are and prudent precisely when firms are
behaviour? short of cash? behaviour? short of cash?

…penalise smaller …, when they increase

…penalise smaller …, when they increase schemes and their sponsors, funding requirements,
schemes and their sponsors, funding requirements, for whom implementing lead to closures
for whom implementing lead to closures regulation is costly? of DB funds?
regulation is costly? of DB funds?

Sponsors’ primary fear (a fear expressed by

Figure 6b (sponsors) - Impact of stricter regulations on the ALM
of PFs: Do stricter regulations…
86% of them) is that stricter regulations
100 will “require higher contributions during
85.7% economic downturns, precisely when firms
78.6%
80 are short of cash”. This fear in itself should
be evidence for the need to adopt ALM
60
50% techniques that make it possible to protect
42.9%
40 funding ratios and ward off the risk of having
to raise contributions; nonetheless, sponsors
20
are concerned about the impact of longevity
0
on the funding ratios and think modern ALM
…foster risk …require higher contributions techniques are important but not sufficient
management during economic downturns,
and prudent
behaviour?
precisely when firms are
short of cash?
to prevent deficits. Because these techniques
…penalise smaller …, when they increase
are not sufficient, new ways to transfer
schemes and their sponsors, funding requirements,
for whom implementing lead to closures
pension risk—recent developments in the
regulation is costly? of DB funds?
mortality market in the United Kingdom are
promising—may be required.

Recent regulatory initiatives are not widely

praised; indeed, only half of respondents
agree that these initiatives have fostered
sound risk management practices. Only
in the Netherlands is regulation seen
(by 75% of respondents) as having given a
boost to risk management. This view may be
the result of Dutch prudential regulation,
which requires pension funds to monitor

An EDHEC-Risk Institute Publication 17

 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

4. Results by Theme

risks and makes limited allowances for the cash account (the risk-free portfolio
underfunding. This positive view of Dutch for the asset-only investor), the liability-
regulation, however, is not significant at hedging portfolio (the risk-free portfolio for
the 5% level, probably because of a limited the ALM investor), and the performance-
number of answers from Dutch pension seeking portfolio (the optimal portfolio of
funds. risky assets). The allocation to risky assets
depends in the main on the surplus and on
Table 3: Statistical significance of difference between Dutch
and non-Dutch responses on the impact of regulations of risk
risk aversion” (Amenc et al. 2009, 29).
management techniques
Sample Agree Disagree Fisher’s ANOVA
Groups exact test
Dynamic strategies can, in theory, be
Netherlands 9 3 Not Not used to replicate the optimal payoff
significant significant (from optimisation), so, from a theoretical
Ex-Netherlands 65 65 (p=0.1331) (p=0.1681) standpoint, dynamic strategies should be
preferred to other forms of investing.
4.2 ALM Techniques are Considered By contrast, static investments in
Efficient but Derivatives are Preferred derivatives have theoretical drawbacks.
to Dynamic Asset Allocation First, most traded derivatives have a single
The second section of the questionnaire underlying asset, usually a broad equity
reviews the perceived use and limitations market index, a swap rate, or the German
of the modern ALM techniques meant to bond market. While combinations of these
improve pension fund risk management. traded derivatives can ward off deficits,
“These techniques, which can be called they do not make it possible to replicate
dynamic liability-driven investments, the optimal payoff a dynamic strategy
involve dynamic allocation to three blocks: would have provided. For instance, when

Figure 7: Do you agree with the following statements?

On dynamic strategies: dynamic strategies ensure minimum 7.2% 20.9% 48.9% 15.8% 7.2%
funding constraints are met
Dynamic strategies are difficult to implement because 5% 17.9% 37.9% 35.7%
management agreement is needed to rebalance a portfolio
On derivatives: derivatives are the most efficient means of 6.5% 26.4% 42.9% 17.1%
ensuring that prudential constraints are met
Pension liabilities are embedded options and are too complex 23.4% 35.6% 33.3%
to be replicated by traded derivatives
Longevity risk is the greatest risk faced by the pension system
23.4% 27% 38.3%
not yet addressed by modern ALM techniques

On practices: current funding shortfalls reflect the reluctance of

15% 39.3% 24.3% 17.1%
the pension industry to use modern ALM techniques

Current funding shortfalls reflect the ineffectiveness of 14.3% 48.6% 22.9% 6.4% 7.9%
derivatives or of modern ALM techniques

Liability-driven investment is already well understood 17.3% 25.9% 50.4%

by our entity
LDI techniques are used in our firm (in the design of 15.1% 12.2% 25.9% 40.3% 6.5%
investment strategies, in risk management or as analytical tools)

not at all somewhat (no idea)

not really very much so

18 An EDHEC-Risk Institute Publication

 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009
4 - For instance, 64.7% of
respondents and 73.2% of
pension funds agree that
dynamic strategies ensure
minimum funding constraints
are met.
4. Results by Theme
indexation is conditional, as it often is in
continental Europe (in the Netherlands,
indexation is conditional on the funding
ratio of the pension funds; in Germany, or
in with-profit insurance-like arrangements,
it is conditional on financial returns),
liabilities depend on the investment
strategy of pension funds, so liabilities
alone cannot be replicated (it is not easy
to separate the liability-hedging portfolio
from the performance-seeking portfolio).
So, if liabilities cannot be replicated
statically with derivatives, the optimal
payoff cannot always be replicated, either
(for instance, when the funding ratio is
close to the minimum). Overall, from an
economic standpoint (without accounting
for liquidity risk and prudential constraints),
derivatives may be farther from optimal
than dynamic strategies.
Despite their mastery of modern ALM
techniques (76.3% of respondents state
that “liability-driven investment is already
well understood by our entity” and 66.2%
that “LDI techniques are used in our firm”)
and the acknowledgement that these
techniques are efficient,4 respondents
also underline practical difficulties:
73.6% (78.5% of pension funds) report
that “dynamic strategies are difficult
to implement because management
agreement is needed to rebalance a
portfolio”. After all, in many countries,
trustees or managers of the pension
fund are generally responsible for asset
allocation and are sometimes reluctant to
give up this responsibility (pension funds
generally appoint fund managers to manage
assets and, if necessary, to rebalance assets
within a given asset class, not between
asset classes).
Because of the organisational difficulties
of implementing dynamic asset allocation
techniques, respondents prefer derivatives:
indeed, 60% report that derivatives are
the most efficient means of ensuring that
prudential constraints are met (76.2% of
those who find that derivatives are more
efficient than dynamic strategies find
that dynamic strategies are difficult to
implement).
All Dutch respondents believe that
derivatives are superior to dynamic
strategies. As noted in Amenc et al.
(2009), in risk-based regulations such
as the Dutch prudential framework,
dynamic strategies are not recognised as
an efficient risk-mitigation tool in the
standard formula, so they do not help
reduce funding requirements (derivatives
are recognised as fully efficient but are
subject to a charge for counterparty
risk). In such frameworks, derivatives
enjoy more advantageous treatment and
are favoured by pension funds and their
advisors.
In addition, derivatives may be instrumental
in providing protection when dynamic
strategies fail—during market crises, for
instance, when liquidity dries up and selling
large volumes is practically impossible.
This advantage is greater for larger pension
funds, whose size makes them more
sensitive to liquidity. For instance, with
€1.5Bn under management, the average
Dutch pension fund is approximately fifteen
times larger than the average UK pension
fund, with £0.1Bn under management).
An EDHEC-Risk Institute Publication 19
 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009
5 - This result is statistically
significant, with a two-tailed
p-value of 2.13%
6 - http://www.ipe.com/
news/Consultants_predict_
potential_longevity_market_
of_15bn_updated__31714.
php
20 An EDHEC-Risk Institute Publication
4. Results by Theme
4.3 Why the Underfunding?
As pension funds are again beset by
deficits, EDHEC has argued (Sender 2009)
that current funding shortfalls reflect
the reluctance of the pension industry
to use modern ALM techniques. Overall,
54.3% of respondents disagree with this
view, and though the disagreement is not
statistically significant (see table 1), it is
only here that respondents do not agree
with EDHEC’s views. In addition, 81.3% of
UK sponsors and pension funds disagree
with this statement.5
Beyond the significant UK disagreement,
stakeholders in pension funds (pension
funds and their sponsors) have views
opposed to those of providers of products
(investment banks, asset management firms,
and fiduciary managers), and this opposition
is statistically significant. These providers
tend to believe that current funding ratios
are the result of the reluctance of pension
funds to use modern ALM techniques, a
hardly surprising belief, since their role
is precisely to sell these very techniques
to the pension fund community; pension
funds, by contrast, believe that funding
shortfalls are not caused by their reluctance
to use these techniques (again, hardly a
surprising belief given their responsibility
for these ratios).
Table 4: Pension stakeholders vs. providers of products
Sample Agree Disagree Fisher’s
Groups exact test
Pension funds
19 36 +*
+ sponsors
Fiduciary
managers +
Investment 14 9 (0.0446)
banks & asset
Managers
Interestingly, 63.9% of all respondents also
disagree that current funding shortfalls
reflect the ineffectiveness of derivatives
or of modern ALM techniques. In short,
identifying the reasons for the current
underfunding of pension funds calls for
further investigation:
• First, participants have underscored the
importance of longevity risk and its impact
on current funding ratios: for 65.3% of
respondents, longevity risk is the greatest
risk faced by the pension system yet not
addressed by modern ALM techniques. After
all, until very recently6 derivatives could
not be used to transfer longevity risk to the
capital markets. Historically, increasing life
expectancy has had a great impact on the
funding ratio of DB pension funds.
• In addition (not mentioned in the survey),
in some countries, pension deficits have
deeper historical roots than a recent
reluctance to apply the latest-generation
ALM techniques, and they usually involve
inappropriate contribution-setting policies
and counterproductive tax codes. In the
United Kingdom, for instance, the tax code
limited the possibility of high funding ratios,
which, together with underestimated liability
values, contributed to making underfunding
the rule. More modern valuation principles
revealed the underfunding of UK pension
funds, and current underfunding makes it
hard to use modern ALM techniques, whose
primary aim is protect the surplus (here,
ANOVA alas, illusory).
+*
4.4 Regulators Should Encourage
Long-Term Approaches to Investing but
(0.0473)
Set Minimum Funding Constraints
The third section of the call for reaction
deals with short-termism. In the late 1990’s
and in the early years of the current decade
 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009
4. Results by Theme
7 - This outcome is
significant at the 1% level.
one school of thought focused on portfolio
choices for long-term investors, with
authors such as Bodie (1995), Brennan et
al. (1997), Barberis (2000), Campbell and
Viceira (2003; 2005), Bandi and Perron
(2008). For these authors, the notion of
term structure of risk refers to the idea
that for some assets the variance of returns
(or of unexpected returns) does not rise
linearly with time, as it would were returns
independently identically distributed (i.i.d).
In particular, mean reversion in asset
returns (for instance, equity returns tend
to show mean reversion) means that the
term structure of equity returns (and other
high-risk asset classes) usually slopes
downwards.
Figure 8: Do you agree with the following statements?
On short-termism: a short-term focus makes the replication
of real liabilities difficult
On pro-cyclicality: regulation that encourages a short-term
focus and involves mass sales of risky assets from pension funds 7.7%
during downturns creates systemic risk
On accounting: immediate recognition of the volatility of the
surplus in the accounts of the sponsor is a bad idea
On prudential regulations: PFs should have strict minimum
funding ratios: even long-term investors should fully limit 7.7%
the short-term downside risk
On constraints and risk-monitoring: a lack of short-term
8.5%
constraints often means risk is not monitored at all
not at all
A second school of thought, exemplified
by authors such as Bodie (1983) and
Hoevenaars et al. (2008), has extended the
idea that the term structure of risk can be
transposed to an asset-liability management
framework. Hoevenaars et al. (2008) find
that, over the long run, real assets (such as
equities, real estate, commodities, and hedge
funds) allow the replication of liabilities
indexed to inflation and that “benefits of
long-term investing are larger when there
are liabilities”.
With the recent emergence of inflation
swaps and bonds, inflation has become a
tradable risk factor, but wages are not traded
on exchange, so they are not fully replicable
over the short term. So, today, indexing
liabilities to wages, the most traditional form
of indexing, found in last-wage pension
plans in the UK and a goal of many Dutch
pension plans, may be a perfect illustration
of the benefits of long-term ALM strategies;
it also illustrates the burden imposed by
short-termist regulations.
82.4% of respondents agree that a short-
term focus makes the replication of real
liabilities difficult.7 Respondents from the
Netherlands, where most pension plans have
12.7% 26.8% 55.6%
28.9% 57.7% 4.9%
11.3% 19% 25.4% 41.5%
24.6% 35.9% 28.9%
28.6% 38.6% 20% 4.3%
somewhat (no idea)
not really very much so
conditionally indexed liabilities, agree to
the tune of 100%. Respondents from the
United Kingdom, where liabilities are more
traditional, are less likely to agree (75.6%).
Respondents also express wider concerns
about short-termism:
• 86.6% think that regulation that
encourages a short-term focus and involves
mass sales of risky assets from pension
funds during downturns creates systemic
risk. The modern form of prudential
An EDHEC-Risk Institute Publication 21
 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009
8 - Each percentage is
significant, but the difference
between sample populations
is not.
22 An EDHEC-Risk Institute Publication
4. Results by Theme
regulation is indeed the risk-based form, these pension funds, minimum funding
which regulates the capacity to take risks ratios would mean higher funding ratios
and requires that risky assets be sold during and additional contributions.
downturns (therefore mimicking some of
the results from dynamic asset allocation
strategies in the presence of minimum 4.5 Internal Models are of Utmost
funding constraints). Importance to Pension Funds and
Regulations Should Provide Incentives
• 66.9% of respondents8 (78.6% of
to Build Them
sponsors, 87.8% of UK respondents)
As the responses to the questionnaire show,
think that immediate recognition of the
pension fund specialists think that pension
volatility of the surplus in the accounts
funds should take a long-term approach to
of the sponsor is a bad idea. Sponsors, as
investing and that short-term regulations
well as respondents from the UK, where
are counterproductive; yet they also think
FRS 17 involves more recognition in the
that there should be minimum funding
balance sheet than does IAS 19, bring up
constraints.
the perceived impact of stricter accounting
standards on sponsors whose pension
Amenc et al. (2009) have argued that
commitments are large. EDHEC will provide
internal models are a possible solution to
under separate cover a detailed analysis of
the apparent contradictions:
the proposed changes to IAS 19.
“Risk-based regulations are meant to foster
Finally, a majority of respondents agree
the development of good risk-management
that, although they should encourage a
practices. In the Basel accords, risk
long-term approach to investing, prudential
management is simply a qualitative
regulations should also involve short-term
obligation. In Solvency II, incentives for
constraints such as minimum funding
good risk management are such that
ratios:
capital requirements can be measured
• 64.8% of respondents (66.7% in the
with internal models, so that the risk of
Netherlands, 51.2% in the UK; the difference
insolvency or underfunding is limited to
is not significant) think that pension funds
0.5% per year for insurance companies.
should have strict minimum funding ratios,
Internal models must be used to manage
as even long-term investors should fully
and control risks and are thus best defined
limit the short-term downside risk.
not as risk measurement software but as a
• 58.6% (88.3% in the Netherlands, 46.3%
full risk management system. […]
in the UK; the difference is significant at
the 5% level) think that a lack of short-
Most recent regulation permits the use of
term constraints often means risk is not
internal models for the definition of solvency
monitored at all.
requirements after regulatory approval.
This allowance is present in Solvency
II and the Dutch prudential regulation
In our opinion, the relative aversion of
and to some degree in UK regulation.
respondents from the UK to minimum
Approval is conditioned primarily on the
funding ratios is a result of the structural
use of internal models in the following
underfunding of UK pension funds. For
 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

4. Results by Theme

9 - This is not significant at

the 5% threshold. After all,
there are limited answers from
Dutch pension funds.
fields: design of investment strategies,
risk monitoring and limit setting,
definition of the indexation policy,
contribution and funding policy (planning).
When these conditions are met, the
funding requirements made of pension
funds will be aligned to the nature of their
risks—in particular, funding requirements
will be reduced when pension funds use
risk-mitigation techniques and instruments
unrecognised by the standard formula
(dynamic strategies, long-term investing)”
(Amenc et al. 2009, 151).
when these constraints become overly
restrictive.
These arguments have been extremely well
received by the pension fund community
and should thus be taken into account by
the regulators.
• The EDHEC study argues that risk
management protects minimum funding
ratios better than high initial funding ratios
do, and 67.6% of respondents agree with
this affirmation. 75% of respondents from
the Netherlands,9 the only country to have

Figure 9: Do you agree with the following statements?

Risk management is more instrumental in protecting minimum 5% 15.8% 38.1% 29.5% 11.5%
funding ratios than high funding ratios
There must be incentives in building internal models—these
capture the specifics of pension funds and ensure best practices 8.5% 37.6% 43.3% 7.1%
in risk management
For internal models to be used in prudential reporting, model 5% 25% 61.4% 7.1%
or estimation risk must be properly accounted for
Regulation should remain very basic. Any sophistication in 5.5% 21.8% 39.4% 32.4%
regulatory approaches has great drawbacks.

Allowing internal models would penalise smaller pension funds

5% 36.2% 36.2% 13.5% 4.3%

not at all somewhat (no idea)

not really very much so

One of the main conclusions of the study
is that pension funds should build internal
models for their investment strategies,
because ultimately these models will be
used in setting funding requirements. Using
models will underscore the benefits of the
long-term approach to investing. In the
construction of such models, we emphasise
the importance of a thorough study of the
replication of liabilities, in particular of
their indexation to inflation and wages.
We also show how to build investment
strategies that lessen the sensitivity of the
pension fund or its sponsor to regulatory
constraints, an important element
adopted a risk-based prudential framework,
express their agreement.
• The superior efficiency of risk
management is a very strong theoretical
justification for internal models, so it comes
as no surprise that 80.9% of respondents
(78.6% of pension funds, 88.3% of advisers
and actuaries) think that there must be
incentives to build internal models, as these
models capture the specifics of pension
funds and ensure best practices in risk
management.
• 86.4% of respondents think that, for
internal models to be used in prudential
reporting, model or estimation risk must be

An EDHEC-Risk Institute Publication 23

 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

4. Results by Theme

properly accounted for. But few commercial that smaller institutions would be penalised
applications take estimation risk into by stronger capital requirements than larger
account. And when it is assumed that the institutions with similar risk profiles. We
parameters of the distributions are known interpret respondents’ relative unconcern
with perfect foresight, the predictive power with the possible penalties caused by
of estimation tools is greatly overstated and the use of internal models as a sign of
the risks taken are possibly underestimated. confidence in ALM and in the internal
In other words, accounting for parameter models developed and offered by such
risk may lead to a different (less risky) third parties as fiduciary management
asset allocation. In a context in which companies, third parties that will then
stocks are not used to hedge liabilities, be responsible for monitoring risk. These
Barberis (2000, 1) states that “the weak external offerings may allow economies
statistical significance of the evidence for of scales and make it less costly for the
predictability makes it important to take pension fund industry to rely on modern
estimation risk into account; a long-horizon ALM.
investor who ignores it may overallocate to
stocks by a sizeable amount”. CEIOPS (2009)
states that “it is generally agreed that while
mitigation techniques may reduce some
risks, they raise other new risks (such as
operational, counterparty and liquidity risks
among others). Therefore, it is necessary
to ascertain that these new risks are, on
the one hand, proportionate, and, on the
other hand, appropriately captured in the
capital requirements”.
• The significant backing (71.8%) for the
notion that regulation should remain very
basic calls for a two-tier approach, in which
there is a basic requirement for all funds
and the possibility to quantify requirements
more precisely with internal models.
• Last, it surprised us that only 49.7%
of participants (43.9% in the UK, 50%
in the Netherlands) were concerned that
allowing internal models would penalise
smaller pension funds. After all, because
of the fixed costs of an internal model
not acquired from a third party (software,
development time, qualified staff for risk
management), pension funds with fewer
assets under management may experience
larger unit costs, and some have worried

24 An EDHEC-Risk Institute Publication

5. Conclusion

An EDHEC-Risk Institute Publication 25

 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

5. Conclusion

The responses to our call for reaction As a consequence, a specific measurement

corroborate the arguments made in the
EDHEC study (Amenc et al. 2009) of the
impact of accounting and prudential
regulations on the ALM of European
pension funds.
of the combined risk of sponsor default and
underfunding is required. Contributions
must be raised or assets may be pledged
by the sponsor when this combined risk
arises.

In particular, respondents agree that pension Last, 78.5% of pension funds report that
funds should take a long-term approach dynamic strategies are difficult to implement
to investing, but they also think that they because management agreement is needed
should manage their short-term constraints; to rebalance a portfolio. Organisational
they agree that risk management protects problems keep pension funds from
minimum funding ratios better than high benefiting from dynamic investment
funding ratios do, and as such they believe strategies, even though these strategies
strongly that regulations should encourage are viewed with favour by both academics
risk management—for instance, by allowing and practitioners: at the same time, 73.2%
internal models. of pension funds agree that dynamic
strategies ensure that minimum funding
Dutch pension funds, which have already constraints are met.
implemented risk-based regulation
with strict minimum funding ratios, are
supportive of the idea that minimum
funding ratios should be implemented,
as these ratios foster risk management.
British pension funds, by contrast, with
their chronic underfunding, fear that
minimum funding ratios would involve a
counterproductive tightening of prudential
regulation of pension funds.

Respondents also point out, as we do, that

the funding ratio of the pension fund is
not, on its own, a sufficient indicator of
the degree of protection afforded pension
benefits: the risk to the benefits depends
on the combined risk of underfunding
and sponsor default. Respondents argue
that the use of modern ALM techniques
cannot fully ensure that a pension fund
is never underfunded, not only because
funding depends on the contribution policy
but also because longevity risk has added
significantly to liabilities.

26 An EDHEC-Risk Institute Publication

6. Appendices

An EDHEC-Risk Institute Publication 27

 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009
6. Appendices
6.1 Statistical Methodology
Throughout the survey, we have tested and
reported whether respondents’ answers
were statistically significant or not.
Three tests have been used throughout
the survey, as described below. In all cases,
one star indicates significance at the 5%
level and two stars significance at the 1%
level.
Binomial test
To assess whether respondents’ agreement
or disagreement with EDHEC’s main
conclusions is statistically significant, we
use a two-tailed binomial test, grouping
in one category those who report that
they agree somewhat or very much, and
in another those who disagree strongly or
somewhat.
The binomial test is an exact test of the
distribution of outcomes classified in two
categories, with the number of draws, the
number of outcomes in each category,
and the null (implied) probability of each
draw for the test used as inputs. In the
current publication, the null (implied)
probability tested is 50%; that is, we test
the assumption that respondents as a
group have no opinion, so each respondent
has a random probability of agreeing or
disagreeing with EDHEC’s view.
We use a two-tailed test; in other words,
we assess not only the probability under
the null that there are at least as many
respondents that agree as observed but
also the probability of the opposite extreme
(disagreement with EDHEC’s views).
The two-tailed test is, of course, more
powerful than the one-tailed test, which
28 An EDHEC-Risk Institute Publication
only assesses the probability that there at
least as many respondents agreeing with
EDHEC’s views.
With N the number of respondents, p the
number of positive answers, and d the
number of negative answers, with the
notation m=min (p,d), the p-value reads
P=2*B (m, N, 50%), where B is the
cumulative distribution function of the
binomial probability.
Fisher’s exact test
When two samples need to be compared, we
use either Fisher’s exact test or an analysis
of variance (see next sub-section).
Fisher’s exact test assesses the equality of
binomial probabilities. In most cases, as we
test whether one sub-sample (for instance,
one country or the group of pension funds
as a whole) differs in its opinion from
another sub-sample (for instance, the
rest of the sample), we use a two by two
test; i.e., we assess whether the binomial
probability of the first sub-sample is equal
to that of the other sub-sample. When
there are three sub-samples, two by three
tests are sometimes used.
The logic of the test is as follows:
assuming two samples with two binomial
probabilities,
Neg Pos
Geography 1 a b
Geography 2 c d
Fisher showed that the probability of
obtaining any such set of values was given
by the hypergeometric distribution:
Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009
6. Appendices
where n=a+b+c+d and is the binomial
coefficient.
Fisher’s exact test is exact when the
marginals, that is, a+b and c+d, are known,
as they are here (the number of respondents
for each geography is given at the end of
the survey; only the distribution function
of the two sub-samples is unknown).
ANOVA – Analysis of variance
The simple ANOVA test assesses whether
the means of different sub-samples are
equal, under the assumptions that they
have the same variance.
When there are only two samples to
compare, the Student two-sample t-test is
adapted and can be viewed as a specific case
of the ANOVA method. The more general
one-way ANOVA tests for differences in
the mean of independent groups, assuming
the same variance.
The ANOVA method consists of comparing
the variance of the group means and the
mean of the variances of observations of
each group (the within-group variance),
after adjusting for the numbers of degrees
of freedom.
where
,
I = number of “treatments” [groups]
and
,
nT = total number of cases.
When the samples are not independent,
their means will differ, so both F and F*
will be high.
F* has a Fisher distribution.
The test is based on the four possible
answers to the questions; blanks and “I
don’t know” responses are filtered out. We
assume that the variable of interest can
have a quantitative interpretation, since
it represents the intensity of participants’
beliefs, from “strongly disagree” to “very
much agree”.
6.2 Respondents Raise the Issue of
Corporate Failures and Corporate Risk
a) The issue of corporate failures—the
case of bankrupt institutions
As one respondent notes, “the impact
of corporate failures in an economic
downturn, and how liabilities should be
met in an underfunded pension scheme”
is an important one.
When the sponsor of a pension fund goes
bankrupt, preservation of members’ rights
becomes the primary concern.
The first issue is purely legal. Stewart
(2007) argues that members’ rights are
often unsecured and that they should be
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6. Appendices
reinforced to ensure that members and
other creditors are treated equally. As things
stand now, other creditors have a greater
ability to modify the terms of lending in
such a way as to move up in the creditor
rankings—in other words, to be repaid
sooner than other creditors. Creditors and
sponsors may, in Stewart’s terms, resort to
“strategic bankruptcies” (to shed pension
liabilities), deliberate underfunding, or
“avoidance tactics” (such as rearranging
the corporate structure). Moreover, under
bankruptcy protection, where creditors
renegotiate to avoid full bankruptcy,
members of underfunded schemes, who
are both creditors and employees, have the
strongest incentives to prevent bankruptcy
and are in general more likely than others
to renounce rights.
Stewart (2007) and the OECD’s “Guidelines
for the protection of the rights of members
and beneficiaries” recommend that “Where
insolvency guaranty schemes do not exist,
there should be a priority position for due
and unpaid contributions, equal at least
[to] the position of due and unpaid taxes”
(11).
Another problem is the limited protection
offered by external guarantee mechanisms,
such as pension benefit insurance schemes.
These schemes, such as the UK Pension
Protection Fund (PPF) or the German
PSaVG, guarantee a minimum benefit in
the event of sponsor bankruptcy. However,
pension rights are almost always cut
when made good on by guarantee funds,
so a well funded pension fund is in the
interest of members; moreover, as long
as these guarantee funds are financed
by contributions from existing defined-
benefit pension funds, they are subject to
30 An EDHEC-Risk Institute Publication
the risk of the closure of these pension
funds. In this case, a reduced paying base
may mean that higher contribution rates
are needed to finance past deficits from
closed pension funds.
b) Management of sponsor default risk
A respondent stated that the management
of corporate pension schemes is poorly
understood and that in the UK asset
allocation and scheme funding strategy
should depend above all on the strength
of the sponsor covenant–the likelihood
that it will become insolvent in the short
or intermediate term.
Regulations are, in effect, becoming tighter;
underfunding must be corrected in shorter
and shorter periods. Because pension funds
are invested in risky assets, which are
correlated with the state of the economy,
pension funds tend to be underfunded
during recessions, when sponsors are least
able to erase deficits; thus, sponsor risk
must be measured to protect members’
rights. Pension fund prudential regulations,
however, fail to assess pension fund risk
as the combined risk of underfunding and
sponsor default:
“From a theoretical standpoint, pension
liabilities are a particular claim on
the assets of the sponsor. They are a
collateralised form of debt held by the
workers and pensioners of the sponsor, a
form in which the assets of the pension
plans are the collateral, in exchange for
which the company receives the present
value of lower wage demands.
This analysis suggests that the rational
valuation of pension liabilities regarded as
(defaultable) claims issued by the sponsor
Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009
6. Appendices
company to workers and pensioners should
be cast within the context of a standard
corporate finance model for defaultable
bond pricing, […] and reflected in the ALM
strategy of the pension fund.
[…] Suppose that pension management
attempts to maximise the market value
of the pension benefit to be received by
plan members. Participants make no future
contributions in the event of deficits, and
have no additional benefits in the event
of surpluses.
• When the risk of default is ignored—in
other words, assuming unlimited capacity
to erase plan deficits—plan participants
are indifferent to the asset allocation and
funding policy of the pension plan. After
all, the benefit received does not depend on
the terminal asset value or on the terminal
funding ratio.
• When the probability of sponsor default
is taken into account, the participant will
seek to minimise the impact of the joint
probability of underfunding and default.
When liabilities are fully hedgeable and
the pension fund is sufficiently funded,
employee welfare is maximised when
the pension fund replicates the liability
and does not take any further risk.
When the liability is not fully hedgeable
(i.e., wage-indexed liabilities or longevity
risk), the pension fund will seek protection
against the risk of default of the sponsor,
perhaps with credit default swaps (CDS).
[…] We will note that this valuation exercise
is very similar to that of the fair pricing
for pension insurance. In the US, for
example, the Pension Benefit Guaranty
Corporation (PBGC) charges sponsors a
premium determined solely by the extent of
the funding shortfall; the sponsor’s overall
financial health is ignored. Pension plans
pay the PBGC yearly insurance premiums:
$19 per worker or retiree plus $9 for each
$1,000 of unfunded vested benefits in
single employer plans.
The British Pension Regulator, by contrast,
explicitly determines the levy paid to the
PPF as a function of both underfunding and
the likelihood of sponsor default” (Amenc
et al. 2009, 132).
Practical problems arise when the likelihood
of sponsor default rises. One option,
usually feared by sponsors, is to increase
contributions: 60.6% of respondents (65%
of pension funds, 85.7% of sponsors) think
that stricter regulations require higher
contributions during economic downturns,
precisely when firms are short of cash.
An alternative is simply to require that the
sponsor pledge assets as guarantees in the
event of insolvency. Here, the choice and
management of these assets is of some
importance; in the short-term, liquid assets
may be needed by the sponsor if it is near
bankruptcy.
86.6% of respondents (90.7% of pension
funds, 100% of sponsors) fear that
regulation that encourages a short-term
focus and involves mass sales of risky assets
from pension funds during downturns
creates systemic risk. Pledging more assets
during downturns could obviate the need
to sell off risky assets and thus allay this
widespread fear.
An EDHEC-Risk Institute Publication 31
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6. Appendices

32 An EDHEC-Risk Institute Publication

7. Bibliography

An EDHEC-Risk Institute Publication 33

 Reactions to an EDHEC Study on the Impact of Regulatory Constraints on the ALM of Pension Funds — October 2009

7. Bibliography

• Amenc, N., L. Martellini, and S. Sender. 2009. Impact of regulations on the ALM of
pension funds. EDHEC publication.
• Bandi, F., and B. Perron. 2008. Long-run risk-return trade-offs. Journal of Econometrics
143:349-374.
• Barberis, N. 2000. Investing for the long run when returns are predictable. Journal of
Finance 55:225-264.
• Bodie, Z. 1995. On the risk of stocks in the long run. Financial Analysts Journal 51(3):
18-22.
• Bodie, Z. 1983. Commodity futures as a hedge against inflation. Journal of Portfolio
Management 9(3):12-17.
• Brennan, M., E. Schwartz, and R. Lagnado. 1997. Strategic Asset Allocation. Journal of
Economic Dynamics and Control 21:1377-1403.
• Campbell, J., and L. Viceira. 2005. The term structure of the risk-return trade-off.
Financial Analysts Journal 61(1): 34-44.
• Campbell, J., and L. Viceira. 2003. Strategic asset allocation. Review in Financial
Counseling and Planning 14(1): 63-65.
• CEIOPS. 2009. Draft advice for level 2 implementing measures on Solvency II: SCR
standard formula—Allowance of financial mitigation techniques.
• Hoevenaars, R., R. Molenaar, P. Schotman, and T. Steenkamp. 2008. Strategic asset
allocation with liabilities: Beyond stocks and bonds. Journal of Economic Dynamics and
Control 32(9): 2939-2970.
• OECD. 2003. OECD guidelines for the protection of rights of members and beneficiaries
in occupational pension plans. OECD publications.
• Sender, S. 2009. The European pension fund industry again beset by deficits. April.
EDHEC publication.
• Stewart, F. 2007. Benefit protection: Priority creditor rights for pension funds. OECD
working papers on insurance and private pensions.

34 An EDHEC-Risk Institute Publication


Founded in 1906, EDHEC is
one of the foremost French
business schools. Accredited by
the three main international
academic organisations, EQUIS,
AACSB and Association of MBAs,
EDHEC has for a number of
years been pursuing a strategy
for international excellence
that led it to set up
EDHEC-Risk in 2001.
With 46 professors, research
engineers and research
associates, this centre has
the largest European asset
management research team.
Reactions to an EDHEC Study on the Impact of Regulation on the ALM of European Pension Funds — August 2009
About EDHEC-Risk Institute
The choice of asset allocation
and risk management
EDHEC-Risk structures all of its research
work around asset allocation and risk
management. This issue corresponds to
a genuine expectation from the market.
On the one hand, the prevailing stock market
situation in recent years has shown the
limitations of diversification alone as a risk
management technique and the usefulness
of approaches based on dynamic portfolio
allocation. On the other, the appearance of
new asset classes (hedge funds, private equity,
real assets), with risk profiles that are very
different from those of the traditional
investment universe, constitutes a
new opportunity and challenge for the
implementation of allocation in an asset
management or asset-liability management
context. This strategic choice is applied to
all of the centre's research programmes,
whether they involve proposing new methods
of strategic allocation, which integrate the
alternative class; taking extreme risks into
account in portfolio construction; studying
the usefulness of derivatives in implementing
asset-liability management approaches;
or orienting the concept of dynamic
“core-satellite” investment management in
the framework of absolute return or target-
date funds.
3.5% Fees
11% Stock Picking 40% Strategic
Asset Allocation
45.5 Tactical
Asset Allocation
Source EDHEC (2002) and Ibbotson, Kaplan (2000)
An applied research approach
In an attempt to ensure that the research
it carries out is truly applicable, EDHEC has
implemented a dual validation system for the
work of EDHEC-Risk. All research work must
be part of a research programme, the relevance
and goals of which have been validated from
both an academic and a business viewpoint by
the centre's advisory board. This board is made
up of internationally recognised researchers,
the centre's business partners and
representatives of major international
institutional investors. The management of
the research programmes respects a rigorous
validation process, which guarantees the
scientific quality and the operational usefulness
of the programmes.
Six research programmes have been
conducted by the centre to date:
• Asset allocation and alternative
diversification
• Style and performance analysis
• Indices and benchmarking
• Operational risks and performance
• Asset allocation and derivative
instruments
• ALM and asset management
These programmes receive the support of
several financial companies, both from
within France and abroad, representing
some thirty different sponsors (including
AXA Investment Managers, Barclays Global
Investors, BNP Paribas Investment Partners,
Citigroup, CACEIS, Deutsche Bank, FBF,
Fortis, Eurex, LODH, NYSE Euronext, HSBC,
Pictet, Robeco, Morgan Stanley, NewEdge,
SG CIB, State Street, UBS, UFG, and many
others).
An EDHEC-Risk Institute Publication 35
 Reactions to an EDHEC Study on the Impact of Regulation on the ALM of European Pension Funds — August 2009
About EDHEC-Risk Institute
In addition, EDHEC has developed a
close partnership with a small number of
sponsors within the framework of research
chairs. These research chairs correspond
to a commitment over three years from
the partner on research themes that are
agreed in common. The following research
chairs have been endowed to date:
• ‘Regulation and Institutional Investment’,
in partnership with AXA Investment
Managers (AXA IM)
• ‘Asset-Liability Management and
Institutional Investment Management’
in partnership with BNP Paribas Investment
Partners
• ‘Risk and Regulation in the European
Fund Management Industry’,
in partnership with CACEIS
• ‘Structured Products and Derivative
Instruments’,
sponsored by the French Banking Federation
(FBF)
• ‘Financial Engineering and Global
Alternative Portfolios for Institutional
Investors’,
in partnership with Morgan Stanley
Investment Management (MSIM)
• ‘Private Asset-Liability Management’
in partnership with ORTEC Finance
• ‘Dynamic Allocation Models and New
Forms of Target-Date Funds’
in partnership with UFG
• ‘Advanced Modelling for Alternative
Investments’
in partnership with Newedge Prime
Brokerage
• ‘Asset-Liability Management Techniques
for Sovereign Wealth Fund Management’
in partnership with Deutsche Bank
• ‘Core-Satellite and ETF Investment’
in partnership with CASAM.
36 An EDHEC-Risk Institute Publication
The philosophy of the centre is to validate
its work by publication in international
journals, but also to make it available to
the sector through its Position Papers,
published studies and conferences.
Each year, EDHEC organises two conferences
for professionals with a view to presenting
the results of its research: EDHEC
Alternative Investment Days (London) and
EDHEC Institutional Days (Paris), attracting
more than 2,000 professional delegates.
EDHEC also provides professionals with
access to its website, www.edhec-
risk.com, which is entirely devoted to
international asset management research.
The website, which has more than 30,000
regular visitors, is aimed at professionals
who wish to benefit from EDHEC’s analysis
and expertise in the area of applied
portfolio management research. Its
monthly newsletter is distributed to more
than 350,000 readers.
EDHEC’s distinguished international
faculty includes renowned researchers
and professors in finance and economics
whose work has appeared in the major
academic journals worldwide, including
Professor Noël Amenc, Professor René
Garcia, Professor Pierre Mella-Barral,
Professor Lionel Martellini, Professor
Florencio Lopez de Silanes and Professor
Joëlle Miffre.
Research for Business
The centre’s activities have also given rise
to the business offshoot EDHEC Asset
Management Education.
EDHEC Asset Management Education helps
investment professionals to upgrade their
Reactions to an EDHEC Study on the Impact of Regulation on the ALM of European Pension Funds — August 2009

About EDHEC-Risk Institute

skills with advanced risk and asset

management training across traditional
and alternative classes.

The EDHEC PhD in Finance

The PhD in Finance at EDHEC Business
School is designed for professionals who
aspire to higher intellectual levels and aim
to redefine the investment banking and
asset management industries.

It is offered in two tracks: a residential

track for high-potential graduate students,
who hold part-time positions at EDHEC
Business School, and an executive track
for practitioners who keep their full-time
jobs.

Drawing its faculty from the world’s best

universities and enjoying the support
of the research centre with the greatest
impact on the European financial industry,
the EDHEC PhD in Finance creates an
extraordinary platform for professional
development and industry innovation.

An EDHEC-Risk Institute Publication 37

 Reactions to an EDHEC Study on the Impact of Regulation on the ALM of European Pension Funds — August 2009

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38 An EDHEC-Risk Institute Publication

EDHEC-Risk Institute
393-400 promenade des Anglais
BP 3116
06202 Nice Cedex 3 - France
Tel.: +33 (0)4 93 18 78 24
Fax: +33 (0)4 93 18 78 41
E-mail: research@edhec-risk.com
Web: www.edhec-risk.com