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Recent Research: Highlights from November 2013

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"Are Risk-Parity Managers at Risk Parity?"
The Journal of Portfolio Management (Fall 2013)
Edward Qian

Risk parity has become an accepted investment strategy, to some degree. Its main advantage is its use of risk allocation, as opposed to the capital allocation used by the traditional asset allocation approach. A balanced risk allocation provides true diversification; therefore risk parity should deliver better risk-adjusted return over time. Despite the acceptance and the fact that the term “risk parity” has been in use for almost ten years, the investment community seems confused about risk parity’s true definition. Is it just a quantitative risk-budgeting technique? Is it about operational leverage? Or is it about high exposures to fixed income and low exposures to equities? In this paper, the author aims to define the principle of risk parity investing. He then examines a sample of risk parity managers, using the return-based style analysis pioneered by William Sharpe. The results show that, according to the defined principle, a number of risk parity managers in our sample are not using true risk parity.

"The Glidepath Illusion… and Potential Solutions"
The Journal of Retirement (Fall 2013)
Robert D. Arnott, Katrina F. Sherrerd, and Lillian Wu

Target-date investment strategies purport to meet the two primary objectives of any retirement savings program: maximizing the real value of investors’ nest eggs while minimizing uncertainty around prospective income in retirement. The authors demonstrate that the classic glidepath approach to retirement investing—moving from equity-centric to bond-centric investing as we age—does not meet these objectives. The authors summarize the flaws in traditional glidepath implementation and explore illustrative changes to the rules-based, mechanistic solution for retirement planning that can improve the expected outcome for investors, using simulations to test alternatives. Their findings show that, even with simple rules-based approaches, there are better ways to achieve our financial objectives for retirement.

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"An Open Quadrant: High-Yield, Long-Term Institutional Project Loans"
The Journal of Structured Finance (Fall 2013)
John Ryan

This article is about a type of senior debt capitalization that currently does not really exist, but likely will develop soon—long-term, high-yield project finance loans for infrastructure in Organization for Economic Cooperation and Development (OECD) countries. The author predicts that a subset of institutional investors will fill this open segment of the project finance loan market, because senior, secured, long-term, high-yield loans will meet many of their investment objectives while utilizing their capabilities and providing them with a competitive advantage. He also predicts that a number of project owners and sponsors will demand this loan product once available, because it can support their specific senior capitalization objectives, especially with respect to minimizing refinancing risk while optimizing leverage and flexibility.

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