Advances in the Practice of Public Investment Management : Portfolio Modelling, Performance Attribution and Governance

This book covers the latest advances in the theory and practice of public investment management. It includes the most up-to-date developments in the implementation of public asset management – including multiple contributions on portfolio allocation in varying interest-rate and credit-risk environments. Other highlights include implementation, performance attribution and governance issues surrounding reserves management, portfolio construction techniques appropriate for public investors and an in-depth discussion of the challenges to achieving international diversification. Preface 5 Contents 8 Notes on Contributors 11 List of Figures 19 List of Tables 22 Part I: Foreign Reserves Management Strategies: Implementation, Performance and Governance 26 Chapter 1: Hedging Potential Liabilities of Foreign Reserves Through Asset Allocation 27 1.1 Introduction 27 1.2 Asset-Liability Management in International Reserves Portfolios 28 1.3 Measuring Reserve Adequacy 31 1.4 Methodology 36 1.5 Data Description 38 1.6 Estimation and Results 39 1.7 Concluding Remarks 45 Appendix: Selected Factors from Wilshire’s Axiom Used to Explain Reserves Liabilities 47 References 48 Chapter 2: Setting the Appropriate Mix Between Active and Passive Management in the Investment Tranche of a Foreign Reserves Portfolio 50 2.1 Introduction 50 2.2 Sources of Alpha 52 2.3 Adding the Sources of Alpha to the Market Portfolio 56 2.4 Simulation 59 2.5 Conclusion 64 References 66 Chapter 3: A New Fixed-Income Fund Performance Attribution Model: An Application to ECB Reserve Management 68 3.1 Introduction1 68 3.2 The Methodology 71 3.3 Main Features of the ECB Reserve Management Framework 78 3.4 Results 80 3.5 Conclusions 93 References 94 Chapter 4: Sovereign Wealth Fund Investment Performance, Strategic Asset Allocation, and Funding Withdrawal Rules 96 4.1 Introduction 96 4.2 Shifts in SWF Strategic Asset Allocations During 2010–15 98 4.3 SWF Investment Performance over the Last Decade 102 4.4 SWF Investment Value Chain and Implications for SAAs and Investment Performance 106 4.4.1 Policy Objectives and Funding and Withdrawal Frameworks 106 4.4.2 Enhancing the Investment Value Chain Through Appropriate Funding and Withdrawal Rules 107 4.4.3 A Stylized Framework of Macrofiscal Linkages and Funding and Withdrawal Rules 115 4.5 Concluding Remarks 117 References 120 Part II: Asset Allocation and Interest Rate & Credit Risk Environment 123 Chapter 5: A Macro-Based Process for Actively Managing Sovereign Bond Exposures 124 5.1 Introduction 124 5.2 Model Set-Up 126 5.3 Data and Estimation 131 5.4 Excess Return Predictability 132 5.4.1 In-Sample Backtesting 135 5.4.2 Out-of-Sample Backtesting 142 5.5 Discussion 145 5.6 Conclusions 147 Annex 148 References 149 Chapter 6: Carry On? 151 6.1 Introduction 151 6.1.1 Carry 153 6.1.2 Our Research 155 6.2 Methodology and Data 155 6.2.1 Data 156 6.2.2 Calculating Carry 157 6.2.3 Constructing Carry Strategy Portfolios 160 6.2.4 Transaction Costs 161 6.3 Results 162 6.3.1 Cross-Market 162 6.3.2 Cross-Curve 168 6.3.3 Cross-Market and Cross-Curve 172 6.3.4 Time-Varying Fluctuations and the Carry Signal 172 6.4 Conclusion 175 References 178 Chapter 7: Short-Term Drivers of Sovereign CDS Spreads 180 7.1 Introduction 180 7.2 Related Literature 183 7.3 Description of the CDS Market 183 7.4 Data 185 7.5 Empirical Strategy and Results 189 7.5.1 Results 194 7.5.2 Robustness Check 201 7.6 Conclusion 229 References 232 Chapter 8: Long-Term Expected Credit Spreads and Excess Returns 233 8.1 Introduction 233 8.2 Risk-Neutral Valuation Model 235 8.2.1 Defaultable Zero-Coupon Bond Excluding the Bond Basis 235 8.2.2 Defaultable Zero-Coupon Bond Including the Bond Basis 236 8.2.3 Modeling Default Probabilities 237 8.2.4 Defaultable Coupon-Paying Bond 238 8.3 Data 239 8.3.1 Raw Data 239 8.3.2 Smooth Marginal Default Probabilities 240 8.3.3 Recovery Rates 241 8.3.4 Government Bond Yields and Term Structure 242 8.3.5 Credit Spreads 242 8.3.5.1 Extended Sample of Option-Adjusted Credit Spreads 242 8.3.5.2 Credit Spread Term Structures 244 8.3.6 Bond Basis 245 8.4 Methodology 245 8.4.1 Model Parameters 245 8.4.2 Calibration Credit Spread Term Structures 247 8.4.3 Expected Credit Excess Returns 248 8.5 Results 249 8.5.1 Credit Spread Term Structures 249 8.5.2 Credit Excess Returns 253 8.6 Conclusion 254 Appendix 256 References 260 Part III: Portfolio Construction 263 Chapter 9: Regime Identification for Sovereign Bond Portfolio Construction 264 9.1 Introduction 264 9.2 Regime Identification 266 9.3 Alternative Regime Indicators 269 9.4 Empirical Analysis 272 9.4.1 Predictive Power of the Regime Indicators 272 9.4.2 Portfolio Construction 275 9.4.2.1 Methodology 278 9.4.2.2 Results 280 9.4.2.3 Stylised Facts 286 9.5 Concluding Remarks 288 References 290 Chapter 10: Benchmark-Relative and Absolute-Return Are the Same Thing: Conditions Apply 292 10.1 Portfolio Objectives 292 10.2 Adding Constraints to Improve Performance 297 10.3 Convergence of Benchmark-Relative and Absolute-Return Portfolios 300 10.4 Identifying Optimal Tracking Error Levels 301 10.5 How to Avoid Tracking Bears 302 10.6 Implications for Investors and Conclusions 304 Appendix: Simulation Details 305 References 306 Chapter 11: Factors and Sectors in Asset Allocation: Stronger Together? 307 11.1 Introduction 307 11.2 Data and Methods 308 11.3 Descriptive Statistics 310 11.4 Contest 314 11.5 Combination 317 11.6 Discussion and Conclusion 321 Appendix 322 References 324 Part IV: Asset Classes for Public Investors 326 Chapter 12: The Impact of Benchmark Investing by Institutional Investors on International Capital Allocations 327 12.1 Introduction 328 12.2 Data 332 12.3 Conceptual Framework 333 12.4 Evidence 339 12.5 Conclusions 349 References 352 Chapter 13: Equity Markets Integration and Active Portfolio Management 355 13.1 Introduction 355 13.2 Literature Review 360 13.3 Hypothesis and Methodology 362 13.4 Data 363 13.5 Results by Country 364 13.5.1 Co-integration Tests 364 13.5.2 Portfolio Analysis 372 13.6 Results by Industries 375 13.6.1 Co-integration Tests 375 13.6.2 Portfolio Analysis 378 13.7 Conclusion 379 References 380 Chapter 14: Government Bond Clienteles and Yields 382 14.1 Introduction 382 14.2 Data and Methodology 385 14.2.1 GoC Bond Description 385 14.2.2 Investor Classification 390 14.2.3 Portfolio Duration Characteristics 390 14.2.4 Summary Statistics of GoC Yields and Flows 393 14.2.5 Empirical Test Methodology 395 14.3 Empirical Results 396 14.3.1 Short-Duration Bond Sector 397 14.3.2 Medium-Duration Bond Sector 399 14.3.3 Long-Duration Bond Sector 400 14.3.4 Robustness Checks 401 14.4 Conclusion and Future Work 402 References 404 Index 405 Front Matter ....Pages i-xxviii Front Matter ....Pages 1-1 Hedging Potential Liabilities of Foreign Reserves Through Asset Allocation (Daniel E. Diaz, Julián David García-Pulgarín, Cristian Porras, Marco Ruíz)....Pages 3-25 Setting the Appropriate Mix Between Active and Passive Management in the Investment Tranche of a Foreign Reserves Portfolio (Daniel Vela Barón)....Pages 27-44 A New Fixed-Income Fund Performance Attribution Model: An Application to ECB Reserve Management (Francesco Potente, Antonio Scalia)....Pages 45-72 Sovereign Wealth Fund Investment Performance, Strategic Asset Allocation, and Funding Withdrawal Rules (Michael G. Papaioannou, Bayasgalan Rentsendorj)....Pages 73-99 Front Matter ....Pages 101-101 A Macro-Based Process for Actively Managing Sovereign Bond Exposures (Jacob Bjorheim, Joachim Coche, Alex Joia, Vahe Sahakyan)....Pages 103-129 Carry On? (Joachim Coche, Mark Knezevic, Vahe Sahakyan)....Pages 131-159 Short-Term Drivers of Sovereign CDS Spreads (Marcelo Yoshio Takami)....Pages 161-213 Long-Term Expected Credit Spreads and Excess Returns (Erik Hennink)....Pages 215-244 Front Matter ....Pages 245-245 Regime Identification for Sovereign Bond Portfolio Construction (Santiago Alberico, Joachim Coche, Vahe Sahakyan, Omar Zulaica)....Pages 247-274 Benchmark-Relative and Absolute-Return Are the Same Thing: Conditions Apply (Robert Scott)....Pages 275-289 Factors and Sectors in Asset Allocation: Stronger Together? (Marie Brière, Ariane Szafarz)....Pages 291-309 Front Matter ....Pages 311-311 The Impact of Benchmark Investing by Institutional Investors on International Capital Allocations (Claudio Raddatz, Sergio L. Schmukler, Tomás Williams)....Pages 313-340 Equity Markets Integration and Active Portfolio Management (Gabriel Petre, Olga Sulla, Daniel Vela Barón)....Pages 341-367 Government Bond Clienteles and Yields (Jianjian Jin, Francisco Rivadeneyra, Jesús Sierra)....Pages 369-391 Back Matter ....Pages 393-394