Reactions to the EDHEC Study - Faculty and Research

An EDHEC-Risk Institute PublicationReactions to the EDHEC Study“Optimal Design of CorporateMarket Debt Programmes in thePresence of Interest-Rate andInflation Risks”May 2012with the support ofInstitute

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012About the AuthorsNoël Amenc is Professor of Finance and Director of EDHEC-Risk Institute.He has a master's degree in economics and a PhD in finance andhas conducted active research in the fields of quantitative equitymanagement, portfolio performance analysis, and active asset allocation,resulting in numerous academic and practitioner articles and books.He is a member of the editorial board of the Journal of PortfolioManagement, associate editor of the Journal of Alternative Investmentsand a member of the scientific advisory council of the AMF (the Frenchfinancial regulatory authority).Felix Goltz is Head of applied research at EDHEC-Risk Institute. Hecarries out research in empirical finance and asset allocation, witha focus on alternative investments and indexing strategies. His workhas appeared in various international academic and practitionerjournals and handbooks. He obtained a PhD in finance from theUniversity of Nice Sophia-Antipolis after studying economics andbusiness administration at the University of Bayreuth and EDHECBusiness School.Vincent Milhau holds master's degrees in statistics (ENSAE) andfinancial mathematics (Université Paris VII), as well as a PhD in finance(Université de Nice-Sophia Antipolis). In 2006, he joined EDHEC-RiskInstitute, where he is deputy scientific director. His research focus ison portfolio selection problems and continuous-time asset-pricingmodels.Masayoshi Mukai is an analyst at EDHEC-Risk Indices and Benchmarks.He attended college at the University of California at Berkeley,where he graduated with high honors and was a Regents’ andChancellor’s scholar. He also holds an MPhil in Management fromthe University of Cambridge, Judge Business School and is a memberof Girton College. His research interests are in the area of equity andfixed income indexing innovation.4 An EDHEC-Risk Institute Publication

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20122. Background and Methodology1 - Each of these methodshas unique risks anddrawbacks, and there isgenerally a trade-off betweenaccuracy and cost. Forexample, inflation swaps(ignoring counterparty risk)are a direct hedge, however,they may be prohibitivelycostly. TIPS similarly havelow returns. Ang et al. (2011)have studied the relationshipbetween specific stocks andinflation, while others havefound that, generally, equitiesare negatively correlated withinflation in the short-term,but positively correlatedover longer horizons. Thus,equities, as well as real estateand commodities have beenidentified as inflation hedges,albeit imperfect ones (see e.g.Amenc et al. 2009).2 - For example, in March2012, US TIPS were sold withrecord negative yields (seee.g. Eddings 2012).3 - Strong investor demandfor inflation-linked corporatebonds is reflected in the“sell-out” of Tesco’s recentlyissued (Dec. 2011) inflationlinkedbond offering (seeHyde 2011).4 - See e.g. Inderst (2010)who finds that infrastructurecompanies, as well as utilities(which sometimes haveregulated price increases tiedto inflation indices) haveinflation-linked cash flows.5 - As mentioned, utility andinfrastructure companieshave been known to haverevenues strongly correlatedto inflation, while, forexample, others have noted anegative correlation betweeninflation and the revenuesof banking companies(which hold high amounts offinancial assets; see Boydet al. 2001).2.1. Background: The case forinflation-linked corporate bondsInflation risk has been a growing concernfor all investors while for some, suchas pension funds which have liabilitiesdirectly tied to an inflation index, inflationhedging has always been of criticalimportance. The assets used by investorsto hedge inflation risk typically includesovereign inflation-linked bonds, such asU.S. Treasury Inflation Protected Securities(TIPS), inflation swaps, equities, andcommodities. 1 Sovereign bonds tied to aninflation index, however, have lost some oftheir appeal to investors. In particular, thelow returns of these bonds 2 coupled withrising uncertainty of sovereign issuers’credit-worthiness have contributed toan environment where inflation-linkedbonds issued by corporations may emergeas an appropriate substitute for sovereigninflation-linked bonds. 3Many institutional investors, while theyoften have fixed liabilities, are free tochoose in terms of defining their assetallocation. Conversely, the assets ofcorporations which issue bonds forfinancing are relatively fixed, whilethey have the opportunity to adjusttheir liabilities through various formsof debt-issuances, including inflationlinkedbonds which are typically tied toan inflation index such as the CPI, andfloating rate bonds which are tied tothe evolving level of interest rates. Firmswith high correlation between their cashflows and inflation can effectively hedgethe inflation risk inherent in their cashflows by issuing inflation-linked debt. Forexample, it is often argued that firms inthe utility sector 4 have revenues whichincrease with inflation, thus offeringnatural compensation for an obligationto pay inflation-linked coupons on bondsissued. This same type of debt can beused by investors to hedge inflationbasedliabilities. Furthermore, corporatebonds share a credit risk component withcorporate liabilities (particularly pensionliabilities), making them a more naturalliability hedge than sovereign bonds(Scherer 2006). Thus inflation-linkedcorporate bonds potentially provide ameans to reduce the risk of certain issuerswhile simultaneously reducing the risk ofinvestors.Despite the fact that levels of correlationof corporate cash flows with inflationvary widely across companies, 5 corporatedebt issuances are nearly uniform in theirtreatment of inflation risk – with most ofthem refraining from issuing inflationlinkeddebt. As a consequence, the marketfor inflation-linked corporate debt is notwell developed. For the UK, Leaviss (2010)estimates the outstanding amount ofinflation-linked corporate debt at $11billion, compared to a total market of$342 billion for corporate bonds. Anotherillustration of the scarcity of inflationlinkedcorporate bonds is that amongstthe 94 corporate bonds available from theretail bonds outlet of the London StockExchange, there are only two inflationlinkedbonds.The lack of development of the corporateinflation-linked debt market in practice,has a parallel in the academic literaturewhich has relatively little to say on howto optimally choose – as an issuer –between different types of debt (e.g.inflation-linked versus nominal debt). Theacademic literature on debt-management8 An EDHEC-Risk Institute Publication

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20122. Background and Methodology6 - Leland (1994), Lelandand Toft (1996) and Ju andOu-Yang (2006) all examinedcapital structure theoryassuming fixed-rate debt.7 - For some extremeparameter values we foundthat an optimal level requireda negative position (whichcould be obtained throughderivative-based tools).and capital structure has studied theidea of an “optimal” capital structure (i.e.the decision of how to split the firm’ssources of financing between equity anddebt), however, these models of optimalcapital structure typically assume fixedratebonds, 6 and thus ignore the possiblechoices among different types of debt.In particular, such a narrow focus ondebt-versus-equity financing ignoresthe impact of hedgeable risk factorsoriginating from firm assets and how theycould be mitigated through an optimaluse of different types of debt.A recent EDHEC-Risk Institute paper titled“Optimal Design of Corporate MarketDebt Programmes in the Presence ofInterest-Rate and Inflation Risks” hasexamined optimal debt structures ofcorporate issuers who have the optionto issue different types of debt. Ratherthan focusing solely on the decision touse debt-versus-equity for financing,the paper studies the optimal choiceamong different types of debt, lookingat floating-rate and inflation-linkedbonds in particular. The study considershow such elements of the debt structurewould help to hedge inflation and interestrate risks that are present on the assetside. As a premise, the paper assumed thatthe objective pursued by optimising debtstructure is to maximise firm value, asopposed to decreasing the average cost ofdebt servicing or to make it less volatile. Aprominent finding was that hedging therisk factors that impact the asset (evenpartially), led to lower variability of cashflows, net of debt costs, thus decreasingthe chance of default and consequentlymaximising firm value. Moreover, theleverage ratio that is attained with anoptimal mix of fixed-rate debt, floatingrateand possibly inflation-indexed bondsis shown to be higher than that attainedwith nominal bonds only. In other words,optimising debt structure enables thefirm to take on more debt, which showsthat optimal capital structure depends onthe chosen debt structure.The study clearly shows that thecorrelation between asset values andinterest rates, and the correlationbetween asset values and inflation, willinfluence the optimal mix of fixed-ratedebt, floating-rate debt and inflationlinkeddebt. 7 In particular, higher levels ofcorrelation of asset value with inflationshould incite the issuer to offer lessfixed-rate debt and more inflation-linkeddebt. Different levels of correlation alsoproduced different levels of increases tofirm value, with higher absolute values ofcorrelation resulting in a larger increase,and higher positive correlation resultingin the largest increase, as depicted in thefollowing table taken from the study.Table 1. Depicts the benefit of adopting an optimal debtstructure which includes inflation-linked bonds across firmswith different levels of correlation between firm risk andinflation riskCorrelation between firm's riskand inflation riskRelative increase in firm valuefrom optimising debt structure-0.5 0 0.515.2% 10.8% 45.4%Proper interpretation of these resultsrequires analysing firm risk within thecontext of firm-wide cash flows andfirm-wide uncertainty. Traditional debtmanagement strategy has establishedthe clear goal of liability minimisation.Employing such a narrow focus on thecost of debt has led to the standardconclusion that variable rate bonds areAn EDHEC-Risk Institute Publication9

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20122. Background and Methodologysimply a tool to pursue active views onfuture inflation or interest rates. If a firmfocuses on liabilities in isolation, issuingdebt which increases variability of debtcosts is naturally contrary to the goalof minimising and stabilising liabilities.The overall goal of a corporate issuer,however, is to maximise total firm value,while evaluating liabilities within its ownconfined framework ignores the impactof factors affecting the entire firm.Particularly for firms with revenue highlysensitive to interest rates or inflation (e.g.as depicted in Table 1), evaluating debtwith the goal of simple cost reductioncan have substantial effects on total firmvalue, as these tractable risk factors impactcash flows from assets and liabilities. Thus,a clear distinction can be made betweena pure liability strategy which segregatesliabilities from firm-wide risk factors, andone which integrates assets and liabilitiesinto a single coordinated framework.Parallel to a corporate issuer’s integratedasset-liability management strategy isan investor’s framework which evaluatesasset allocation within the context ofits liabilities. With regard to both issuersand investors, employing a strategyconstrained strictly to either assets orliabilities limits the ability to hedge firmwiderisks.The adoption of inflation-linked bonds aseither an investment or a form of issueddebt has distinct effects on investors andissuers, as described in the following table.The EDHEC-Risk study produces a strongtheoretical argument that issuanceof inflation-linked bonds could be ofmutual benefit to both corporations andinvestors. Current practices, however,are in disaccord with this finding, withrelatively few firms issuing inflationlinkedbonds. Thus, it was important toisolate the perspective of key stakeholderson our conclusions and to identify anypractical barriers to the development ofthe corporate bond market.Our analysis of the professional perspectivewas meant to be comprehensive andprecise; accordingly, two separatequestionnaires were issued to corporatefinance departments and institutionalinvestors, with questions tailored to theirunique concerns.Table 2IssuerInvestorPure Liability (or Asset) Focus-Useof fixed-rate debt- Fixed-rate debt allows for reduced risk from a puredebt-management perspective (i.e. it minimisesuncertainty/variability of debt-servicing cost).- If the investor’s focus is on nominal return, standardfixed debt has a certain cost (ignoring credit risk).Integrated Asset-Liability Focus-Useof inflation-linked debt- Reduces risk from an asset-liability managementperspective; reduces variability of firm-wide cashflows, net of debt payments, thus reducing chance ofdefault and as a result, maximising firm value- Allows for inflation risk matching of assets andliabilities- Perfect inflation hedge; possibility of directlymatching liabilities tied to same inflation index.- If liabilities are linked to inflation, then inflationlinkedcorporate bonds are a way to create a safeasset – liability-hedging portfolio (LHP).- In particular corporate bonds may be morereasonable than sovereign bonds when hedgingcorporate pension fund liabilities (Scherer 2006).10 An EDHEC-Risk Institute Publication

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20122. Background and Methodology12 An EDHEC-Risk Institute Publication

3. Survey ResultsAn EDHEC-Risk Institute Publication13

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20123. Survey Results10 - It is important to notethat some regions andcurrencies where inflationis rampant may have thestrongest need for inflationlinkeddebt programs.be likely to issue inflation-linked bonds. Itwould also be very important to contrastthe responses with the rest of the issuerquestionnaire to highlight any unapparentissues or sources of hesitation (e.g. if therespondents otherwise recognised thebenefits of inflation-linked debt, but notedthat their firm was unlikely to issue any, itwould indicate that there were other issuesthat need to be addressed).Figure 8. Do you think that issuance of this kind of debt couldbe of interest to your own company? (Issuers)Viewing the results within the context ofcurrent practices – in contrast to the verysmall proportion of corporations that issueinflation-linked bonds – nearly a third ofrespondents state that this type of debtcould be of interest, indicating that theremay be an increase in the issuance ofcorporate inflation-linked bonds in thefuture.3.4.1 Qualitative insight fromrespondent comments:The 40% of respondents who answered“No” is in sharp contrast to the strongresponses in agreement with thetheoretical basis for inflation-linked bonds(e.g. 84% of respondents who agreedthat issuing inflation-linked bonds maydecrease risk from an ALM perspective,and 75% of respondents who agreedor strongly agreed that issuing inflationlinkedbonds would substantially increasefirm value). As the discrepancy may beattributed to respondent-specific issuessuch as internal bureaucratic barriers ora unique negative correlation betweenrevenues and inflation, a comment sectionwas included to provide respondents anopportunity to express any individualisedconcerns.Of the 10 respondents who stated thattheir company would be unlikely toissue inflation-linked debt, four providedexplanations. Two respondents stated thattheir business activities were uniquelyinappropriate for inflation-linked bonds;one of these two firms had revenuesnegatively correlated with inflation anda prohibitively small debt-program, whilethe other had an optimal structure whichincluded no debt. One respondent notablystated that they had revenues in multiplecurrencies, making it too difficult to predicttheir net inflation risk. 10 The remainingrespondent who provided comments statedthat inflation risk was not a major riskA Short Note on Diversification and HedgingDiversification is seen by many as the fundamental tenet of finance and risk management.The application of diversification (i.e. methods employed to achieve diversification)have evolved over the years, from the cardinal proposition that two stocks are moredesirable than one, to the recognition that some nominally diversified portfolios lackgenuine diversification of risk, in that they are concentrated in a small number ofhighly correlated stocks. Even adequate diversification, however, is merely a necessaryattribute, and far from sufficient to achieve the goals of proper risk management. While16 An EDHEC-Risk Institute Publication

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20123. Survey Resultsdiversification is a fundamental building block, it is not the ultimate aim, and is insteada tool used to pursue one specified objective that is subordinate to the investor’s overallgoal.Properly contextualising diversification requires identification of all sources of risk, and acoordination of all the means employed to manage them. Thus, the scope of the pursuitof diversification can be segregated into a performance seeking portfolio (PSP), whichhas the clearly defined goal of extracting available risk premia.11 - A recent Goldman Sachsresearch report identifiedlow levels of correlationbetween the Barclays USTIPS Index and several equityindices, broad bond indices,and a commodity index (theabsence of an inflation-linkedcorporate bond index makesdirect comparison infeasible).It is further important to recognise the limits of diversification. Diversification iscommonly misperceived as an ubiquitous tool for risk minimisation. As the marketdownturn in 2008 made evident, diversification fails to protect against a convergenceof correlation. Similarly, in the asset-liability context, diversification is inappropriate tohedge or immunise risk originating from liabilities. In accordance with an application ofthe fund-separation theorem, a liability-hedging portfolio (LHP), which abstains fromseeking returns or diversification, is the appropriate means to employ a dedicated methodto hedging liabilities.factor affecting company cash flows.3.5 Questions Tailored to InvestorsThe appropriate framework to analysethe applicability of inflation-linked bondsas hedges is one that eschews an assetonlyperspective, and instead adopts anintegrated asset-liability managementperspective. While the primary focusof our study was how corporate issuerscould improve practices by adopting abroader analysis, similar considerationsmay also precipitate a modification ofan investor’s firm structure. For investors,delineating a portfolio dedicated to hedgingliabilities – which, for many, may be asignificant departure from standardpractices – can be essential to immunising adifficult-to-manage risk factor such asinflation.a distinct objective compared to that of aliability-hedging portfolio. Inflation-linkedbonds have historically low correlation withother asset classes and could thus contributeto a portfolio’s improved risk-rewardprofile. 11 To address asset-allocationconsiderations we included a questionseeking recognition of the diversificationpotential of inflation-linked corporate bonds.It would be helpful to identify all attractiveattributes of this type of debt instrument,and whether it would be sought out forits contribution to risk-adjusted returngeneration, or for controlled risk matching,or both.Figure 9. Would you consider inflation-linked corporate bondsto be a useful addition to the strategic mix of asset classes?While inflation is clearly and measurablytied to many investors’ liabilities, it isalso a prominent risk factor within theperformance-seeking portfolio, which hasAn EDHEC-Risk Institute Publication17

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20123. Survey ResultsFigure 10. If so, would you see them as being more useful fordiversifying equity risk within performance-seeking portfolios,or for inflation risk matching in liability-hedging portfolios?81% of respondents consider inflationlinkedcorporate bonds as a useful additionto the strategic mix of asset classes. Thisindicates that the market for inflationlinkedcorporate debt would not belimited to those seeking liability hedges.Of the 81% who responded affirmatively,over 40% recognised that inflation-linkedbonds have equity-diversifying potential,while over 94% recognised the riskmatching potential.3.5.1 Final Question to InvestorsAs we recognise that inflation-linkedcorporate bonds are a relatively noveladdition to the debt market, we wantedto gain a thorough understanding of theperceived benefits and shortcomings ofinflation-linked corporate debt, as well astheir potential applications and usefulnessin different contexts. We therefore askedrespondents to hypothetically identifyspecific characteristics and uses that theywould find favourable and unfavourable.This allowed us to not only identifythe important issues, but to assesstheir perceived importance relative to eachother.The questions pertained to a variety ofissues including general investmentconcerns such as the need for diversificationand lower costs, as well as investorspecificor organisational matters such asrelevant rules or programs and policies.We also examined key issues specificallyrelated to the nature of the issuer –for instance, we contrasted inflationlinkedcorporate debt with its sovereigncounterpart in regard to liquidity, qualityof credit-ratings, and credit-worthiness inthe event of a spike in inflation.In accordance with the strong recognitionof the hedging properties of inflationlinkedbonds, 61% of respondents citedthe diversification and liability-hedgingpotential as a favourable attribute.It is also notable that only 14% ofrespondents felt that corporate debt is lessFigure 11. As far as investing in the liability-hedging portfolio is concerned, what would be your arguments for investing or notinvesting in inflation-linked corporate bonds?I am favourable because:18 An EDHEC-Risk Institute Publication

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20123. Survey ResultsFigure 12. As far as investing in the liability-hedging portfolio is concerned, what would be your arguments for investing or notinvesting in inflation-linked corporate bonds?I am not favourable because:risky with regard to risk documentation,forecastability and stability, and availabilityof reliable ratings.It is worth noting that the leastfavourable attribute is recognised by 33%of respondents, compared to the mostfavourable attribute which is recognisedby 61%. Our responses further reveal thatcredit-worthiness – within the context ofan inflation-linked corporate bond – mightbe one of the more prominent concernsheld by investors. As we provided an “other”option to capture possible issues whichwere left out, we can be fairly certainthat these two broad questions capturedthe essence of the most favourable andunfavourable characteristics perceived byour respondents.An EDHEC-Risk Institute Publication19

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20123. Survey Results20 An EDHEC-Risk Institute Publication

4. ConclusionAn EDHEC-Risk Institute Publication21

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20124. ConclusionOur study examined the relevant academictheory and proposed a functional modelto evaluate a corporation’s optimal debtstructure. The breadth and practicalnature of the paper resulted in several keyissues emerging with clarity. To presenta thorough analysis of the abstractconcepts, current practices and futureprogression, we thought it would be bestto supplement our study with practitionerinsight through a formal call for reaction– the results of which confirm many ofthe conclusions of our research.the central tenet of the paper: that formany firms, current debt-managementpractices can be improved through theissuance of inflation-linked debt.Three questions which pertained togeneral concerns were asked to bothgroups of respondents. As depicted in thefollowing graphs, the perspectives wereremarkably similar across both investorsand issuers.Potential issuers exhibited substantialagreement with the positive attributes ofinflation-linked debt, while over half ofrespondents recognised the prospects forthe development of a highly liquid marketas a result of this type of research. Overall,the responses reflect strong agreementwith many of our key propositions, andFigure 13. Contrast of responses of questions asked to both parties22 An EDHEC-Risk Institute Publication

ReferencesAn EDHEC-Risk Institute Publication23

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012References• Amenc, N., Martellini, L. and Ziemann, V. 2009. Inflation-Hedging Properties of RealAssets and Implications for Asset-Liability Management Decisions. The Journal of PortfolioManagement, Summer, 94-110.• Ang., A., Briere, M., and Signori, O. 2011. Inflation and Individual Equities. Working Paper.• Bao, J., Pan, J. and Wang, J. 2011, The Illiquidity of Corporate Bonds. The Journal ofFinance, 66: 911–946.• Boyd, J., Levine R., and Bruce D. 2001, The Impact of Inflation on Financial SectorPerformance. University of Minnesota, Journal of Monetary Economics.• Chen, L., Lesmond, D., and Wei, J. 2007, Coporate Yield Spreads and Bond Liquidity.Journal of Finance 62, 119-149.• De Jong, F. and Driessen, J. 2005, Liquidity Risk Premia In Corporate Bond Markets,Working Paper, University of Amsterdam.• Eddings, C. 2012, Treasury Sells Inflation Notes at Record Low Negative Yield. BloombergNews: http://www.bloomberg.com/news/2012-03-22/treasury-sells-inflation-notes-atrecord-low-negative-yield.html• Edwards, A. K., L. E. Harris, and M. S. Piwowar 2007. Corporate bond market transactioncosts and transparency. Journal of Finance 62, 1421–1451.• Goldman Sachs Asset Management, 2010. A Reference Guide to Inflation-LinkedBonds. http://www.goldmansachs.com/gsam/docs/instgeneral/general_materials/primer/reference_guide_to_inflation-linked_bonds.pdf• Gross, B. 2010. Interview. PIMCO's Bill Gross On Corporate Versus Sovereign Bonds:March Commentary. http://www.marketfolly.com/2010/03/pimcos-bill-gross-on-corporateversus.html• Hyde, D. 2011 Tesco Bank ends inflation-linked bond after ten days of huge interestsees it sell out and more. This is Money. http://www.thisismoney.co.uk/money/investing/article-2074125/Tesco-inflation-linked-corporate-bond-ends-sell-out.html• Inderst, G. Infrastructure as an Asset Class. EIB Papers, Vol. 15, No. 1, pp. 70-105, 2010.• Ju, N., and H. Ou-Yang (2006). A model of optimal capital structure with stochasticinterest rates. Journal of Business 79 (5), 2469–2502• Leaviss, J. 2010. Index-linked corporate bonds could combat inflation fears, saysM&G. http://citywire.co.uk/wealth-manager index-linked-corporate-bonds-could-combatinflation-fears-says-mandg/a436442• Leland, H. 1994. Corporate debt value, bond covenants, and optimal capital structure.Journal of Finance 49 (4), 1213–1252.• Leland, H., and Toft, K. 1996. Optimal capital structure, endogenous bankruptcy, andthe term structure of credit spreads. Journal of Finance 51 (3), 987–1019.• Longstaff, F., 2002, The Flight-to-Liquidity Premium in US Treasury Bond Prices. Journalof Business 77, 511-526.24 An EDHEC-Risk Institute Publication

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012References• Martellini, L. and Milhau, V. 2011. Optimal Design of Corporate Market Debt Programmesin the Presence of Interest-Rate and Inflation Risks. EDHEC-Risk Institute Publication.• Scherer, B. 2006. The case for liability driven investment. Deutsch Bank Asset Management.• The City UK, 2011. Bond Markets. Financial Market Series.An EDHEC-Risk Institute Publication25

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012References26 An EDHEC-Risk Institute Publication

About Rothschild & CieAn EDHEC-Risk Institute Publication27

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012About Rothschild & CieRothschild has been involved in investmentbanking since its beginning over twohundred years ago when Rothschildbusinesses were established in the principalcities of Europe at the end of the 18thcentury. Today, the Rothschild Group isone of the world’s leading financial advisoryand asset management organisations whichis family controlled and independent. It hasan established network of offices aroundthe world with more than 2000 people inover 40 countries (including the USA, UK,France, Switzerland, Singapore, China,…).Rothschild Global Financial Advisoryis involved in providing impartial andexpert M&A and strategic advice as wellas financing and restructuring adviceacross the range of equity and debt capitalmarkets. Rothschild & Cie Gestion is theasset management arm of the RothschildGroup in France.Rothschild & Cie Gestion manages EUR22bn in assets and offers a diversifiedproduct range, with expertises in equities(focusing on European equities), bonds(including govies, Euro credit and Europeanconvertibles), balanced management,and long-only as well as alternativemulti-management.28 An EDHEC-Risk Institute Publication

About EDHEC-Risk InstituteAn EDHEC-Risk Institute Publication29

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012About EDHEC-Risk InstituteFounded in 1906, EDHEC isone of the foremostinternational business schools.Accredited by the threemain international academicorganisations, EQUIS, AACSB,and Association of MBAs,EDHEC has for a number ofyears been pursuing a strategyof international excellence thatled it to set up EDHEC-Risk in2001. With eighty professors,research engineers, and researchassociates, EDHEC-Risk hasthe largest asset managementresearch team in Europe.The Choice of Asset Allocationand Risk ManagementEDHEC-Risk structures all of its research workaround asset allocation and risk management.This issue corresponds to a genuineexpectation from the market. On the onehand, the prevailing stock market situationin recent years has shown the limitations ofdiversification alone as a risk managementtechnique and the usefulness of approachesbased on dynamic portfolio allocation. On theother, the appearance of new asset classes(hedge funds, private equity, real assets),with risk profiles that are very differentfrom those of the traditional investmentuniverse, constitutes a new opportunityand challenge for the implementation ofallocation in an asset management or assetliabilitymanagement context.This strategic choice is applied to all of theInstitute's research programmes, whetherthey involve proposing new methods ofstrategic allocation, which integrate thealternative class; taking extreme risks intoaccount in portfolio construction; studyingthe usefulness of derivatives in implementingasset-liability management approaches;or orienting the concept of dynamic“core-satellite” investment management inthe framework of absolute return or targetdatefunds.Academic Excellenceand Industry RelevanceIn an attempt to ensure that the researchit carries out is truly applicable, EDHEC hasimplemented a dual validation system forthe work of EDHEC-Risk. All research workmust be part of a research programme,the relevance and goals of which havebeen validated from both an academicand a business viewpoint by the Institute'sadvisory board. This board is made up ofinternationally recognised researchers,the Institute's business partners, andrepresentatives of major internationalinstitutional investors. Management of theresearch programmes respects a rigorousvalidation process, which guarantees thescientific quality and the operationalusefulness of the programmes.Six research programmes have beenconducted by the centre to date:• Asset allocation and alternativediversification• Style and performance analysis• Indices and benchmarking• Operational risks and performance• Asset allocation and derivativeinstruments• ALM and asset managementThese programmes receive the support ofa large number of financial companies.The results of the research programmesare disseminated through the EDHEC-Risk locations in Singapore, whichwas established at the invitation ofthe Monetary Authority of Singapore(MAS), the City of London in the UnitedKingdom, and Nice, France. In addition, ithas a research team located in the UnitedStates.EDHEC-Risk has developed a closepartnership with a small number ofsponsors within the framework of researchchairs or major research projects:• Core-Satellite and ETF Investment,in partnership with Amundi ETF• Regulation and InstitutionalInvestment, in partnership with AXAInvestment Managers30 An EDHEC-Risk Institute Publication

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012About EDHEC-Risk Institute• Asset-Liability Management andInstitutional Investment Management,in partnership with BNP ParibasInvestment Partners• Risk and Regulation in the EuropeanFund Management Industry,in partnership with CACEIS• Exploring the Commodity FuturesRisk Premium: Implications for AssetAllocation and Regulation,in partnership with CME Group• Asset-Liability ManagementTechniques for Sovereign WealthFund Management,in partnership with Deutsche Bank• The Benefits of Volatility Derivativesin Equity Portfolio Management,in partnership with Eurex• Structured Products and DerivativeInstruments, sponsored by the FrenchBanking Federation (FBF)• Advanced Modelling for AlternativeInvestments, in partnership withNewedge Prime Brokerage• Advanced Investment Solutions forLiability Hedging for Inflation Risk,in partnership with Ontario Teachers’Pension Plan• The Case for Inflation-LinkedCorporate Bonds: Issuers’ and Investors’Perspectives,in partnership with Rothschild & Cie• Solvency II Benchmarks,in partnership with Russell Investments• Structured Equity InvestmentStrategies for Long-Term Asian Investors,in partnership with Société GénéraleCorporate & Investment BankingThe philosophy of the Institute is tovalidate its work by publication ininternational academic journals, as well asto make it available to the sector throughits position papers, published studies, andconferences.Each year, EDHEC-Risk organises twoconferences for professionals in order topresent the results of its research, one inLondon (EDHEC-Risk Days – Europe) andone in Singapore (EDHEC-Risk Days – Asia),attracting more than 2,000 professionaldelegates.EDHEC also provides professionals withaccess to its website, www.edhec-risk.com,which is entirely devoted to internationalasset management research. The website,which has more than 50,000 regularvisitors, is aimed at professionals whowish to benefit from EDHEC’s analysis andexpertise in the area of applied portfoliomanagement research. Its monthlynewsletter is distributed to more than1,000,000 readers.EDHEC-Risk Institute:Key Figures, 2010-2011Nbr of permanent staff 85Nbr of research associates 19Nbr of affiliate professors 26Overall budget €11,200,000External financing €6,215,000Nbr of conference delegates 1,850Nbr of participants at EDHEC-RiskIndices & Benchmarks seminars391Nbr of participants at EDHEC-RiskInstitute Risk Management seminars419Nbr of participants at EDHEC-RiskInstitute Executive Education seminars356An EDHEC-Risk Institute Publication31

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012About EDHEC-Risk InstituteThe EDHEC-Risk Institute PhD inFinanceThe EDHEC-Risk Institute PhD in Financeis designed for professionals who aspireto higher intellectual levels and aim toredefine the investment banking and assetmanagement industries. It is offered in twotracks: a residential track for high-potentialgraduate students, who hold part-timepositions at EDHEC, and an executive trackfor practitioners who keep their full-timejobs. Drawing its faculty from the world’sbest universities and enjoying the supportof the research centre with the greatestimpact on the financial industry, the EDHEC-Risk Institute PhD in Finance creates anextraordinary platform for professionaldevelopment and industry innovation.indices and benchmarks that provide moreefficient or more academic-based solutionsto investors’ needs than current offersavailable on the market.Research for BusinessThe Institute’s activities have also givenrise to executive education and researchservice offshoots. EDHEC-Risk's executiveeducation programmes help investmentprofessionals to upgrade their skills withadvanced risk and asset managementtraining across traditional and alternativeclasses. In partnership with CFA Institute,it has developed advanced seminars basedon its research which are available to CFAcharterholders and have been taking placesince 2008 in New York, Singapore andLondon.While EDHEC-Risk makes important publiccontributions to the advancementof applied financial research and theimprovement of industry practices,the insights drawn from EDHEC-Risk’s“Indices & Benchmarking”, “ALM and AssetManagement” and “Derivatives and AssetManagement” research programmes overthe past several years have led to a series of32 An EDHEC-Risk Institute Publication

EDHEC-Risk InstitutePublications and Position Papers(2009-2012)An EDHEC-Risk Institute Publication33

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012EDHEC-Risk Institute Publications(2009-2012)2012• Amenc, N., F. Goltz, M. Masayoshi, P. Narasimhan and L. Tang. EDHEC-Risk Asian IndexSurvey 2011 (May).• Guobuzaite, R., and L. Martellini. The Benefits of Volatility Derivatives in Equity PortfolioManagement (April).• Amenc, N., F. Goltz, L. Tang, and V. Vaidyanathan. EDHEC-Risk North American IndexSurvey 2011 (March).• Amenc, N., F. Cocquemas, R. Deguest, P. Foulquier, L. Martellini, and S. Sender. Introducingthe EDHEC-Risk Solvency II Benchmarks – maximising the benefits of equity investmentsfor insurance companies facing Solvency II constraints - Summary - (March).• Schoeffler, P. Optimal market estimates of French office property performance (March).• Le Sourd, V. Performance of socially responsible investment funds against an efficientSRI Index: The impact of benchmark choice when evaluating active managers – an update(March).• Martellini, L., V. Milhau, and A.Tarelli. Dynamic investment strategies for corporatepension funds in the presence of sponsor risk (March).• Goltz, F., and L. Tang. The EDHEC European ETF survey 2011 (March).• Sender, S. Shifting towards hybrid pension systems: A European perspective (March).• Blanc-Brude, F. Pension fund investment in social infrastructure (February).• Ducoulombier, F., Lixia, L., and S. Stoyanov. What asset-liability management strategyfor sovereign wealth funds? (February).• Amenc, N., Cocquemas, F., and S. Sender. Shedding light on non-financial risks – a Europeansurvey (January).• Amenc, N., F. Cocquemas, R. Deguest, P. Foulquier, Martellini, L., and S. Sender. GroundRules for the EDHEC-Risk Solvency II Benchmarks. (January).• Amenc, N., F. Cocquemas, R. Deguest, P. Foulquier, Martellini, L., and S. Sender. Introducingthe EDHEC-Risk Solvency Benchmarks – Maximising the Benefits of Equity Investments forInsurance Companies facing Solvency II Constraints - Synthesis -. (January).• Amenc, N., F. Cocquemas, R. Deguest, P. Foulquier, Martellini, L., and S. Sender. Introducingthe EDHEC-Risk Solvency Benchmarks – Maximising the Benefits of Equity Investments forInsurance Companies facing Solvency II Constraints (January).• Schoeffler.P. Les estimateurs de marché optimaux de la performance de l’immobilierde bureaux en France (January).2011• Amenc, N., F. Goltz, Martellini, L., and D. Sahoo. A Long Horizon Perspective on theCross-Sectional Risk-Return Relationship in Equity Markets (December 2011).• Amenc, N., F. Goltz, and L. Tang. EDHEC-Risk European Index Survey 2011 (October).34 An EDHEC-Risk Institute Publication

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012EDHEC-Risk Institute Publications(2009-2012)• Deguest,R., Martellini, L., and V. Milhau. Life-Cycle Investing in Private WealthManagement (October).• Amenc, N., F. Goltz, Martellini, L., and L. Tang. Improved Beta? A Comparison of Index-Weighting Schemes (September).• Le Sourd, V. Performance of Socially Responsible Investment Funds against anEfficient SRI Index: The Impact of Benchmark Choice when Evaluating Active Managers(September).• Charbit, E., Giraud J. R., Goltz. F. and L.Tang Capturing the Market, Value, or MomentumPremium with Downside Risk Control: Dynamic Allocation Strategies with Exchange-TradedFunds (July).• Scherrer, B. An Integrated Approach to Sovereign Wealth Risk Management (June).• Campani, C.H. and F. Goltz. A Review of corporate bond indices: Construction principles,return heterogeneity, and fluctuations in risk exposures (June).• Martellini, L., and V. Milhau. Capital structure choices, pension fund allocation decisions,and the rational pricing of liability streams (June).• Amenc, N., F. Goltz, and S. Stoyanov. A post-crisis perspective on diversification for riskmanagement (May).• Amenc, N., F. Goltz, Martellini, L., and L. Tang. Improved beta? A comparison of indexweightingschemes (April).• Amenc, N., F. Goltz, Martellini, L., and D. Sahoo. Is there a risk/return tradeoff acrossstocks? An answer from a long-horizon perspective (April).• Sender, S. The elephant in the room: Accounting and sponsor risks in corporate pension plans(March).• Martellini, L., and V. Milhau. Optimal design of corporate market debt programmes in thepresence of interest-rate and inflation risks (February).2010• Amenc, N., and S. Sender. The European fund management industry needs a better graspof non-financial risks (December).• Amenc, N., S, Focardi, F. Goltz, D. Schröder, and L. Tang. EDHEC-Risk European privatewealth management survey (November).• Amenc, N., F. Goltz, and L. Tang. Adoption of green investing by institutional investors:A European survey (November).• Martellini, L., and V. Milhau. An integrated approach to asset-liability management:Capital structure choices, pension fund allocation decisions and the rational pricing ofliability streams (November).• Hitaj, A., L. Martellini, and G. Zambruno. Optimal hedge fund allocation with improvedestimates for coskewness and cokurtosis parameters (October).An EDHEC-Risk Institute Publication35

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012EDHEC-Risk Institute Publications(2009-2012)• Amenc, N., F. Goltz, L. Martellini, and V. Milhau. New frontiers in benchmarking andliability-driven investing (September).• Martellini, L., and V. Milhau. From deterministic to stochastic life-cycle investing:Implications for the design of improved forms of target date funds (September).• Martellini, L., and V. Milhau. Capital structure choices, pension fund allocation decisionsand the rational pricing of liability streams (July).• Sender, S. EDHEC survey of the asset and liability management practices of Europeanpension funds (June).• Goltz, F., A. Grigoriu, and L. Tang. The EDHEC European ETF survey 2010 (May).• Martellini, L., and V. Milhau. Asset-liability management decisions for sovereign wealthfunds (May).• Amenc, N., and S. Sender. Are hedge-fund UCITS the cure-all? (March).• Amenc, N., F. Goltz, and A. Grigoriu. Risk control through dynamic core-satellite portfoliosof ETFs: Applications to absolute return funds and tactical asset allocation (January).• Amenc, N., F. Goltz, and P. Retkowsky. Efficient indexation: An alternative to cap-weightedindices (January).• Goltz, F., and V. Le Sourd. Does finance theory make the case for capitalisation-weightedindexing? (January).2009• Sender, S. Reactions to an EDHEC study on the impact of regulatory constraints on theALM of pension funds (October).• Amenc, N., L. Martellini, V. Milhau, and V. Ziemann. Asset-liability management inprivate wealth management (September).• Amenc, N., F. Goltz, A. Grigoriu, and D. Schroeder. The EDHEC European ETF survey (May).• Sender, S. The European pension fund industry again beset by deficits (May).• Martellini, L., and V. Milhau. Measuring the benefits of dynamic asset allocation strategiesin the presence of liability constraints (March).• Le Sourd, V. Hedge fund performance in 2008 (February).• La gestion indicielle dans l'immobilier et l'indice EDHEC IEIF Immobilier d'EntrepriseFrance (February).• Real estate indexing and the EDHEC IEIF Commercial Property (France) Index (February).• Amenc, N., L. Martellini, and S. Sender. Impact of regulations on the ALM of Europeanpension funds (January).• Goltz, F. A long road ahead for portfolio construction: Practitioners' views of an EDHECsurvey. (January).36 An EDHEC-Risk Institute Publication

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012EDHEC-Risk Institute Position Papers(2009-2012)2012• Uppal, R. Financial Regulation (April).• Amenc, N., F. Ducoulombier, F. Goltz and L. Tang. What are the risks of European ETFs?(January).2011• Amenc, N., and S. Sender. Response to ESMA consultation paper to implementingmeasures for the AIFMD (September).• Uppal, R. A Short note on the Tobin Tax: The costs and benefits of a tax on financialtransactions (July).• Till, H. A review of the G20 meeting on agriculture: Addressing price volatility in thefood markets (July).2010• Amenc, N., and V. Le Sourd. The performance of socially responsible investment andsustainable development in France: An update after the financial crisis (September).• Amenc, N., A. Chéron, S. Gregoir, and L. Martellini. Il faut préserver le Fonds de Réservepour les Retraites (July).• Amenc, N., P. Schoefler, and P. Lasserre. Organisation optimale de la liquidité des fondsd’investissement (March).• Lioui, A. Spillover effects of counter-cyclical market regulation: Evidence from the 2008ban on short sales (March).2009• Till, H. Has there been excessive speculation in the US oil futures markets? (November).• Amenc, N., and S. Sender. A welcome European Commission consultation on the UCITSdepositary function, a hastily considered proposal (September).• Sender, S. IAS 19: Penalising changes ahead (September).• Amenc, N. Quelques réflexions sur la régulation de la gestion d'actifs (June).• Giraud, J.-R. MiFID: One year on (May).• Lioui, A. The undesirable effects of banning short sales (April).• Gregoriou, G., and F.-S. Lhabitant. Madoff: A riot of red flags (January).An EDHEC-Risk Institute Publication37

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 2012Notes……………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………………38 An EDHEC-Risk Institute Publication

For more information, please contact:Carolyn Essid on +33 493 187 824or by e-mail to: carolyn.essid@edhec-risk.comEDHEC-Risk Institute393 promenade des AnglaisBP 311606202 Nice Cedex 3 — FranceTel: +33 (0)4 93 18 78 24EDHEC Risk Institute—Europe10 Fleet Place - LudgateLondon EC4M 7RB - United KingdomTel: +44 207 871 6740EDHEC Risk Institute—Asia1 George Street - #07-02Singapore 049145Tel.: +65 6438 0030www.edhec-risk.com