Reactions to the EDHEC Study - Faculty and Research

More documents

Recommendations

Info

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
Page 1: An EDHEC-Risk Institute Publication
Page 8 and 9: Reactions to the EDHEC Study “Opt
Page 10: Reactions to the EDHEC Study “Opt
Page 13: 3. Survey ResultsAn EDHEC-Risk Inst
Page 21 and 22: 4. ConclusionAn EDHEC-Risk Institut
Page 23 and 24: ReferencesAn EDHEC-Risk Institute P
Page 27 and 28: About Rothschild & CieAn EDHEC-Risk
Page 29 and 30: About EDHEC-Risk InstituteAn EDHEC-
Page 33 and 34: EDHEC-Risk InstitutePublications an
Page 40: For more information, please contac

Reactions to the EDHEC Study - Faculty and Research

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?