Thought Leadership

As institutional investors increase their allocations to non-domestic securities, the associated currency risk becomes an increasingly pertinent subject in need of addressing. Our advisory position on currency hedging is that for most clients, the drawbacks can be significant and the benefits over the longterm may be small and are not guaranteed. There are no easy answers in regards to currency management. In this paper we provide background on the currency market, develop a decision making framework as it pertains to whether or not to hedge currency, and share our thoughts and experience in regards to implementation should clients determine hedging currency is appropriate given their specific circumstances.

Treasury Inflation-Protected Securities (TIPS) are government secured debt instruments that are structured to provide a hedge against unexpected inflation. TIPS appeal to risk-averse investors who are concerned about losing purchasing power of an investment over a short time. A TIPS option gives investors some short-term protection against unexpected inflation.

Most participants with a long time horizon, however, will find that a combination of stocks and bonds delivers a higher expected return, net of inflation. A dedicated TIPS investment option in a defined contribution plan is appropriate when used as a complementary fixed income alternative relative to a broad intermediate fixed income option.

Self-directed brokerage windows (windows) offer defined contribution plan participants flexibility to invest in opportunities not available through the plan’s core line-up. Windows allow participants access to a broad array of stock and bond investments, including mutual funds and, in some cases, individual stocks and bonds. Windows can also be designed to exclude certain investments, such as single issuer stocks and bonds, while maintaining their key function of providing participants a broadened range of investment opportunities.

Derivative instruments offer numerous benefits to investment managers and the clients they serve. The goal of this paper is to give a high level overview of derivatives and their role in fixed income portfolios. While providing an introduction to fixed income derivatives, we highlight the immense growth of the market, the current uses of various derivative instruments, the issues currently facing the market as well as derivatives’ impact on fixed income portfolios. This paper is intended to be an educational piece in order to provide clarity to our clients on the complex instruments that are used to more effectively manage risk in their portfolios.

Distressed prices in the secondary markets for non-agency residential and commercial mortgage-backed securities (“RMBS” and “CMBS,” respectively), resulting from liquidity and credit risk concerns in the current market environment, present a margin of safety for PPIP investments. The potential to capitalize on these distressed prices while controlling mortgage credit risk through skilled active management, as well as the availability of low-cost nonrecourse financing from the Treasury, makes PPIP attractive for many investors. Clients who wish to initiate an allocation to PPIP investments must, however, possess 1) the ability and willingness to accept illiquidity in their investment programs, and 2) an appreciation of, and comfort with, risks associated with levered, distressed investments.

EnnisKnupp’s capital markets modeling assumptions play a critical role in the advice rendered to clients, given the impact of the asset allocation decision on the success of the overall investment program. Continued market volatility has resulted in adjustments to our projections, which are presented here in our most recent biannual assumptions update.

Prior to the current financial crisis, the asset-backed securities (ABS) market provided a significant source of funding for consumer purchases during the past decade, as shown in the attached chart below. That market came to a screeching halt last year, drying up credit for consumers and businesses, as fixed income investors fled asset backed securities as part of an overall flight to government guaranteed securities, pushing up yield spreads on existing ABS and eliminating demand for new ABS issuance. As one of its many programs to deal with the current crisis, the Term Asset-Backed Loan Facility (TALF) was created by the Federal Reserve in an attempt to revive demand for new issuance ABS, with the goal of reducing borrowing costs for new car purchases, credit card purchases, student loans, and small business loans.

Infrastructure has many desirable investment characteristics that are especially important given the current macro issues. Infrastructure investment may perform relatively well during difficult market environments and across a range of economic conditions. Given the current administration’s focus on infrastructure and the deepening global recession, institutions that have, or are contemplating an allocation to infrastructure should consider a core-satellite approach that will provide a diversified program.

Asset transitions are inevitable and necessary in managing an institutional investment program. They can also result in significant costs for a plan. An asset transition is defined as the movement of assets involving one or more investment managers among one or more asset classes. Transitions often involve electronic and open market trading that can expose a plan to significant costs and risks.

EnnisKnupp Capital Markets Modeling Survey Results - March 2009