Asset M anagement – Current Trends and Challenges

1. Asset Management– Current Trends and Challenges Mladen Latković Risk Manager Raiffeisen Mandatory Pension Fund Mgmt Co. Croatian Quants Day Department of Mathematics, Faculty of Science, Zagreb, 22 February 2008

2. Summary • Pension funds investment goals • Applying MVO in practice • Black-Litterman model • Global diversification • New investment styles and products

3. Pension funds investment goals • Croatian pension system: • 1st pillar: Pay-As-You-Go (defined benefit) • 2nd pillar: • pension funds (defined contribution) – accumulation phase • pension insurance company – retirement phase • Mandatory pension funds: • long-term savings vehicles (bear investment risk) • AuM (as of Dec/07): € 2.9 bn • Investment goals: • positive real return (long term) • towards absolute return strategy (avoid drawdowns)

4. Modern Portfolio Theory in practice • Markowitz MVO: • unknown values of asset returns and covariances • estimation risk – MVO is “error maximizer” • diversification diminishes with increasing risk tolerance • instability to small changes in parameters • possible solutions: • resampling procedure (Michaud, 1998) • robust optimization (El Ghaoui & Lebret, 1997; Ben-Tal & Nemirovski, 1998)

5. Constrained MVO • constraints reduce estimation risk: • simple constraints (min/max exposure, cardinality constraints) • Equivalent Number of Assets (Bouchaud et al., 1997; Rouvinez 2003):

6. Black-Litterman model • provides mechanism for calculating an implied expected returns of assets • optimal portfolio should be close to the market • Bayesian approach: market equilibrium returns + investors subjective views on expected returns of a (sub)portfolio (with given level of confidence)  mixed estimate of expected returns

7. BL extensions • multi-factor models, recession risk (Krishnan & Mains, 2005) • non-normal markets (Giacometti et al., 2005; Meucii, 2006) • hedge funds (Martellini & Ziemann, 2008)

8. Globaldiversification • Asset classes (traditional view): • equity • fixed income • real estate • commodities • private equity • hedge funds • Multi-asset funds examples – university endowment funds • double digit returns, low risk, moderate drawdowns • stable allocations

9. New investment styles and products • financial innovation • exposure to alternative betas – different risk premiums than traditional (equity, interest rates, credit) • style factors in equity markets (e.g., small cap vs. large cap) • volatility, liquidity, spread • new products: • structured products (capital guaranteed, structured risk profile) • hybrid securities • commoditisation of hedge fund type strategies • UCITS III directive • expanding universe of appropriate investments • derivatives not just for hedging • hedge funds replicators • 130/30 strategy (130 long, 30 short)

10. Thank you! Mladen Latković Risk Manager Raiffeisen Mandatory Pension Fund Management Company Magazinska 69, Zagreb E-mail: mladen.latkovic@rmf.hr Phone: +385-1-6003-938 Web: www.rmf.hr