Factor Investing in Asset–Liability Management
Investment management in the new era can be defined as the art and science of efficiently spending institutional or individual investors’ dollar and risk budgets to help them achieve their meaningful goal-driven objectives (for individuals) or liability-driven objectives (for institutions), subject to a number of regulatory constraints or otherwise. Whatever the context, meaningful investment solutions are in fact invariably based on three fundamental sources of added value, each reflecting one particular form of risk management technique : (1) the use of an efficient risky performance-seeking portfolio (PSP); (2) the use of an efficient safe liability-hedging or goal-hedging portfolio; and (3) the use of an efficient allocation strategy for efficient risky and safe building block portfolios.
The risky portfolio should be efficient at harvesting risk premia across and within asset classes: It’s all about diversification!
The safe portfolio should be efficient at matching risk factor exposures on the asset and liability sides: It’s all about hedging!
The allocation to the efficient risky and safe portfolios should secure investors’ essential goals while generating a high probability of achieving their aspirational goals: It’s all about insurance!