ISSUE NO: 12

THE CORTEX REPORT

Research Papers and Articles

SEPTEMBER 2011

This report lists selected research papers and articles published over the past three months, in academic journals, industry publications, as well as popular magazines and periodicals, that may be of interest to trustees and staff of large institutional funds in North America. Table of Contents TOPICS
Alternative Investments Asset Allocation Capital Markets Currency Management Defined Contribution & 401(k) Plans Equity Management Fixed Income Governance Hedge Funds Inflation Protection International Investments Investment Management & Portfolio Strategy Laws & Regulations Pension Fund Management Performance Measurement Private Equity Public Sector Pension Plans Real Assets Risk Management Socially Responsible Investing The Financial Crisis of 2008

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AUTHOR(S)

TITLE

PUBLICATION

DATE

Alternative Investments
Mercer An Overview of a Comparative Analysis of Alternative Credit Strategies Mercer August 2011

Summary or Abstract: Over the past few years, institutional investors have been increasing allocations to fixed income and alternative assets. Doing so has increased the level of portfolio sophistication within both allocations, with some investors looking for higher yield or more diversification, or to take opportunistic positions resulting from market dislocations. Whatever the reason, the overall desire has been to make sound investment decisions on risk and return grounds. While the alternative credit strategies that investors consider today have existed for a number of years, they have not previously been popularly invested in and are thus not widely understood. Although alternative credit strategies have attractive merits, they will not be suitable for all. Web link: http://www.mercer.com/articles/1418785

Asset Allocation
Patrik Jakobson and Neill Nuttall Think Strategic, Act Tactical: Allocating Capital in the New Reality JP Morgan June 2011

Summary or Abstract: As investment strategies become increasingly complex, traditional asset allocation frameworks need to evolve with the global markets. We believe that an actively managed asset allocation program with a robust approach to managing intermediate-term tactical insights can deliver portfolios that generate greater returns with better risk profiles. Web link: http://www.jpmorgan.com/cm/Satellite?blobcol=urldata&blobheader=application%2Fpdf&blobkey =id&blobtable=MungoBlobs&blobwhere=1158638461253&ssbinary=true Travis Bagley and Aran Murphy Transitioning to LDI Strategies Russell Investments June 2011

Summary or Abstract: What are the transition management considerations when moving from an asset-focused, traditional portfolio strategy (e.g. 60% equities / 40% bonds) to a liability driven asset allocation? This paper provides perspective on the transition management aspects of liabilitydriven investing (LDI). It discusses first the context and motives for moving into a liability matched investment portfolio, and then describes two of the potential strategies for portfolio transitioning. It concludes with the tactical considerations of the transition for a plan sponsor. Web link: http://www.russell.com/institutional/research_commentary/transitioning_to_LDI.asp

Sbastien Page and Mark The Myth of Diversification: Risk Factors A. Taborsky versus Asset Classes

Journal of Portfolio Management

Summer 2011

Summary or Abstract: Diversification often disappears when you need it most. We often hear that we live in a new normal world in which markets oscillate between two regimes: risk on and risk off. In such a world, diversification across asset classes might work on average, but it might feel like having your head in the oven and your feet in a tub of iceeven though your average body temperature is OK, your chances of survival are low. Investors have long recognized that economic conditions frequently undergo regime shifts. The economy typically oscillates between 1) a steady, low-volatility state characterized by economic growth, and 2) a panic-driven, highvolatility state characterized by economic contraction. Evidence of such regimes has been well documented in market turbulence, inflation, and GDP growth. In our new-normal world, regime shifts will continue to cause significant challenges for risk management and portfolio construction. Web link: http://www.iijournals.com/doi/full/10.3905/jpm.2011.37.4.001

AUTHOR(S)
Wai Lee

TITLE
Risk-Based Asset Allocation: A New Answer to an Old Question?

PUBLICATION
Journal of Portfolio Management

DATE
Summer 2011

Summary or Abstract: In recent years, we have witnessed an alarmingly large and growing amount of literature on portfolio construction approaches focused on risks and diversification rather than on estimating expected returns. Numerous simulations applied to different universes have been documented in support of these approaches based on their apparent outperformance versus passive market capitalizationweighted or static fixed-weight portfolios. Many studies attribute the better performance of these risk-based asset allocation approaches to superior diversification. Given the absence of clearly defined investment objective functions behind these approaches as well as the metrics used by these studies to evaluate ex post performance, this article puts these approaches into the same context of mean-variance efficiency in an attempt to understand their theoretical underpinnings. In doing so, he hopes to shed some light on what these approaches attempt to achieve and on the characteristics of the investment universe, if indeed these approaches are meant to approximate mean-variance efficiency. He concludes that there is no theory to predict, ex ante, that any of these risk-based approaches should outperform. Web link: http://www.iijournals.com/doi/abs/10.3905/jpm.2011.37.4.011

Capital Markets
Rebecca Patterson A New Fiscal World Order: Implications for JP Morgan Investors August 2011

Summary or Abstract: In many ways, recent macro events and risksthe U.S. downgrade, the debt-ceiling resolution and Europes fiscal challengesare marking a turning point for the global economy and markets and, in our view, a new fiscal world order. This article discusses several key implications for investors Web link: http://www.jpmorgan.com/pages/jpmorgan/am/ia/research_and_publications/implications_for_inve stors_page

Currency Management
Cynthia Steer Foreign Exchange Policy Oversight: Where is it? Russell Investments August 2011

Summary or Abstract: Over the past month, global markets have reacted with concern and volatility to perceptions of rising, global risk. Whether it is sovereign risk or concerns about global growth, markets have been fearful and unsettled. Foreign exchange markets have been affected no differently. However, investors are more aware of the currency components in their portfolios than possibly any time in the last 20 years. But are they prepared from a policy perspective? This short note attempts to summarize some of the questions we should be asking about the role of currency in our portfolios. It addresses some basic questions we, as an industry, have not yet answered and argues that maybe now is the time to respond. Web link: http://www.russell.com/institutional/research_commentary/foreign_exchange_policy_oversight.asp

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PUBLICATION

DATE

Defined Contribution & 401(k) Plans

W. Van Harlow Optimal Asset Allocation in Retirement: A Downside Risk Perspective Putnam Institute June 2011

Summary or Abstract: Once an individual has retired, asset allocation becomes a critical investment decision. Unfortunately, there is no consensus on what the optimal allocation should be for retirees of varying age, gender, and risk tolerance. This study analyzes the allocation question through a focus on the downside risks created by uncertainty over investment returns and life expectancy. It finds that the range of appropriate equity asset allocations in retirement is strikingly low compared with those of typical lifecycle and retirement funds now in the marketplace. In fact, for retirement portfolios whose primary goal is to minimize the risk of depletion and sustain withdrawals, optimal equity allocations range between 5% and 25%. This quite conservative level of equity holdings changes little even with significant changes in assumptions on capital market returns. The study suggests that the higher equity allocations used in many popular retirement investment products today significantly underestimate the risks that these higher-volatility portfolios pose to the sustainability of retirees savings and to the incomes on which retirees depend. Web link: https://content.putnam.com/literature/pdf/PI001.pdf Qianqiu Liu, Rosita P. Chang, Jack C. De Jong, Jr., and John H. Robinson Are Lifecycle Funds Getting a Bum Rap? Journal of Wealth Management Fall 2011

Summary or Abstract: In an effort to determine whether recent criticism regarding the efficacy of lifecycle mutual funds is justified, this article makes a robust comparison of two glidepath strategies commonly employed in lifecycle funds, both with each other and with a range of constant allocation portfolios designed to simulate risk-based lifestyle mutual funds. A concerted effort is made to make the model design realistic, and the analysis considers the lifecycle and lifestyle strategies through the accumulation and withdrawal phases of retirement planning. The results tend to cast a favorable light on lifecycle funds and suggest that recent research critical of lifecycle funds may be too narrowly focused. By considering a robust range of accumulation and withdrawal scenarios as well as multiple measures of risk, this analysis finds that lifecycle funds may be a rational choice for a surprisingly wide spectrum of workers and retirees. Web link: http://www.iijournals.com/doi/abs/10.3905/jwm.2011.14.2.068

Equity Management
Bob Collie and John Osborn Defensive Equity: Is the Market Mispricing Risk? Russell Investments June 2011

Summary or Abstract: Intuitively, investors might expect stocks that are less risky than other stocks stocks we refer to as defensive stocks to deliver lower returns than the broad market over the long term. That does not seem to have been the case, however. Among the factors that have been suggested as contributing to this apparent anomaly is the widespread use of marketrelative benchmarking by mutual funds and institutional accounts. For investors who expect this defensive effect to persist, the strategy offers the possibility of a reduction in portfolio risk and a more attractive trade-off between risk and reward. Web link: http://www.russell.com/institutional/research_commentary/defensive_equity.asp Mark Anson The Evolution of Equity Mandates in Institutional Portfolios Journal of Portfolio Management Summer 2011

Summary or Abstract: The asset allocation decision is one of the most important determinants of overall fund performance for institutions around the world. Pension funds, endowments, and foundations spend considerable time deciding how to split up the trillions of dollars they collectively control. Inevitably, the largest allocation is to the equity slice of the pie. The reasons are several: higher returns, largest asset class in which to invest, good liquidity, easiest to understand, and the cheapest to transact in. The author traces the evolution of equity mandates as institutional investors have become more sophisticated in their approach to the equity markets including international investing, global mandates, FamaFrench risk factors, and risk parity. Web link: http://www.iijournals.com/doi/abs/10.3905/jpm.2011.37.4.127

AUTHOR(S) Fixed Income

Douglas J. Peebles

TITLE

PUBLICATION

DATE

The Tyranny of Bond Benchmarks

AllianceBernstein

June 2011

Summary or Abstract: As interest rates have trended ever lower over the past three decades, investors have generally done well sticking to a fixed-income benchmark. But the upheavals of the recent past have taught many that an index provides no safe haven. Web link: https://www.alliancebernstein.com/Research-Publications/Research-Articles/Tyranny-ofFI-Benchmarks/Stories/Tyranny-of-the-Benchmarks-Series.htm Paul Hatfield and Simon Perry Investing in Debt: Opportunities in Secured Bank Loans BNY Mellon August 2011

Summary or Abstract: In 2010, the authors produced an overview of what they described as opportunities for investors in secured bank loans. Since then many of the trends they highlighted have developed further, and a clearer view is now emerging of the potential attractions of the loan market to investors. This article is an update restating the case for the asset class, reviewing important developments over the last year, and providing an outlook for the market. Web link: http://us.bnymellonam.com/core/library/documents/knowledge/AlphaTrends/sAlcentra_Investing.p df William J. Morgan, Cory L. Pollock, James P. Shanahan, and Jon J. Salstrom Bank Loans: Whats the Attraction? JP Morgan August 2011

Summary or Abstract: Bank loans are justifiably earning an increasing amount of attention and investment among the traditional institutional investor base. This article describes the compelling attributes of bank loans and the rationale behind their increasing appeal. Web link: http://www.jpmorgan.com/cm/Satellite?blobcol=urldata&blobheader=application%2Fpdf&blobkey =id&blobtable=MungoBlobs&blobwhere=1158646666855&ssbinary=true

Brian M. Concannon, A Primer on Floating-Rate Bond Funds Vanguard August 2011 Donald G. Bennyhoff and Summary or Abstract: With short-term rates near 0%, investors seeking protection from a Yan Zilbering potential rise in interest rates may be considering an investment in floating-rate bond funds (also known as bank loans, syndicated loans, leveraged loans, and loan-participation funds). To assist investors in evaluating floating-rate funds, this paper reviews key characteristics of the funds and addresses the suggestion that the funds offer both principal protection and above-average yields. Web link: https://institutional.vanguard.com/VGApp/iip/site/institutional/researchcommentary/article/InvResFl oatingRate

Governance
Jill Marshall and Liqian Ren Does Leadership Style Matter? Investment Vanguard Committee Decision-Making Study June 2011

Summary or Abstract: Conventional wisdom suggests that leadership style, as defined by the extent to which leaders share or retain their decision-making authority, could dramatically alter the effectiveness of investment committee decision-making. Surprisingly, in a recent survey, Vanguard research found that leadership style does not matter a lot. Although a democratic leadership style was the most popular compared to autocratic or laissez-faire styles, there was little indication that these investment committees achieved increased productivity or superior behavior among their members. Web link: https://institutional.vanguard.com/VGApp/iip/site/institutional/researchcommentary/article/InvCom mLeadershipStyle

AUTHOR(S) Hedge Funds

Antony E. Ghee

TITLE

PUBLICATION

DATE

Hedge Funds: A Sensible Approach to Oversight

Journal of Investment Management

Third Quarter 2011

Summary or Abstract: After years of debating whether additional regulation should be imposed on hedge funds, legislative initiatives, such as the Dodd-Frank Act, have recently been enacted and could significantly alter the scope of government oversight in an industry that has, until recently, been subject to little regulatory scrutiny. The purpose of this article is not to critique recent legislative initiatives, but rather discuss the historical failings of regulators to detect fraud and other misconduct at early stages. In doing so, this article will also focus on recurring themes that are prevalent in fraud related misconduct, and offer suggestions upon which regulators may improve their efforts to detect fraud before investors suffer significant losses. The proposals outlined herein are intended to alter the behavior of the unethical while minimizing the impact to industry practitioners that operate with integrity. Web link: https://www.joim.com/abstract.asp?ArtID=414

Inflation Protection
Philip Hodges, Kevin Kneafsey, Thomas Mcfarren and Duane Whitney Are Hedging Properties Inflated? BlackRock August 2011 Summary or Abstract: If you knew today that inflation would surge in the US within the next two yearsand that the markets had not yet priced in this informationwhat changes would you consider making to your portfolio? This article looks at seven asset classes to reveal each ones historical ability to hedge inflation. For each asset class, the article highlights the conventional wisdom surrounding its relationship with inflation, compares this with what financial theory suggests it should be, and evaluates the historical record during inflationary periods. Web link: https://www2.blackrock.com/webcore/litService/search/getDocument.seam?venue=PUB_INS&sour ce=InvestmentInsightsApr2011Email&contentId=1111145424 Brian Upbin, Anand Venkataraman and Scott Harman Inflation-Linked Index Products: An Overview Journal of Indexes September/ October 2011

Summary or Abstract: Inflation is an important risk factor for investors concerned about the purchasing power of future cash flows to be received or future liabilities to be paid. This is true for traditional debt investors seeking a positive real return on assets; for pension plans; and for other asset owners with future cash flow obligations that must be funded by their investment portfolios. To address these risks, investors may seek high positive real returns with traditional fixed-income assets or tap into a large and growing component of the fixed-income/OTC derivative universe that is directly linked to inflation. These inflation-linked bond and swap instruments offer returns or payoffs that are linked to inflation, but have also created an opportunity to express directional market views on expected inflation by comparing the valuations of inflation-linked and nominal assets. This article discusses the landscape for both inflation-linked bonds and inflation swaps, covering the basic mechanics of these instruments and details on the structure and growth of the overall market. It also discusses other inflation-linked index products that are used by market participants when accessing, evaluating and managing inflation. Web link: http://www.indexuniverse.com/publications/journalofindexes/joi-articles/9741-inflationlinked-index-products-an-overview.html

International Investment
Clifford S. Asness, Roni Israelov, and John M. Liew International Diversification Works (Eventually) Financial Analysts Journal May/June 2011

Summary or Abstract: Critics of international diversification observe that it does not protect investors against short-term market crashes because markets become more correlated during downturns. Although true, this observation misses the big picture. Over longer horizons, underlying economic growth matters more than short-lived panics with respect to returns, and international diversification does an excellent job of protecting investors. Web link: http://www.cfapubs.org/doi/abs/10.2469/faj.v67.n3.1

AUTHOR(S)
Christopher Philips, Joseph Davis, Andrew Patterson and Charles Thomas

TITLE
Considering Global Fixed Income

PUBLICATION
Journal of Indexes

DATE
May/June 2011

Summary or Abstract: Traditionally, U.S. investors have achieved diversification of a domestically focused portfolio primarily through the use of international equities. However, over the past 10 years, the global investable market has changed markedly, largely as a result of the growth and maturation of world bond markets, combined with the ongoing globalization of businesses and capital flow. International bonds now make up more than 35 percent of the worlds investable assets, and yet many domestic investors have little or no exposure to these securities. Are there empirical or practical considerations that would justify such a home bias in U.S. investors portfolios? This article examines the strategic case for an allocation to international bonds by addressing their potential diversification benefits, risks and costs, paying particular attention to the role of currency. Web link: http://www.indexuniverse.com/publications/journalofindexes/joi-articles/9129considering-global-fixed-income.html

Dave Berger, Kuntara Pukthuanthong, and J. Jimmy Yang

International Diversification with Frontier Markets

Journal of Financial Economics

July 2011

Summary or Abstract: This article provides an analysis of frontier market equities with respect to world market integration and diversification. Principal component results reveal that frontier markets exhibit low levels of integration. In contrast with developed and emerging markets, frontier markets offer no indication of increasing integration through time. Furthermore, individual frontier market countries do not exhibit consistent rates of changing integration. Structural break tests identify breakpoints in integration, as well as integration dynamics across countries. The article shows that frontier markets have low integration with the world market and thereby offer significant diversification benefits. Web link: http://www.sciencedirect.com/science/article/pii/S0304405X11000420

Francis Gupta

Developed, Emerging Or Frontier Markets?

Journal of Indexes

July/August 2011

Summary or Abstract: This article discusses a new methodology introduced by Dow Jones Indexes early in 2011 for classifying global equity markets. This methodology is novel in its approach to categorizing markets in that its classifications are based entirely on market-centric attributes and investor-centric experiences in those markets. Web link: http://www.indexuniverse.com/publications/journalofindexes/joi-articles/9432developed-emerging-or-frontier-markets.html Alexander Kozhemiakin Emerging Markets Local Currency Debt: Capitalizing on Improved Sovereign Fundamentals BNY Mellon August 2011

Summary or Abstract: Emerging markets local currency debt is a large and liquid asset class that represents some of the most credit worthy emerging market sovereigns, offers two distinct sources of return (currency and local bond yields), and provides the potential to generate equity-like returns without taking on direct equity risk. Web link: http://us.bnymellonam.com/core/library/documents/knowledge/AlphaTrends/sStandishEM_LCdebt. pdf

AUTHOR(S)
William Perry

TITLE
The Case For Emerging Market Corporates

PUBLICATION
Journal of Indexes

DATE
September/ October 2011

Summary or Abstract: Over the last decade, emerging market (EM) economies have benefited greatly from macroeconomic stabilization and the liberalization of trade and financial markets. Since early 2000, EM corporate debt has evolved from a marginal market with $20 billion in annual issuance volume (mostly from Latin American issuers) to a global market with average annual issuance in excess of $100 billion with representation from all four major regions (Asia, Latin America, Central and Eastern Europe, and the Middle East/Africa). According to this article, an allocation to EM corporate debt could be an attractive option for investors seeking an opportunity to diversify away from other traditional fixed-income asset classes and add potential excess riskadjusted returns. Web link: http://www.indexuniverse.com/publications/journalofindexes/joi-articles/9739-the-casefor-emerging-market-corporates.html

Investment Management & Portfolio Strategy

Richard Ferri The Power of Passive Investing Journal of Indexes May/June 2011 Summary or Abstract: The Power Of Passive Investing: More Wealth With Less Work, by Richard Ferri, hit shelves in December 2010. The book, which includes a foreword by Vanguard founder John Bogle, makes the argument for buy-and-hold index investing based on numerous academic studies, while offering guidance on how to construct low-cost portfolios with index-based investment vehicles. This article is an excerpt from Chapter 8, Active and Passive Asset Allocation, which addresses the issue of timing by comparing the approaches of so-called tactical asset allocators and passive investors. Web link: http://www.indexuniverse.com/publications/journalofindexes/joi-articles/9130-thepower-of-passive-investing.html W. Van Harlow and Keith The Right Answer to the Wrong Question: C. Brown Identifying Superior Active Portfolio Management Putnam Institute June 2011

Summary or Abstract: The debate over the value of active portfolio management has often centered on whether the average active manager is capable of producing returns that exceed expectations. This paper argues that a more useful way to frame this issue is to focus on identifying those managers who are the most likely to generate superior risk-adjusted returns (i.e., alpha) in the future. Using a style-classified sample of mutual funds, it documents several tractable relationships between observable fund characteristics and the funds future alpha, most notably the tendency for performance to persist over time. While median managers produce positive riskadjusted performance approximately 45% of the time, it documents a selection process that improves an investors probability of identifying a superior active manager to almost 60%. It concludes that there is a place in the investors portfolio for the properly chosen active manager. Web link: https://content.putnam.com/literature/pdf/PI003.pdf J.J. McKoan and Michael Ning Seeking Asymmetric Returns AllianceBernstein July 2011

Summary or Abstract: The 2008 financial crisis has led many investors to reexamine some of the key assumptions that lie at the heart of modern portfolio theory. As researchers rethink theoretical models of the investment world, we anticipate that a key trend in portfolio management will be a focus on asymmetric returnsinvestment strategies that maximize upside potential while capping downside risks. The key to such strategiesand to achieving sustainable positive returns over timeis a dynamic risk-management process that limits the probability of large portfolio losses. Web link: https://www.alliancebernstein.com/Research-Publications/White-Papers/AsymmetricReturns/Stories/AsymmetricReturns.htm

AUTHOR(S)
Janus Capital

TITLE
Stay Active: The Case for Active Management

PUBLICATION
Janus Capital

DATE
July 2011

Summary or Abstract: Using skill and insight to construct portfolios remains the best opportunity for long-term investors to generate alpha. Active stock picking can distinguish between tomorrows outperformers and underperformers and it has the potential to reward patient investors. Over the long-term, results and academic research support active management if the manager is truly active and not an undeclared, shadow indexer. For the last 10 years, the major equity indices have been middling performers, while managers who are most different from the index have tended to outperform the most. It makes sense: those who invest as all others do are bound to be average. Web link: https://ww4.janus.com/institutional/jiam?command=secureFileController&assetName=WhyActiveFi xedIncomeMakesSense_Doc&insightType=Whitepaper&insightType=Whitepaper&flag=1 Charles D. Ellis The Winners Game Financial Analysts Journal July/August 2011

Summary or Abstract: Practitioners of the investment management profession are underperforming for their clients and for their profession because of three errors: defining their mission as beating the market, allowing the values of their profession to be eclipsed by the economics of the business, and not providing much-needed investment counseling. The solution is to incorporate investment counseling into the heart of their clientmanager relationship. Web link: http://www.cfapubs.org/doi/abs/10.2469/faj.v67.n4.3 Lewis Braham The Devils Invention Journal of Indexes July/August 2011

Summary or Abstract: In "The House That Bogle Built," journalist Lewis Braham digs into the details of the life of the man known as the father of indexing and to many as "Saint Jack." The book follows Bogle from his tumultuous childhood through the founding of one of the world's bestknown mutual fund companies to his ouster from his own company and rebirth as an investor advocate. This article is an excerpted version of Chapter 11, which recounts the development and rise of Vanguard's indexing business and the advent of the ETF boom. Web link: http://www.indexuniverse.com/publications/journalofindexes/joi-articles/9433-thedevils-invention.html Onur Erzan, Ogden Hammond and Juan Banet The Second Act Begins for ETFs McKinsey & Company August 2011

Summary or Abstract: Not since the advent of index funds, hedge funds, or possibly the mutual fund itself, has the asset management industry witnessed an innovation as profound as exchangetraded funds (ETFs). This disruptive investment vehicle has given individual investors access to asset classes and strategies once out of reach, attracted assets at an industry-leading clip and turned the passive investment arena into a hotbed of competition. Now, as ETFs mature, they are poised to move into a second act, which will present both greater strategic challenges and new opportunities for growth. Web link: http://www.mckinsey.com/clientservice/Financial_Services/~/media/Reports/Financial_Services/ET F_SecondActFINAL.ashx

Bradford Cornell

Investment Strategies and Investment Track Records

Journal of Portfolio Management

Summer 2011

Summary or Abstract: There are two fundamentally distinct ways in which investment management services can be evaluated: on the basis of a proposed investment strategy or on the basis of an investment track record. Of the two, the track record is the gold standard. Contrary to accepted wisdom, the perspective presented here is that track records provide little basis for assessing investment managers. A superior approach is to compare investment strategies directly on an ex ante basis rather than relying on historical data. Web link: http://www.iijournals.com/doi/full/10.3905/jpm.2011.37.4.003

AUTHOR(S)
Chito Jovellanos

TITLE
The Impact of Investment Operations on Portfolio Performance

PUBLICATION
Journal of Investing

DATE
Fall 2011

Summary or Abstract: This research summarizes intriguing evidence on the impact of an asset managers overall investment operations on individual portfolio performance. This exploratory analysis of operational data associated with 61 institutional portfolios across 14 managers (over the October 1999August 2009 period) suggests that robust investment operations can mitigate potential outflows of excess return within a portfolio ranging from 51242 basis points (relative to the benchmark and gross of fees). The dissipation of returns stems from implementation shortfalls associated with a broad spectrum of activities performed within investment operations. The authors inquiry was motivated by the insufficiency of existing approaches that evaluate ops simply through the lens of expenses, workflows, and best-practices adoption while ignoring the more central question of how overall operational efficiency contributes directly to performance of the firms portfolios. Web link: http://www.iijournals.com/doi/abs/10.3905/joi.2011.20.3.040

Laws & Regulations

OECD 2010 Survey of Investment Regulation of Pension Funds OECD June 2011

Summary or Abstract: This report describes the main quantitative investment regulations applied to pension funds in OECD and selected non-OECD countries as of December 2010. It covers all types of pension plans financed via pension funds. Where regulations vary depending on the type of plan (occupational, personal, mandatory, voluntary, DB, DC, etc), the tables identify the types of plan that the investment regulations apply to. The information collected concerns all forms of quantitative portfolio restrictions (minima and maxima) applied to pension funds at different legal levels (law, regulation, guidelines, etc). Web link: http://www.oecd.org/dataoecd/9/1/48094890.pdf

Pension Fund Management

John R. Minahan The Role of Investment Philosophy in Evaluating Investment Managers NEPC June 2011

Summary or Abstract: This paper defines the concept of investment philosophy and discussing, with illustrations from Dr. Minahans consulting experience, how the concept can be applied to evaluating investment managers. Web link: http://www.nepc.com/research/79the_role_of_investment_philosophy_in_evaluating_investment Karin Peterson LaBarge Securities Lending: Still No Free Lunch Vanguard July 2011

Summary or Abstract: Because securities lending is a rather straightforward process, many investors have perceived it as a relatively risk-free way to increase the return on an equity or bond portfolio. However, there are pitfalls. This paper examines these risks, which were highlighted during the late-2000s credit crisis, and also compares the two approaches to securities lending. Web link: https://institutional.vanguard.com/VGApp/iip/site/institutional/researchcommentary/article/InvResC orpFin

AUTHOR(S)
Michael Peltz and Frances Denmark

TITLE
How Do The Best Investors Manage Portfolios In Challenging Times?

PUBLICATION
Institutional Investor

DATE
August 2011

Summary or Abstract: On the morning of May 17, nine leading pension, endowment and foundation investors gathered for a roundtable discussion at the Union League Club in New York City. Ever since the financial crisis hit their funds in late 2007, institutional investors have been dealing with increasing risks from both natural and man-made disasters. Although most funds turned in positive performances in 2010, assets remain below their 2007 highs. During the lively and collegial discussion, the participants took a hard look at fund governance in addition to sharing their thoughts on a variety of investments, from venture capital and hedge funds to commodities and Japan. This article provides excerpts from that discussion. Web link: http://www.institutionalinvestor.com/article.aspx?articleID=2878303&single=true Sacha Ghai, Marcos Tarnowski and Jonathan Ttrault The Best of Times and the Worst of Times for Institutional Investors McKinsey & Company August 2011

Summary or Abstract: These are the best of times and the worst of times to be an institutional investor. Though 2010 has delivered some respite for most institutions, portfolios by and large have yet to fully recover from the 2008-2009 crisis, and many global risks continue to loom on the horizon. Despite widely varying points of view and concerns, the consensus of CEOs, CIOs, investment managers, and economists is that the near-term future holds almost unprecedented levels of both uncertainty and opportunity for global investors. The objective of this paper is to provide senior executives from institutional investors with fresh perspectives on approaches that institutions should take to navigate the shifts in the investment landscape. It is based on work conducted with leading global institutional investors as well as a series of discussions with over 50 industry experts and investment professionals of institutions collectively managing more than $3 trillion in assets. Web link: http://www.mckinsey.com/clientservice/Financial_Services/~/media/Reports/Financial_Services/Ins titutional.ashx

Performance Measurement
Felix Goltz and Vronique Le Sourd Does Finance Theory Make the Case for Capitalization-Weighted Indexing? Journal of Index Investing Fall 2011

Summary or Abstract: Indexers often evoke financial theory to claim that cap-weighted stock market indices are good investment choices. This article analyzes the existing literature to see whether the recommendation of holding cap-weighted indices is indeed grounded in financial theory. Although the capital asset pricing model (CAPM) theory does lead to a recommendation to hold the market portfolio, the models practical relevance is limited by its unrealistic assumptions. If we relax those assumptions, theory does not predict that the market portfolio is efficient. In addition, the CAPM also fails in empirical tests, showing that it is not the true asset pricing model. Even if the CAPM were the true model, and the market portfolio was efficient, a stock market index is a very poor proxy for the market portfolio, because it includes only a fraction of the economywide wealth. Thus, from a theoretical perspective, cap-weighted stock market indices seem to have no particular appeal. Web link: http://www.iijournals.com/doi/abs/10.3905/jii.2011.2.2.059

Private Equity
Preqin Overview of Private Equity Real Estate Funds of Funds Preqin June 2011

Summary or Abstract: Funds of funds have traditionally been a significant source of capital for private equity real estate fund managers, as well as providing access to the asset class for investors that lack the resources, finance, knowledge or experience required for manager selection and committing to funds directly. This special report calls upon some of the key content from the 2011 Preqin Private Equity Real Estate Fund of Funds Review to provide an overview of the latest industry developments. Web link: http://www.preqin.com/docs/newsletters/RE/Preqin_Special_Report_PE_RE_FOF.pdf

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AUTHOR(S)
John Vester

TITLE
How Do Private Equity Investors Create Value?

PUBLICATION
Journal of Private Equity

DATE
Fall 2011

Summary or Abstract: For the past four years, Ernst & Young has conducted in-depth annual surveys in North America on the largest private equity (PE) investment exits, to enable disciplined quantitative analyses for the purpose of identifying the major drivers of investment return. The results have been published and presented regularly in various forums, and each edition of the annual E&Y PE Value Creation Study (as it has become known) delves into new areas of investigation to keep the current findings innovative and fresh. This article presents for the first time a coherent and cumulative summary of the major findings from all of the editions of this substantive PE exit research and analyses over exit years from 2006 to 2009 for the largest PE exits in North America. Web link: http://www.iijournals.com/doi/abs/10.3905/jpe.2011.14.4.007

Public Sector Pension Plans

Jun Peng and Ilana Boivie Lessons from Well-Funded Public Pensions: An Analysis of Plans that Weathered the Financial Storm National Institute on Retirement Security June 2011

Summary or Abstract: This study identifies common elements of public sector defined benefit pension plans that remained well-funded despite two severe economic downturns. It examines selected statewide public pension plans to identify six features that enabled those plans to remain sustainable and affordable. Web link: http://www.nirsonline.org/index.php?option=com_content&task=view&id=613&Itemid=48 Alicia H. Munnell, JeanPierre Aubry, Josh Hurwitz, and Laura Quinby An Update on Locally-Administered Pension Plans Center for Retirement Research at Boston College July 2011

Summary or Abstract: The financial crisis and ensuing recession have had an enormous impact on state-administered pension plans. Funded levels declined sharply, the Annual Required Contribution (ARC) increased to make up for the fall in funding, and the percent of ARC paid declined as the bottom fell out of state revenues. In response, states have increased employer and employee contributions, cut employment, slowed wage growth, and lowered benefits for new employees (and in a few instances reduced COLAs for current employees, but these initiatives have been challenged and are currently in the courts). Less is known about how locally-administered plans have fared in the last four years. This brief attempts to fill that gap. Web link: http://crr.bc.edu/briefs/an_update_on_locally-administered_pension_plans.html

Alicia H. Munnell, JeanPierre Aubry, Josh Hurwitz, and Laura Quinby

Unions and Public Pension Benefits

Center for Retirement Research at Boston College

July 2011

Summary or Abstract: State and local pensions have been headline news since the 2008 financial collapse reduced the value of their assets, leaving a substantial unfunded liability. The deterioration in the funded status of these plans raised pension costs at the same time that the ensuing recession wreaked havoc with state and local budgets. Legislatures across the country have responded by reducing pension benefits primarily for new employees and increasing employer and employee contributions. As part of that process, governors in several states have launched initiatives to curb collective bargaining in the public sector. One possible implication is that governors view unions as responsible for pushing up state and local pension benefits. This brief identifies the impact of public sector unions and other factors on benefit levels, wages, and employment. Web link: http://crr.bc.edu/briefs/unions_and_public_pension_benefits.html

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AUTHOR(S)
Robert Novy-Marx and Joshua Rauh

TITLE
Public Pension Promises: How Big Are They and What Are They Worth?

PUBLICATION
Journal of Finance

DATE
August 2011

Summary or Abstract: The authors calculate the present value of state employee pension liabilities using discount rates that reflect the risk of the payments from a taxpayer perspective. If benefits have the same default and recovery characteristics as state general obligation debt, the national total of promised liabilities based on current salary and service is $3.20 trillion. If pensions have higher priority than state debt, the value of liabilities is much larger. Using zero-coupon Treasury yields, which are default-free but contain other priced risks, promised liabilities are $4.43 trillion. Liabilities are even larger under broader concepts that account for salary growth and future service. Web link: http://www.afajof.org/journal/abstract.asp?ref=0022-1082&vid=66&iid=4&aid=6&s=9999

Real Assets
Mark Weisdorf and Serkan Baheci The Infrastructure Moment - Favorable Trends in Infrastructure Investing JP Morgan July 2011

Summary or Abstract: Infrastructure generates relatively predictable, growing and low volatility cash flows that exhibit little correlation to equity and fixed income returns. The severity of the Global Financial Crisis, combined with certain tipping point changes to long-term trends, make now a particularly compelling time to invest in infrastructure. Web link: http://www.jpmorgan.com/cm/Satellite?blobcol=urldata&blobheader=application%2Fpdf&blobkey =id&blobtable=MungoBlobs&blobwhere=1158642858150&ssbinary=true Rebecca Patterson Commodity Considerations in a New Fiscal World Order JP Morgan August 2011

Summary or Abstract: Even as commodity prices continue to climb, investors may be wondering if it is too late to increase their exposure to the asset class. This article describes several reasons why commodities are likely to be an investment to seriously consider over the long term. Web link: http://www.jpmorgan.com/pages/jpmorgan/am/ia/research_and_publications/commodity_consider ations_in_a_new_fiscal_world_order_page Hans R. Stoll and Robert E. Whaley Commodity Index Investing: Speculation or Diversification? Journal of Alternative Investments Summer 2011

Summary or Abstract: A number of seemingly unrelated commodities experienced simultaneous price spikes in 2007 and 2008. Congress investigated the increase in prices and concluded that the price increases were attributable not to supply and demand fundamentals but rather excessive speculation from commodity index investing. In this article, the authors evaluate whether commodity index investing is a disruptive force in commodity futures markets. Using the U.S. Commodity Futures Trading Commissions Commitments of Traders reports, the authors conclude that because of its passive, long-only nature, commodity index investing is not speculation. In addition, the authors conclude that commodity index flows, whether due to rolling over existing futures positions or establishing new ones, have little impact on futures prices. Web link: http://www.iijournals.com/doi/abs/10.3905/jai.2011.14.1.050

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AUTHOR(S) Risk Management

Robert Litterman

TITLE

PUBLICATION

DATE

Who Should Hedge Tail Risk?

Financial Analysts Journal

May/June 2011

Summary or Abstract: In a somewhat ironic turn of events, many investment banks began selling insurance against equity tail risk to institutional investors following the financial crisis. Ironic because one might expect that investment banks, with high leverage and quarterly earnings reports to worry about, would be the natural buyers of such insurance and long horizon investors the natural sellers. Surely, those with deep pockets and long horizons, who would be little affected by the crisis, should be selling insurance to those with short horizons and leveraged positions, which would be most highly affected. Web link: http://www.cfapubs.org/doi/abs/10.2469/faj.v67.n3.7 Kevin McLaughlin and David Newman Financial Risk Management of DB Plans for Mercer Multinationals June 2011

Summary or Abstract: This article explores the approaches that some companies are taking to evaluate the financial risks of their global retirement plans, and the ways in which they mitigate that risk. The article also explores the implications of these new approaches for ongoing governance and the operation of retirement plans. Web link: http://www.mercer.com/articles/1330905 William Mast Redefining Credit Risk Journal of Indexes July/August 2011

Summary or Abstract: For more than a century, the big three bond rating agencies have been the unchallenged arbiters of corporate creditworthiness. Rating references are embedded in hundreds of guidelines, laws and private contracts that affect a broad range of financial concerns. The recent financial crisis, however, laid bare a material weakness in the traditional agencies models: Their ratings are backward-looking because they are predicated on historical data that is observed at a discrete point in time. Given this constraint, these agencies have not been favorably positioned to react quickly to rapid changes in a creditors financial health. Hence, evidence of accounting fraud in a companys financial statements may elude their scrutiny. Additionally, the legacy credit rating agencies have demonstrated that they remain ill-equipped to assess the risks of some complex, structured products. There is now considerable momentum in the markets and on legislative agendas to explore and evaluate alternative ways to assess the credit ratings of public companies. In fact, theres a body of recent research that points to the credit default swap (CDS) market as a source for a more fluid, market-driven metric to gauge the creditworthiness of an issuer. Web link: http://www.indexuniverse.com/publications/journalofindexes/joi-articles/9426redefining-credit-risk.html

Socially Responsible Investing

Mercer Global Investor Survey on Climate Change Mercer June 2011 Summary or Abstract: This year saw the first jointly sponsored report by the European Institutional Investors Group on Climate Change (IIGCC), the North American Investor Network on Climate Risk (INCR) and Australia/New Zealand Investor Group on Climate Change (IGCC), collectively the investor groups. The report provides an overview of the investment practices of investors around the world relating to their actions on climate change, in addition to presenting case studies of best practice. Mercer was commissioned to develop the survey underlying the report, as well as verifying and analyzing the responses from the 90 participating signatories, and authoring the report. The report analyses how investors are building their knowledge of climate change and its implications for their investments and considers how they are taking account of climate change in their investment decision-making and engagement activities with regard to their assets. It also considers how investors are individually and collaboratively encouraging policymakers to provide a policy framework that is supportive of long-term investment decisionmaking and the move to a low carbon economy. Web link: http://www.mercer.com/articles/1210735

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AUTHOR(S)
Remy Briand, Roger Urwin and Chin Ping Chia

TITLE
Integrating ESG into the Investment Process

PUBLICATION
MSCI

DATE
August 2011

Summary or Abstract: In recent years, many institutional investors have been increasingly recognizing that the long-term sustainability of their investments matters. Environmental, Social and Governance (ESG) factors are becoming important considerations for investors to focus on given their influence on a portfolio's risk and return profile. Some asset owners are starting to embrace the concept of "Universal Ownership", where they see the long-term exposure to the whole economy through their portfolio as requiring specific investment actions. Mitigating risks due to exposure to ESG factors and dealing with externalities in order to produce higher sustainable long-term returns has become an integrated part of the portfolio management process for many investors/asset owners. The aim of this paper is to provide a framework for integrating ESG considerations into the investment process of mainstream institutional investors. In particular, it introduces a portfolio analytical concept that aims to measure how well ESG factors are integrated across the entire portfolio and that can be used to set quantifiable objectives for improvement. Web link: http://www.msci.com/resources/research_papers/integrating_esg_into_the_investment_process_2. html

Meg Voorhes and Joshua Recent Trends in Sustainable and Humphreys Responsible Investing in the United States

Journal of Investing

Fall 2011

Summary or Abstract: Today, nearly one out of every eight dollars under professional management in the United States is invested according to strategies of sustainable and responsible investing (SRI), also known as socially responsible investing. This article provides a brief overview of sustainable and responsible investing in the United States, beginning with a review of its growth over the last 15 years. It explains SRI as an investment discipline, identifies key SRI strategies, and summarizes how and why institutional investors and money managers are practicing SRI today. Web link: http://www.iijournals.com/doi/abs/10.3905/joi.2011.20.3.090 Lloyd Kurtz and Dan di Bartolomeo The Long-Term Performance of a Social Investment Universe Journal of Investing Fall 2011

Summary or Abstract: This article presents a multi-decade, holdings-based attribution analysis of a U.S. social investment index. This analysis finds that differences between the indexs returns and those of the S&P 500 Index are fully explained by conventional investment factors. This is true for the full time period under study as well as for two subperiods (January 1992November 1999 and December 1999June 2010) that coincide with periods of nominal outperformance and underperformance by the index. The authors find that unexplained returns are not statistically different from zero in either the full time period or in either of the two subperiods. This is beneficial for investors motivated by social values because it suggests that the risk exposures created by social screens can be managed through careful portfolio construction. It is less encouraging for investors seeking a performance advantage through the use of social or environmental factorsthe analysis suggests that, for this universe at least, market valuations already correctly incorporate this information. Web link: http://www.iijournals.com/doi/abs/10.3905/joi.2011.20.3.095 John Dravenstott and Natalie Chieffe Corporate Social Responsibility: Should I Invest for It or against It? Journal of Investing Fall 2011

Summary or Abstract: In this article, the authors compare the returns of a portfolio composed of socially responsible companies with those of a portfolio composed of companies without that distinction. They find that socially responsible companies perform worse than irresponsible companies. The reason for this seems to depend on the individual socially responsible investment (SRI) screens. Some screens have a positive impact on returns, some have a negative impact. Corporate governance is the only SRI screen with a positive relationship to returns: A positive rating helps returns, while a negative rating hurts returns. Most other screens show an inverse relationship: Companies with poor social responsibility have higher returns, or companies with good social responsibility have lower returns. Web link: http://www.iijournals.com/doi/abs/10.3905/joi.2011.20.3.108

14

AUTHOR(S)

TITLE

PUBLICATION

DATE

The Financial Crisis of 2008

Raimond Maurer, Olivia S. Mitchell, and Mark Warshawsky Retirement Security and the Financial and Economic Crisis: An Overview Pension Research Council - The Wharton School August 2011

Summary or Abstract: The global financial and economic crisis severely undermined the future of retirement security. At a recent Impact Conference sponsored by the Wharton School's Pension Research Council (PRC) and the Boettner Center for Pensions and Retirement Research at the University of Pennsylvania, academics, practitioners, and policy analysts joined to explore how retirement planning and long-term financial security have changed, following the crisis. This paper summarizes key lessons and conclusions. Web link: http://www.pensionresearchcouncil.org/publications/document.php?file=976

This report is not intended to be an exhaustive list of all research papers and articles published during the period. Cortex Applied Research Inc. is not responsible for, and does not necessarily endorse, any of their findings and conclusions. It has no financial interest in, or business relationship with, any of the authors, institutions or publications. Cortex Applied Research Inc. is a management consulting firm that specializes in assisting public and corporate pension plans in enhancing their governance and decision-making practices. www.cortexconsulting.com
Cortex Applied Research Inc. 2011

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