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Liability Index Fund: The Liability Beta Portfolio

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Abstract

Historically, the practice of trustees of defined benefit programs has been to make the asset allocation decision based on prevailing risk-return relationship for asset classes without regard to the plan’s economic funded ratio, liability structure, and liability economic growth rate. Once the asset allocation decision is made, the market index that best represents that asset class is selected as the performance benchmark. Ignoring the liability structure has been the major reason for the failure of both private and public pension funds to achieve their true objective of funding the liability benefit payment schedule at a stable and low cost to the plan sponsor. For trustees to properly manage pension assets in light of the true objective, they need a liability index customized to the fund’s unique benefit payment schedule. In this article, we explain how this should be accomplished and how Alpha and Beta portfolios should be redefined in order to work in harmony with the plan’s true objective.

Suggested Citation

  • Ryan, Ronald & Fabozzi , Frank, 2011. "Liability Index Fund: The Liability Beta Portfolio," Journal of Financial Transformation, Capco Institute, vol. 33, pages 29-33.
  • Handle: RePEc:ris:jofitr:1472
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    Keywords

    Pension Funds; Asset/Liability Management; Asset Classes; Asset Allocation; Liability Index; Alpha/Beta;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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