Liability-Driven Investment for Pension Funds: Stochastic Optimization with Real Assets

29 Pages Posted: 23 Apr 2021 Last revised: 9 Aug 2021

See all articles by Chul Jang

Chul Jang

Bayes Business School, City, University of London; Hanyang University

Andrew Clare

City University London - Sir John Cass Business School

Iqbal Owadally

Cass Business School, City, University of London

Date Written: April 23, 2021

Abstract

Using a multi-stage stochastic programming method, we suggest an optimal liability-driven investment(LDI) strategy for a closed defined-benefit pension fund including real assets. The objective is to jointly optimize contribution, funding ratio, and buyout cost, subject to a constraint on downside risk in terms of expected shortfall of assets relative to liabilities. Over a 10-year planning horizon, the optimal LDI strategy with a key-rate duration-matching bond portfolio outperforms the corresponding strategy with a duration-convexity matching bond portfolio as well as a strategy with an aggregate bond index-tracking portfolio. When real assets are introduced, the optimal LDI strategy includes significant investment in infrastructure and real estate, illiquidity notwithstanding. Nevertheless, delays in sales of real assets induced by illiquidity can increase downside risk.

Keywords: liability-driven investment, pension fund, real assets, stochastic programming

JEL Classification: C61, C63, G22, G23, J32

Suggested Citation

Jang, Chul and Jang, Chul and Clare, Andrew D. and Owadally, Iqbal, Liability-Driven Investment for Pension Funds: Stochastic Optimization with Real Assets (April 23, 2021). Available at SSRN: https://ssrn.com/abstract=3832434 or http://dx.doi.org/10.2139/ssrn.3832434

Chul Jang

Bayes Business School, City, University of London ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Hanyang University ( email )

College of Business and Economics
55 Sangrok-gu
Ansan, 15588
Korea, Republic of (South Korea)

Andrew D. Clare (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Iqbal Owadally

Cass Business School, City, University of London ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

HOME PAGE: http://https://www.cass.city.ac.uk/faculties-and-research/experts/iqbal-owadally

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