NEPC uses some of the most sophisticated asset modeling capabilities in the industry to customize each program's asset allocation to the specific needs of that client. This requires a careful analysis of the client's cash flow projections, risk aversions, rate of return requirements, permissible asset classes, and any unique policy or regulatory considerations.
Once a client's objectives and constraints are identified, we simulate various combinations of diverse asset classes and investment strategies to isolate those that meet the client's return objectives at minimum risk levels. We help our clients to understand risk and define risk relative to their individual investment program, not simply in terms of a summary statistic like standard deviation.
Step 1. Getting Started: We work with the client and outside professionals to collect the pertinent actuarial or spending data to conduct the study and begin our modeling process by replicating the fund's liability and/or cash flow needs.
Step 2. Understanding the Role of Liabilities/Spending in Asset Allocation:In order to fully incorporate a client's goals and objectives, the asset allocation process must completely account for liabilities and spending requirements. Any potential portfolio must represent the most efficient risk-return tradeoff, but only after considering how that portfolio will interact with plan liabilities or future spending requirements. By projecting allocations alongside liabilities, we can incorporate estimates of spending and contributions over the next ten years. We give each client the tools necessary to determine the appropriate asset allocation relative to the specific cash flow projections of the specific plan, not the average allocation of the average investment program.
For each asset class, we annually develop projections of returns based on a blend of historical data; adjustments based on our experience and our estimation of the applicability of the past to the future, and our assessment of current market conditions. Our forecast includes return, risk, yield and correlation assumptions for each asset class. The model is then used to determine the optimal combination of asset classes that offers the highest level of return at the lowest level of risk.
Step 3. Asset Allocation: Our asset allocation process is a multi-faceted approach. We use mean-variance approach as a tool for framing asset allocation decisions but integrate several other asset allocation models - risk budgeting, scenario analysis, and liquidity analysis - in order to fill in the gaps that can exist when relying on solely the mean-variance model and some of its shortcomings (normal distribution of returns; static assumptions for inputs) which, if ignored, can result in a portfolio exposed to concentrated risks and significant drawdowns.
Step 4. Presentation of Results: We provide a detailed final report on our findings and investment policy proposals. The report includes our inputs and assumptions, deterministic and stochastic projections of fund spending and contributions, and optimal combinations of asset classes. In addition, we provide details on the characteristics of these optimal portfolios, including: risk and return expectations, risk allocations and performance in alternative economic scenarios. We also recommend the appropriate investment policy and structure.
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