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Part 1
Asset Allocation and Institutional Investors
CHAPTER 1
Asset Allocation Processes and the Mean-Variance Model
1.5 Investment Policy Objectives
1.5.7 Using Risk Aversion to Manage a Defined Benefit Pension Fund

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To complete our discussion of objectives, we now consider an application of the previous framework to present the objectives of a defined benefit (DB) pension fund. The following information is available:

Current value of the fund: €V billion

Number of asset classes considered: N

Return on asset class i: Ri

Weight of asset class i in the portfolio: wi

Return on the portfolio:

Assuming that the preferences of the DB fund can be expressed as in Equation 1.5, the portfolio manager will select the weights, wi, such that the expected utility is maximized. That is, Equation 1.8 expresses the objective function that is maximized by choosing the values of wi. Of course, the portfolio manager must ensure that the weights will add up to one and some or all of the weights will need to be positive.

(1.8)

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