A Composite Portfolio Benchmark for Pension Plans

Abstract

Successful management of a pension plan portfolio requires the focusing of investment attention on the asset configuration of the total portfolio. This focus is facilitated by a composite benchmark portfolio called the Multiple Markets Index (MMI). The MMI measures the composite performance of nine distinct asset classes representing the broad spectrum of primary wealth-generating investments available to the institutional investor. It is designed to offer an attractive return at risk levels acceptable to such investors. Of the 80 asset classes and subclasses considered for inclusion in the MMI, nine were selected-domestic large capitalization equities, domestic small capitalization equities, international equities, venture capital, domestic bonds, international dollar bonds, nondollar bonds, real estate and cash equivalents. Portfolio optimization procedures were used to assign appropriate weights to these classes. The weights assigned were supported by the theoretical implications of New Equilibrium Theory, which suggest that institutional investors should overweight higher-risk asset classes such as domestic common stock and venture capital and underweight bonds, cash and international securities. The MMI should outperform an equal-risk portfolio comprising only domestic stocks and bonds (the 60-40 mix typical of pension portfolios) by approximately 60 basis points a year. Furthermore, data over the 1960-84 period indicate that the MMI would have outperformed the SEI linked median balanced manager by approximately 3 per cent per year.