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Neutral indices for French investors

The LOL indices, the result of a joint effort between Lombard Odier and Banque du Louvre, were launched in Paris last December. The idea behind these indices is to provide benchmarks for each major institutional category that are as neutral as possible, and that reflect the performance of the opportunity set available to an institutional manager, given regulatory constraints.

In France, each institutional category is legally constrained in the amount it can invest in specified asset classes up to a certain percentage. As neutral indices were the goal, the LOL indices reflect the average of all possible portfolios invested within those constraints. The indices are built by generating every possible portfolio using very small increments of 0.5% for each category. For instance, a first portfolio would be invested 100% in cash, a second would have 99.5% in cash and 0.5% in French bonds, and so on until the upper bound for an asset class is reached. This approach generates a very large number of simulated portfolios, from 10m to as many as 100bn for some categories!

The return of the index is then computed as the average return of all portfolios, using generally accepted benchmarks for each asset class. As far as possible, the sub-indices are performance indices, that is, they include income such as dividends. The returns of the indices are computed monthly and have been back-calculated to December 1990, as some sub-indices are not available before that date.

This methodology provides a neutral asset management reference reflecting the performance of all possible portfolios in a given institutional category and makes it possible to analyse discrepancies between the return of an institutional portfolio and the neutral, fixed-weight index. Furthermore, as the indices use fixed weights - assuming the legal framework is unchanged - they are easily replicable for a passive investor. The indices are computed on a monthly basis, as tracking a fixed-weight index on a daily basis would require too many portfolio rebalancings. This is quite different from a survey of actual portfolios, as in the latter case the average weights are only known after the fact. In Switzerland, indices of a similar kind have been successfully used for over 10 years.

The first task in building the LOL family was to identify the main categories and their legal characteristics, in order to be able to generate all possible portfolios. The six indices are the following:

  • Caisses de retraite Arrco (ARRCO);
  • Caisses de retraite Agirc (AGIRC);
  • Caisses Autonome Mutualiste (CAM);
  • Compagnies et Mutuelles d’Assurances (CMA);
  • Institutions de prévoyance (IP);
  • Caisses Autonome de Retraite des Professions Indépendantes (CARPI).

The table shows the composition of the indices and how they performed from 1991-96. During the period, the fixed-income-intensive LOL indices have been helped by high (and falling) rates and performed well.

Jacques Roulet is head of the quantitative unit at Lombard Odier in Geneva

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