THESIS ABSTRACT SENIOR PUBLIC ADMINSTRATION COLLEGE OF MANAGEMENT NATIONAL TAIWAN UNIVERSITY

THESIS ABSTRACT
SENIOR PUBLIC ADMINSTRATION
COLLEGE OF MANAGEMENT
NATIONAL TAIWAN UNIVERSITY
NAME：Lee, Ruey-Ji MONTH/YEAR：JUNE,2005
ADVISER：Hung, Mao-Wei
TITLE：Study on the optimal asset allocation portfolio in the local investment environment of the Labor Insurance
The article is to present a factual research study on the optimal asset allocation portfolio in the local investment environment of the Labor Insurance Fund. The article may be considered as an asset allocation investment reference for the financial supervisory authority in pension fund investment management. In the various stages of the economic cycles, assuming that there are four types of funds, each with its respective asset mix, while employing the mean-variance method in forming the portfolios’ expected return and risk, thereby constructing the four different type of efficient frontiers. With the optimal asset allocation strategy is to maximize total return from per unit of risk, aid by Value at Risk (VaR) as a constraint, thus forming the optimal investment portfolio.

Based on outcome of the research analysis, as following,
1. Sample analysis
A. Sample analysis of various asset classes at the various stages of economics cycle had reviewed: In our sampling period and over the period of a complete economic cycle, equity has exhibited the characteristic of a high risk-high return asset, whilst under a period of an economic contraction cycle, equity has displayed a characteristics of a high risk-low return asset. Analysis also showed that over a period of a complete economic cycle, and that of an expansion cycle, corporate bond has been the asset with highest rate of return to risk, and under a period of contraction cycle, government bond has been the asset that demonstrated highest rate of return to risk.

B. The correlation of various asset classes at various stages of economic cycles: In the various stages of economic cycles, asset with fixed income characteristic has demonstrated high correlation, while the correlation amongst equity assets has been relative low. In a period of on expansion cycle and in period of a complete economic cycle, steel sector has demonstrated negative correlation with that of fixed income assets, as a result the addition of steel stocks should lower the overall risk of a investment portfolio.
2. Analysis of the different type of funds under the various economic cycles reviewed:
A. The portfolio’s standard deviation, expected return and efficient frontier of the “no-constrain in asset mix” portfolio in the various stages of economics cycle: In a period of economic contraction cycle, the deviation of the portfolio’s standard deviation and its expected return are lesser than that in the other two stages. Whilst the efficient frontier in an expansion cycle will tend to move upper leftward, compared to the efficient frontier in a period of a complete economic cycle period. The implication is that given a specific risk level, the expected return of a portfolio should be relative higher in an expansion cycle compared to that of the other various cycles.

B. The best investment portfolio in the various stages of economics cycles. . At the various of stages of economic cycles, the “no-constrain in asset mix” portfolio and the bond portfolio have favored fixed income assets. Whilst the equity portfolio has favored the plastic sector in period of a complete economic cycle, as well as in a period of an expansion cycle. In period of contraction cycle the equity portfolio has favored the technology sector. Corporate bond retain the highest weight in a balanced portfolio, in regardless of which stage of economic cycle.

3. The application of Value at Risk (VaR) in asset allocation:
A. The denotation of VaR is in the form rate of return. In the various stages of economic cycle, both the equity portfolio and balance portfolio has demonstrated negative VaR. Whereas, the ”no-constraint” portfolio and bond portfolio has shown positive VaR, and the portfolios’ expected return were relatively lower. This also implies that if the risk level is increased then higher expected return can be generated for both the ”no-constraint” portfolio and bond portfolio.

B. The best investment portfolios when both VaRs of the ”no-constraint” portfolio and bond portfolio is near zero. In the period of a complete economic cycle, and also in the period of a expansion cycle, the equity weight is likely allow to increase, thereby increase the expected return and standard deviation of the portfolio. This also lowers the rate of return to risk. In the period of a contraction cycle, and the fact that expected return is likely to be negative, this will result in expected return to decline and increase in standard deviation.

4. Practical application of the asset allocation strategy by the Labor Insurance Fund reviewed that:
A. The optimal asset allocation strategy, which is not subjected to the current rules and regulations, imposed the authority.
In the various stages of economic cycles, the weight of fixed income assets should be at maximum level, while the weight of financial stocks and others stocks should be kept at minimum level. In period of a whole economic cycle, the weight of cash deposit should be reduced, while weight of plastic, steel, auto and technology sectors should then be increased. The effect of the steel sector weight is more apparent in period of an expansion cycle compared to that in a period of a whole economic cycle. The hypothesis was further confirmed during the course of data sampling. Overall, in the various stages of the economic cycles, as the weight of cash deposit decreases, the expected return of portfolio amplify, while the overall risk raises as well.

B. The optimal asset allocation strategy, which is subjected to the current rules and regulations, imposed the authority.
Taking into considerations that there are no quick fixed to the current Labor Insurance investment regulations and also recognize the recent trend of increase disinvestments of equity assets by insurance companies in both United States and United Kingdom, there is a need to understand and identify the optimal investment portfolio, in the presence of the current legal constraints. This article has identified that in the period of a whole economic cycle and in period of an expansion cycle, the optimal investment portfolio would have a fixed income asset weight of 94% or more. Furthermore, if we are to allow VaR to close to zero, and increase risk tolerance in order to seize higher return, the research identified that the required reduction in fixed income weight is minor, at 82% or more. As a result the equity weight in the optimal portfolio should then be increased from 2.7% to 9.8%, by adding mainly the steel sector, which already has a weight in the optimal portfolio. Increasing weights of the plastic sector should also add diversification to the equity position. In the period of a expansion cycle, the equity weight of the optimal portfolio should then increase from 3.4%, adjusting the VaR, to 15.5%, with weight increase mainly going into the steel, insurance, technology, and plastic sectors. The steel sector should have the largest weighting among the four sectors.