In this contribution we consider alternative risk funding solutions for pension funds as typical representatives of institutions with a strong risk exposure on the fixed asset side. The focus is on financial risk rather than the traditionally insurable part of pension fund risk. We put forward a simple insurance concept against stock market risk, in which the pensions funds and their shareholders are the insureds, the cells of an assumed rent-a-captive facility reinsure part of the the pension funds' exposure and a defined excess portion of asset risk is transferred to the reinsurance market in the wider sense, i.e. including the capital or derivative/OTC market. In particular we develop a dual trigger concept incorporating both an absolute and a relative means of capital protection. The latter benchmarks the investment strategy of the pension funds by means of the (algorithmic) trading vehicle of the core company against a direct "shadow investment" in the Dow Jones Industrial Average.

In this post we continue the discussion launched in previous posts, i.e. [3] and [9], highlighting the limitations of diversification in the sense of Makrowitz but also those of employing derivative instruments (e.g. Put options) as stop loss type of insurance when stock markets contract. We stress that the balance sheets of organisations with a business related overhead in fixed asset positions, such as life (re-)insurers or pension funds, are affected most by the latter limitations. This sets the stage for discussing possible alternative solutions in the following posts.

 The current 'bearish' market conditions pose challenges to the investment decisions of both private and institutional investors. Although it was observed in our February 2008 study that also in a bearish market substantial returns on investment can be realized, getting the entry and exit points right for investment or disinvestment decisions is by far more essential as compared to a 'bullish' market. In continuation of the analysis of long-term indicators of turning points in the Dow Jones Industrial Average along the past 40 years (see above link), we will endeavour to scrutinize in this study the power of more short- to medium-term predictions, especially those of turning pints. This analysis is carried out by employing so-called wavelet transforms to the Dow Jones data used in above mentioned study, but completed as of present date. Results of the study are expected towards the end of the year.

As with all contributions in our Journal, constructive comments or hints are welcome.

As alluded to in our Dow Jones post in February 2008, structured products granting capital protection can be cost-intensive if capital protection is achieved by means of hedging. In this post we introduce a fictitious but substantial private investor who pursues and investment strategy in stocks which assures capital protection at a 95% level of confidence and which (up to the initial portfolio set-up) is free of transaction costs and costs of hedging. This post is supplemented by a small C++ optimization executable to mimic the outcome of such a strategy.

Submission to the ASTIN Bulletin in November 2007.