Asset Allocation

Question 1

Investment governance

Answer 1

Ensures that appropriate individuals or groups make informed investment decisions and conduct oversight activities on behalf of investors

Question 2

Strategic Asset Allocation

Answer 2

The investment committee, which is the highest level of governance structure, will typically approve the strategic asset allocation decision.

Question 3

A proposed asset allocation will be developed after…

Answer 3

1. The IPS is constructed
2. Investment results are simulated over the appropriate time horizon(s)
3. The Risk and Return attributes of all possible asset allocation strategies are considered

Question 4

Reporting Framework

Answer 4

A reporting framework allows stakeholders to evaluate performance, investment guideline compliance, and the investment program’s progress toward achieving its stated goals and objectives.

The framework should outline the current status of the program, where it is in relation to its goals and objectives, and how management decisions have added or subtracted value.

Question 5

Objective of effective governance

Answer 5

To match the investor’s objectives with their constraints while ensuring that investment decisions comply with relevant laws and regulations. Investment governance also seeks to improve investment performance by aligning asset allocation with implementation

Question 6

Effective Investment Governance Models

Answer 6

1. Establish long-term and short-term investment objectives
2. Allocate rights and responsibliities within the governance structure
3. Specify processes for creating an investment policy statement (IPS)
4. Specify processes for creating a strategic asset allocation
5. Apply a reporting framework to monitor the investment program’s stated goal and objectives
6. Periodically perform a Governance audit

Question 7

Investment objectives

Answer 7

• The objective for a pension fund is for plan assets to meet current and ongoing plan liabilities
• The objective for an endowment is to achieve a rate of return that exceeds the return required to fund current and ongoing distributions
• The objective for an individual investor is to have sufficient assets for retirement while adhering to constraints and risk preferences

Question 8

A proposed asset allocation will be developed after

Answer 8

1. IPS is constructed
2. Investment results are simulated over the appropriate time horizon(s)
3. The risk and return attributes of all possible asset allocation strategies are considered

Question 9

A Reporting Framework

Answer 9

Allows stakeholders to evaluate performance, investment guideline compliance, and the investment program’s progress toward achieving its stated goals and objective. The framework should outline the current status of the program, where it is in relation to it goals and objectives, and how Management decisions have added or subtracted value.

Question 10

Governance Audit

Answer 10

An independent third party should audit the effectiveness of the governance structure, policies, and procedures. The auditor examines governing documents, determines the organization’s capacity to effectively execute decisions based on those documents, and reviews portfolio efficiency given any governance constraints.

Question 11

Economic Balance Sheet

Answer 11

Contains an organization’s financial assets and liabilities, as well as any nonfinancial assets and liabilities that are applicable to the allocation decision

Question 12

Decision-Reversal Risk

Answer 12

is the risk of reversing investment decisions at the worst possible time (I.e., creating the maximum loss) Some ways to mitigate decision reversal risk include:
* Defining a strategy: Writing out a complete strategy before starting the process
* Governance team: Having a governance team
* Articulating objectives: Articulating the objectives of the investment program
* Allocating decision rights: Allocating decision rights and responsibilities among the functional units
* Establishing a reporting framework: Establishing a reporting framework
* Undertaking governance audits: Undertaking governance audits

Question 13

Extended portfolio assets and liabilities

Answer 13

The nonfinancial assets and liabilities are referred to as extended portfolio assets and liabilities because they are no included on traditional balance sheets

Question 14

Asset-based asset allocation

Answer 14

Asset classes have traditionally been used as units of analysis when making asset allocation decisions. This process is known as asset-based asset allocation

Question 15

Asset only approaches

Answer 15

make asset allocation decisions basedly solely on the investors assets

Question 16

Surplus optimization

Answer 16

Based on the principles from mean-variance asset allocation. The surplus is computed as the investor assets value minus the present value of investor liabilities

Question 17

Liability-relative approaches

Answer 17

Involve asset allocation decisions based on funding, liabilities, with the objective of paying liabilities when they come due

Question 18

Goals-based Approaches

Answer 18

Geared toward asset allocations for sub-portfolios, which help individuals or families achieve lifestyle and aspirational financial objectives

Question 19

Goal-Based investing (GBI)

Answer 19

Asset allocation focused on investor’s goals

Question 20

Liability-driven Investing (LDI

Answer 20

Asset allocation focused on funding liabilities

Question 21

Relevant Risk Measure for MVO (Mean-variance optimization)

Answer 21

Standard Deviation of portfolio returns, which incorporates asset class volatilities and asset class return correlations.

Question 22

How to measure relative risk and downside risk

Answer 22

With a mean-variance framework. For example, the risk relative to a benchmark can be modeled with tracking error and downside risk can be modeled with value at risk (VaR), semivariance, or maximum drawdown

Question 23

What are the main drivers of risk for liability-relative asset allocation approaches

Answer 23

The differences between asset and liability characteristics (e.g., size, sensitivity to interest rate changes)

Question 24

Which of the following investment objectives would most likely be associated with a defined pension fund?

a. Plan assets should meet current and future plan liabilities
b. Assets should provide for retirement subject to each investor’s constraints and risk tolerance
c. The rate of return should meet the current distribution rate plus future inflation

Question 25

3. Which of the following asset allocation approaches is focused on achieving lifestyle and aspirational financial objectives?

A. Asset-only approach.
B. Goals-based approach.
C. Liability-relative approach.

Question 26

4. The asset allocation approach that is concerned with the risk of not having enough assets to
   pay liabilities when they come due is known as:
   A. asset-only.
   B. goals-based.
   C. liability-relative.

Question 27

Asset Class

Answer 27

Is a group of assets that have similar investment characteristics. Each asset class has its own quantifiable systematic risk

Question 28

strategic asset allocation

Answer 28

strategic asset allocation is a conscious effort to gain the desired exposure to systematic risk via specific weights to individual asset classes. In other words, strategic asset allocation reflects the investor’s desired systematic risk exposure.

Question 29

Three categories of “super asset classes”

Answer 29

1. Capital Assets, which provide a continuous source of value (e.g., dividends)
2. consumable or transformable assets, which can be consumed or transformed into a source of value (e.g., commodities)
3. Store-of-value assets, which provide value when exchanged or sold (e.g., currencies, art)

Question 30

Criteria that can be used to specify asset classes:

Answer 30

• Assets in an asset class should have similar attributes from both a descriptive and statistical perspective.
• Assets cannot be classified into more than one asset class. If it can be legitimately argued that assets can be placed in more than one class, the descriptions of the classes are too vague.
• Asset classes should not be highly correlated in order to provide desired diversification. A high correlation between classes would indicate that the classes are related from a risk and return standpoint. This would defeat the purpose of holding separate classes in an allocation.
• Asset classes should cover all possible investable assets. This factor not only increases the set of investable assets, but also pushes up the efficient frontier (i.e., increases expected return at all levels of risk).
• Asset classes should contain a sufficiently large percentage of liquid assets. If liquidity and transaction costs are significant, the asset class may not be ideal for investment because it lacks sufficient liquidity.