CAIA L2 - 4.1 - Types of Asset Owners and the Investment Policy Statement

Question 1

Explain

Main difference
between
endowments and foundations

4.1 - Types of Asset Owners and the Investment Policy Statement

Answer 1

Foundations must spend a minimum amount of their assets on an annual basis in order to maintain their tax-advantaged status in countries such as the United States

4.1 - Types of Asset Owners and the Investment Policy Statement

Question 2

Identify

4 types of
pension funds

4.1 - Types of Asset Owners and the Investment Policy Statement

Answer 2

• National pension funds
  Operated by governments - provide retirement income. Large funds with the longest time horizons
• Private defined benefit (DB) funds
  Pension benefits to employees are known (or defined). May be indexed for inflation. Shorter in time horizon vs national pension funds; Alternative investments are likely.
• Private defined contribution (DC) funds
  Contributions are known (or defined). Beneficiary decides allocation to each investment. Fewer alternative investments (vs DB)
• Individually managed retirement accounts
  Essentially a savings plan for one person. Often excludes private alternative investments.

4.1 - Types of Asset Owners and the Investment Policy Statement

Question 3

Formula

Expected return
(for various asset classes)

4.1 - Types of Asset Owners and the Investment Policy Statement

Answer 3

expected return = short-term real riskless rate + expected inflation + risk premium

Short-term real riskless rate
- Stable, minimum 0%
- Lower than real growth rate

Expected inflation
- Much less stable given its dependence on central bank policies and long-term growth

Risk premium per asset class
- Assume historical amounts if past estimates of volatilities, correlations, and risk exposures are unchanged

4.1 - Types of Asset Owners and the Investment Policy Statement

Question 4

List

Challenges
of Return Estimation
for Alternative Assets

4.1 - Types of Asset Owners and the Investment Policy Statement

Answer 4

1. Short History - Despite the longer history for classes such as commodities and real estate, there is a much shorter history for classes such as private equity and hedge funds.
2. Higher participation => Lower alpha - Alpha may have accounted for a large portion of past returns, but with increased participation in alternative assets by investors, the amount of alpha will diminish going forward.
3. New alternatives = no history - It appears likely that new alternative asset classes will be developed in the future, which obviously have no historical track record.

4.1 - Types of Asset Owners and the Investment Policy Statement

Question 5

List

3 Types of Internal Constraints
and
2 Types of External Constraints
(for clients)

4.1 - Types of Asset Owners and the Investment Policy Statement

Answer 5

• Liquidity -
• Time Horizon - Commodities have long term mean reversion => longer time horizon = increase allocation. Shorter time horizon = Private equity reduction.
• Sector and Country Limits - Ex: some foundations = no tobacco
• Tax Status -
• Regulations - Limits on pension funds

4.1 - Types of Asset Owners and the Investment Policy Statement

Question 6

Quote

Roles and Responsibilities of:
- Board of Trustees
- Investment/Finance Committee
- Internal Staff
- Investment Adviser(s) and/or Outsourced Chief Investment Officer (OCIO)
- Trustee/Custodian and Other External Providers

4.1 - Types of Asset Owners and the Investment Policy Statement

Answer 6

Board of Trustees
- Approves the IPS and asset allocation strategy
- Performs periodic reviews of the investment(s) to ensure they are satisfying the objectives.
- The IPS will indicate the particular sections where the board does not delegate decision-making duties.

Investment/Finance Committee
- Makes recommendations on specific areas delegated by the board.

Internal Staff
- Responsible for operational activities and monitoring of the investments.
- Certain internal staff may be given greater authority to act for specific key tasks; when there is insufficient internal staff, some tasks may be given to the chief financial officer.

Investment Adviser(s) and/or Outsourced Chief Investment Officer (OCIO)
- Adviser(s) - Specific deliverables and fiduciary duties that should be clearly stated to ensure everyone is aware of what is required.
- OCIOs may have substantially more discretion and fiduciary duties relating to personnel and asset allocations.

Trustee/Custodian and Other External Providers
- For key external providers, their duties, responsibilities, and fiduciary duties should be clearly stated.

4.1 - Types of Asset Owners and the Investment Policy Statement