CAIA L2 - 4.1 - Types of Asset Owners and the Investment Policy Statement Flashcards
Explain
Main difference
between
endowments and foundations
4.1 - Types of Asset Owners and the Investment Policy Statement
Endowments are set up by nonprofit organizations for the purpose of raising funds to support specific activities.
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
Identify
4 types of
pension funds
4.1 - Types of Asset Owners and the Investment Policy Statement
-
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
Formula
Expected return
(for various asset classes)
4.1 - Types of Asset Owners and the Investment Policy Statement
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
List
Challenges
of Return Estimation
for Alternative Assets
4.1 - Types of Asset Owners and the Investment Policy Statement
- 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.
- 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.
- 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
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
- 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
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
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
Define Soverign Wealth Funds
LO 4.1.3
SWFs are used by national governments to maintain intergenerational equity—a portion of current funds generated in the country are taken from the current generation and set aside for the benefit of subsequent generations.
Funds in a sovereign wealth fund are generated through a country’s savings and
accumulated budget surpluses and surplus reserves.
Common sources of capital for sovereign wealth funds include: natural resource revenues,
consistent trade surpluses, and foreign aid receipts.
List the IPS steps an asset owner benefits from
LO 4.1.8
- stating the client’s long-term investment objectives together with the methodology to achieve them
- advising the client and accounting for investment beliefs when determining risk tolerance
- overseeing the investment strategy and performing actual to budget comparison of investment results.
- assisting other stakeholders in understanding the investments
- keeping the client focused on big-picture issues with the portfolio
and how the strategy is linked to the objectives - functioning as a guiding document for those in a fiduciary capacity.
What are the primary considerations in determining asset allocation percentages
LO 4.1.5
Determining asset allocation percentages, including caps and floors, primarily considers
absolute asset allocation size, relative asset allocation size, and liquidity.
