Ch15: Choosing an appropriate investment strategy

Question 1

Investment objectives need to be: (3)

Answer 1

• Well stated and specific
• Quantified
• Measurable

Question 2

Objectives may be described as: (2)

Answer 2

• Meet liabilities as they fall due
• Control incidence of future obligations for a third party

Question 3

Fund objectives (3)

Answer 3

• Being able to meet its liabilities as they fall due
• Providing that it will be able to do so on an ongoing basis in:
  * a realistic basis
  * a statutory basis
• Proving thet it could do so on a discontinuance basis

Question 4

Risk meanings in investments (2)

Answer 4

• Risk as variability of return
• Risk as probability of failure to achieve investment objective

Question 5

Relative performance risk

Answer 5

• Risk of underperforming competitors
• Aim is normally to provide the highest possible return to investors within constraints set out by stated objectives
• Performance comparisons are usually straightforward, given that objectives of competitors are similar

Question 6

Investment risk appetite depends on: (4)

Answer 6

• Nature of the institution - Compare predictability of future liabilities
• Constraints of governing body - Trustees or directors
• Documentation (beneficiary expectations)
• Legal or statutory controls

Question 7

Factors influencing long-term investment strategy (18)

Answer 7

• Constraints on investment strategy:
  * Size of assets (Absolute - Relative to liabilities)
  * Tax - preference on capital growth or income yielding assets; different institutions taxed differently
  * Accounting rules
  * Statutory, legal or voluntary restrictions on how to invest
  * Expectations of various stakeholders (stated,marketing,past performance)
  * Statutory valuation and solvency requirement
  * ESG considerations
• Strategy followed by competitors
• Need for diversification - to avoid specific risks
• Institutional objectives
• Institution’s risk appetite
• Expected long-term returns
  * After tax and consider variance and co-variance between returns
• Existing asset portfolio
• Liabilities:
  * Currency of existing liabilities (need to allow for expected changes in currencies over one period - degree to mismatch by currency to max returns)
  * Uncertainty of existing liabilities (timing and amount + need for liquidity)
  * Nature of existing liabilities (fixed or varying)
  * Term of existing liabilities - reinvestment risk or liquidity risk (Low or high income-yielding investments + Inflation exposure)
  * Future accrual of liabilities (reliance on future CF’s)

Question 8

Benchmark investment strategy may not be investible: (5)

Answer 8

• Regulatory restrictions
• Available assets
• Size of fund
• Risk appetite/tolerance
• Diversification

Question 9

Need for liquidity depends on: (2)
What to consider when determining how much to be held in liquid assets

Answer 9

• Reliability on future inflows
• Status of organization (wound-up or ongoing)
• Too much cash - cash drain
• Avoid selling assets (crystalise losses + realise capital gains tax)

Question 10

Circumstances when investor may be relaxed about volatile asset values (5)

Answer 10

• No immediate need to realise assets in near future
• No need to prove solvency on market value basis
• Massive free assets
• No pressure to produce consistent short-term performance
• Perfectly matched assets and liabilities (unit funds)