Chapter 25: Investment Strategy - Institutions Flashcards
How should an institutions investment objective be framed?
In terms of:
- required return
- allowable level of risk
- timing of the cashflows
Examples of objectives of a pensions scheme
- to meet liabilities as they fall due
- to control the sponsor’s future contribution rate
- to have sufficient assets to meet liabilities on an ongoing basis
- to have sufficient assets to meet liabilities if the scheme discontinues
Examples of what the word “risk” might mean
- standard deviation of investment returns
- probability of complete ruin
- probability of failing to meet the investor’s objective
- risk of underperforming competitors.
Institutional risk appetite depends on (4)
- nature of the institution
- constraints of its governing body
- documentation
- legal or statutory controls
15 Main factors that will influence a long-term investment strategy
- nature
- term
- currency
- uncertainty
of existing liabilities - future accrual of liabilities
- expected long-term return of various asset classes
- tax treatment of different assets and of the investor
- statutory, legal or voluntary restrictions on the investor
- valuation and solvency requirements
- the size of the assets in absolute terms and relative to the liabilities
- the existing portfolio
- strategy followed by peers
- risk appetite of the institution
- institution’s objectives
- the need for diversification
Why might some investors prefer a low income-yielding assets to high income-yielding assets?
There is less income to have to worry about reinvesting (which reduces dealing costs)
Some investors may have little short-term outgo to meet.
Low income-yielding assets may appeal to institutions that pay a high level of income tax relative to capital gains tax.
Low income-yielding assets tend to be more volatile than high income-yielding assets since they have a longer discounted-mean term.
This may appeal to:
- longer-term investors,
- risk seekers,
- investors with significant free assets,
- investors who don’t need to worry about demonstrating solvency on a market value basis.
What should you take into account when selecting individual investments in relation to the existing portfolio.
the covariance of the return with the assets in the existing portfolio, and hence the level of diversification and specific risk in the portfolio.
What is meant by a tactical asset allocation?
a short-term deviation from the long-term strategy in an attempt to maximise returns.
Factors to consider when making a tactical asset allocation
- extra dealing expenses
- risk of shifting asset prices by switching a large amount of assets
- constraints of changes that can be made to the portfolio
- whether the extra expected return outweighs the additional risk
