Chapter 25: Investment strategy - Institutions

Question 1

4 Definitions of Risk

Answer 1

• probability of default
• expected variability of return
• risk of underperforming compared with competitors
• probability of failing to achieve the investor’s objectives.

Question 2

4 items influencing risk appetite of an institution

Answer 2

• nature of the institution
• constraints of its governing body and documentation (trust deed & rules, p/h documentation)
• legal or statutory controls
• level of free assets

Question 3

4 Main features of liabilities that influence investment strategy

Answer 3

• nature
• term
• currency
• degree of uncertainty in timing and amounts

Question 4

Nature of a liability

Answer 4

whether or not they are subject to inflationary increases.

Question 5

15 Key factors influencing investment strategy

Answer 5

S - Size of the assets, (in relation to liabilities and in absolute terms)
T - Tax (both treatment of the asset and the investor)
R - Risk appetite of the institution
E - Existing asset portfolio
S - Statutory valuation and solvency requirements
S - Strategy followed by other funds
E - Expected long-term return from various asset classes
D - Need for DIVERSIFICATION

F - Future Accrual of Liabilities
O - Objectives of the institution
R - Restrictions (statutory, legal or voluntary) on how the fund may invest.
T - Term of the existing liabilities
U - Level of UNCERTAINTY of the existing liabilities (both in amount and timing)
N - Nature of existing liabilities
E - Currency of Existing liabilities

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Accounting Requirements
Environmental, Social and Governance considerations

Question 6

2 Main factors governing the institution’s preference for income or capital growth from their investments

Answer 6

• Tax

- Cashflow requirements

Question 7

Tactical asset allocation

Answer 7

Departure from the benchmark position in an attempt to maximise return.
this may conflict with the minimisation of risk.

Question 8

5 Factors to be considered before making a TACTICAL ASSET SWITCH

Answer 8

• level of the free assets
• expected extra return to be made relative to the additional risk
• constraints on the changes that can be made to the portfolio
• expenses of making the switch
• problems of switching a large portfolio of assets

Question 9

Principal aim of an investing institution

Answer 9

To meet its liabilities as they fall due.

the overriding need is to minimise risk.

Question 10

5 Possible objectives of a fund

Answer 10

• Meeting liabilities as and when they fall due
• Demonstrating solvency (on an ongoing, statutory and discontinuance basis)
• Minimising the burden on 3rd parties eg. trying to reduce the amount an employer has to contribute to a pension fund by taking aggressive investment strategy
• Maximise returns
• Outperform competitors

Question 11

Relative performance risk

Answer 11

The risk of underperforming ones competitors

Question 12

4 Groups of people who decide on the risk tolerance of different types of institutions:

Answer 12

• trustees (of trusts)
• members (of DC pension funds)
• directors (of companies)
• donators (of charities)

Question 13

4 Common problems of switching large portfolios

Answer 13

• Shifting market prices
• Timing issues
• Dealing costs
• Capital Gains Tax liability crystallizes

Question 14

2 Different sets of liabilities to match simultaneously

Answer 14

• the liabilities that they need to meet on an ongoing basis

- a statutory basis for proving solvency