Chapter 3: The investment framework of the institution

Question 1

Actuarial risk

Answer 1

The probability of failing to achieve the investor’s objective.

Question 2

The risk tolerance of an institution will depend on: (3)

Answer 2

• the nature of the institution
• the constraints of its governing body and documentation
• legal or statutory controls

Question 3

The principal aim of an investing institution

Answer 3

To meet its liabilities as they fall due.

The overriding need is to minimise risk.

Question 4

The main factors that will influence a long-term investment strategy: (14)

Answer 4

• The nature of the existing liabilities: are they fixed in monetary terms, real, or varying in some other way?
• The currency of the existing liabilities
• The term of the existing liabilities
• The level of uncertainty of the existing liabilities, both in amount and timing.
• Tax, both the tax treatment of different investments and the tax position of the investor, must be considered.
• Statutory, legal or voluntary restrictions on how the fund may invest.
• The size of the assets, both in relation to the liabilities and in absolute terms.
• The expected long-term return from various asset classes.
• Statutory valuation and solvency requirements.
• Future accrual of liabilities
• The existing portfolio, including its liquidity.
• The strategy followed by other funds.
• The amount of risk that the investor is prepared to take.
• The investor’s objectives.

Question 5

Tactical asset allocation

Answer 5

The attempt to maximise return by departing from the benchmark position and hence conflicting with the minimisation of risk.

Question 6

5 Factors to be considered before making a tactical asset switch

Answer 6

• The expected extra returns to be made relative to the additional risk
• Constraints on the changes that can be made to the portfolio
• The expenses of making the switch
• The problems of switching a large portfolio of assets
• The ability to switch back to the long-term benchmark when required.