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CAIA Level 2 2021 > Institutional Asset Owners and Investment Policies > Flashcards

Institutional Asset Owners and Investment Policies Flashcards

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1
Q

Four types of pension funds

A
  1. National Pension Funds
  2. Private Defined Benefit Pension Funds
  3. Private Defined Contribution
  4. Individually Managed Accounts
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2
Q

Four Main decisions to address in the institutional investment process

A

strategic asset allocation, fund selection, method of diversification, and liquidity management

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3
Q

What is Strategic Asset Allocation?

A

(SAA) creates a portfolio allocation that will provide the asset owner with the optimal balance between risk and return over a long-term investment horizon

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4
Q

Why are long-term returns from alternative asset classes hard to estimate?

A

Some asset classes are new, Alpha decay, Innovative new solutions come up

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5
Q

an objective

A

objective is a preference that distinguishes an optimal solution from a suboptimal solution

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6
Q

Types of constraints

A

Internal (imposed by the asset owner) and external (not under direct control of asset owner)

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7
Q

Types of internal/external constraints

A 
Internal
1. Liquidity
2. Time Horizon
3. Sector & Country limits
External
1. Tax status
2. Regulations
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8
Q

Investment policy statement (IPS)

A

a document that describes the primary goals for an investment program and lays out a framework to achieve those goals

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9
Q

Six benefits to a good IPS

A
  1. Articulates the investors long-term investment objectives and outlines policies to help meet those objectives.
  2. Provides guidance around risk tolerance and investment beliefs of the investor and governing bodies.
  3. Monitors the investment program and measures outcomes against objectives.
  4. Helps new staff, board, and investment/finance committee members get up to speed on investments.
  5. Allows the investor to maintain focus on important strategic issues and take a holistic view.
  6. Serves as a roadmap for the fiduciaries and provides guidance throughout all phases of the market cycle.
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10
Q

What does the first part of an IPS contain

A

Description of asset owner, scope of the IPS, fiduciary standards, purpose of IPS

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11
Q

5 Most common decision-making parties included in an IPS

A

Board, IC, Internal staff, Investment adviser(s), Trustees/Custodians

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12
Q

IC Responsibilities

A
  • Periodically review IPS / recommend changes
  • Periodically review and evaluate investment results
  • Selecting/Monitoring investment managers
  • Selecting/Monitoring custodians and other SPs
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13
Q

Common investment objective of endowments

A

a return target X% above inflation, specifically connected to long-term spending needs.

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14
Q

Common investment objective of pension funds

A

a return target X% above the liability discount rate

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15
Q

Topics for additional consideration in IPS (4 examples)

A
  1. Responsible Investing
  2. Proxy Voting
  3. Brokerage and other investment related expenses
  4. Liquidity policy
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16
Q

How are foundations different from endowments? (4 differences)

A
  1. Grant-making institutions
  2. Finite lives
  3. Subject to minimum spending rates
  4. Less likely to be funded from ongoing donations
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17
Q

Operating foundations

A

Income generated by an endowment is used to fund the operations of the charitable organization (most similar to endowment)

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18
Q

Change in endowment or foundation value

A

Income from gifts - Spending + Net investment Returns

19
Q

Foundation spending requirement

A

minimum 5% per year on operating expenses and charitably activities

20
Q

Six attributes of the endowment model

A
  1. Aggressive asset allocation
  2. Effective investment manager research
  3. First-mover advantage
  4. Access to network of talented alumni
  5. Acceptance of liquidity risk
  6. Sophisticated investment staff and board oversight
21
Q

Return Attribution

A

Contributions from SAA + Security Selection + Market Timing or Asset Allocation

22
Q

liquidity-driven investing

A

an investment approach emphasizing the role of the liquidity of investments and the time horizon of the investor in the asset allocation decisions

23
Q

Three approaches to managing the assets of a DB plan

A
  1. Asset-focused risk mgt. (riskiness measured in assets only)
  2. Asset-Liability Risk mgt. (minimize surplus risk)
  3. Integrated Asset-Liability Risk mgt. (funding status is considered)
24
Q

Four Factors Driving the Impact of Liabilities on a Plan’s Risk

A
  1. Change in interest rates (most important)
  2. Inflation
  3. Retirement Cycle
  4. Mortality Rate
25
Q

accumulated benefit obligation (ABO)

A

PV benefits currently accumulated by workers and retirees. (small for young firms; easy to calculate)

26
Q

surplus risk

A

the volatility and tracking error of value of assets vs liabilities (PBO)

27
Q

Liability-driven investing (LDI)

A

Minimize surplus risk by building a portfolio with assets that have a high correlation with the change in plans liabilities

28
Q

Financial phases relative to retirement

A

accumulation phase and decumulation phase

29
Q

3 Risks to retirees

A
  1. Longevity risk
  2. Market risk
  3. Inflation risk
30
Q

Reserve account of a Central Bank

A

consists of central bank’s holdings of foreign currency

31
Q

Balance of payments formula

A

Reserve account = Current Account + Capital Account

32
Q

Current account deficit

A

Deficit: imports > exports

33
Q

Capital Account Surplus

A

Imported Capital > Exported Capital

34
Q

Gwartney et al. (2003) explains that currencies are likely to appreciate when (5 criteria):

A
  1. Lower inflation rate
  2. Higher real interest rate
  3. Policies that attract capital
  4. Slower income growth
  5. Competitive advantage in export-oriented industry
35
Q

Four types of Sovereign Wealth Funds

A
  1. Stabilization Fund (Countercyclical)
  2. Savings Fund (Intergenerational Equity)
  3. Reserve Funds (Pension or Investment)
  4. Development Funds (Socio-economic objectives)
36
Q

Four common motivations for a SWF

A
  1. Protect Nation’s economy
  2. Counter unwanted liquidity
  3. Grow level of savings for future generations
  4. Invest money in infra (move away from commodities)
37
Q

Asset allocations per type of SWF

A

Stabilization -> Mostly fixed income
Savings/Reserve -> Highly diversified
Reserve -> Mostly equities

38
Q

Two types of sterilization

A
  1. intervene in fx markets to prevent fx appreciation

2. invest in dollar or euro denominated securities outside home country

39
Q

Reserve adequacy

A

estimated size for stabilization fund before investing in risky assets

40
Q

Linaburg-Maduell Transparency Index (4 principles)

A
  1. Fund Manages own website
  2. Fund identifies external managers, if applicable
  3. Fund provides clear strategies & objectives
  4. Fund provides up-to-date annual statements
41
Q

Santiago principles (4 points)

A
  1. Clear investment policy
  2. Diligence, prudence, and skill in investment practices
  3. Only focus on maximization of risk adjusted returns
  4. Not seeking advances of privileged information
42
Q

Four macroeconomic variables that define each asset class

A

Asset Class Return = Real Return + Inflation + Growth + Risk Premium

43
Q

3 ways a family office can increase tax efficiency with hedge funds

A
  1. Focus on investments with a long term horizon (> 1y)
  2. Invest in HF managers that trade more 1256 securities.
  3. Select tax-efficient managers

CAIA Level 2 2021 (9 decks)

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