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2021 CFA Level III > Institutional investor Portfolio Management > Flashcards

Institutional investor Portfolio Management Flashcards

1
Q

common charactiertics

A
  1. scale: asset size AUM
  2. LT investment horizon
  3. regulatory framework
  4. Governance framework
  5. principle-agent issue
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2
Q

IPS include:

A
  1. return: specific, clearly defined, actuarially based, total return focus
  2. risk:
    more objective using established risk measures and formal governance structures to control risk;
    greater asset base may allow greater risk to be undertaken
  3. constraint
  4. liquidity
    specific liability steam that is formally managed
    plan sponsor is source of regular and extraordinary funding
  5. time horizon:
    perpetual/very long
    assuming enrollment to new participants remains open
  6. tax
    tax-exempt
  7. legal/regulatory
    highly regulated by ERISA at the federal level
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3
Q

Norway’s sovereign wealth fund

A
  • passively agreed allocation to public equity & bonds (with traditional 60/40% base allocation )
  • little or no exposure to alternative asset
  • tight tracking error limits

adv:
low cost and fees
easy for board to comprehend

disadvantage:
no opportunity for outperformance of markets

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4
Q

Yale University endowment

external managed asset

A
  • high allocation to alternatives
  • significant active management
  • externally managed assets

adv: potential for outperformance of market

disadvantage:
- difficult for small institutions without expertise in alternatives
- may also be difficult for large managers due to capacity issue of external mangers
- high fees/ costs

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5
Q

Canada Pension Fund

internal managed asset

A
  • high allocation to alternative
  • significant active management
  • internally managed assets
  • use a reference portfolio of passive public assets as benchmark that can be easily understand

adv:
- potential for outperformance of market and development of internal capacities

disadvantage:
- potentially expensive and difficult to manage

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6
Q

LDI liability driven

A

AA:
focus is on maximizing expected surplus
(A-L) return and managing surplus volatility

adv:
explicitly recognizes liabilities as part of inv. process

disadvantage:
certain risk of liability (longevity) are difficult to hedge

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7
Q

DB face mortality/longevity risk

A
  • risk of general increase in life expectancy faced by sponsor

inv. objective:
achieve a target return over a specified LT horizon which assuming a level of risk that is consistent with meeting its contractual liabilities

2rd objective:
minimize PV of cash contributions, the sponsor will be required to provide

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8
Q

DC face longevity risk by employee

A
  • older participant will have shorter investment horizon
  • life-cycle option
    participant-switching option ( move to more conservative AA as aging)
    participant/ cohort option (pooling participant with other investment)

objective:

primary: prudently grow assets to meet spending needs in retirement
2rd: to outperform the passive asset class returns of the default option’s strategic asset allocation

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9
Q

Funded ratio =

A

fv of pa/ pv of pbo

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10
Q

factor increase liability

A
  • service/tenure
  • salary
  • longevity
  • additional/ matching contribution
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11
Q

factor decrease liability

A
  • increase in discount rate

- return expectation

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12
Q

factor increase risk tolerance

A
  • increase in investment horizon
  • plan close to new participants
  • fund status surplus
  • low debt ratio
  • high profitability
  • large size of plan
  • young workforce
  • low correlation with operation result
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13
Q

risk exposure of Pension plan

A

the lower correlation of sponsor operating results and the returns of pension assets, the greater the risk tolerance of plan

the low correlation implies that in times of plan underperformance, the sponsor is likely to be more profitable and able to increase plan contributions

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14
Q

provision for early retirement

A

imply a low risk tolerance as the shorter investment horizon means the plan has less time to recover from short-term losses

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15
Q

liquidity need higher when

A
  • the proportion of retired lives in the plan is higher
  • the workforce of the employer is older since the time to pay benefits will be shorter
  • plan has higher fund status, since this will likely lead to lower sponsor contributions and more benefits part will need to be met from existing plan asset
  • the plan participants have the ability to switch or withdraw from the plan, an event that usually triggers payment to participants
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16
Q

external constraints

A

DB:
regulatory by countries
tax
accounting rule

education for DC plan participants
DC plan are tax deferred

17
Q

Sovereign wealth funds

A

main features/mission:

  1. ## budget stabilization funds
  2. ## development funds
  3. saving’s fund
  4. reserve funds
    designed to earn returns on excess return on fx holding by central banks

aim to reduce negative cost of carry through boosting returns or reserves

  1. pension reserve funds
    used to save and invest to meet future pension and liability of government
18
Q
  1. budget stabilization funds

FI & CASH

A
  • uncertain liabilities linked to commodity price/ cyclical industries
  • short term investment horizon because budget support required on a ST basis

liquidity:
must maintain the highest liquidity level and invest in asset with low risk of significant loss in the short term

inv. objective:
- capital presentation
- aim to earn return above inflation with a low prob of losses
- should avoid assets correlated with the source of gov’t revenues

19
Q
  1. development funds

infrastructure project driven by social economic mission

A
  • nature of liabilities linked to socioeconomic investment made by the fund
    -some LT horizons infrustrucue
    some medium term horizon

liquidity:
liabilities are not clearly defined, low liquidity

inv. objective:
- support a nation’s economic development and increase long-run economic growth
- implicit objective is to earn a real rate of return greater than real domestic GDp growth or productivity growth

20
Q
  1. Saving’s fund

equity & alternative PE & real assets

A

liabilities are linked to future generation , therefore LT

lowest liquidity

inv. objective:
- maintain purchasing power of asset, overtime while making ongoing speeding on gov’t budgeting needs

21
Q
  1. reserve funds

similar to saving’s fund but lower allocation to alternatives

A
  • investment horizon are very long
    typically no near term liabilties

liquidity:
lower than stabilized fund
but higher than saving funds

inv. objective:

earn a return in excess of yield the gov’t central bank pays on bonds

22
Q
  1. pension reserve funds

high equity and alternative due to LT and low liquidity needs

A
  • liabilities are linked to future pension pmt
    long term
  • fund may have an accumulation stage in which contributions are made and a decunulation phrase where benefits are drawn, time horizon will depend on when these stage occur

liquidity:
vary, being lower during the accumulation stage and higher during the decumulation stage

inv. objective:
earn returns to meet future unfunded pension and social pmt provided by the gov’t

23
Q

University endowments

high risk tolerance from donation and gifts
and low spending rate

primary to reserve the purchasing power of the assets in perpetuity while achieving returns adequate to maintain the level of speeding
second: to outperform a passive BM or a peer group of similar endowment

> 50 % in alternatives

A

main feature/mission:

set up by gift/ donation while are invested to earn return that provide ongoing support to the university’s operating budget

  • has a perpetual investment horizon

spending t+1 = W (spending t * (1+inflation)
+(1-w) * (spending rate * avg AUM)

24
Q

2 different types of spending policies result from different value of Weight:

A
  1. constant growth rule w=1

the endowment provides a fixed (real) annual payment to the university once adjusted for inflation by the higher education price index (HEPI)
Spending rule has caps and floors represent max and min % value of AUM.

  1. market value rule (w=0)
    annual payments are a respecified % (spending rate b/w 4-6%) of the 3-5 year moving average of asset value.
    payment are pro cyclical in that speeding will fluctuate in the moving average of asset values
  2. hybrid rule (0
25
Q

Private foundation

inv. objective:
primary: generate a real return over CPI inflation of the spending rate and investment expense
secondary: to outperform a policy benchmark

AA: lower risk tolerance than endowment due to higher liquidity requirement

A

main mission/features

  • non-proft institutions set up to make grants to support specific charitable causes
  • to maintain PPP in perpetuity and earn returns sufficient to support the grant-making activities of the foundation

liabilities and inv. horizon:

  • typically have a perpetual inv. horizon
  • legally required to spend 5% of asset
  • the higher liquidity requirements of foundation imply a lower risk tolerance than university endowment
26
Q

Banks

liquidity: regulatory require banks to have sufficiently liquid assets to cover near-term expense, cash outflows, and to have adequate level of capital from stable sources

A

primary function:
earn profits by taking deposit from savers and making loans to borrowers

ST liabilities are deposit from customers
LT : debt

inv. horizon is influenced by the difference between the LT liquid assets and the ST liquid liabilities

27
Q

Insurers

liquidity needs affect by level of int. rates

A

life insurer
long duration liability

property & casualty insurer
short duration higher uncertainty

28
Q

change in equity capital

bank & insurer b/s management

A

change % E = % change a(m) - % change L (m-1)

m = A/E leverage multiple

De = Da(M) - Dl(M-1) * change in I/change in y

Da = MD of asset

change in i/ change in y increase estimate change in yld of liabilities
relative to a unit change in yld of asset ,y

Std e ^2 = M^2 * STDa^2
+(M-1)^2STDl ^2
- 2M(M-1)stdA* stdL * correlation (A,L)

29
Q

Std decrease

A

hold diversified FI
hold high quality FI
hold more liquid instrumetn

30
Q

erase std L

A

surrender penalties
predictability of underwriting loss
diversifying insurance business
derivatives transparency and collateralizatin

31
Q

increase correlation

A

maintain similar duration for A/L

prepayment penalties of bonds
variable annuities
hold common stock

2021 CFA Level III (12 decks)

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