Investment Strategy

Question 1

What are the 2 principles of investment?

Answer 1

Liabilities and Assets

Liabilities - Select investments appropriate to the liabilities nature, term and currency and the risk appetite of the provider

Assets - Subject to the liabilities part, maximise overall return on assets (income and capital growth)

Question 2

8 limitations of investments caused by Regulation

Answer 2

CAMP CAT ME

Currency to match A and L
Amounts of specifics asset used for solvency demonstrations
Mismatch reserve needed
Proportions of particular assets needed e.g. gilts

Custodianship of assets
a
Type of asset

Mismatching limit to the extent of it
Exposure to counterparty limits

Question 3

What is mismatching?

Answer 3

Holding assets that don’t match the nature of liabilities

Question 4

Factors effecting investment strategy?

Answer 4

SOUNDER TRACTORS

Size of assets (absolute and relative)
Objectives
Uncertainty to liabilities
Nature of liabilities
Diversification
Existing portfolio
Return (expected long-term)

Tax treatment of assets/investor
Restrictions (legal, stat, voluntary)
Accrual of liabilites
Currency of existing liabilities
Term of existing liabilities
Other funds' strategies (competitors)
Risk appetite
Solvency requirements

Question 5

How can you split the investment strategy factors?

Answer 5

Assets/liabs/regulation/company

Question 6

What liability factors effect inv. strategy

Answer 6

Fixed/variable (nature)
real/not real
currency
term
uncertainty in amount
uncertainty in term
future accrual
size vs assets

Question 7

What regulatory things effect inv strat

Answer 7

Tax of investments and company
valuation requirements
solvency requirements
restrictions (legal/stat/voluntary) on how fund invests

Question 8

What assets factors effect investment strategy?

Answer 8

Size of assets, absolute and relation to liabs
Expected long term return
excisting portfolio
diversification?

Question 9

What company factors/ideas effect inv strategy

Answer 9

Strategy followed by other funds
risk appetite
objectives

Question 10

What 2 particular things should you look at in matching guaranteed liabiltiles?

Answer 10

Term and probability of payments

Question 11

How to invest if inflation linked guarantees?

Answer 11

Index linked securities

match expected term of liablility outgo

Question 12

How to invest if discretionary benefits?

Answer 12

Asset to provide highest expected return subject to policyholder reasonable expectations

Question 13

How to invest if investment-linked guaranteed liablitiles

Answer 13

Invest in assets relelevant to the specific formula guarantees are based on
might use collective investment scheme on ftse or derivatives

Question 14

How else can you invest if guaranteed liabilties

Answer 14

Immunisation

Question 15

If you have a large surplus and guranteed monetary benefits, how/why do you invest it?

Answer 15

Use as solvency cushion
mismatch policy
mismatching reserve
finance capital growth and other projects

Question 16

If you have large free surplus and investment-linked liabilities, how do you invest?

Answer 16

can’t mismatch due to all risk being then on the policyholder and all profits to you

Question 17

If you have a large surplus and discretionary benefits, how do you invest it?

Answer 17

mismatching
buffer against insolvency
limited matching to keep defined benefit level
as long as you take into account p/h reasonable expectations in terms of amoutn recieved and level, then do what you want, if in regulations

Question 18

What types of benefit payments are there?

Answer 18

Guaranteed in money terms
Guaranteed to an index of prices/earnings or similar
Investment-linked
Discretionary

Question 19

What’s the net liability outgo formula?

Answer 19

benefit payments+expense outgo (linked to index) - prem/contribution income (fixed or linked)

Question 20

What things do individuals suffer from that companies don’t when investing?

Answer 20

Size of expenses relative to investment
lack of info/expertise
not enough assets for direct investment to some classes

Question 21

Describe active management

Answer 21

Red Jellyfish Replay Cute Ideas

Restrictions on investments decrease
Judgement used for future long/short term performance on individual investments
Returns should be greater
Costs of extra transactions offset the greater returns
Judgements can be incorrect

Question 22

Describe passive management

Answer 22

Beautiful recipes tickle books

Benchmarked, so hold assets to reflect it
Restricted freedom
Tracking errors possible
Bad performance of index possible

Question 23

What are the 2 ypes of tracking error measurment?

Answer 23

Prospective (forward looking) and Restrospective (backward looking)

Question 24

Explain retrospective tracking error

Answer 24

Annualised SD of difference between portfolio and benchmark RETURN

Question 25

Explain prospective trackin error measurement

Answer 25

Estimate annualised SD of portfolio return relative to benchmark
Assume current structure of portfolio unaltered
Use quantative modelling
Volatility assumptions
Correlation assumptions for stocks/markets

Question 26

What are the 3 componenets of market risk?

Answer 26

Strategic, active, structural

Question 27

Explain strastegic risk in 2 points

Answer 27

Risk of poor performance of strategic benchmark relative to liabilities
Strategic benchmark is closes portfolio to match liabilities

Question 28

Explain active risk in 2 points

Answer 28

Risk of poor performance of active fun relative to portfolio benchmark
Measure by tracking error

Question 29

Explain structural risk in 2 points

Answer 29

Aggregate of the portfolio benchmarks doesn’t match total fund benchmark
Usually in very small schemes or peer group benchmarking, else small

Question 30

Explain what risk budgeting is?

Answer 30

EMOL

Establish how much risk should be taken
Maximize return by allocating it efficiently
Overall risk allocated between strategiv and active risk
Lower risk through diversification and increased expected return are possible because the manager is free to look at this

Question 31

List 6 types of liability hedging

Answer 31

MACS AIM

Mean-variance optimisation without reference to liabilities
A/L modelling
Currency hedging
Shadow strategy of other institutional investors

A..
Immunisation
Market cap asset allocation

Question 32

What types of problems can liability hedging have (include immunisation)

Answer 32

HULZ MaMaCY

High price of assets to match liabilities
Uncertainty of liability outgo
Length and size of assets may not be possible
ZCB’s risk free are needed for perfect match

Monetary liabilities sorted in immunisation not real
Mismatching profits not possible if immunised
Changes that are large in interest rates are not covered in immunisation
Yield curve not flat in reality for immunisation