Investments

Question 1

What are the principles of investment?

Answer 1

(a) A company should select investments that are appropriate to the nature, term and currency of the liabilities
(b) The investments should also be selected so as to maximise the overall return on the assets, where overall return includes both investment income and capital gains; and,
(c) The extent to which (a) may be departed from in order to meet (b) will depend, inter alia, on the extent of the company’s free assets and the company’s appetite for risk.

Question 2

How can an ALM be constructed?

Answer 2

1. Specify objectives
2. Decide on appropriate time horizon
3. Collect and prepare data
4. Perform a large number of simulations
5. Record results
6. Use to results to measure achievement of objectives in relation to different scenarios
7. Test salient strategies
8. Give final advice

Question 3

How can ALM be used to determine an investment strategy?

Answer 3

Use ALM to determine the right portfolio of assets to choose
This portfolio needs to match the liabilities in nature, term and currency
But also, need to meet objective of achieving return within risk appetite

Question 4

What are the different options available to savings vehicles?

Question 5

What are the different investment styles?

Answer 5

Liability-driven investment (LDI) - it focuses on aligning a portfolio’s assets with the liabilities of an investor, typically pension funds or insurance companies. The goal is to match or manage the risks related to liabilities (like future pension payments) by structuring investments to reduce mismatches between asset performance and liabilities.

Active management. Assets and underlying securities are selected individually through an active process with the aim of outperforming a benchmark. Can use growth (start-ups), value (companies close to or below intrinsic value), income (high dividend payouts), momentum (invest in overperforming) strategy

Passive management. Investment in funds that track an index or exchange traded funds (ETF), usually at much lower cost than active management.

Question 6

Outline what needs to be considered when determining an investment strategy.

Answer 6

1. The goal is to have the highest chance of being able to meet benefit obligations, with lowest possible level of risk.
2. Amount of free assets and funding level- the more free assets, the riskier the company can be in their investment strategy.
3. The tax implications, for example if capital gains tax is more than income tax could cause preferences to certain types of assets.
4. Any regulations related to what investments need to or cannot be made - no overseas assets or at least 50% bonds.
5. The strength of the sponsor covenant - the weaker, the more risk averse the investment strategy should be.
6. The nature, currency and term of the liabilities, need to be considered.
7. The cost of managing the investment strategy includes switching between assets.
8. ALM can be used to determine the most appropriate strategy.

Question 7

Main points when it comes to DB investment strategy

Answer 7

Focus on liability-driven investing (LDI)
Asset-liability matching
Use of long-duration bonds to match long-term liabilities
Diversification into growth assets (equities, property etc.) for return enhancement

Question 8

Main points when it comes to DC investment strategy

Answer 8

Lifecycle/target-date funds
Multi-asset balanced funds
Individual investment choice options
Default investment strategies

Question 9

Main points when it comes to PMI

Answer 9

Short-term focus due to nature of liabilities
Emphasis on liquidity and capital preservation
Use of cash and short-term fixed income instruments
Limited allocation to growth assets for long-term reserves

Question 10

What are lifecycle/target-date funds?

Answer 10

Automatically adjust asset allocation over time
Become more conservative as the target date (usually retirement) approaches
Follow a predetermined “glide path”
Simplify investment decisions for individuals

Question 11

What are multi-asset balanced funds?

Answer 11

Invest in a mix of different asset classes
Aim to balance growth and income
Can have fixed or flexible asset allocations
Provide diversification in a single investment

Question 12

Regulations related to the investment

Answer 12

restrictions on the types of assets that can be held
restrictions of the amount of particular assets that can be used to demonstrate solvency to the regular
restrictions on the maximum exposure to a single counterparty / country
requirement to hold certain proportion of a particular asset class
requirement to hold a mismatching reserve
restrictions on the extent of mismatching that is allowed
requirement to match liabilities by currency
custodianship of assets, e.g., restrictions on who is permitted to look after them
restrictions on the valuation method, e.g., allowing liabilities to be discounted at a higher risk-discount rate if the backing assets are government bonds

Question 13

Investment consultants

Answer 13

Investment consultant are professional advisors that advise the beneficial owner on issues related to asset allocation, the legal form under which the assets are held, the investment manager to be appointed to manage the assets, and the mandates that the investment managers are given. Implemented consulting. Investment consultants are given limited authority to implement investment decisions, instead of providing advice only.
Fiduciary management. Investment consultants are given full authority to make and implement investment decisions