Lesson 11 Flashcards
11.1.1 Depict the investment cycle for a DB pension plan (5)
- Set investment objectives and constraints
- Determine long term investment strategy
- Determine investment manager structure and roles
- Select investment managers
- Monitor investment results against objectives
Rinse and repeat
11.1.2.a Describe the main purpose of the first step in the investment cycle for a DB pension plan
- Set investment objectives and constraints
This step identifies investment objectives such as the rate of return objective and constraints such as the type of investments that will be allowed
11.1.2.b Describe the main purpose of the first step in the investment cycle for a DB pension plan
- Determine long term investment strategy. This step involves determining the types of asset classes that will be authorized for use in the portfolio and a long term plan to allocate fund assets among those asset classes
11.1.2.c Describe the main purpose of the third step in the investment cycle for a DB pension plan
- Determine investment manager structure and roles. This step involves determining the investment manager structure that will be used to implement investment policy.
11.1.2.d Describe the main purpose of the fourth step in the investment cycle for a DB pension plan
- Select investment managers. This step involves selecting the types and numbers of investment managers that best suit the plan objectives that will be used to invest the pension fund within the guidelines set out in the investment policy. Both quantitative and qualitative factors are considered in investment manager selection.
11.1.2.e Describe the main purpose of the fifth step in the investment cycle for a DB pension plan
- Monitor investment results against objectives. This step provides plan fiduciaries with measurements that provide a basis for decision making and allows for the effective discharge of plan governance responsibilities.
11.2.f Describe what happens after the completion of the investment cycle for a DB pension plan
Once the cycle has been completed for the first time the SIPP is reviewed.
This includes a review of steps 1-3 and the monitoring process set up in 5 which may lead to the reconsideration of the manager structure initially established in step 4. In effect, with review, the process is started over.
11.1.3 Describe the role of the investment return assumption in the actuarial return model
The investment return assumption helps balance the projected future benefit needs and plan expenses with invested assets. It helps determine what benefits can be afforded. It depends on the performance of the fund’s investment process. In the long run the benefit level is driven by actual returns.
11.2.1 Outline factors to be considered when determining the pension plan’s asset allocation strategy (12)
1) Liquidity requirements
2) Obligations/liabilities of the plan
3) How to establish liability matching to ensure interest rate movements don’t upset equilibrium between assets and liabilities.
4) Acceptable investment performance that maximizes returns in accordance with acceptable risks
5) Types of benefits offered
6) Time horizon of investments held
7) Tolerance for risk
8) Amount of capital to invest
9) Asset size
10) Future needs for capital to pay pension obligations
11) Financial position of the plan
12) Their outlook: on interest rates, inflation, economic growth etc.
11.3.1 Explain the application of the prudent person rule to derivative investments in a pension fund as outlined in FSCO Investment Guidelines Notes IGN-002 Prudent Investment Practices for Derivatives
Derivatives can be used to hedge in pension funds to reduce certain risks. However the nature and complexity of derivatives is such that they can increase other risks.
The administrator must ensure derivatives used comply with the prudent person rules. Derivatives are judged primarily in terms of the overall context of the plan and its investment portfolio. Prudence includes making decisions considering all sufficient and relevant information and minimizing the risk of large losses associated with a large exposure to one counterparty, asset or class. Derivatives should be compared to other investments with the same potential benefits.
11.3.2 Describe the best practices for risk mitigation relating to pension plan investments in derivative as outlines in the FSCO Investment Guidelines Notes IGN-002 Prudent Investment Practices for Derivatives (7)
1) Valuations of non-exchange traded derivatives periodically provided by sources independent from counterparties
2) Appropriate legal documentation including collateral requirements used with counterparties of nonstandard over the counter derivative trades
3) Appropriate legal advice obtained and due diligence completed including consideration of the ability to contain losses.
4) Appropriate mechanisms in place to permit the administrator to contain losses
5) Original documents stored safely in accordance with FSCO’s document retention policy
6) limits to derivative exposures set by the administrator
7) Compensation policies relating to derivative investments set to discourage excessive risk taking
What does legal due diligence include?
Legal due diligence includes reviewing and evaluating terms and conditions to contracts
In respect to a best practices for risk mitigation describe some limits to derivatives exposure
Limits to derivative exposure should include both soft limits, where positions must be analyzed and hard limits where positions must be liquidated to comply with the quantitative limits set
11.4.1 Define “responsible investment” and provide examples of issues that may be considered in responsible investing as outlines in SHARE, Putting Responsible Investing Into Practice
Responsible investment is most commonly defined as the integration of ESG factors in the investment management process.
ESG issues are taken into account in the selection, retention, and disposition of investments. Responsible investment is based on the belied that ESG factors can have an impact on the financial performance of investments and reflects an active ownership approach.
11.4.2.a Outline the requirements under the Environmental section of ESG to qualify as a responsible investment under the UN supported Principles for Responsible Investing (UN PRI)
Issues relating to the quality and function of the natural, environmental and natural systems such as greenhouse gas emissions, climate change, renewable energy, energy efficiency, and air, water or resource depletion or pollution
11.4.2. Outline the requirements under the Social section of ESG to qualify as a responsible investment under the UN supported Principles for Responsible Investing (UN PRI)
Issues relating to the rights, well being, and interests of people and communities such as human rights, labor standards in supply chains, workplace health and safety, human capital management and employee relations, and diversity consumer protection and controversial weapons
11.4.2 Outline the requirements under the Environmental section of Governance to qualify as a responsible investment under the UN supported Principles for Responsible Investing (UN PRI)
Issues relating to the governance of companies and other investee entities.
In the context of market equities, these include board structure, size, diversity, skills and independence, executive pay, shareholder rights, ethics issues, bribery, corruption
11.4.3 What is emission of pollutants into water in the context of incorporating ESG factors
This is an externality which represents significant costs shifted from the company to the community.
11.4.4 Outline the premise of public fiduciary duty in the context of incorporating ESG factors into an investment policy.
The Public fiduciary hypothesis assumes that the overall financial returns generated by financial markets are the most important determinant of a pension fund’s success.
institutional investors are seen as part of a network of fiduciaries. It is argued that because of their scale and structure courts should impose obligations of trust on institutional fiduciaries not only toward their beneficiaries but also to the public at large to engage in collective and collaborative actions to address ESG issues
11.4.5.a Explain the “shareholder value case” rationale for incorporating responsible investment practices in asset management structures
The “Shareholder value case” is the premise that ESG helps investors avoid risks not captures in financial analysis. As well as identifying investment opportunities in companies with strong environmental records or growing the green economy.
11.4.5.a Explain the “values based case” rationale for incorporating responsible investment practices in asset management structures
The values based case is based on the premise that the move to responsible investment has been driven by the expectations of pension plan members and beneficiaries, foundations donors and stakeholders, as well as general society. The expectation is that companies behave in a manner that is consistent with broader positive social values
11.4.6 Describe how ESG considerations can drive fiduciary actions regarding pension plan investment decisions as outlined in SHARE
1) if the ESG can be reasonably expected to have a material impact on the financial performance of the investment consideration must be considered by the plan fiduciaries
2) If ESG can reasonably be expected to be the subject of a clear consensus among beneficiaries consideration must be considered by the plan fiduciaries
3) If ESG consideration provides a point of differentiation between equally attractive alternatives the consideration may be considered by plan fiduciaries.
Proxy voting, shareholder agreement, Economically targeted investments and screening are all permitted investment strategies provided they are authorized by the investment policy and carried out in a prudent and impartial manner.
11.4.7 Explain the legal implications of responsible investing in the pension context as seen in the UK and the US
Court decisions in the UK and US suggest that overall, responsible investing strategies must conform to fiduciary requirements to give a fund the best possible return.
However there is an increased societal expectation that the plan will behave as a responsible investor and play a constructive role in the economy as they grow in size and influence.
11.4.8 Outline the provisions that a plan sponsor includes in it’s SIPP is intending to follow responsible investment practices as outlines in SHARE (10)
1) Acknowledgement of fiduciary duty requirements which the fund is bound to operate under
2) allowance for the consideration of extra financial criteria
3) for mission based investors, an indication of whether or not rate of return is the paramount consideration
4) An allowance for appropriate diversification levels in accordance with legal requirements
5) Consideration of the structure of the fund’s liabilities or perpetuity requirements
6) Indications of which responsible investment strategies are permissible
7) Indications of whether investments will be managed in house or externally
8) indications of permitted categories of investment
9) a description of how proxy voting rights will be exercised
10) a description of how policy implementation will be monitored, including fund performance.
List 4 responsible investing strategies
1) proxy voting
2) shareholder engagement
3) ETIs (Economically targeted investments)
4) screening
11.4.9 Describe proxy voting as a responsible investing strategy
Attached to voting shares are proxy votes for public companies which give the shareholder a say in how the company is run. Investment policies typically outline how these get voted.
Except for very large funds the actual casting is typically carried out by an investment manager or proxy voting service.
Responsible investors can use their votes to encourage companies to improve transparency and responsibility of ESG issues
11.4.10 Explain how pension plans can influence proxy voting in a pooled fund
Pension plans invested in pooled funds generally cannot direct the voting of proxies.
A plan can try to negotiate an arrangement to permit the voting of a proportionate number of proxies in accordance with the fund’s investment guidelines. At a minimum they can advise the fund manager of their voting preferences and request a voting report.
11.4.11 Describe the steps considered by a pension fund in implementing a shareholder engagement strategy to address ESG (5)
1) Consult key stakeholders to determine issues of importance
2) Determine what ESG criteria will provide the framework (specific or broad)
3) Decide what engagement strategies will be initially employed
4) Finalize how and by whom engagement activities will be coordinated
5) Seek professional advice (current fund managers, alternative service providers for specialized engagement services)
6) Establish a monitoring provision to assess the long term costs and benefits associated with carrying out a shareholder engagement strategy
11.4.12 Describe ETIs and provide examples
ETIs (economically targeted investments) are also known as community investments. They seek t generate a market rate of return along with providing specific social, economic and environmental benefits.
Generally investing in ETIs is prudent and permissible as long as investment retention is commensurate with other investments with similar profiles.
eg: affordable housing, providing capital yo small/medium companies, revitalizing inner cities, supporting non traditional industries such as renewable
11.4.13 Explain why plan sponsors choose ETI as a responsible investing practice (3)
1) To support social or economic development or environmental protection within a specific geographic region
2) Advance technological developments in a targeted industry
3) Cultivate job creation and business development in a specific sector or for disadvantaged groups such as women or minorities
11.4.14 Explain steps considered by pension funds when implementing an ETI strategy in the context of responsible investing (5)
1) determine the types of collateral social, economic or environmental returns the fund seeks to achieve. May want to consult key stakeholders
2) Determine the types of investment vehicles that are viable for ETIs (venture capital, private placements, debt financing, real estate)
3) Identify the percentage of assets to allocate the ETIs and the fund’s overall risk return profile
4) Evaluate each investment decision for an ETI on a case-by-case basis
5) Collaborate with other investors interested in ETIs. Pooling assets and expertise can help create a viable ETI investment vehicle. Collaborators include pension funds, foundations, public sector, along with financial intermediaries
11.4.15.a Explain the importance of screening in the context of responsible investing
Historically screening has been used as a negative screen. A tool for addressing ethical and reputational risks particularity for mission or value based investor.
Positive screening is now also being used. Positive screens incorporate normal investment risk analysis along with the consideration of ESG criteria to assess which companies perform best when measured against similar companies in an investment universe.
11.4.15.b list three types of screening
1) Negative/exclusionary screening - exclude from a fund or portfolio certain sectors, companies or practices based on ESG criteria
2) Positive/best in class screening. Investing in sectors, companies or projects based on a positive ESG performance relative to industry peers
3) Norms based screening, vetting against minimum standards of business practice based on international norms
11.4.16 Identify reasons for screening in the context of responsible investment as outlines in SHARE
1) Eliminate specific risks from their portfolio
2) Protect the fund’s reputation as an investor supporting companies that are committed to responsible business practices
3) Respond to key stakeholders expectations around ethical standards.
11.5.1 Outline how PBA regulates the inclusion of ESG factors in a SIPP
PBA requires disclosure in a SIPP of whether or not ESG factors are to be considered. However ESG is not a defined term in PBS regulations
If ESG factors are incorporated into the investment strategy then plan administrators must disclose how those factors are incorporated
11.5.2.a List two approaches for incorporating ESG factors into investment policy
1) Integrate ESG factors into the fundamental investment analysis to the extent they are relevant to investment performance.
2) Integrate ESG factors from an ethical or moral perspective
11.5.2.b Describe the approach for incorporating ESG factors into investment policy that involves integrating them into investment analysis to the extent that they are relevant to investment performance
This approach is driven by a belief that effective research, analysis and management of ESG factors can play a role in assessing the valuation of an asset.
It involves assessing a wider range of risks and opportunities. It recognizes the long term nature of ESG factors and the impact they may have on the sustainability of industries or companies.
This sees ESG as a factor among many. While all factors should be considered it is up to the administrator to evaluate which are relevant and how to account for them
11.5.2.b Describe the approach for incorporating ESG factors into investment policy that involves integrating ESG factors from an ethical or moral perspective
A administrator should be cautious to endure its approach doesn’t conflict with fiduciary duties. The best interests of the plan beneficiaries have traditionally been defined by the courts as their financial best interests with the result that there is a potential conflict of interest with investing with other goals in mind, such as moral or ethical considerations
11.5.3 Identify information that must be disclosed , required by FSCO (ON), once it has been identified in the SIPP that ESG factors are to be incorporated (3)
1) Either a broad statement that the administrator includes all ESG factors or a list of factors incorporated (such as particular categories or factors)
2) A brief explanation of the approach taken to incorporate ESG factors
3) A description of the scope of the application of ESG factors. The disclosure considers whether ESG factors are considered across the entire pension fund or only certain portions of the pension fund.
11.6.1 List 6 factors to be considered by a plan sponsor/trustee when determining the type of manager structure to implement.
1) Asset allocation
2) Use of passive/active fund management
3) Use of segregated investments and/or pooled funds
4) Approach to soft dollar investments
5) Use of derivatives
6) Approach to responsible investment
11.6.2.a Explain the balanced fund management approach
Done by one manager whose expertise includes the supervision of portfolios containing a variety of asset classes and who invests in all assets, or by using a number of balanced managers each managing a portion of the fund.
Each manager decides on both: asset allocation and security selection
11.6.2.a Explain the specialist fund management approach
A number of specialist managers can be engaged for each broad asset class or for narrow asset classes.
Each manager only decides security selection. The idea is to focus on identifying and utilizing the particular strengths of the available managers. Asset mix is held fixed by the investment policy benchmark.
11.6.3 Explain the role of a swing manager
When the specialist approach is used the swing manager can be used to achieve changes in the asset mix.
They are market timers and have a wide range of assets.
They move assets into and out of the market or switch assets frequently. The actual asset mix changes are achieved by varying the mix in the swing manager’s fund since the specialists must remain fully invested at all times.
11.6.4 Describe two basic investment styles for stock funds
1) Value investing - managers focus on price and search for stocks selling for less in the market than they believe they are worth. There is less emphasis on expected revenue/earning, these are often out of favour companies.
2) Growth investing. Manager search for stocks they think will increase substantially in price because of anticipated growth in future earnings.
They look for stocks with high P/E ratios that have potential to provide greater returns. Stocks purchased by growth managers also carry greater risk because of volatile prices. They are more aggressive than value managers
11.6.5 Outline characteristics of top-down and bottom-up styles of active management
1) Top down starts with broad international or national economic outlook then comparing relative attractiveness of markets, then industries, and finally buys/sells securities within the identified areas or sectors.
2) Bottom starts with an analysis of fundamentals such as dividend yield, P/E, earnings growth of each stock and the looks at the securities from a current economic/market/industry outlook/ The preferred securities are then organized into a portfolio subject to diversification constraints.
11.6.6 Describe what investment management fees area and how they are determined
Investment management fees are fees payable to investment firms/managers for the management of a portfolio.
Fees can be asset based (% of assets), performance based (vs a benchmark) or a combination.
Fees for active DB plans typically scale down with asset level ranges. 100 bp on the first dollar manage may turn into 15bp on assets over $100M
11.6.7 Describe bundled fees, provide examples of two kinds
Bundled fees combine multiple fees and may include: Transaction, management, custody and other admin fees.
1) All- in fees. Fees specific to a particular client. Can include investment management, trading expenses, custody or other admin fees
2. Wrap fees - fees specific to a particular investment product. In the US the SEC defines a wrap account as a separately managed account (SMA). A SMA is any advisory program where a specified fee or fees not based upon any transactions in a clients account, is charged for investment advisory services. A SMA typically has contract or contracts involving a sponsor acting as the investment advisor, an investment management firm Can be all inclusive, asset based fees.
