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.