Managing Institutional Investor Portfolios

Question 1

contrast a defined-benefit plan to a defined-contribution plan, from the perspective of the employee and employer and discuss the advantages and disadvantages of each

Answer 1

Pg 374 - 376

Question 2

discuss investment objectives and constraints for defined-benefit plans

Answer 2

Risk Objectives:
- Plan funded Status - higher surplus - higher risk
- Sponsor financial Status - lower debt to asset ration high profitability - Higher risks
- Plan features - early retirement - less risk
- Work force characteristics - higher young and active workers - higher risk
Plan and sponsor risk exposore - low correlation higher risk taken
Defining the risk: Absolute risk or Relative risk
Relative risk can be defined in terms of shortfall risk
Return Objective
- Should start with consideration of discount rate used to value the pension liabilities
- Should a little over the discount rate
- Return based on pension income - to increase the income
Return and risk objectives of retired lives different from active lives. More conservative for retired lives.

Question 3

Constraints of DB plans

Answer 3

Liquidity:
- Greater number of retired lives, greater liquidity,
- Smaller contributions, greater liquidity
- Plans features, greater liquidity
Time Horizon:
- Plan is going concern or plan termination is expected
- Age of workforce and proportions of active lives
Can be multistaged depending on the individuals.
Tax Concerns
- Usually tax exempt
Legal and regulatory Factors:
- All pension funds are govt regulated. Pension plan trustee is in fiduciary role and is expected to work in the best interst of the beneficiaries.
Unique Circumstances:
- Human and financial resources available to plan sponsor
- Self-imposed constraint on investing in certain industries.

Question 4

Risk Management and Investment of DB pension plans

Answer 4

• Managing investment in relation to operating investments - Correlation between the risk of plan and the sponsor - if it positive - than lower risk taken if the operating risk is high and vice versa
• Coordinating pension investment with pension liabilities - Sufficient to fund the pension liabilities without further contributions
  Investments:
  More interest - rate sensitive securities in assets as the liabilities are interest rate dependent.

Question 5

IPS for DC plan

Answer 5

The plan participants decide their own risk and return objectives

Question 6

Hybrid and other plans

Answer 6

Combination of DC and DB plans

Eg: Cash balance, pension equity, target benefit, floor plans

Question 7

Foundations & Types

Answer 7

Grant making institutions funded by gifts and investment assets
Pg 396

Question 8

Foundations - Investment Objs and constraints

Answer 8

Risk Objective:
- Aggressive because no liabilities attached.
- Foundations can make higher rates of returns than PP of the assets and hence can take additional risk
Return Objective:
- Differenet objectives and different time horizons
- Long term is to preserve the purchasing power of the assets allowing spending at an appropriate rate
Spending rate * Inflation * Management Expenses
Liquidity Requirements:
- Anticipated and unanticipated requirements
- Anticipated are the spending rate which is not inclusive of the management expenses
- Some assets in reserve for contigencies
Time Horizon:
Depends on the type of foundation
Tax Concerns:
Income not related to the charitable purpose of the foundation referred unrelated business income and subject to regular corporate taxes.
Legal and Regulatory Factors:
- Varies on country basis
Unique circumstanceS:
- Special challenge with the donor restricts the investment to one particular company.
- Entering into swaps with the donor’s permission to offset the risk taken above.

Question 9

Endowments - Def, Investment Objectives and Constraints.

Answer 9

Investment Objective:
Risk:
- Based on spending policy. With smoothing and avg spending rules: More risk (short term) not possible to take short term risk with those who do not have smoothing rule.
- Depends on endowment’s role in operating budget
- Enhance the short term volatality before pursuing strategies that are consistent with only a long term horizon
Return objective:
- High return objective significant stable flow of income to operations.
-Maintain long term purchasing power after inflation
- Return should exceed the spending
Spending rate+Inflation+ Cost of generating the income
Liquidity Requirements:
- Limited need
- Cash needed which are met through yield, normal sale of securities etc.
- Can invest in illiquid assets
Time Horizon:
- Usually long term
Tax Concerns:
- Not a concern
Legal and Regulatory Requirements:
UMIFA in US - governs the endowments
- Spend endowment investments and income
- Comply with tax and reporting laws
- Ensure no part of income accrues benefit to private individuals
Unique Circumstances:
- Constraints on type of investments it should consider due to the types of endowments
- Ethical policies

Question 10

Life-Insurance Industry

Answer 10

Risk Objectives:
- Limited risk tolerance
- Risk based capital
- Two interest rate risks faced: Valuation Concerns and Reinvestment Risk
Credit risk
Cash flow volatality
Return Objective:
- Earn positive net interest spread
- Sub portfolio return objective - segmentation
- Grow surplus to support expanding business
Liquidity Requirements:
- Volatile and annuity requirements require liquidity to be in check for insurance cos.
- Disintermediation
- Asset marketability risk

Time Horizon:
Long Term
Tax Concerns:
- Focus on after tax returns

Legal and Regulatory:
Eligible Investments
Prudent investor rule
Valuation methods

Unique circumstances:
- Company size and suffiecieny of the portfolio