overview Flashcards
investment governance
organization of decision-making responsibilities and oversight activities
governance structure
+ governing investment commitee
+ investment staff
+ third-party resources
Effective governance models
+ articulate long, short-term objectives of investment program
+ Allocate decision rights & responsibilities among functional units; take account of knowledge, capacity, time, position in the governance hierachy
+ Specify processes for developing & approving IPS
+ Specify processes for developing & approving SAA
+ Establish framework to monitor program towards goals - objectives
+ preodically audit
decision-reversal risk
the risk of reversing a chosen course of action at exactly the wrong time, the point of maximum loss
economic balance sheet
include:
+ Conventional assets & liabilities (financial asset & liability)
+ Extended portfolio assets & liabilities
extended portfolio assets & liabilities of individual investors
Extended portfolio assets:
+ human capital (PV of earnings)
+ PV of pension income
+ PV of expected inheritances
Extended portfolio liabilities:
+ PV of future consumptions
extended portfolios assets & liabilities of institutional investor
Extended portfolio assets:
+ underground mineral resources
+ PV of future interllectual property royalties
Extended portfolio liabilities:
+ PV of payouts for foundation
3 broad approaches to AA
(1) Goal-base
(2) Asset-only
(3) liability-relative
objective of Asset-only approach
maximize Sharpe ratio in
+ acceptable level of risk
+ constraints of IPS
owner of asset-only
+ Foundation, endownment
+ sovereign wealth fund
+ Individual investors
objective of liability - relative approach
+ fund liailities
+ invest excess for growth
owner of liabilities relative approach
+ banks
+ insurers
+ Define benefit pensions
objective of goal-based approach
archive goals with specified required probabilities of success
strategic asset allocation
an asset allocation in long-term investment planning
decision-reversal risk
+ is the risk of reversing investment decisions at the worst possible time
+ Effective investment governance aims to minimize decision-reversal risk
content of IPS
(1) • Introduction
(2) investment objectives
(3) • Investment constraints
(4) • Duties and responsibilities\
(5) • Investment guidelines
(6) • Reporting
in decision rights and responsibilities of effective governence, what is the most important
• delegation to those (1) who are best qualified (2) to make informed decisions
governance audit, what is the most should conduct
conducted by an independent 3rd party
Characteristics of asset-only approach
Focus solely on the asset side of the investors’ BS
Characteristics of liability relative approach
Choose an asset allocation in relation to the objective of funding liabilities
Characteristics of goal base approach
- Used primarily fod individuals and families
- Specify asset allocation for sub-portfolios, each of which aligned to specific goals
- Each goal include: cashflow, time horizon and risk tolerance.
Example of asset only approach
MVO
example of liability relative approach
Surplus MVO
Risk metric of asset only approach
- Volatility of return: standard deviation of portfolio
- Risk relative to benchmarks: tracking risk
- Downside risk: semi-variance, VaR
- Monte Carlo simulation: tail risk
Risk metric of liability relative approach
- Risk of having insufficient assets to pay obligations when due (shortfall risk)
- Volatility of contribution needed to fund current and future liabilities
risk metric of goal based approach
- Risk of failing to achieve goals: max accetable prob of not achieveing goal
- Overall profolio risk = weighted sum of the risks associated with each goal
Criteria for specifying asset classes
(1) relatively homogenuous
(2) mutually exclusive
(3) bring diversification benefit (low correlation between different asset classes)
(4) make up the majority of world investable wealth
(5) have the capacity to absorb a meaningful proportion of an investor’s portfolio
3 super classes of assets
(1) Capital assets:
+ Source of value (interest/dividend)
+ Value by NPV
(2) Consumable/transformable assets
+ Can be comsumed/transformed
+ Do not yield ongoing stream of value
(3) Store of value assets
+ Neither income generating nor valuable as a consumable or an economic input
+ Value is realized through sale/exchange
+ Eg: currency, art,…
Process of asset allocation
(1) quantify:
+ objectives
+ risk tolerance
(2) Determine
+ investment horizon
+ requirements and constraints
+ suitable asset allocation approach
(3) Specify asset classes + CME
(4) combination of asset allocation choices
(5) Test/simulat potential stress cases
goal classification system of Brunel 2012
• Personal goals
• Dynastic goals
• Philanthropic goals
goal classification system of Chhabra 2005
• Personal risk bucket
• Market risk bucket
• Aspirational risk bucket
Disadvantage of goal based
• Sub-portfolios add complexity
• Goals may be ambiguous or may change over time
Higher transaction cost of an asset class will result in……rebalancing ranges
wider
More risk averse investors will result in …… rebalancing ranges
tigher
Belief in momentum will result in …… rebalancing ranges
wider
Beief Mean reversion will result in …… rebalancing ranges
narrow
Taxes (is cost) discourage rebalancing will result in …… rebalancing ranges
wider
Low correlate will result in …… rebalancing ranges
narrow
High volatility of the rest of portfolio will result in …… rebalancing ranges
narrow coridor
nondiversifiable risk
+ market risk or
+ priced risk or
+ systematic risk
other name of Diversifiable risk
+ non-market risk
+ non-priced risk
+ company-specific risk
+ unsystematic risk
Type of investors
(1) Barnewall Two-Way Model: Passive - Active
(2) Bailard, Biehl, and Kaiser Five-Way Model:
Individualist - Celebrity - Gardian - Adventure - Straight arrow
(3) Behavioral investor type:
PFIA: Passive preserver - Friend follower - Independent individualist - Active accumulator
Distinguish SAA - TAA - DAA - GTAA
SAA = related to long term
TAA = deviate from SAA
DAA = TAA + motivated by longer-term valuation signals or economic views
GTAA = opportunistic investment strategy that seeks to take advantage of pricing or valuation anomalies across multiple asset classes, typically equities, fixed income, and currencies
what side the goal-based focus on ?
(1) Asset side
(2) Liability side
(2) liability side
Liability-hedging portfolio (definition)
focused on funding liabilities and, for any remaining balance of assets, a risky-asset portfolio
2 kind of rebalancing approach
(1) proportional range
(2) cost-benefit approach
what kind of manager get out of constraint to employ complex strategies ?
A. Internal manager
B. External manager
A. Internal manager
what constraint the internal manager get out of ?
(1) employing complex strategies
(2) the oversight committee lack individuals with sufficient investment understanding
Tax rate apply for Municipal fixed income
tax exempt -> tax rate = 0
