PORTFOLIO MANAGEMENT FOR INSTITUTIONAL INVESTORS

Question 1

Describe the common characteristics of institutional investors that differs them from a private wealth client.

Answer 1

1. Size
2. Time horizon
3. Regulatory framework
4. Governance framework
5. Principal-agent issues

Question 2

Identify what should be included in an institutional investors IPS

Answer 2

1. Institution mission and investment objective
2. Investment horizon and liabilities that needs to be paid by the institution
3. External contraints that affect the asset allocation (legal, regulatory, tax and accounting)
4. Asset allocation policy
5. Rebalancing policy
6. Reporting requirements

Question 3

Describe the Norway’s sovereign wealth fund model, give advantage and disadvantage

Answer 3

Passive approach of investment
Low exposure to alternative investment
Often use the 60% equity / 40% bonds
Tight tracking error

Advantage :

Easy to understand for the board
Low cost and fees

Disadvantage :

No opportunity for outperformance of markets

Question 4

Identify the key risk characteristics that a manager must take into consideration when assesing pension funds ability to take on risk

Answer 4

Workforce characteristics : Young workforce increase ability to take risk

Plan funded status : High funded status increase risk tolerance

Sponsor financial status : Lower debt ratio and high contant profitability increase risk tolerance

Size of plan compared to sponsor : Lower plan compared to sponsor increase risk tolerance

Common risk exposure between plan and sponsors

If the plan offers provision for early retirement and lump sum distributions

Question 5

Identify the different mission that Sovereign Wealth Funds can have.

Answer 5

1. Budget Stabilization fund : Country revenus is linked to natural ressources or other cyclical industries. Will use this fund when the industries in questions in not in a good state and country revenu is lower.
2. Development funds : Investments in infrastructure project or supporting key industries.
3. Savings Funds : Will be use to assure the well being of future generation
4. Reserve funds : Will invest excess foreign reserve in order to earn higher returns than the regular low yield returns that they contained.
5. Pension reserve funds : Used to save and invest to meet future pension liabilities of gvts.

Question 6

Regarding the different mission of a SWF, what are the liabilities and investment horizon linked to each.

Answer 6

Budget stabilization fund : Uncertain liabilities, linked to commodity/economic industries. Short term horizon, budget support is announced on short term basis.

Development funds : Liabilities linked to the different investment made. Investment horizon can be long or short, depends on the nature of the investment.

Savings : Liabilities linked to future generation. Investment horizon is long.

Reserve funds : Liabilities are the yield promised on the bonds issued by the governments. Investment horizon are really long.

Pensions reserve : Liabilities linked to future pensions payments. Investment horizon is long term.

Question 7

What is the formula to estimate the dollar amount of spending each year of an endowment

Answer 7

Spending t +1 = w (Spending rate t x (1+inflation) + (w-1) spending rate * AUM average of the endowment.

Question 8

Describe the different spending policies that an endowment can implement.

Answer 8

1. Contrant growth : W will be equal to 1. Give more certainty of the amount that will be paid.

2- Market value rule : w = 0. Payouts are a prespecified rate (between 4-6%). Endowment spending rate will fluctuate in line with the moving average of the AUM.

3 - Hybrid rule. ( w will be between 0 and 1)

Question 9

What similarity does a private foundation and an endowment have ?

Answer 9

Their investment objective is similar. They are required to maintain purchases power, hence keep up with inflation, while being able to maintain a predetermined spending rate.

Question 10

Explain how you determine the investment horizon of a bank

Answer 10

by taking the difference between the banks long term illiquid assets and the banks short term liquid assets.

Question 11

Explain the primary objective objectives of banks and insurance company

Answer 11

Primary objective is to maximise the market value of the company’s equities while making sure that liabilities can be met.

Question 12

How can we capture the effects of the movements of a banks/insurers assets and liabilities has on the company’s equity

Answer 12

% change in equity = % change in assets (L) - % change in Liabilities * (L-1)