Topic 4: Institutional Asset Owners and Investment Policies Flashcards
Why standard optimisation models (e.g. MVO) cannot be used?
- issues with estimating risk premium, correlations
- lumpy asset classes
- availability of some investments
What is the Corpus
Initial contribution of an endowment
Spending rate vs Liability Discount Rate vs inflation. Which is for Foundation/Pension/Endowment
Foundation: spending
Pension: liability
Endowment: inflation
What are the three basic dimensions for naive allocation
- Absolute allocation size
- Allocation relative to portfolio
- Regular liquidity needs
What is the most appropriate benchmark for evaluating total portfolio performance?
- Broad peer group
- Weighted benchmark of broad market indices
- Market index for each strategy
Total portfolio performance should be assessed based on a weighted benchmark consisting of broad market indices aligned with the asset owner’s strategic allocation targets.
Other responses: A market index for each strategy or a peer group is used to evaluate the performance of the managers in the portfolio.
Which U.S. asset owner is required, for tax purposes, to distribute a minimum percentage of their assets each year?
Foundation
What is the difference between Foundation and Endowment?
Foundation:
- gives grants, while endowments are investment funds
- tend to have finite lives, while endowments are perpetual
- subject to min. spending
- less likely to receive funding from ongoing donations
Six attributes of the Endowment Model
- Aggressive Asset Allocation
- Effective manager selection
- First mover advantage
- Access to network
- Acceptance of liquidity risk
- Sophisticated investment staff and board oversight
What is tail risk?
Risk of sizeable portfolio value loss, resulting in returns that are in the far left end of return distribution
Sheikh and Sun (2012) suggest that the optimal level of liquid fixed-income holdings in a typical endowment portfolio best corresponds to which of the following ranges?
6 to 14%
When is rebalancing beneficial?
- Mean-reverting
- Oscillating
- Trending
- Flat
Rebalancing is beneficial in mean-reverting markets; i.e., it can enhance returns and reduce risks.
Other response: Rebalancing can reduce returns in trending markets
Rank assets from lowest to highest inflation beta:
Equities
T Bills
Treasury Bonds
Commodities
US equities
- Treasury Bonds
- US equities
- T Bills
- TIPS
- Farmland
- Commodities
Three types of pension plans
- defined benefit
- defined contribution
- govt social security plans
Three approaches to managing assets in defined benefit plans. Explain:
1. Asset focused:
2. Asset-liability:
3. Integrated asset-liability:
- Asset focused: Cash considered riskless assets. earns max expected returns
- Asset-liability: SD is low when correlation between asset and liability is high. Less risky when a volatile asset that is positively correlated with change in liability
- Integrated asset-liability: negative correlation with the sponsor’s profitability is preferred
In the asset-liability framework, hedging bucket can be constructed in three ways. Explain:
1. Duration matching
2. Cash flow matching
3. Overlay approach
Duration matches liabilities
Future cash inflows match expected liability cash outflows
Uses financial derivatives which may result in leveraged positions. Overlay method advantage is that you don’t need to give up growth portfolio, i.e. interest rate swap to receive fixed interest rate in exchange for variable