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CFA 3 2019 > Institutional Investor Portfolios > Flashcards

Institutional Investor Portfolios Flashcards

1
Q

••••Institutional Investor••••

DB Plan Vs DC Plan

A

DB Plan

  • Company bears investment risk (company owned)
  • Assets/Liability is put on the balance sheet

DC Plan

  • Has portability since participant owns
  • Employee makes investment decision
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2
Q

••••Institutional Investor••••

DB Plan Return Objective

A
  • = actuarial liability discount rate
  • Could be higher (1-2%) if:
    • Sponsor wants to minimize future contribution & maintain / increase income
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3
Q

••••Institutional Investor••••

Factors Affecting Pension Fund Risk Tolerance

A
  1. Plan Surplus: positive = higher risk tolerance.
  2. Financial Status & Profitability: Debt-to-equity and profit margin.
  3. Profits and Pension: High correlation = less risk tolerance
  4. Liquidity: Liquidity provisions = less risk tolerance. (early retirement/lump-sum withdrawals)
  5. Time Horizon: Longer = higher risk tolerance (low avg worker age, retiree to employee ratio)
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4
Q

••••Institutional Investor••••

DB Plan Liquidity

A

Liquidity is affected by:

  • # of retired lives (more retired = more benefits paid)
  • amount of contributions
  • Plan features (early retirement/lump-sum)
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5
Q

••••Institutional Investor••••

DB Plan Time Horizon

A
  • going-concern (determined by liability duration)
  • Sometimes multi-stage (active lives vs retired lives)
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6
Q

••••Institutional Investor••••

DB Plan Taxes, Legal, and Unique

A

axes - Tax-exempt (unless stated which then is a constraint)

Legal - ERISA regulated

Unique - Small plans have limited staff (restricted asset classes or industries)

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7
Q

••••Institutional Investor••••

Cash Balance Plan

A
  • small defined-benefit plan that is portable at retirement
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8
Q

••••Institutional Investor••••

Foundations vs Endowments

A
  • Same for IPS purposes
  • Foundation - funded by gifts
  • Endowments - long-term funds owned by a non-profit organzation
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9
Q

••••Institutional Investor••••

Types of Foundations

A
  1. Independent: from person or family
    1. Requires 5% spending of assets
  2. Company Sponsored: legally independent from company
    1. Requires 5% spending of assets
  3. Operating: Sole purpose of funding a company (museum, zoo)
    1. Requires 85% spending of dividends and interest
  4. Community: Publicly sponsored
    1. No spending requirements
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10
Q

••••Institutional Investor••••

Foundation Return Objectives

A

Preserve real value and meet spending requirements

Example for Return (compounded):

Management costs 0.30%, distribution 5%, inflation 2%

Required return = (1.003)(1.05)(1.02) - 1 = 7.42%

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11
Q

••••Institutional Investor••••

Foundation/Endowment Spending Rules

A
  1. Simple: just a percent of MV
  2. Smoothing:
    1. Rolling 3- year: avg MV of last 3 years (uses MV, not avg of %)
      1. Makes more stable, ↑ risk tolerance
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12
Q

••••Institutional Investor••••

Foundation/Endowment Risk Tolerance

A

Highest (perpetual time horizon). Lower if there are liquidity requirements

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13
Q

••••Institutional Investor••••

Foundation/Endowment Taxes

A

Mostly tax exempt

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14
Q

••••Institutional Investor••••

Life Insurance Return Objectives

A
  • actuarial rate to meet obligations
  • Earn additional net interest spread to increase surplus (to pay fees, etc.)
    • Surplus = competitive advantage (can charge less on premiums)
  • May be segmented by line of business
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15
Q

••••Institutional Investor••••

Life Insurance Risk Tolerance

A
  • Asset Liablity Management (ALM): match asset to liabilties to manage surplus
    • Could expose surplus to interest rate risk
  • Heavy regulated; limits on assets and amounts
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16
Q

••••Institutional Investor••••

Disintermediation risk

A

Definition: Allowing policy holders to borrow against the contractual rate.

Increases when interest rates increase. Surplus would decrease

17
Q

••••Institutional Investor••••

Life Insurance Taxes

A

Crediting rate is not taxed

Corporate share is taxed and increases with surplus

18
Q

••••Institutional Investor••••

Casualty Company Differences

A
  • Shorter liability duration (uncertain due to timing)
  • Longer processing periods for payouts
    • called long tailed risk (managed by matching with fixed income)
  • Can be highly concentrated (geographically and event risk)
  • Less predictable cash flows
19
Q

••••Institutional Investor••••

Casualty Return Objectives

A
  • Increase profitability (positive spread over crediting rate)
  • Grow the surplus
20
Q

••••Institutional Investor••••

Bank Objectives

A
  • Manage interest rate risk: short duration to offset loans
  • Manage liquidity: high liquidity to offset loans
  • Generate income
  • Diversify credit risk
  • Return: earn a positive interest spread
  • Risk: ALM (most conservative)
21
Q

••••Institutional Investor••••

Non Life vs Life Insurance Companies

A

Non-Life

Risk Tolerance Less regulated

Time Horizon Shorter but with long tail

Liquidity Higher and less certain

Inflation risk Yes (life = No)

CFA 3 2019 (14 decks)

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