Ch 15: Choosing an appropriate investment strategy Flashcards
What criteria should an investment objective for an institutional investor satisfy?
1) Clearly stated
2) Quantifiable
3) Framed in terms of risk, total required return and timing of cashflows
Give 4 examples of possible investment objectives for an institutional investor
1) To meet liabilities as they fall due
2) To control the incidence of future obligations on a third party (e.g. employer pension contributions)
3) To provide sufficient funds to be able to demonstrate ability to meet liabilities as they fall due (can be on statutory or realistic basis)
4) To demonstrate that there are sufficient funds to meet the liabilities if discontinuance were to occur.
Give 3 examples of how risk might be defined for an institutional investor
1) Standard deviation or volatility of return from an investment (MVPT/CAPM)
2) The probability of ruin (or complete failure of an investment)
3) The probability of failing to achieve the investor’s objectives.
On what 3 things does the risk appetite of an institutional investor depend?
1) The nature of the organisation
2) The constraints of its governing body and documentation
3) Legal or statutory controls.
List 15 factors that influence the long term investment strategy of an institutional investor
SOUNDER TRACTORS
Size of the assets (absolute/relative)
Objectives
Uncertainty of the liabilities
Nature of the liabilities
Diversification
Existing asset portfolio
Return (expected long term
Tax treatments of the asset/investor
Restrictions - statutory/legal/voluntary
Accrual of liabilities inn the future
Currency of existing liabilities
Term of existing liabilities
Other fund’s strategies (competition)
Risk appetite
Solvency requirements and accounting requirements
Why might an institutional investor prefer high-income yielding investments to low-income yielding investments?
The investor:
- Currently has a high cash outflow requirements and wants to avoid the expense and uncertainty or realizing assets
- Is not worried about investment risk
- Pays a higher rate of tax on capital gains than on income
When would an overseas market be considered ‘cheap’?
If:
Expected return in local currency
+ Expected depreciation of domestic currency > expected return in home currency
The investor should consider investing overseas if the margin of the LHS over the RHS exceeds the risk margin the investor required for overseas investment.
When selecting individual assets for a fund, what 3 factors should the investor consider?
1) The expected return net of tax and expenses
2) The volatility of returns
3) Whether the assets selected has a low covariance with the other assets in the portfolio -> diversification -> reduced specific risk
Why will the investor want to maximize returns subject to constraints?
1) For competitive reasons, to continue to attract new customers.
2) To maximise shareholder returns.
3) To minimise the cost of providing for the liabilities.
Outline the characteristics of the liabilities of an individual
1) Consist of future spending (including debt payments)
2) Mainly real, but not necessarily linked to a standard price inflation index
3) Mainly dominated in the domestic currency.
4) Both short-term and long-term liabilities
5) Some uncertainty in amount and/or timing
Outline the characteristics of the assets of an individual
1) Consist of current wealth and future income
2) Occupational income: a real asset
3) Pensioners income: may be fixed in nature or real
4) Uncertainty in relation to receipt of income
Since both the income and expenditure of individuals may be uncertain, what sort of assets should they consider holding?
Liquid assets or consider using insurance
List 10 factors affecting the long term investment stragetegy of an individual
1) Matching the nature, term, currency and uncertainty of the liabilities.
2) A need for income to live on vs growth for future.
3) Risk appetite and volatility acceptance.
4) Diversification requirements, to reduce risk.
5) Maximising expected returns on investments, net of tax and expenses
6) The individual’s tax status and the tax treatment of the asset.
7) Low free assets, which constrain the ability to mismatch and take risks.
8) High relative/absolute expenses when investing small amounts
9) Amount of information available.
10) Amount of assets available for direct investment
List 3 factors that a retired individual needs to consider in relation to investment strategy
1) Generating sufficient income to live from their assets.
2) Maintaining that income in real terms, to maintain purchasing power
3) Allowing for sufficient growth in capital
How can a retired individual generate sufficient income to live from the assets they own?
1) Annuities
2) High income yielding assets
3) Periodic redemption of assets
4) Periodic sale of low income yielding assets
