C12/13- Investment Flashcards
Main assets classes of investment used by pension schemes
- Cash
- Fixed interest bonds, government and corporate
- Index linked bonds
- Equities
- Property
- Derivatives
Describe how LDI strategies work
- Set with explicit reference to the liabilities
- Aims to reduce or hedge inflation and interest rate risks
- Duration of pension scheme liabilities is often longer than that of the assets held, leading to interest rate risks
- Often involve swaps, which allows controlling mismatch in the durations of assets and liabilities
- Tends to be used as approaching full funding, as can reduce the volatility of funding level and hence increase the security of benefits and reduce volatility of contributions
Describe how longevity bonds and swaps work
- For longevity bonds, coupon payments are linked to mortality experience of a particular set of lives
- Coupon payments reduce in line with population mortality experience
- If longevity is higher than expected payments will be higher, broadly hedging longevity risks
- Hedge will not be perfect if the population underlying the bond is not the same as the scheme
- Larger schemes may be able to arrange a longevity swap where payments are linked to the membership rather than the national population
List 5 types of investment product
- Managed fund
- Income drawdown
- With-profit arrangements
- Deposit administration
- Annuities
Fiduciary management
Complete delegation of investment authority by the scheme to an investment advisor
Assets still held directly by the scheme
Individuals who have previously operated an income drawdown arrangement may decide to buy an annuity because:
- Need security of guaranteed income
- Need increased level of income
- Price or annuities have fallen relative to the value of the fund held
- If they further defer purchasing an annuity, will experience further mortality drag ie be charged for their survivorship and lose the subsidy from those annuitants who die early
Services offered by the provider of an investment product
- Administration
- Documentation
- Professional advice eg accounting, legal, Actuarial
Stakeholders and investment strategy for DB scheme
Members - want low risk assets unless significant discretionary benefits are available to them and sponsor has no difficulty paying
Scheme sponsor - may be will to bear risk of assets underperforming in exchange for outperformance and so lower contributions. Some may prefer low risk so can focus on business operations
Features of investment proceeds a sponsor needs to consider when deciding assets to hold
- Size
- Timing
- Nature
- Predictability/volatility
- Taxation
- Expenses
Trustees aims when setting an investment strategy
- Ensure there are sufficient assets available to meet the liabilities as they fall due and to match the liabilities by nature, certainty, currency and term
- Maximise return subject matter to an acceptable degree of risk
When is consideration of the volatility of an asset held by a DB scheme important?
- Funding regime requires valuations at set intervals
- any doubts about the willingness and ability of the sponsor to make good any deficits that arise, particularly if the scheme is poorly funded or very mature
Examples of investment default
- Default on bond repayment
- Obsolescence of a building or change of popularity of an area, reducing the value of property
- Poor Business performance by company leading to lord of shareholder value or insolvency and total loss of share value
Marketability
Measure of the ease with which a buyer may be found for the investment
Liquidity
Measure of how quickly an asset can be converted into cash
Why might it be appropriate for a DB scheme to hold investments with a high running yield?
When the liability involve a high level of benefit outgo relative to cashflow in to the scheme
