Investment Objectives Flashcards
Why is human capital more equity-like than presumed?
- Workers have more company shares/options
- A bonus culture is quite common for some levels of staff
- Public listed employers have directors that are performance remunerated so motivated to right size the firms resources to the economic cycle - including staff.
- Increasing use of contract, temporary and part-time employment arrangements makes peoles employment and income more tied to the fortune of companies and the economic cycle.
- Workers have acquiesced to new and more flexbile emplyer practives by permitting the risk of DC pension. This now means that people start their earnings career expecting to fequently change employer, which permits employers to also adopt greater flexbility.
If this is true then it suggests that workers should diversify away from equity-like job risk.
Diversification means human capital and financial capital are different things. At the start of a persons career, human capital is high and financail capital is low. This implies a low exposure to equity investments when young, so should look at fixed income.
A person starting out with a loq equity allocation would then increase this allocation as financial capital grows and human capital declines.
Lifestyling would then happen which involves reducing the variability of returns in the financial portfolio, so reducing allocation to equities. This gives a hump shamp in allocation to equities.
Each client will have a varying amount of human capital characterstics and so understanding the clients employment is a task for the wealth manager.
An investment objective is set to help achieve the overall objectives of the client which could be 1) to maximise the probability of obtaining an average annualised net return over the next 3-years greater than z with vol no greater than y 2) To achieve with 99% probability that the und covers 100% of the liability with acceptable risk.
Most objectives are 1) target replacement income 2) benchmark driver 3) best efforts 4) lump sum or liability driven
Then a client must decide whether to be real or nomianl in their objective
The asset allocation will then be determined by the need to meet the investment objective, eg. LTAA, CPPI, Asset-Libability, risk partiy
