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CFA Level III > R13 - Managing Institutional Investor Portfolios > Flashcards

R13 - Managing Institutional Investor Portfolios Flashcards

1
Q

Defined contribution plan?

A

employer: makes specified contribution and provides set of investment choices
employee: selects the investment. Investment policy is part of IPS. Employee assets are portable

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2
Q

Defined benefit plan?

A

employer:
- responsible for future benefit payments.
- bears investment risk

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3
Q

DB plan terminology: Surplus?

A

Plan assets - PV of liabilities

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4
Q

DB plan terminology: Active-lives?

A

plan liabilities for participants working and accruing benefits

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5
Q

DB plan terminology: Retired-lives?

A

plan liabilities for participants drawing benefits

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6
Q

DB plan terminology: Deferred-lives?

A

plan liabilities for participants no longer working but not yet drawing benefits

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7
Q

DB plan terminology: Frozen plan?

A

No new entrants allowed or no new benefits accrued

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8
Q

DB plan typical return objectives?

A
  • generate sufficient return to cover liabilities
  • Minimum return equal to actuarial discount rate
  • absolute return objective
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9
Q

DB plan return objective for active vs retired lives?

A

active - future benefits less certain

retired - future benefits more certain

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10
Q

Factors that affect DB plan ability to bear risk: Funded status?

A

negative surplus = underfunded and decreased ability

positive surplus = overfunded and increased ability

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11
Q

Factors that affect DB plan ability to bear risk: Financial status/profitability of plan sponsor?

A
  • weak status/profitability decreases ability

- strong status increases

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12
Q

Factors that affect DB plan ability to bear risk: correlation between plan returns and sponsor business returns?

A

+ correlation decreases ability

- correlation increases ability

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13
Q

Factors that affect DB plan ability to bear risk: plan features affecting liquidity needs?

A
  • higher liquidity needs decrease ability

- lower liquidity needs increase ability

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14
Q

Factors that affect DB plan ability to bear risk: workforce characteristics affecting liquidity demands or time horizon?

A
  • higher liquidity needs and shorter time horizon decreases ability
  • lower liquidity needs and longer time horizon increases ability
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15
Q

DB plan typical risk objectives?

A
  • manage std dev of surplus (or assets)

- achieve 100% funded status

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16
Q

DB plan time horizon?

A

-functionally determined by plan and current participant characteristics

  • duration of plan liabilities
  • assets used to fund current participants
  • may be split between retired lives and active lives
  • may be long term

-for a terminating plan, horizon is termination datae

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17
Q

DB plan taxes?

A

-generally tax exempt, except for special situations

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18
Q

DB plans legal?

A

-obligation to manage assets with benefit to participants

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19
Q

DB plan liquidity?

A

-as required to meet plan payouts

  • higher needs indicated by:
  • –higher ratio of retired/active lives
  • –older workforce
  • –higher ratio of plan disbursements/sponsor contributions
  • –plan features like early retirement and lump-sum distribution
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20
Q

DB plan unique?

A

-often none

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21
Q

Hybrid plans: ESOP?

A
  • set up to buy company stock

- may be able to contribute with pre or after-tax funds

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22
Q

Independent foundation: description, purpose, source of funds, spending requirements?

A

desc - single donor, private or family
purpose - makes grants with aim of contributing to society
source - corporate sponsor
requirements - 5% of avg markt value of assets during preceding year (ex inv management fees)

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23
Q

Operating foundation: desc, purpose, source of funds, spending requirements?

A

purpose - funding an org
source - can by group, individual, or family
requirements - 85% of dividends plus interest income (maybe also 3.33% of assets)

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24
Q

Community foundation: desc, purpose, source of funds, spending reqs?

A

desc - publicly sponsored grant-awarding org
purpose - fund social, educational, religious, other
source - general public/large donors
spending reqs - none

25
Q

Return objective of foundations?

A

typical obj - preserve real value and meet spending targets

also - maintain intergenerational neutrality so real value maintained

26
Q

Spending rules of foundations?

A

simple - x% of beginning market value; but this makes distributions volatile

smoothing rules - purpose of reducing volatility of distributions

example - x% of avg 3yr market value

27
Q

Risk tolerance of foundations?

A

ability - perpetual time horizon; flexibility of spending reqs; need to maintain purchasing power; if deemed appropriate by foundation board

reduces ability - recipients depend on distributions; lack of smoothing rules

28
Q

Liquidity constraints of foundations?

A
  • needs for cash in excess of contributions received
  • smoothing helps
  • cash equivalent needs usually low
29
Q

Legal and regulatory constraints of foundation?

A
  • generally less regulated

- varies by country and type

30
Q

Unique constraints of foundations?

A

varies and case specific, for example:

  • concentrated holdings; restrictions on sale; prohibited investments
  • socially responsible investing
  • board biases/opinions
  • inadequate resources for due diligence on comples investments
31
Q

Return objectives of endowments?

A
  • maintain principal
  • maintain perpetual purchasing power
  • distributions sustainable and reliable
  • total return should cover spending, inflation, and fees
32
Q

Endowment spending rules?

A

simple - x% of beginning market value
rolling avg - x% of last 3yrs
geometric - y% of spending is x% of avg last 3yrs mrkt value, while (1-y%) is past distribution of amount adj for inflation

33
Q

Endowment risk tolerance?

A
  • normally high due to perpetual time horizon
  • reductions of risk tolerance:
  • –lack of smoothing rules
  • –receivers are heavily dependent on distributions
  • –directors focused on short term
34
Q

liquidity and legal/regulatory constraints on endowments?

A

liquidity - needs generally limited

legal/reg - varied; normally less regulated

35
Q

life insurance return objective?

A
  • earn crediting (accumulation rate) necessary to meet promised benefits
  • earn net interest spread above crediting rate
36
Q

life insurance risk tolerance?

A

-invest using fiduciary principles for quasi-trust funds

  • match asset to liability characteristics
  • –duration mismatch of A/L exposes surplus to interest rate risk and capital adequacy problems
  • –reinvestment risk - reinvesting coupon at rate lower than original purchase yield
  • cash flow volatility - anything hindering timely collection of income reduces reinvestment earnings/return
  • credit risk - can reduce returns
37
Q

life insurance liquidity concerns?

A
  • typically predictable

- special considerations - disintermediation/asset marketability

38
Q

life insurance liquidity issues: disintermediation?

A

disintermediation increases when int rates increase and asset sold at depressed value

39
Q

life insurance liquidity issues: asset marketability?

A

product mix has moved to shorter duration

40
Q

life insurance time horizon?

A
  • traditionally long duration

- match asset duration to liability

41
Q

life insurance taxes?

A
  • policyholder share not taxed generally

- corporate share taxed

42
Q

life insurance legal and regulatory concerns?

A

heavily regulated:

  • eligible investments
  • % of types allowed (lists)
  • valuation methods
43
Q

casualty insurance compared to life insurance?

A
  • casualty has shorter liability duration
  • longer processing period of payout (long tail on claims)
  • uncertain payouts/amounts (life is uncertain in timing, but amount is certain)
44
Q

issues with casualty insurance?

A
  • business risk can be concentrated geographically

- face an underwriting/profitability cycle

45
Q

describe underwriting/profitability cycle.

A
  • often tied to economic cycle
  • after period of underwriting losses and low profits insurers increase standards and raise premiums
  • profits attract capital which increases underwriting capacity
  • increased capital/competition in lowers premiums and underwriting standards
  • losses come and standards tightened again
46
Q

casualty insurance company return objective key considerations?

A
  1. support competitive pricing
  2. increase profitability
  3. grow the surplus
  4. tax considerations - emphasize taxable bonds when tax rate is zero and profits are negative; tax exempt when opposite is true
  5. total return focus - regulatory/accounting rules favor active management; realized gains increase surplus

In summary: want to earn positive spread

47
Q

casualty insurance company return objective differences from life insurance companies?

A

objectives and results more varied for casualty:

  • regulations more relaxed
  • product mix and liability durations differ
  • companies focus on asset appreciation strategies
  • capital adequacy and surplus vary
48
Q

casualty insurance company risk objective key considerations?

A
  1. cash flow needs are large/erratic
  2. common stock to surplus ratio: equity investing mostly limited to surplus account; risk appetite lower during inflation and bear markets
  3. few specific regulatory limits vs life insurance companies
49
Q

casualty insurance company liquidity concerns?

A
  • high liquidity needs
  • typically:
  • emphasize highly liquid securities
  • match assets to known specific needs
  • hold high quality government bond portfolio
  • if there is surplus, can invest that more aggresively
50
Q

casualty insurance company time horizon concerns?

A
  • horizon relatively short to match liability duration
  • generally accept more interest rate risk than in life companies
  • allows for larger mismatch of asset/L duration
  • mismatch related to underwriting cycle

Duration swings in US with underwriting cycle:

  • when profitable and t>0
  • –focus on tax exempt bonds and extend asset duration as tax exempt yield curve tends to be steep
  • when unprofitable and t = 0
  • –emphasize taxable bonds and reduce asset duration
51
Q

casualty insurance companies: legal/regulatory/unique concerns?

A

regulation:

  • -permissive vs life companies
  • -no asset valuation reserve

unique:
–specific to company or case

52
Q

For banks, the securities portfolio is a residual after what?

A

after meeting reserves and loan demand.

53
Q

Bank security portfolio objectives?

A
  • manage interest rate risk: shorter duration to offset longer loan portfolio duration.
  • manage liquidity: high liquid short term gov securities to offset illiquied riskier loans
  • generate income for bank
  • diversify credit risk
54
Q

Bank security portfolio return objective?

A

contribute to earning positive spread over cost of funds (interest paid on deposits)

55
Q

Bank security portfolio risk objective?

A
  • focus on asset/liability management and protecting surplus

- risk tolerance is below average

56
Q

Bank security portfolio legal/regulatory concerns?

A
  • extensive
  • limits on holding common stock and below investment grade securities
  • capital requirements
  • some regulations are minimum liquidity levels and max leverage
  • leverage adjusted duration gap (LADG) measures interest rate risk
57
Q

Bank security portfolio liquidity/time horizon concerns?

A

liquidity: driven by deposits/withdrawals

time horizon: driven by maturity of liabilities

58
Q

Bank security portfolio taxes and unique concerns?

A

taxable - incentive to hold losers and sell winners

unique - case specific

59
Q

For what kinds of companies to use ALM vs Asset Only?

A

ALM where definable, measurable liabilities:

  • DB pension plans
  • Insurance companies
  • Banks

Asset only where not:

  • Foundations
  • Endowments

CFA Level III (17 decks)

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