Source - Portfolio Management for Institutional Investors - Arjan Berkelaar, Kate Misic and Peter C. Stimes
0. Formulas
1. Pension plans account for US$35 trillion, SWF $7 trillion (end of 2016), Endowments US 1.6 trillion
2. IPS - Asset allocation policy and investment guidelines are typically included in an appendix that can be modified more easily
3. Institutional investors codify their mission, investment objectives and guideline in an Investment Policy Statement (IPS)
4. A typical example of principal-agent problem is where performance fee structures are designed by external fund managers to provide attractive compensation to them via a high base fee, which is due regardless of fund preformance. This fee structure gives little incentive for the fund manager to produce superior performance
5. The endowment model is followed by many institutional investors such as university endowments, foundations, soverign wealth funds and defined benefit pension plans
Mission-related investing
6. Foundations often rely exclusively on
7. Volatilty measures
a. Banks and Insurers - VaR & CVaR
b. Endowment - volatility of returns
c. Pension Funds - surplus volatility
Objectives Sample for Endowment
The Objective of XYZ endowment is to maintain the purchasing power of its assets while financing up to x% of university expenses (scholarships, fellowships, faculty salaries). The target return is y% with reasonable level of risk. The volatility of returns should not exceed z% annually
DB and DC
Mortality risk - those in the pool who die prematurely leave assets that help fund benefit payments for those who live longer than expected
Insurers -
Given the nature of their product suite, life insurers maintain both a general account and separate account.
|
Products |
Bearer of Investment Risk |
Account |
|
Whole and term life
insurance |
Company |
General |
|
Universal life
insurance |
Company |
General |
|
Fixed annuities |
Company |
General |
|
Variable life insurance |
Policyholder |
Separate |
|
Variable annuities |
Policyholder |
Separate |
General account - where insurers maintain their assets to fund liabilites and bear the investment risk
Separate account - where customers bear the investment risk
The insurance industry is tightly regulated in most countries, usually by state or national authorities.
Notes from mini cases
Mini-Case A ->
1.
Mini-Case B -> Move portfolio from Fixed Income IG securities -> automobile loans
1. Reduces the insurer's liquidity. If the company has excess regulatory capital, no impact to additional reg cap requirements
2. The port redeployment is likey to raise the insurer's earnings, because the expected yield on the auto loans net
1. Impact on regularoty risk-based captial requirements - no effcect, subst one
2. Substituting fixed-rate securities in place of variable-rate securities tends to increase the modified duration of the banks
Mini-Case D -> Lower allocations to Govt Securities & raising alloc to Corp/Asset-Backed sec
1. Corp debt securities have hifger yields and thus shorter durations than govt securities of similar maturity.
2. Asset-based securities tend to have lower effective durations than corp bonds and govt bonds.
3. Change from Govt to Corp/Asset-backed would lower company's overall liquidity and lower regulatory risk-based captial measures.
4. Finally, the rellocation would increase expected earnings and set the stage for price gains if credit spreads vs. govt securities contract to more normal levels.