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23 Cards in this Set

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Trustees’ program structure re pension fund investment:
1] Retain professional expertise – admin staff, attorneys (legal counsel help determine trustees’ fiduciary responsibilities), actuaries, auditors, investment advisers, etc. 2] Develop financial profile – assets; obligations for retirees and beneficiaries, etc., expected future contributions 3]Adopt investment policies – return objectives, risk constraints, diversification requirements 4]Formalize investment program – investment committee, asset allocation plan, portfolio management strategies, monitoring/evaluation/control
Types of money managers (who buy and sell securities according to investment strategies and market conditions):
1] Bank trust dept – offer balanced funds and pooled funds (e.g., fixed income or stock or even mutual funds) 2] Money management firms (SEC registered advisers) – invest directly on clients’ behalf – may also do same as bank trust depts. 3] Specialty managers – real estate, international securities, etc. 4] Index funds managers – portfolio consists entirely of stocks or bonds held in amounts proportionate to the representation in a market index
Formal investment policies typically involve 3 sections:
1] Rate of return target or objective is set forth 2]Risk constraint statement – identify system’s tolerance for risk – can be expressed in relation to overall market or in absolute terms 3]Diversification (cannot eliminate risk) statement – to ensure individual losses don’t undermine the entire portfolio
Formalized investment program typically involves 7 related activities:
1] Big picture portfolio analysis – s/b studied in the context of its objectives and funding requirements; primary components; recent performance compared w/ general market indices 2]Asset allocation 3]Money manager selection 4]Strategic decision making 5]Monitoring and controlling performance 6]Evaluation and adjustments 7]Reporting
Asset classes include
cash equivalents (short-term investments usually considered risk free); bonds and other fixed income securities; stocks; real estate, venture capital, etc.
Cash serves two purposes:
provides reserve buying power so that bargains can be bought as they are discovered; AND purchase other assets when the time is right – portfolio trustees should have their assets in cash when they believe other vehicles are overpriced.
Trustees must be familiar w/ the legal restrictions that typically include state statutes or local laws that govern:
1] Composition and operations of the board of trustees 2] Fiduciary responsibilities (keep minutes, inappropriate decisions, limitations on behavior) 3]Specific investments of pension plans
3 general forms of authorization for legal authority for investments:
1] specific legal list – identifies instruments that may be allowed 2] insurance company clause – restricts pension fund’s investments to instruments otherwise allowed by regulated insurance companies w/in the state 3]prudent investment clause
The long term investment objective of a pension fund is
to obtain a good return on investment consistent w/ the risk tolerances of the plan sponsors, trustees and the fund itself.
Diermeier’s 1985 studies of long-term investment returns are attributed to
86% asset allocation (by far the most important reason that an investment portfolio will do well or poorly); 7% timing of transaction and 7% securities selection.
In a market economy, the production of goods and services depends upon two factors of production:
: labor and capital
Investment professionals measure risk in a different quantitative way thru measurement of volatility defined as
statistical measure of the frequency and size of deviation from an average return). Volatility is measured thru use of term called standard of deviation (premised on probability theory) – w/c defines a probable range w/in w/c prices would be likely to fluctuate.
Unsystematic risk vs systematic risk
Unsystematic risk – risk attributable to only a specific stock or bond Systematic risk (most impt for portfolios w/c are already diversified)– risk of owning the entire class of securities
The only way for pension fund trustees to minimize the risk to their portfolio of an entire market sector collapsing is thru
the allocation of assets into unrelated investments – to do this, investor must fund instruments that have good long term return prospects but are likely to perform differently in the short run. The ideal investments would be those w/c produce good long term returns but move in opposite directions in the short run thereby canceling each other’s short term volatility
Correlation
degree to w/c one asset goes up in value when another also goes up in value. Perfectly correlated assets increase in identical proportions and would have correlation coefficients of +1.0 – on the other hand, if an asset goes up in value and another declines in value, they are inversely correlated and would have a negative correlation coefficient. The lower the correlations, the more likely that it is possible to improve returns w/o adding risks or to diminish the risk of a given level of return.
2 Ways to approach the process of a normal asset allocation plan:
Naïve investment approach – attempts to replicate a normal universe – e.g., naïve global approach w/c simply mirrors the world portfolio or naïve public universe investing w/c attempts to duplicate the asset allocation used by other public funds AND Liability sensitive approach – tries to tailor the portfolio to the fund’s liability profiles (the projected future payments to beneficiaries)
The typical result of a strategic asset allocation policy will be
a target level for asset percentages.
If a policy shift is desired in response to changing capital markets, it is most likely to fall into the category of
(involves opportunities to acquire undervalued assets for potential appreciation or extraordinary income) asset allocation or asset timing.
Underweight stocks
means to hold stocks less than their normal or strategic % of the portfolio.
In asset timing, the most popular techniques involve financial models that examine
economic fundamentals
The selection of portfolio managers s/b driven by
the asset allocation process, and not the reverse. This means the role of a given manager s/b pre-determined by the board of trustees or the investment committee on the basis of a portfolio master plan.
Portfolio manager selection process includes 8 steps
1] Establishing criteria 2]Selecting potential candidates 3]Gathering information 4] Analyzing data 5]Choosing candidates to interview 6]Interviewing finalists 7] Negotiating contract 8]Distributing assets
The final stage of the pension investment program is
the reporting (to the constituents) function: aside from accounting reports in the notes to financial statements; should include: asset allocation; comparison between target or asset allocation plan and the current one; narrative description of any special asset allocation studies/major developments in the capital market and changes in financial managers.