Course overview

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18 Νοε 2013 (πριν από 3 χρόνια και 9 μήνες)

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OVERVIEW

MFIN5600 INSTITUTIONAL WEALTH MANAGEMENT

1

INSTITUTIONAL INVESTORS: WHO ARE THEY?

2

INSTITUTIONAL INVESTORS: WHO ARE THEY?

3


Mostly tax
-
free institutions: pension funds, endowments, foundations


They can manage their assets in house, or outsource to professional portfolio managers

DECISION MAKING PROCESS: PLANNING

1. Planning


Establish investment objectives, risk tolerance, and constraints


Put these in the Investment Policy Statement (IPS)


Form capital market expectations and determine the optimal asset allocation


Most plans work with an institutional client consultant: Mercer, Towers Watson, Russell, Aon Hewitt…etc.

4

DECISION MAKING PROCESS: EXECUTION

2. Execution


Passive or active
investing?


Outsource
management or manage in
-
house
?


Conduct manager searches (with the help of a manager search consultant?)



5

DECISION MAKING PROCESS: FEEDBACK

3. Feedback


Periodic performance
evaluation: mostly likely quarterly


Monitoring


Rebalancing (when current asset allocation deviates “substantially” from the target)


6

DECISION MAKING PROCESS: RECAP



Three stages:

1.
Planning

2.
Execution

3.
Feedback



A little bit more on each stage….

7

PLANNING: RETURN OBJECTIVES


Establish a return objective or target


Depends on current and future spending needs


Objective can be an absolute percentage (e.g., 5% per annum), or a relative percentage (CPI + 3%)


Example: Canada Pension Plan Investment Board (CPP IB)


CPI + 4%


An actuarial estimate based on the plan’s liabilities


For pension plans, falling short of the objective consistently would necessitate:


An increase in contribution, and/or


A cut in pension benefits



8

PLANNING: RISK OBJECTIVES


If there are no free lunch plans, then risk and return are related


How to measure risk?


Variance/standard deviation


Downside risk, value
-
at
-
risk (
VaR
), conditional
VaR


Tracking error


Investor’s ability to take risk


Current and future spending needs (e.g., age of the work force)


Affects the plan sponsor’s operating budget, if there is a funding deficit

9

PLANNING:
IPS


Investment Policy Statement (IPS)


Required by law in most jurisdictions


In Canada, more commonly referred to as the Statement of Investment Policies and Procedures (SIP&P)


Outlines objectives, constraints, benchmarks for performance, manager requirements for reporting…etc.


Most start with a general objective: “to maximize return without undue risk of loss”


Manager has to ensure that all future investment decisions are consistent with outlined objectives and constraints. When
necessary and with board (Directors or Trustees) approval, the IPS can be updated (e.g., to add a previously disallowed asset

class)


10

PLANNING: INVESTMENT CONSTRAINTS


What asset classes and strategies are allowed


Are short positions allowed?


Are private equity investments allowed?


Limits on allocation to certain assets?


Responsible investing?

11

PLANNING: RESPONSIBLE INVESTING (RI)


An investment constraint


Environmental, social, and corporate governance (ESG) factors for screening investments


Can be viewed as a risk management tool


Positive screens: industries fund wants to invest in, employment standards, sustainability


Negative screens: “sin” stocks, human rights violation, nuclear energy


Major Canadian pension plans are
signatories of UN’s
Principles of Responsible Investment (PRI)


Implementation is a separate issue


Plans are slow to include SRI policy in their IPS (larger plans taking lead)


Impact of RI screens on investment risk and return


empirical evidence is mixed


12

PLANNING: CAPITAL MARKET EXPECTATIONS


In order to determine the optimal asset allocation, need to have all the inputs


Expected returns, variances,
covariances


The inputs are usually medium
-

to long
-
term forecasts for each asset class


Depends on how frequently the plan revisits the optimal allocation


Typically rely on historical return distributions, with some adjustments based on macroeconomic forecasts for the
planning horizon

13

PLANNING: ASSET ALLOCATION


Strategic asset allocation


A optimized long
-
term asset allocation with specific return and/or risk objectives, tailored for a client


Will change only if long
-
term market expectations change, and/or changes to client’s objectives and risk profile


Not
affected by short
-
term market
fluctuations,
a
s distinct from
tactical asset allocation (TAA)
, which aims to time the
market


TAA: an active investment strategy, involves short
-
term adjustments to portfolio weights based on short
-
term predictions of rela
tive
performance across asset classes


14

STATIC
VS

DYNAMIC STRATEGIC ASSET ALLOCATION


Static or
s
ingle
period optimization is the simplest


Does not consider links across time periods


Less
complex to model and
implement


Repeat when there are changes to market expectations and/or investment objectives



D
ynamic
asset
allocation Outcomes
in one period directly affect the optimal decision
in
the following period


Example: If mean reversion exists in stock returns, then stocks are less risky if horizon is long, and optimal allocation to
stocks should be higher
than otherwise


Example: take into
account serial correlations in
the variance of returns



15

PLANNING: RISK BUDGETING


How should the desired level of risk be allocated amongst various asset classes?


Motivation for including other asset classes in the portfolio, especially after the financial crisis

16

Market Cap

Equity
Fixed Income
Risk Contribution

Equity
Fixed Income
EXECUTION: APPROACHES TO INVESTING


Passive


Buy and hold a benchmark portfolio


Indexing


Do not respond to changes in market expectations


Active


Holdings differ from benchmark according to portfolio manager’s assessment


Goal is to beat the benchmark (“add value”)

17

EXECUTION: SELECTION AND IMPLEMENTATION



Larger funds have internal staff to manage all or parts of the portfolio


Smaller funds (even funds with billions of assets) rely mostly on external portfolio managers


Spring 2012 Ontario government budget
-

appoints an advisor to develop a framework to consolidate smaller public
-
sector
pension plans in terms of asset management (economy of scale)

18

DIGRESSION: THE ARITHMETIC OF ACTIVE MANAGEMENT


Sharpe (FAJ 1991)


Sum up all the assets held by professional portfolio managers


The sum resembles the market portfolio


What is the implication for the average alpha of portfolio managers?


Some managers have positive alphas, some have negative


Conclusion: after fees, active investment is a
negative sum game

19

FEEDBACK: PERFORMANCE EVALUATION


Monitor progress toward goals and measure manager skill


Skill assessment has three main components:


Measurement


rate of return


Appraisal


relative to a benchmark


Attribution


sources of return include asset allocation, sector selection, security selection

20

FEEDBACK: REBALANCING


As time passes, actual asset mix will likely deviate from optimal asset mix


Consider the traditional 60/40 portfolio (60% equity, 40% fixed income)


If the stock market generated a higher return than bonds in the past year, then which asset class would be over its target
weight in the portfolio?


Selling when there has been a run
-
up in price and vice versa


Need to determine the frequency and timing of rebalancing

21

CURRENT LANDSCAPE: GLOBAL PENSION ASSETS


Towers Watson Global Pension Asset Study 2013

22

CURRENT LANDSCAPE: INDIVIDUAL PLAN ASSETS


Largest plan: Global


Government Pension Investment Fund of Japan (GPIF)


US $1,108.9 billion (2012 Q3)


Largest plan: North America


California Public Employee Retirement System (CALPERS)


US $259.3 billion (2013 Q2)


Largest plan: Canada


Canada Pension Plan Investment Board (CPPIB)


Cdn

$183.3 billion (2013 Q1)

23

CASE STUDY: CPPIB

24


Created in 1997; 18 million plan members


Plan was deemed unsustainable due to changing demographics and increased life expectancy


Contribution rate was increased to 4.95% for both employers and employees (i.e., 9.9% total) in 2003

CASE STUDY: CPPIB


Current asset allocation


By geographical region and by asset class

25

CASE STUDY: CPPIB


Reference portfolio


A “low
-
cost, low complexity portfolio of public market investments” that is deemed sufficient to generate the target return
(that would make the CPP sustainable at the current contribution rate for the long term ~ 75 years)


A passive portfolio or benchmark for gauging the performance of the fund

26

10%

55%

30%

5%

Canadian equities
Global equities
Canadian bonds
Foreign soverign bonds
CASE STUDY:
CPPIB


Reference portfolio introduced in 2006, implemented in 2007.


Objective of the IB is to create value
-
added investment returns ≥ that of the reference portfolio


Performance:



27

Annualized

return

Fiscal year 2013

10.2%

5
-
year

4.2%

10
-
year

7.4%