Herbert von Soltanini, CFA, manages a variety of balanced portfolios for Great Performance Asset Management (GPAM). GPAM has a broad base of clients covering the entire spectrum of institutional investors. The firm manages money globally, but the bulk of its clients are located in Europe and the Americas.
Soltanini is scheduled to travel to the US in a few weeks for annual meetings with key clients in New York, Boston, and Chicago. Great Performance requires portfolio managers to review the investment policy statements (IPS) of each client before the annual meeting to ensure that the IPS still meets the current requirements of the client, and that the IPS is up to date before any revisions are made to it as a result of the annual meeting.
In preparation for the trip, Soltanini asked his assistant, Domenico Bachandel, to review the relevant United States-based clients and the status of their investment policy statements. Bachandel immediately finds a potential discrepancy in the IPS among the firm’s pension fund clients, and asks Soltanini for a meeting to discuss the problem.
Soltanini manages portfolios for many large plans. Although the majority of the plans are defined benefit, there are also several defined contribution plans for which Soltanini manages investment funds. The status of the defined benefit plans varies considerably. Most try to maintain contributions in line with actuarial requirements, but Soltanini’s defined benefit pension clients cover the full spectrum, from severely underfunded to significantly overfunded.
In addition, the range of beneficiaries varies widely as well. Some of Soltanini’s oldest client relationships are with the defined benefit plans sponsored by long-established firms. These firms’ employee bases often consist mostly of skilled manufacturing workers with high salaries and generous pension benefits. They generally have a very large proportion of retirees and extremely high requirements for current income to pay the benefits of the plan’s retirees. Often, their plans are severely underfunded. A clear example is Riverbank Manufacturing, which covers all employees with a defined benefit plan. The plan is extremely generous and drastically underfunded because more plan participants are retired than are currently employed.
In contrast, Soltanini has more recently developed relationships with many firms in the service sector, especially financial services, communications, and technology. Most of these firms have defined contribution plans, but Soltanini also manages several defined benefit plans sponsored by service sector firms as well.
The defined benefit plans for the newer clients tend to be fully-funded. In fact, many of them are significantly overfunded because the firms make large pension contributions in good years to give themselves the flexibility to reduce required contributions in bad years. These plans tend to have a very small percentage of retirees – in many cases, less than 5% – and very high turnover among workers, so that only a small percentage become vested in the plan.
In addition, these plans tend to offer less generous pension benefits than the plans established earlier by the manufacturing firms. Consequently, many of Soltanini’s service sector clients find that funding their defined benefit plans is relatively inexpensive for the plan sponsor. Sunrise Telecom is a perfect example of this. Only 3% of the plan participants at Sunrise are retired, and it experiences a very high turnover among workers. Previous contributions to the pension plan have provided sufficient portfolio assets to make the plan substantially overfunded.
Bachandel is concerned because his review showed a great divergence of investment objectives in the IPS for the various pension clients and several of the IPS for the plans appear to conflict. The IPS for the plan at Riverbank Manufacturing indicates a very low tolerance for risk, while that for Sunside Telecom indicates a very high risk tolerance. Given that these are both defined benefit plans, Bachandel wonders why the IPSs are so different.
At the meeting with Soltanini, Bachandel suggests one possible explanation for the discrepancies by saying, “The return requirements for defined benefit pension plans don’t have to be similar since they are determined by the life cycle stage of the beneficiaries.” Soltanini points out, “The risk tolerance of the plan will depend on the risk tolerance of the beneficiaries.”
Bachandel also raises concern about the IPS statements in general, since the problems extend beyond the pension fund clients. He sees a striking difference in the IPS of the various insurance companies for which Great Performance manages portfolios, as well.
Bachandel clarifies for Soltanini, “The return requirements for life insurance companies depend primarily on policy pricing and financial strength.” He hypothesizes to Soltanini that this fact could explain the discrepancies in their stated return requirements. Soltanini adds that all their insurance company clients will most likely have similar risk tolerances. “The risk tolerance at both life and casualty insurance companies is likely to be below average because of regulatory constraints.”
Bachandel and Soltanini decide that there is no obvious problem with the client investment policy statements. They agree to wait and review the IPS with the clients at the upcoming annual meetings.
The most likely event to be successfully diversified away in a portfolio would be:
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unanticipated corporate loss. | |
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unanticipated inflation. | |
Portfolios can diversify unsystematic risk but cannot diversify systematic risk. Corporate events are sources of unsystematic risk in a portfolio and thus can be diversified away. Inflation, consumer confidence and the business cycle are all sources of systematic risk. (Study Session 18, LOS 71.a)
Regarding Bachandel’s and Soltanini’s assertions about the risk tolerance of defined benefit pension plans:
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Soltanini’s statement is incorrect; Bachandel’s statement is correct. | |
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Soltanini’s statement is incorrect; Bachandel’s statement is incorrect. | |
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Soltanini’s statement is correct; Bachandel’s statement is correct. | |
Both statements are incorrect. Bachandel’s statement is incorrect because return requirements depend on the life cycle stage of beneficiaries at defined contribution, not defined benefit, plans. Soltanini’s statement is also incorrect because the risk tolerance of a defined contribution, not defined benefit, plan is determined by the risk tolerance of the beneficiaries. (Study Session 18, LOS 71.f)
Which of the following is least likely to be considered part of the planning phase of the portfolio management process?
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Determining the appropriate investment strategy. | |
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Selecting appropriate individual investments. | |
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Developing an investment policy statement. | |
The planning phase of the portfolio management process consists of analyzing objectives and constraints, developing an IPS, determining the appropriate investment strategy, and selecting an appropriate asset allocation. Selecting appropriate individual investments is part of the execution phase, not the planning phase. (Study Session 18, LOS 71.b)
Regarding Bachandel’s and Soltanini’s assertions about the return requirements and risk tolerances for insurance companies:
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Soltanini’s statement is correct; Bachandel’s statement is incorrect. | |
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B) |
Soltanini’s statement is incorrect; Bachandel’s statement is correct. | |
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C) |
Soltanini’s statement is correct; Bachandel’s statement is correct. | |
Soltanini’s statement is correct since both life and non-life insurance companies tend to have below average risk tolerance because of significant regulatory constraints. Bachandel’s statement is incorrect because the return requirements of non-life insurance companies depend primarily on policy pricing and financial strength. The return requirements of life insurance companies depend primarily on policy holder reserve rates. (Study Session 18, LOS 71.f)
The most accurate characterization of the proper use of strategic asset allocation would be:
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market expectations determine the objectives and constraints of the investor, which translate into strategic asset allocation. | |
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active investment strategies should be used instead of strategic asset allocation when the portfolio manager believes he can exceed market returns. | |
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forecasts of risk-return characteristics of asset classes included in the portfolio connect market expectations to the objectives and constraints of the investor. | |
Active and passive investment strategies are investment approaches, not replacements for strategic asset allocation. Passive approaches are less, not more, responsive to changes in expectations. Market expectations do not determine the objectives or constraints of the investor. (Study Session 18, LOS 71.c)
Which of the following is least likely to be considered one of the five main classes of investment constraints?
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Willingness to assume risk. | |
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The five main classes of investment constraints are liquidity, time horizon, legal and regulatory concerns, tax considerations, and unique circumstances. Willingness to assume risk is an aspect of risk tolerance, which is considered an investment objective, not an investment constraint. (Study Session 18, LOS 71.c) | 
发表于 2010-4-15 21:58
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