Managing Institutional Investor Portfolios －LO pools, companies, investment

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 5: Portfolio Management for Institutional Investors
Reading 21: Managing Institutional Investor Portfolios
LOS k: Contrast investment companies, commodity pools, and hedge funds to other types of institutional investors.

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Which of the following CORRECTLY describes the primary source of invested funds to meet funding requirements for an endowment fund and an investment company?

Endowment Fund

Investment Company

A) Own assets Own assets

B) Assets pooled from investors Assets pooled from investors

C) Assets pooled from investors Own assets

D) Own assets Assets pooled from investors

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Answer and Explanation

The primary difference between investment companies and other institutional investors such as an endowment fund is the source and use of their invested funds. The endowment fund will invest its own assets to meet various funding requirements while the investment company will collect funds from investors to meet the needs of the investors.

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Dr. Jack Wolfe, a finance professor with the University of Tulsa asked his students to identify differences between a pension fund and a growth mutual fund. Kelly Musch, a student in Wolfes class, turned in a paper with two statements:

Statement 1:	The pension fund is likely to have more flexibility to significantly change its asset allocation.
Statement 2:	The pension fund could invest in the mutual fund, but the mutual fund could not invest in the pension fund.

When grading Muschs paper, Dr. Wolfe should:

A) agree with Statement 1 and Statement 2.

B) disagree with Statement 1 and Statement 2.

C) agree with Statement 1, but disagree with Statement 2.

D) disagree with Statement 1, but agree with Statement 2.

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Answer and Explanation

When grading the paper, Dr. Wolfe should agree with both of Muschs statements. Musch has indirectly hit on the two key differences between a mutual fund (investment company) and other types of institutional investors such as pension funds. The pension plan uses its own assets to meet various funding requirements while the mutual fund invests money pooled from investors based on advertised objectives and constraints. It would be relatively easy for the pension fund to have a meeting and decide to adjust its asset allocation, while the growth mutual fund, which advertises its objectives in a prospectus would likely have to change the prospectus that governed the objective of the fund and possibly hold a shareholder proxy vote. Statement 2 is also correct. The mutual fund invests funds on behalf of other investors, while the pension fund is part of a company. Since the pension is an investor itself, the pension fund could invest in the mutual fund, but the mutual fund could not invest in the pension.

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Connie King prepared a memo for her supervisor that listed the similarities and differences between the investment objectives of a life insurance company versus the investment objective of a commodity pool. The memo contained the following statements:

Statement 1:	Both life insurance companies and commodity pools are taxable entities.
Statement 2:	Life insurance companies invest in order to meet various funding requirements while commodity pools invest according to objectives advertised to investors.
Statement 3:	The source of invested assets for both life insurance companies and commodity pools are assets pooled from investors.

Kings memo is:

A) correct with respect to Statements 1, 2, and 3.

B) correct with respect to Statement 2, but incorrect with respect to Statements 1 and 3.

C) incorrect with respect to Statements 1, 2, and 3.

D) correct with respect to Statements 1 and 2, but incorrect with respect to Statement 3.

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Answer and Explanation

King is correct with respect to Statement 1. Both commodity pools and life insurance companies are taxable entities. The primary difference between commodity pools, and other institutional investors (like life insurance companies) is the source and use of their invested funds. King is correct with respect to Statement 2 in that the use of funds for the two types of investors is different. Life insurance companies invest in order to meet various funding requirements while commodity pools invest according to objectives advertised to investors. King is incorrect with respect to Statement 3, however. The source of invested funds for a life insurance company is its own assets (likely gathered from premium payments) while the source of funds for a commodity pool is assets pooled from investors.