Managing Institutional Investor Portfolios －LO class, investment, contrast, relevant

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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 n: Compare and contrast the investment objectives and constraints of institutional investors given relevant data such as descriptions of their financial circumstances and attitudes toward risk.

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The following statements concern differences between the investment policy statement for an institution and that for an individual. Which of these statements is FALSE? The institutional investment policy statement:

A) is likely to give more prominence to legal constraints.

B) has four main steps--planning, estimation, execution, and feedback--while the individual investment policy statement has three.

C) is likely to give more prominence to regulatory constraints.

D) may have asset structure and liquidity requirements that are driven by the institution's liability structure.

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Answer and Explanation

Both individual and institutional policy statements should have three main steps: planning, execution, and feedback. The institutional statement is more likely to include legal and regulatory constraints, and may have the asset structure and liquidity requirements driven by the institutions liability structure.

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The ending of a general business cycle may indicate the last rounds of increased firm profitability. With the prospects of lower profits on the horizons, a pension fund plan sponsor may wish to take which of the following actions? Shift pension assets into those that have a:

A) high correlation with pension liabilities and low correlation with the firm's operations.

B) low correlation with pension liabilities and high correlation with the firm's operations.

C) high correlation with pension liabilities and high correlation with the firm's operations.

D) low correlation with pension liabilities and low correlation with the firm's operations.

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Answer and Explanation

Pension assets that are highly correlated with pension liabilities and have a low correlation with the firms operations will have a greater probability of meeting pension fund obligations and lowering contributions in the event contributions are required during the upcoming business cycle downturn.

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A nonlife insurance company is facing the end of its underwriting cycle. What should the firm do with respect to the duration of its fixed-income portfolio and the liquidity constraints in its policy statement? The duration of the nonlife insurance companys fixed-income portfolio should be:

A) lengthened in expectation of decreasing claims, and the investment policy statement should reflect the possibility of a decreasing claims environment in its liquidity constraint towards the end of its underwriting cycle.

B) lowered in expectation of decreasing claims, and the investment policy statement should reflect the possibility of a decreasing claims environment in its liquidity constraint towards the end of its underwriting cycle.

C) lengthened in expectation of increasing claims, and the investment policy statement should reflect the possibility of an increasing claims environment in its liquidity constraint towards the end of its underwriting cycle.

D) shortened in expectation of increasing claims, and the investment policy statement should reflect the possibility of an increasing claims environment in its liquidity constraint towards the end of its underwriting cycle.

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Answer and Explanation

Nonlife insurance companies experience a noted underwriting cycle that generates low claim submissions at the beginning of the cycle and high claim submissions at the end of the cycle. The investment policy statement should reflect this changing underwriting cycle reality, which would impact a greater liquidity constraint towards the end of the cycle. Bond portfolio durations should be lowered, if they have not been already, to meet the impending increased claims submissions.

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A portfolio manager at an endowment fund expects inflation to increase over the intermediate to long term. How should the return objective of the investment policy statement reflect these expectations?

A) An exclusive capital gain oriented approach should be followed so that purchasing power is preserved, while at the same time spending requirements must be reduced.

B) A total return objective should be pursued so that spending requirements are met, while at the same time purchasing power of fund assets is maintained.

C) An exclusive income oriented approach should be adopted so that spending requirements can be met in the impending inflationary environment.

D) An exclusive income oriented approach should be adopted so that purchasing power is maintained.

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Answer and Explanation

An endowment fund should adopt a total return objective, especially in an impending inflationary environment. In this way, not only are current spending requirements met, but the ability to meet future spending requirements is also increased.