CFA III- Institutional Investors 关键词清单 2018 – Vol 2

CFA III Institutional Investors 关键词清单 Vol 2

Session 6 Portfolio Management for Institutional Investors

Reading 13 Managing Institutional Investors Portfolios

2 Pension Funds 3M463: 2 大类：defined-benefit plan: specifies the plan sponsor’s obligations
regarding benefit to plan participants. & defined-contribution plan: specifies the sponsor’s
obligations regarding contributions to pension fund. 3M463 hybrid types cash balance plan: a
defined-benefit plan whose benefits are displayed in individual recordkeeping accounts. 3M463
Defined-contribution plan: 1) profit-sharing plan: contributions are based in part on plan
sponsor’s profits. 2) individual, private business, and governmental tax-advantaged savings plans
3M463
DC 和 DB plan 的区别 3M463
 For DC plans, because benefit is not promised, tplan sponsor recognizes no financial liability.
 DC plan participants bear investing risk. DB plan participants bear early termination risk.
 Because records are kept on an individual-account basis, DC plan participants’ retirement
assets are more readily portable ( move to a new plan). 3M464
From an Investment standpoint, DC plans fall into two types: 3M464
 Sponsor directed, like a DB plan, sponsor chooses investments. 比如 some profit-sharing
plans (retirement plans)
 Participant directed: sponsor provides a menu of diversified investment options and the
participants determine their own personalized investment policy. Most DC plans are
participant directed.
2.1 Defined-Benefit Plans: Background & Investment Setting 3M464
fully funded plan; Pension surplus; Underfunded plan: 3M465

Three basic liability concepts under pension plans: 3M465

1. Accumulated benefit obligation (ABO)：present value of pension benefits to date for a
terminated plan. Exclude impact of expected future salary increases.3M465
2. Projected benefit obligation（PBO） ：同 ABO 但 Includes impact of expected compensation
increases & measure pension liability for a going concern.3M465
3. Total future liability: present value of accumulated and projected future service benefits,
including effects of projected future compensation increases.3M465
retired-lives: retirees，正在领退休金
active-lives: 在职职工，还未领退休金
Develop a IPS for DB plan: 3M465
2.1.1 Risk Objectives 3M465:

1
 CFA III- Institutional Investors 关键词清单 2018 – Vol 2
2

Asset / Liability management: a subset of a company’s overall risk management practice that
typically focuses on financial risks created by interaction of assets and liabilities;比如：1) pension
surplus. DB plans state a risk objective on level of pension surplus volatility (i.e., standard
deviation). 2) Another risk objective relates to shortfall risk on plan liabilities achieving: 3M467
- a funded status of 100 percent (or some other level) with respect to the ABO, PBO, or total
future liability;
- a funded status above some level that will avoid reporting a pension liability on balance
sheet;
- a funded status above some regulatory threshold. 3M468
Other goal influencing risk objectives: 3M468
•Minimize the year-to-year volatility of future contribution payments.
•Minimize probability of making future contributions 3M468
2.1.2 Return Objectives 3M468:
DB plan primary return objective: achieve returns that adequately fund its pension liabilities on
an inflation-adjusted basis 3M468
Return requirement beginning with discount rate used to calculate PV of plan liabilities. The
pension fund’s desired return may be higher than its required return (R.R.只要达到 discount rate
即可), 鉴于：3M469
1） minimize future pension contributions.
2） Generate pension income.
3） 组 合 中 active-lives portion of pension liabilities(long-term growth orientation)against
retired-lives portion (immediate liquidity).
2.1.3 Liquidity Requirement 3M470: plan liquidity requirement = net cash outflow = benefit
payments minus pension contributions).
 The greater the number of retired lives, the greater the liquidity requirement, all else equal.
 The smaller the corporate contributions on benefit disbursements, the greater the liquidity
requirement
 Plan features such as option of early retirement and/or option of lump-sum payments create
higher liquidity requirements.
2.1.4 Time Horizon 3M471 for DB plan 取决于：
- whether the plan is a going concern or plan termination is expected; and
- workforce age and proportion of active lives. 3M471
- Multistage: active-lives portion & retired-lives portion 3M472
2.1.5 Tax Concerns 3M472: DB plan 运作一般免税
2.1.6 Legal & Regulatory Factors 3M472 pension plan trusteefiduciary
2.1.7 Unique Circumstances 3M473
1) Human and financial resources available to plan sponsor(smaller pension plans).
2) self-imposed constraint against investing in certain industries or countries. 3M473
Example 7 Apex Sports Equipment Corporation Defined-Benefit Plan IPS 3M474 再看一遍
2.1.8. Corporate Risk Management and the Investment of DB Pension Assets 3M476
Two concerns from risk management perspective: 3M476
1) manage pension investments in relation to operating investments; and
correlation between sponsor operating results and pension asset returns the lower the
correlation, the greater the risk tolerance, all else equal 3M477

2
 CFA III- Institutional Investors 关键词清单 2018 – Vol 2
3

2) coordinate pension investments with pension liabilities.(asset/liability management)

2.2 Defined-Contribution Plans: Background and Investment Setting 3M477
1) Even for participant-directed DC plans, plan sponsor must have a written IPS. IPS documents
the manner in which plan sponsor is meeting the fiduciary responsibility to have an adequate
process for selecting investment options offered to plan participants as well as for periodically
evaluating those options 3M478
2.2.1. The Objectives and Constraints Framework 3M478
2) Plan sponsor does not establish objectives & constraints; The plan sponsor provides
educational resources, but the participant is responsible for choosing a risk and return objective
reflecting his or her own personal financial circumstances, goals, and attitudes toward risk.
3M478
Example 8 Participant Wanting to Make Up for Lost Time 3M478(可再看)
Example 9 Participant Early in Career 3M479
3) Participant-directed DC plan’s IPS is applied to a group of plan participants) rather than for a
specific plan participant: 3M479
Example 10 Investment Policy Statement for BMSR Company Defined-Contribution Plan479
2.3 Hybrid and other Plans
1. A cash balance plan 1) a DB plan as employer bears investment risk. 2) To employees, a DC
plan as they are provided a personalized statement showing their account balance, an annual
contribution credit(percentage of pay based on age), and an earnings credit ( percentage
increase in account balance tied to long-term interest rates). 3M483
2. Employee stock ownership plan (US) or Employee Share Ownership Plan(UK): 1) DC plans
that invest all or the majority of plan assets in employer stock. 2) The contribution is set as a
percentage of employee pay. 3) final value of the plan for the employee will depend on
vesting schedule, contribution level, and the change in stock per-share value.3M483
3. Foundations & Endowments 3M484 二者虽都是 donations,但运作不同
Foundations: grant-making 拨款 institutions funded by gifts and investment assets;
Endowments：1) long-term funds owned by non-profit institutions such as universities, museums,
hospitals, and other organizations involved in charitable activities.3M484 ;2) supplement other
revenue sources such as tuition, fees. 3M484
3.1. Foundations: Background and Investment Setting 3M484independent foundation 为主

3
 CFA III- Institutional Investors 关键词清单 2018 – Vol 2
4

注 endowments and other NGOs don’t face mini spending requirement. 3M485
3.1.1 Risk Objectives 3M486
Higher risk tolerance than defined benefit plans etc as funding needs of organizations supported
by foundations are unbounded ( no defined liability streams) 3M486
3.1.2 Return Objectives 3M486 =minimum annual spending + investment management expenses
+ expected inflation rate （三者可相乘 multiplicative）
long-term return objective is to preserve real value of the investment assets while allowing
spending at an appropriate rate.
3.1.3 Liquidity Requirements 3M486
A foundation’s liquidity requirements are anticipated or unanticipated cash needs.
1) Anticipated needsperiodic distributions prescribed by a foundation’s spending rate.
2) Smoothing rule: averages asset values over a period of time in order to dampen the
spending rate’s response to asset value fluctuation.
3) US Internal Revenue Service (IRS) allows carry-forwards and carry-backs so that as a result of
overspending in prior years, a foundation may be allowed to underspend in a subsequent
year. 3M487
4) Cash reserve: maintain a fraction of annual spending as a cash reserve in the
portfolio .3M487
3.1.4 Time Horizon: 3M487last into perpetuity. All else equal, longer time horizon, greater
ability to bear risk 3M487
3.1.5 Tax concerns 3M487：
Unrelated business income: In U.S., those incomes are not substantially related to a foundation’s
charitable purposes, which is subject to regular corporate tax rates. 3M487
3.1.6 Legal & regulatory Factors 3M488: 看所在国和 foundation 种类。
3.1.7 Unique Circumstances 3M488
Example 12 Fund for Electoral Integrity 3M488 ( Foundation IPS 再看一遍)
3.2 Endowments: Background & Investment Setting 3M489
Legally and formally, the term “endowment” refers to a permanent fund established by a donor
with the condition that the fund principal be maintained over time. 3M489
1) No minimum spending requirement in U.S.
2) Example of spending rules: 3M491
 Simple spending rule:
Spendingt = Spending rate × Ending market valuet–1
 Rolling three-year average spending rule:
Spendingt = Spending rate × (1/3) [Ending market valuet–1 + Ending market
valuet–2 + Ending market valuet–3] 前三年 ending MV 算术平均值
 Geometric smoothing rule.
Spendingt = Smoothing rate × [Spendingt–1 × (1 + Inflationt–1)] + (1 – Smoothing
rate) × (Spending rate × Beginning market valuet–1)
3.2.1 Risk Objectives 3M491:
1) Spending policies with smoothing or averaging rules  accept short-term portfolio volatility
while striving for high long-term investment returns necessary to fund programs and maintain
purchasing power.
2) Endowments without smoothing rule less tolerance for short-term portfolio risk.

4
 CFA III- Institutional Investors 关键词清单 2018 – Vol 2
5

3) Low investment risk does not equate to low risk for meeting endowment spending
objectives.3M492
4) An institution’s risk tolerance depends on the endowment’s role in the operating budget（收入
贡献占比）and the institution’s ability to adapt to drops in spending.
5) On a short-term basis, an endowment’s risk tolerance can be greater if endowment has
experienced strong recent returns and smoothed spending rate is below long-term average or
target rate.3M492
3.2.2 Return Objectives 3M492
1) Endowment funds should maintain their long-term purchasing power after inflation. 3M492
2) mean–variance analysis & Monte Carlo simulations 对算回报率有用. 3M493
3) An endowment’s returns need to exceed spending rate to protect against a long-term loss of
purchasing power. 3M494
4) A good starting point: Return objective = spending rate + cost of generating investment
returns + expected inflation rate 3M494
3.2.3 Liquidity Requirements 3M494: well suited to invest in illiquid, non-marketable securities.
3.2.4 Time Horizon 3M494extremely long term.
3.2.5 Tax Concerns 3M495: endowments by non-profit org are tax exempt 但 unrelated business
taxable income may be subject to tax.
3.2.6 Legal & Regulatory Factors 3M495 UMIFA = Uniform Management Institutional Fund Act
3.2.7 Unique Circumstances 3M495
1) Ethical investment policies 3M496
2) if investment committee has a relatively high turnover, 投资战略容易不断更改 3M498
Example 13 The City Arts School ---Endowment IPS 3M496 (再看一遍)
4. The Insurance Industry 3M499
3 大类：life insurance, health insurance & property & liability insurance 3M499
总体分两类 either as stock companies (companies that have issued common equity shares) or as
mutuals (companies with no stock that are owned by their policyholders). 3M499
4.1 Life Insurance Companies: Background and Investment Setting 3M499
Investment setting: exposure to interest-rate-related risk
Disintermediation: 换回报率高的金融机构投资
1) policyholders borrow against accumulated cash value in insurance products 3M499
2) policyholders will surrender their cash value life insurance policies for their accumulated cash
values to reinvest，趁利率增 3M500
因此 insurers face marketplace pressures to offer competitive cash value accumulation rates or
credited rates 3M500
Universal life, variable life, and variable universal life represent the insurance industry’s response
to disintermediation.==> cash value buildup is linked to investment returns. 3M500
4.1.1 Risk Objectives 3M501
<1>To absorb modest principal loss, US life insurance companies are required to maintain an
asset valuation reserve established by National Association of Insurance Commissioners (NAIC).
<2> risk-based capital (RBC) requirements: companies maintain adequate surplus to cover
their risk exposures relating to both assets and liabilities.另外 applying GAAP to insurance
companies 产生资负表不一致（资产按市价，但负债 life insurance liabilities 没有）3M501
<3> Asset/Liability risk consideration 一直影响 life insurer’s risk objectives,因为 1)need to fund

5
 CFA III- Institutional Investors 关键词清单 2018 – Vol 2
6

insurance benefits (asset 部 分 ); 2) interest-rate-sensitive liabilities （ 源 于 annuities 和

desposit-type contracts）3M501
Risk objectives in relation to interest rate risks: 3M502
一、address mismatch of duration of assets and liabilities
1) Valuation Concerns: In a period of changing interest rates, a mismatch between duration of
an insurance company’s assets and that of its liabilities can lead to erosion of surplus.(利率上
升，资产价格减记，负债不变，surplus 减少) limit risk tolerance. 3M502
2) Reinvestment risk: risk of reinvesting coupon income or principal at a rate less than
original coupon or purchase rate. 例如 annuity contracts where no interest is paid until
maturity. 3M502
二、Control loss caused by credit risk: through broad diversification and seek adequate
compensation for taking risk in terms of expected return or interest rate spread.
三、control cash flow volatility: Loss of income or delays in collecting and reinvesting cash flow
from investments low tolerance. 3M 502
4.1.2 Return Objectives: 3M503
1) net interest spread:
minimum required return = actuaries’ assumed growth rate in policyholder reserves.
net interest spread(desired return) = interest earned - interest credited to policyholders 3M503
2) Total return: comprehensive fair market value accounting standards are developed in the
future 3M504
3) Segmentation of insurance company portfolios has promoted establishment of sub-portfolio
return objectives to promote competitive crediting rates for groups of contracts.
4) the need to grow surplus to support expanding business volume. Common stocks, equity
investments in real estate, and private equity have been the investment alternatives most widely
used to grow surplus.3M505
4.1.3 Liquidity Requirements 3M505 address two risks:
1)Disintermiediation: an asset/liability mismatch can magnify disintermediation effects.
2)Asset marketability risk: easy to liquidate or not 3M505-506
Derivatives market growth has lead many companies to look for derivative-based risk
management solutions. 3M506
4.1.4 Time Horizon: 3M506
1) Asset/liability management practices shorten overall investment time horizon of typical life
insurance company.
2) portfolio segments have differing time horizons & return objectives, reflected in each
segment’s investment policies. 3M506
4.1.5 Tax Concerns 3M506: insurance companies are tax-paying.
简化版: life insurance companies’ investment income can be divided into two parts for tax
purposes: the policyholders’ share (that portion relating actuarially assumed rate necessary to
fund reserves) and the corporate share (the balance that is transferred to surplus). Under
present US law, only the latter portion is taxed. 3M506
4.1.6 Legal & Regulatory Factors: heavily regulated industry primarily at state level in U.S. 3M506
1) Eligible investments: Insurance laws determine asset classes eligible for investment and may
specify quality standards for each asset class. ; Regulations specify the percentage of an
insurance company’s assets that may be invested in a specific class of eligible assets. 3M507

6
 CFA III- Institutional Investors 关键词清单 2018 – Vol 2
7

2) Prudent investor rule: Replace traditional “laundry lists” of approved investments with
prudent investor logic，给予投资灵活性. 3M507
3) Valuation methods: In the European Union, International Accounting Standards specify a set
of valuation procedures. In the United States, uniform valuation methods by the NAIC. 3M507
4.1.7 Unique Circumstances: Company’s size and its surplus position sufficiency 3M508
Example 14 Investment Policy Statement for a Stock Life Insurer 3M508
4.2. Non-Life Insurance Companies: Background and Investment Setting 3M511
Non-life(casualty) sector; 与 life insurance company 不同之处：
 non-life liability durations are shorters;
 some non-life liabilities are exposed to inflation risk
 A life insurance company’s liabilities are certain in value but uncertain in timing, while a
non-life insurance company’s liabilities are uncertain in both value and timing, exposed to
more volatility in their operating results. 3M511
“Long tail” refers to the possibly long time span between the liability-triggering event and the
filing of a claim related to it. 3M511
4.2.1 Risk Objectives 3M512 同 life insurance ability to meet policyholders’ claims
The risks insured by casualty companies are less predictable. 3M512
1) Cash flow characteristics. cash flows from casualty insurance operations can be quite erratic.
casualty companies have low tolerance for principal loss or diminishing investment income.
2) Common stock to surplus ratio: 3M512
The casualty industry has almost no absolute limits imposed by regulation in US. However,
many casualty companies have adopted self-imposed limitations restricting common stocks
at market value to some significant but limited portion (frequently one-half to three-quarters)
of total surplus. 3M513
4.2.2 Return Objectives. 3M513
1) Competitive policy pricing: competition results in low insurance policy premium rates so that
insurance companies set high desired investment return objectives. 3M513
2) Profitability: casualty insurance portfolios are managed to maximize return on capital and
surplus. 3M514
3) Growth of surplus: provides the opportunity to expand the volume of insurance the company
can write. Casualty companies have invested in common stocks, convertible securities, and
alternative investments to grow surplus.3M514
4) Tax considerations: Flexibility to shift between taxable and tax-exempt bonds3M514
5) Total return management: active bond portfolio management strategies designed to achieve
total return, rather than yield or investment income only. 3M514
4.2.3 Liquidity Requirements 3M515
Liquidity needs are higher and less predictable. Investment cash flows will be a primary source of
liquidity. Publicly traded securities will be an additional source of liquidity. (Example 15 3M519)
4.2.4 Time Horizon 3M515
1) casualty liabilities durations are shorter than those of life insurance liabilities.
2) underwriting cycles affect the mix of taxable and tax-exempt bond holdings.
4.2.5 Tax Concerns 3M516: tax-exempt bond income is subject to tax for US casualty insurance
companies; 3M517
4.2.6 Legal & Regulatory Factors 3M517比 life insurance 宽松（permissive）； casualty

7
 CFA III- Institutional Investors 关键词清单 2018 – Vol 2
8

insurance companies are given more flexibility in choosing investments without restriction as to
the amount invested in any particular asset class 3M517
4.2.7 unique circumstances 3M517
Example 15 Investment Policy Statement for a Casualty Insurance Company 3M518

5. Banks and Other Institutional Investors 3M519

5.1. Banks: Background and Investment Setting
A bank’s Asset/Liability risk management Committee(ALCO): 3M520
Profitability measures ALCO will monitor: 3M521
1) Net interest margin = net interest income (即 interest income – interest expense) / average
earning assets. 3M521
2) Interest spread = average yield on earning assets - average percent cost of interest-bearing
liabilities. 3M521
Risk measures ALCO will monitor: 3M521

1) Leverage-adjusted duration gap = DA – kDL, where DA is the duration of assets, DL is the

duration of liabilities, and k = L/A, the ratio of the market value of liabilities (L) to the market
value of assets (A). The leverage-adjusted duration gap measures a bank’s overall interest
rate exposure.
2) Position and aggregate Value at Risk (VaR) : 3M 521
3) Credit risk measures 3M521
Banks’ objectives in managing securities portfolios（主要是 debt securities）按以下重要次序排
列 3M521:
 To manage overall interest rate risk of balance sheet: Bank-held securities are negotiable
instruments trading in liquid markets. Therefore, securities are natural adjustment
mechanism for interest rate risk.
 To manage liquidity. assure adequate cash is available to bank. 3M521
 To produce income:
 To manage credit risk: modify and diversify overall credit risk exposure to a desired
level.3M522
Pledging requirement: required collateral use of assets 3M522
5.1.1 Risk Objectives 3M522
Although high interest margins are preferred, banks must not assume a risk level that jeopardizes
their ability to meet their liabilities to depositors and other entities. Banks have below-average
risk tolerance.
5.1.2 Return Objectives 3M523 the need to earn a positive return on invested capital. For the
interest-income part of return, earn a positive spread over cost of funds.
5.1.3 Liquidity Requirements 3M523 net outflows of deposits & demand for loans. 3M523
5.1.4 Time Horizon 3m523 A bank’s liability structure reflects an overall shorter maturity than its
loan portfolio, limiting its securities portfolio time horizon length in three- to seven-year range
(intermediate term).
5.1.5 Tax Concerns 3M523 Banks’ securities portfolios are fully taxable.3M523
5.1.6 Legal & Regulatory Factors 3M523 Regulations place restrictions on banks’ holdings of
common shares and below-investment-grade risk fixed-income securities. To meet legal reserve

8
 CFA III- Institutional Investors 关键词清单 2018 – Vol 2
9

and pledging requirements banks may need to hold substantial amounts of short-term
government securities. Risk-based capital (RBC) regulations are a major regulatory development
3M523
5.1.7 Unique Circumstances 3M524 no common unique circumstances
Example 16 Investment Policy Statement for a Commercial Bank 3M524
5.2. Other Institutional Investors: Investment Intermediaries 3M526
1) Investment Companies: Mutual funds (open-end), closed-end funds, unit trusts, & ETFs 
a) pooled investor funds b) pure investment vehicles (no other corporate purpose besides
investing). 3M526
2) Commodity pools serve similar purposes, but in futures rather than equity and fixed-income
markets.
3) Hedge funds differ from investment companies in that they market to other institutional
investors and to high-net-worth individuals exclusively & subject to fewer regulations. 3M526
小结：In contrast to other types of institutional investors, one cannot generalize about the
investment objectives and constraints of these types of investors. 3M529（可不背）

Among institutional investors, ALM considerations are particularly important for DB pension
funds, insurance companies, and banks. 3M529(Summary)