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Investment strategy- institutions (Factors affecting the long-term…
Investment strategy- institutions
Criteria for an investment objective
Clearly stated
Quantifiable
Framed in terms of risk,total required return and timing of cashflows
Examples of investment objectives for an institutional investor
To meet the liabilities as they fall due
To control the incidence of obligations on a third party (e.g. employer pension contributions)
To provide sufficient funds to meet the liabilities as they fall due
To provide sufficient funds to meet the liabilities as they fall due
To provide sufficient funds to meet the liabilities on discontinuance
Examples of definitions of risk
Standard deviation or volatility of return from an investment
The probability of ruin (or complete failure of an investment)
The probability of failing to achieve the investor's objectives (e.g. under-performing competitors)
Factors affecting the risk appetite of an institutional investor
The nature of the institution (e.g. pension fund, insurer, bank)
The constraints of its governing body and documentation
Legal or statutory controls
Factors affecting the long-term investment strategy of an institutional strategy of an institutional investor (SOUNDER TRACTORS)
SIze of the assets (absolute/relative)
Objectives
Uncertainty of the liabilities
Nature of liabilties
Diversification
Existing asset portfolio
Return (expected long term)
Tax treatment of the assets/investor
Restrictions- statutory/legal/voluntary
Accrual of liabilities in the future
Currency of the existing liabilities
Term of the existing liabilties
Other funds' strategies (competition)
Risk appetite
Solvency requirements
Why investors may prefer high-income to low-income yielding investments
Currently has high cash outflow requirements and wants to avoid the expense and uncertainty of realising assets
Is not worried about reinvestment risk
pays a higher rate of tax on capital gains than on income.
Factors to consider before making a tactical asset switch
Expected extra returns relative to the extra risk taken
Ability to absorb extra risk, i,e, the level of free assets
Constraints on the ability to make the switch, e.g. regulation
Expenses of making the switch, e.g. dealing expenses
The problems of switching a large portfolio of assets, e.g. price shifting
Tax implications, e.g. crystallising capital gains.
Factors to consider when selecting individual assets for a fund
The expected return net of tax and expenses
The volatility of returns
Whether the asset selected has a low covariance with the other assets in the portfolio => diversification => reduced specific risk