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14-1 asset allocation with real-world constraints (2 constraints in asset…
14-1 asset allocation with real-world constraints
1 introduction
2 constraints in
asset allocation
asset size
limit the opportunty set
economies and diseconomies of scale
sufficient governance capacity
sufficient size
too large - exhaust the capacity of active external investment managers in certain asset classes and strategies
disadvantage and advantage
increasing returns to scale
larger trade sizes incurring greater price impact
cause to pursue ideas outside core investment theses
organizational hierarchies slow down decision making and reduce incentives
smaller asset owners
limited governance infrastructure
assecc to other asset classes and strategies constrained
the commingled vehicles
regulatory restrictions
impose a size constraint
must be either accredited or qualified purchasers in many PE and hedge fund vehicles
liquidity
two dimensions
the liquidity needs of the asset owner
the liquidity characteristics of the asset classes in the opportunity set
long-term investors such as
sovereign wealth funds and endowment funds
exploit illituidity premiums available in
PE RE infrastructure investment
particular circumstances and financial strength of asset owner
resources beyond held in portfolio
evaluate potential liquidity needs in extreme market stress event
to consider in the context of the asset owner's governance capacity
time horizon
a liability to be paid or a goal to be funded define horizon
the changing composition of the asset and liabilities considered
changing human capital
declines over time
changing character of liabilities
nearer-term fully funded, longer-term move progerssively
affect the manner investor prioritizes certain goals and liabilities
lifestyle/consumption goal
required min consumption reguirements
remain very important
baseline consumption nedds
aspirational consumption needs
much lower priority
regulatory and other
external constraints
insurance
companies
investment returns often material contributor to profits or losses
highly focused on matching asset to the projected, probabilistiic cash flows of the risk underwrithing
risk considerations
the need for capital to pay policyholder benefits
other factors directly influence financial strength ratings
risk-based capitall measures, yield, liquidity, the potential forced liquidation of assets to fund negative claims development and credit ratings
allocation to certain
asset classes constrained
set min capital level for each insurer
pensio funds
constrainded by regulation and influenced by tax rules
regulate max or min percentages in certain asset classes
subject to wide
array of funding,
accounting reporting
and tax constraints
funding considerations, risk -
probability contributions exceeding some threshold amount
iterating through various efficient frontiers using different definitions of risk
endowments and
foundations
can adopt a higher-risk aset allocation than other isntitutions
two externally
imposed constraints
tax incentives
provide tax benefits tied to certain min spending requirement
credit-worthiness considerations
external factors may restrict the level of risk-taking
sovereign wealth funds - SWF
government-owned pools of capital invested on behalf the peoples of states or countries with long-term orientation
the governing entities adopt regulaitons
that constrain the opportunity set for asset allocation
there may be cultural or religious factors
environmental social and
governance consideratiosns - ESG
achieved through the impletation of allocation
or choose to set aside a targeted portion for these missions
3 asset allocation for the taxable investor
4 revising the strategic asset allocation
5 short-term shifts in asset allocation
6 dealing with behavioral biases in asset allocation