CFA Level III: Institutional Investors
Questions And Answers With Verified
Solutions 100% Correct!!!
Characteristics of Institutional Investors - ANSWER✔✔1) Scale (Size)
-->Institutions tend to be larger than individual investors.
-->Some institutions may be TOO large for investments or managers with low
capacity These large institutions may choose to directly access investment and
manage them in-house.
2) Long Term Investment Horizon
-->Institutional investors tend to have longer time horizons than individual
investors, and also have relatively low liabilities.
-->Together, these imply that, in general, the ABILITY to bear risk for institutions
tends to be higher than for individuals.
3) Regulatory Framework
-->Institutions are subject to different legal, regulatory, and tax rules than
individual investors.
4) Governance Framework
-->Institutions typically operate under a formal governance structure, which
typically involves a Board of Directors and Investment Committees.
5) Principal-Agent Issues
-->Conflict occurs when a principal (i.e., owner of asset) appoints an agent to act
on their behalf and the agent's interests are not aligned with the principal's
interests.
,-->A typical example of an external principal-agent conflict is a high management
fee paid to a third-party investment managers regardless of performance.
Components of an IPS for an Institution - ANSWER✔✔1) The institution's
mission and investment objectives (i.e., return and risk tolerance).
2) Discussion of the INVESTMENT HORIZON and LIABILITIES that need to be
paid by the institution.
3) External constraints that affect the asset allocation (legal, regulatory, tax, and
accounting).
4) An asset allocation policy (i.e., portfolio weights) with ranges and asset class
benchmarks.
5) A rebalancing policy.
6) Reporting requirements.
The IPS should be reviewed annually and revisions should be made when
necessary due to material changes in investor circumstances and/or market
environment.
Asset Allocation Models: Norway's Sovereign Wealth Fund (SWF) -
ANSWER✔✔Asset Allocation:
-Passively managed allocation to public equities and bonds (with traditional 60%
equity/40% bonds base case allocation)
-Little or NO EXPOSURE to Alternative Assets.
,-Tight tracking error limit.
Advantages:
-Low costs and fees
-Easy for board to comprehend.
Disadvantages:
-No opportunity for outperformance of markets
Asset Allocation Models: Yale University Endowment - ANSWER✔✔Asset
Allocation:
-HIGH allocation to Alternative Assets.
-SIGNIFICANT active management.
-EXTERNALLY managed assets.
Advantages:
-POTENTIAL for outperformance of markets.
Disadvantages:
-Difficult for small institutions without expertise in alternatives to be able to
replicate.
-May also be difficult for large managers to replicate due to capacity issues of
external managers.
-High fees/costs.
Asset Allocation Models: Canada Pension Plan - ANSWER✔✔Asset Allocation:
, -HIGH allocation to Alternative Assets.
-SIGNIFICANT active management
-INTERNALLY managed assets.
-Uses a reference portfolio of passive public assets as benchmark that can be easily
understood/communicated.
Advantages:
-Potential for outperformance of markets and development of internal capabilities.
-Disadvantages:
-Potentially expensive and difficult to manage.
Asset Allocation Models: Liability-Driven - ANSWER✔✔Asset Allocation:
-Focus is on maximizing expected surplus (assets - liabilities) return and managing
surplus volatility
Advantages:
-Explicitly recognizes liabilities as part of the investment process.
Disadvantages:
-Certain risks of liabilities (e.g., longevity) are/can be very difficult to hedge.
Defined Contribution (DC) Plans: Main Features/Mission - ANSWER✔✔Main
Features/Mission of the Institution:
-Designed to save and invest in order to provide income for plan beneficiaries upon
retirement.
Questions And Answers With Verified
Solutions 100% Correct!!!
Characteristics of Institutional Investors - ANSWER✔✔1) Scale (Size)
-->Institutions tend to be larger than individual investors.
-->Some institutions may be TOO large for investments or managers with low
capacity These large institutions may choose to directly access investment and
manage them in-house.
2) Long Term Investment Horizon
-->Institutional investors tend to have longer time horizons than individual
investors, and also have relatively low liabilities.
-->Together, these imply that, in general, the ABILITY to bear risk for institutions
tends to be higher than for individuals.
3) Regulatory Framework
-->Institutions are subject to different legal, regulatory, and tax rules than
individual investors.
4) Governance Framework
-->Institutions typically operate under a formal governance structure, which
typically involves a Board of Directors and Investment Committees.
5) Principal-Agent Issues
-->Conflict occurs when a principal (i.e., owner of asset) appoints an agent to act
on their behalf and the agent's interests are not aligned with the principal's
interests.
,-->A typical example of an external principal-agent conflict is a high management
fee paid to a third-party investment managers regardless of performance.
Components of an IPS for an Institution - ANSWER✔✔1) The institution's
mission and investment objectives (i.e., return and risk tolerance).
2) Discussion of the INVESTMENT HORIZON and LIABILITIES that need to be
paid by the institution.
3) External constraints that affect the asset allocation (legal, regulatory, tax, and
accounting).
4) An asset allocation policy (i.e., portfolio weights) with ranges and asset class
benchmarks.
5) A rebalancing policy.
6) Reporting requirements.
The IPS should be reviewed annually and revisions should be made when
necessary due to material changes in investor circumstances and/or market
environment.
Asset Allocation Models: Norway's Sovereign Wealth Fund (SWF) -
ANSWER✔✔Asset Allocation:
-Passively managed allocation to public equities and bonds (with traditional 60%
equity/40% bonds base case allocation)
-Little or NO EXPOSURE to Alternative Assets.
,-Tight tracking error limit.
Advantages:
-Low costs and fees
-Easy for board to comprehend.
Disadvantages:
-No opportunity for outperformance of markets
Asset Allocation Models: Yale University Endowment - ANSWER✔✔Asset
Allocation:
-HIGH allocation to Alternative Assets.
-SIGNIFICANT active management.
-EXTERNALLY managed assets.
Advantages:
-POTENTIAL for outperformance of markets.
Disadvantages:
-Difficult for small institutions without expertise in alternatives to be able to
replicate.
-May also be difficult for large managers to replicate due to capacity issues of
external managers.
-High fees/costs.
Asset Allocation Models: Canada Pension Plan - ANSWER✔✔Asset Allocation:
, -HIGH allocation to Alternative Assets.
-SIGNIFICANT active management
-INTERNALLY managed assets.
-Uses a reference portfolio of passive public assets as benchmark that can be easily
understood/communicated.
Advantages:
-Potential for outperformance of markets and development of internal capabilities.
-Disadvantages:
-Potentially expensive and difficult to manage.
Asset Allocation Models: Liability-Driven - ANSWER✔✔Asset Allocation:
-Focus is on maximizing expected surplus (assets - liabilities) return and managing
surplus volatility
Advantages:
-Explicitly recognizes liabilities as part of the investment process.
Disadvantages:
-Certain risks of liabilities (e.g., longevity) are/can be very difficult to hedge.
Defined Contribution (DC) Plans: Main Features/Mission - ANSWER✔✔Main
Features/Mission of the Institution:
-Designed to save and invest in order to provide income for plan beneficiaries upon
retirement.
