Your SlideShare is downloading. ×
Microsoft PowerPoint - IAS 2004 Investment Basics CVF_II
Upcoming SlideShare
Loading in...5

Thanks for flagging this SlideShare!

Oops! An error has occurred.


Saving this for later?

Get the SlideShare app to save on your phone or tablet. Read anywhere, anytime - even offline.

Text the download link to your phone

Standard text messaging rates apply

Microsoft PowerPoint - IAS 2004 Investment Basics CVF_II


Published on

  • Be the first to comment

  • Be the first to like this

No Downloads
Total Views
On Slideshare
From Embeds
Number of Embeds
Embeds 0
No embeds

Report content
Flagged as inappropriate Flag as inappropriate
Flag as inappropriate

Select your reason for flagging this presentation as inappropriate.

No notes for slide


  • 1. Investment Basics II Investment Actuary Symposium Boston, Massachusetts November 8, 2004 Charlie Ford, Dick Mattison Agenda - Investment Basics I 1. Interest rates, term structure 2. Rate Math 3. Measurement tools 4. LIBOR 5. Swap curve 6. Credit Default Swaps 7. Derivative Market Pricing 8. Interest Rate Options 9. CAPM, Mean-Variance Efficient Frontier 10. Portfolio Design
  • 2. Agenda 11. The liability-oriented investor 12. Investment Policy and Strategy – portfolio design – risk/reward tradeoff 13. Regulatory constraints 14. Economic Evaluation of assets and liabilities 15. Risk Analysis and Control (hedging) 16. Practical Issues 11. The Liability-Oriented Investor • Mutual Fund Objective – total return against a benchmark • Pension Plan – Benefit Flows • Endowments – capital spending needs • Casualty Insurance – Long-tail claims • Life Insurance – minimum guarantees – regulatory, capital constraints • Individuals – buying a house, paying for college, retiring
  • 3. Liability-Oriented Investing • Specific goals for the funds – definite - endowment capital spending – fixed time - college education – flexible - pension or retirement – options - annuity minimum guarantees • For these, total return is inappropriate – beating S&P 500 or Lehman Corporate Index tells you nothing about whether you can meet your commitments (=liabilities) – Example - specialty portfolio Necessary Steps • Must define your: – Return objectives – Risk tolerance – Time horizon – Liquidity requirements – Regulatory and legal constraints – Tax considerations – Unique needs and preferences Investment Policy
  • 4. 12. Investment Policy Pension Example • Primary Goals – solvency – meet benefit obligations • Secondary Goals – highest long term net return possible – control risk to protect primary goals – avoid excessive contribution rate volatility Investment Policy Pension Example • Return Requirement – Adequate real return consistent with risk tolerance • Risk Tolerance – Limit exposure to absorb capital losses, in order to protect solvency, benefits – Minimize chance of increased contributions during recessions
  • 5. Investment Policy Pension Example • Time horizon – going concern basis, so open-ended • Liquidity requirements – as required by contribution less benefit cash flow projections • Regulatory and legal constraints – ERISA • Tax considerations – plan is set up as a trust, US Federal tax free (put high yielding assets in the plan) • Unique needs and preferences – Contribution and benefit projections for that plan – Plan sponsor’s tolerance for contribution volatility – Sponsor’s industry’s exposure to economic cycle Investment Strategy • Detailed guidance to portfolio managers on how to implement the Policy • Asset Mix Strategy – determines most of the long-term return – review long-range economic & capital market projections – set a target allocation between asset classes • Cash and liquidity guidance • Need for specialist advisers for high yield, REITs, etc. • Performance attribution approach – use to improve the portfolio – not to force advisers into replicating a benchmark
  • 6. Constraints on Asset Sales (a) • Accounting – IMR/Bill S-3 – AVR, for realized losses > 2 NAIC downgrade steps from purchase • Tax (US) – gains and losses taxable in year realized, along with operating income • no above/below the line distinction as with GAAP or Stat – tax-loss carryforward position – gains and losses netted within a tax year – gains and losses netted among affiliates – mergers, acquisitions may include a tax-sharing agreement Constraints on Asset Sales (b) • Embedded Value – system to measure PV(distributable earnings) and attribute its changes – securities in the portfolio have a cash flow pattern – selling changes this - need to replace the PV(cash flows) – gains due to yield curve movements incur tax, but require the full proceeds to be reinvested to replace the cash flows – gains due to credit improvement • ALM – substitution trades – yield curve slope trades • works best if you need to lengthen portfolio duration • consider the portfolio’s laddered maturity structure
  • 7. Constraints on Asset Sales (c) • Credited Rates – a sale may change the portfolio yield used to set credited rates – try to replace the sale in that segment with a new bond with at least the same yield & maturity • Policyholder Equity Issues – use caution when doing rebalance trades between asset segments backing different product classes 13. Regulatory Constraints • SEC – Registered investment adviser - investment manager – public financial statements • NAIC / SVO – asset values, ratings, capital loads • OSFI • Dept of Labor (ERISA) • State Law – asset mix constraints – liquidity filings – Derivatives Use Plan filings
  • 8. What does an Investment Actuary do? • Policy development • Advise portfolio manager – liability cash flow characteristics – accounting and product constraints on trades • Coordinate cash levels, demands with Treasury Dept. • Implement strategy, allocating new purchases by segment • Set credited interest rates, discount rates • Lead asset/liability modeling • Advise product actuaries, senior management – Investment effects on shareholder and policyholder value 14. Economic Evaluation of assets and liabilities 15. Risk Analysis and Control 16. Practical Issues
  • 9. Questions