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Question 1 (12 marks | Word limit: 600 words) LO1: Analyse the processes involved in managing an investment portfolio. (a) Analyse the objectives of the defined benefit fund in terms of the return...

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Question 1 (12 marks | Word limit: 600 words)

LO1: Analyse the processes involved in managing an investment portfolio.

(a) Analyse the objectives of the defined benefit fund in terms of the return requirements.
How do you think they could be improved? (2 marks)

(b) Analyse the objectives of the defined benefit fund in terms of risk management.
How do you think they could be improved? (2 marks)

(c) Propose two (2) new objectives for the defined benefit fund based on both return and riskrequirements. (2 marks)

(d) Analyse the objectives of the balanced fund in terms of the return requirements.
How do you think they could be improved? (3 marks)

(e) Analyse the objectives of the balanced fund in terms of risk management.
How do you think they could be improved? (3 marks)

Answered Same Day Nov 17, 2019 FIN206


David answered on Dec 27 2019
140 Votes
Answer 1(a):
In defined benefit scheme investors does not bear the risk of portfolio performance or market movements. Investors receive a return along with benefits at retirement either in the form of a pension or a lump sum, which are determined by stated criteria usually associated with years of service, salary at retirement and inflation.
The main objective of defined benefit fund in terms of Return requirement is to achieve a total return sufficient to cover pension liabilities in an inflatio.n adjusted base. For example returns will exceed inflation by at least 3% over rolling 3 year periods.
In order to improve the return requirements the scheme should always try to achieve a return over the assets benchmark by forming the portfolio.
However in case of Over-funded scheme the fund should be managed with a long term growth oriented being major focus on capital appreciation.
In case of Under-funded scheme, which is the cu
ent scenario in our case, it is recommended not to take an aggressive investment approach and at the same time sponsor should increase contributions
Answer 1(b):
The objectives of the defined benefit fund in terms of risk management
· Is to achieve high cu
ent and expected firm profitability with low debt to equity ratio of the firm.
· Is to maintain young average age or greater active lives in comparison to retired lives
In order to achieve these objectives, there should be no or very little provisions for early retirement and lump-sum payments. In other words, the focus should be on reducing the time horizon and minimizing the liquidity requirements.
Answer 1(c):
In addition to the general objectives of the defined benefit fund i.e. to achieve sufficient returns to cover pension liabilities of the employees considering inflation factor and to maintain the liquidity requirements, the company should also focus on
· Designing strategies to improve and maintain employee health while containing costs.
· Reduce the number of injuries through enhanced safety efforts and Increase the Return to Work placements.
These objectives will help the company in long run by maintaining the low proportion of retires and terminations respect to active ones. Secondly these provisions provide higher employee satisfaction and ensure no early retirements.
Answer 1(d):
Balanced funds also know as Hy
id fund are a combination of equity, debt and money market component as well in a single portfolio. With the help of these funds one can achieve targeted objectives as these funds can provide either a moderate or higher equity component or can provide higher fixed income for conservative group.
The main objective of balanced fund is to provide investor with the mixture of safety, income and modest capital appreciation.
The best attribute of the funds is that, they can be re-balanced in any market condition depending on the needs of the investor.
The performance of balanced fund can be improved even in difficult market situation if they have a cushion of debt so that they can be better equipped to withstand shocks in falling market. Secondly, in case of rising market, the fund can perform better with hundred percent equity components.
Answer 1(e):
Balanced funds are for those who do not want the hassle of investing in a basket of products that needs to be re-balanced at regular intervals. In other words, these funds are for those who don't want high risk.
The main objective of these funds is to put the cap on the risk .i.e limit the maximum risk and providing moderate return at the same time.
In order to achieve or improve the objective of balanced fund in terms of risk management one should take a balanced Fund with 70% exposure to equity and 30% to debt. If the stock market falls, the fund's equity exposure will drop to the extent of the fall, leaving with no option but to buy more shares to maintain the 70 per cent equity level and at the same time debt provides safety.
Answer 2 (a)
Investment managers are the one who deploy plan assests in such a way which is in best interest of the client or beneficiaries. Investment manager selection process is one of the crucial, often taken lightly, a final step in establishing and implementing a comprehensive investment plan which begins with formulating an investment policy statement.
A specialist investment manager is selected on the basis that they are capable of meeting the client’s investment objectives. It is also necessary to ensure that the manager is well
iefed and understands what is expected of them.
· The guidelines stated for choosing investor manager are quite theoretical and not sufficient enough to make the co
ect choice on the basis of funds.
· The investment policy statement share by the committee does not explain about the performance of the funds.
· The cu
ent investment manager fails in re assessing the existing investment portfolio inspite of the disappointing investment performance, usually re-assessment done by them annually in the cu
ent case.
· The criteria used by the committee for choosing managers is same for both the schemes which is highly unrealistic as same fund manager can never be able to handle and meet up to the expectations of different set of investors
· While forming or choosing the invest manager team or investment manager they are looking for the out performance and A rated managers from their team as well in addition to the external one.
· Similarly they were able to explain the asset allocation policy as well for both defined benefit and definite contribution scheme
· The guidelines clearly explain what is expected from the investment manager.    
According to Tipple, “Disappointment with investment manager selection can be reduced by considering the tangible ‘4 P’s’ (people, process/philosophy, portfolios, and performance) and the intangible ‘4 P’s’ (passion, perspective, purpose, and progress).”
Answer 2 (b)
Even after having a good knowledge on equity analysis and market portfolio theory there are certain technical elements of portfolio management which should be addressed by investment manager hence, the selection of investment manager plays a very crucial role. Once it has been determined which asset class and strategies will be used in practice, the manager selection process can be initiated.
The process of selection of managers for equity portfolio can be improved by reviewing the techniques of alternate managers and monitoring cu
ent managers. One should also aim at considering the value of quantitative and qualitative method for selection of investor manager.
Equity portfolio management is either passive of active.
In case of Passive management, the investment manger should spend more time in closely observing the performance of the benchmark index rather than trying to beat it. In other words, passive management is basically a buy and hold strategy.
In active management, manager needs to use his or her analytical skill and research with the aim to achieve the results above index. The strategies which are used by portfolio managers to beat the indices are fundamental analysis, technical analysis and quant analysis.
While selecting the manager for equity portfolio, whether one should be active management or passive management, the criteria for the same should be compared in terms of:
· Management fees
· Transaction costs
· Risk and return differentials, based on the needs of the investor.
Answer 2 (c)
ESG over lays implies integrating Environment, social and governance issues in investment decision making. Examples of these issues include air and water pollution,
ibery etc. It often called as responsible investing which means one should also consider intangible factors of the company in addition to the financial data while making any investment decision i.e. how that company dealing with its labour force how it deals with the environment and with other stakeholders.
Not considering the ESG factors while making the decision often led to inco
ect decision making, in other words it involves screening of investments from ethical point of view.
Research on ESG overlay
This study, published by Alex Edmans in 2011, shows that the higher the employee satisfaction, the better the stock returns.
This paper analyzes the relationship between employee satisfaction and long-run stock returns. A value-weighted portfolio of the “100 Best Companies to Work For in America” earned an annual four-factor alpha of 3.5% from 1984 to 2009, and 2.1% above industry benchmarks. The results are robust to controls for firm characteristics, different weighting methodologies, and the removal of outliers. The Best Companies also exhibited significantly more positive earnings surprises and announcement returns. These findings have three main implications. First, consistent with human capital-centered theories of the firm, employee satisfaction is positively co
elated with shareholder returns and need not represent managerial slack. Second, the stock market does not fully value intangibles, even when independently verified by a highly public survey on large firms. Third, certain socially responsible investing (SRI) screens may improve investment returns.
Answer 3 (a) (i):
The strategic asset allocation (SAA) of the balanced fund, calculated using a mean variance optimiser is a part of modern portfolio theory (MPT).
The underlying assumptions of MPT include:
• Normal distribution of asset returns — asset returns are distributed around an average return in a ‘bell-shape’ manner
• Rationality of investors — investors will look to maximise returns
• Risk aversion of investors — investors prefer lower returns with known risks over higher returns with unknown risks
• Homogenous investing — investors have the same information on...

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