“MANAGING INSTITUTIONAL INVESTOR PORTFOLIOS” (STUDY SESSION 10) B)...

1. “Managing Institutional Investor Portfolios” (Study Session 10) b) discuss investment objectives and constraints for defined-benefit plans; c) evaluate pension fund risk tolerance when risk is considered from the perspective of the (1) plan surplus, (2) sponsor financial status and profitability, (3) sponsor and pension fund common risk exposures, (4) plan features, and (5) workforce characteristics; i) discuss investment objectives and constraints for foundations, endowments, insurance companies, and banks; m) distinguish among the return objectives, risk tolerances, liquidity requirements, time horizons, tax considerations, legal and regulatory environment, and unique circumstances of pension funds, foundations, endowments, insurance companies, and commercial banks. 2006 Level III Guideline Answers Morning Session - Page 17

Guideline Answer: Template for Question 6 Determine If you disagree, support your opinion with one whether you reason related to portfolio management agree or disagree Statement with each of the Note: Supporting your opinion by simply reversing four statements an incorrect statement will made by Arnold receive no credit. (circle one) Neither foundations nor defined benefit pension plans have return objectives to exclusively maintain purchasing power. “The sole return • Both have spending requirements, foundations to Agree objective of both fund operations (annual disbursements and/or Vrieland and a defined required distributions), and pension plans to fund benefit pension plan is required benefits. Therefore, both may require Disagreeto maintain purchasing returns in excess of inflation. power.” • Some pension plans do not need inflation protection depending on the nature of their liabilities. “Vrieland, unlike a defined benefit pension Agreeplan, does not need to consider the correlation between plan sponsor Disagree financial performance and the performance of the portfolio.” “Like a defined benefit pension plan, the liquidity needs of Vrieland fluctuate over time.” Disagree Morning Session - Page 18Question: 6 Topic: Portfolio Management – Institutional IPS Minutes: 12 There are two portions of the statement for which the candidate may disagree. Primary Objective: The primary objective of Vrieland is not to exist, but rather to achieve its mission. The primary objective of a defined benefit pension plan is not to exist in perpetuity, but rather to provide funding to meet pension liabilities. “The primary objective Infinite Time Horizon of both Vrieland and a Some foundations can be established with limited time horizons, with the intent of being “spent down” plan is to exist in over a predetermined period of time. perpetuity, resulting in an infinite investment Pension funds however have a primary objective of time horizon.” meeting benefit obligations, therefore the time horizon will be based on the expected life of the plan. The expected life of the plan depends on: