18 RELATE TO PORTFOLIO MANAGEMENT FOR INSTITUTIONAL INVES...

Questions 13-18 relate to Portfolio Management for Institutional Investors and GIPS. Jack Rose and Ryan Boatman are analysts with Quincy Consultants. Quincy provides advice on risk management and performance presentation to pension plans, insurance firms, and other institutional portfolio managers throughout the United States and Canada. Rose and Boatman recently attended a meeting with one of their larger pension plan clients. In the meeting, the client asked them to review several proposals that might change the risk to the client of offering retirement plans. In reviewing the client's proposals, Rose and Boatman make the following statements.  Rose: Both defined benefit and defined contribution plans carry similar risk to the sponsoring company and obligate the company to make contributions to benefit the participating employees of the company.  Boatman: Cash balance and ESOP plans are also similar in that they are an exception to the general aversion to investing plan assets in the stock of the sponsor. At the same meeting, Boatman discusses the client's traditional asset only approach to the pension plan and recommends the client adopt an asset/liability management (ALM) approach to the plan. Boatman explains the following. 1. While the plan may have maximized the portfolio's Sharpe ratio, this can still leave the surplus excessively vulnerable to a change in interest rates. 2. ALM is superior because it allows Monte Carlo simulation (MCS) to analyze how the portfolio will perform over various time periods while asset only management cannot use MCS. 3. An asset only approach often overinvests in equities while ALM frequently underinvests in real rate bonds. Rose also has two insurance company clients. One company offers life insurance and the other offers property and casualty insurance. Rose instructs his new assistant to research some of the differences between these two types of insurance companies. The assistant begins by reviewing some terminology he has not worked with before.  The crediting rate (the actuarially assumed rate of return necessary to meet policyholder obligations) portion of portfolio return is generally not taxed for either life or property and casualty companies.  The underwriting cycle for property and casualty companies refers to the swing in profitability as interest rates fluctuate, coupled with a mismatch in asset and liability durations.  Compared to property and casualty companies, life insurance companies have greater exposure to inflation risk and the policy payouts they will make in a given year are more predictable. Quincy Consultants has been retained by Monroe Portfolio Managers for advice regarding performance presentation and GIPS compliance. Monroe is a large firm offering a variety of investment styles with a complex organizational structure. To meet legal requirements of some key clients, each of the four primary investment teams at Monroe is a legal entity. The teams are:  Equity: The unit has its own investment staff and is responsible for all equity portfolios and composites. Many accounts are balanced and portfolio management decisions are made jointly by a fixed income and equity team manager. For client presentations, either manager may be designated as the client portfolio manager, but actual decisions are made jointly.  Fixed Income: The unit has its own investment staff and is responsible for all fixed income portfolios and composites. All equity and fixed income investment decisions are the responsibility of Monroe's investment policy committee (IPC). The IPC is made up of members from both teams.  Real Estate and Private Equity each have their own investment staff but report to a single chief investment officer (CIO), who is responsible for the investment decisions. Their CIO is completely independent of the IPC. All four units share the same non-investment support staff and back office. Rose and Boatman next discuss the performance presentation standards for real estate and private equity portfolios. Discussing the differences between the general provisions of the GIPS standards and those for real estate and private equity portfolios, Rose states the following:

Statement 1: The GIPS general provisions require valuation in accordance

with the definition of fair value and the GIPS valuation

principles. Real estate portfolios can be valued quarterly, but

all real estate investments must be valued at least annually by

an independent third party qualified to perform such

valuations.

Statement 2: In addition to a minimum of annual valuations, private equity

provisions require the annualized since-inception internal rate

of return (SI-IRR) using daily cash flows. Stock distributions

must be considered cash flows.

Statement 3: In presentations for real estate composites, firms are required

to disclose their definition of discretion as well as their

internal valuation methodologies for the most recent period

presented. In addition, for real estate closed-end composites,

firms must present the since-inception paid-in capital and

since-inception distributions for each year.

Statement 4: The GIPS real estate requirements state that the income return

and capital return must be calculated separately.

... Which of the two statements by Rose and Boatman are correct?

A) Only Rose's statement.

B) Only Boatman's statement.

C) Neither statement is correct.

Question #14 of 60

Which of Boatman's comments comparing asset only with ALM is most likely correct?

A) Statement 1.

B) Statement 2.

C) Statement 3.

Question #15 of 60

Which of the assistant's three comments regarding terminology is most correct? The

comment regarding:

A) crediting rate.

B) underwriting cycle.

C) inflation risk and policy payouts.

Question #16 of 60

Which of the following combinations of Monroe's teams would be most appropriate as a firm

for GIPS reporting?

A) Equity as a separate firm.

B) Equity and Fixed Income combined as one firm.

C) Equity, Fixed Income, Real Estate, and Private Equity combined as one firm.

Question #17 of 60

Determine whether Rose's statements 1 and 2 on the GIPS standards are correct or incorrect.

A) Only statement 1 is correct.

B) Only statement 2 is correct.

C) Both statements are correct.

Question #18 of 60

Determine whether Rose's statements 3 and 4 on the GIPS standards are correct or incorrect.

A) Only statement 3 is correct.

B) Only statement 4 is correct.

Question #19 of 60