Institutional Investors Managing Investment Portfolios

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CHAPTER 1: INTRODUCTION

On the capital market, investors are divided into two broad categories of individual investors and institutional investors. Institutional investors can be business or legal entity acting as an intermediary between the individual and the financial market investment.

As always represent large capital investors held an important position in many cases even overwhelming financial market in the world.

Institutional investors have also made important contributions to the theoretical increase investments and investment techniques through the challenge from the management of large amounts of capital.

Today, advances in portfolio theory, efficient investment pressures as well as the emergence of many new investment vehicles is a challenge at the same time help to improve skills for investment portfolio management institutional investors. Due to face the challenges and pressures on, the managers should be aware that behind the portfolio is flesh and blood of their personal prosperity greatly affected by the action of managers. Information media often remind us of the moral hazard can occur, leaving serious consequences for both the customer and portfolio management mistake. The interests of the client must be placed on top. As has been emphasized in the beginning of this book, ethics is an important requirement in the portfolio management of the organization as well as individuals.

This chapter presents the portfolio management process from the perspective of different groups of institutional investors, including: retirement, study promotion funds, charities, insurance companies and banks. In this type of investor organizations representing abundance when considering appropriate investment policy and to illustrate the challenges and the complexity of the task of the institutional fund management.

The content of this chapter is presented as follows. In the second section, the context of the pension fund's investment will be presented, divided into two main parts: defined benefit and defined contribution. For each type of retirement, these elements create an investment policy statement (IPS) - oriented document management and for making all investment decisions will be discussed. The rest are also presented in the order as above including: part 3 - the charity; Part 4 - insurance companies and five banks.

CHAPTER 2: PENSION FUNDS

Retirement fund is invested in long-term assets with a commitment to bring about income damaged location. Businesses or organizations - such as a corporation, trade union, council or state agency - usually the unit making this commitment clearly stating the specific pension plan. These units are referred to as the sponsor pension plans.

The pension plan is divided into two major categories, based on the nature of the commitment. We can plan a defined benefit (DB) or contribution plan identified (DC). A defined benefit plan is a pension plan clearly states the obligations of the plan sponsor benefits for plan participants. In contrast, a defined contribution plan clearly states the obligations of the donor in favor of the contribution to the pension fund rather than benefits to plan participants. There are also plans in the form of hybrid between the two, such as cash balance plans which have the characteristics of both DB and DC plans. A cash balance plan is a defined benefit plan that benefits are clearly presented in the escrow account profile. These accounts indicate the current value of the accumulated benefit of the participants and to create favorable conditions for the creation of a new investment plan in a flexible manner.

Understanding the difference between DB and DC features are very useful. A sponsor DB plans promise employees or members of an organization that benefits income damage location based on defined criteria. For example, an employee may be committed for each year of employment with the company, he or she will receive a fixed interest in cash every month. Or, a plan sponsor can commit to pay a fixed rate on a number of factors related to the wages of workers (for example, last year, an average of the last five years, the average first five years of the past ten years). Donors can also committed to change the rate of pay for those who retired in order to reduce the impact of inflation. In addition, this plan can also include a list of contingency plans in case of early retirement benefits for surviving spouse and other cases.

All DB plans have a common characteristic: they are committed by donors for payment in future financial benefit or pension liability. The nature and behavior of this paragraph shall be uncertain and often complex; therefore, the set of investment rules for DB plans to meet specific challenges.

Commitment of donors to the DB plan was created specifically for the retirement phase - is the amount that the employee has the ability to draw. In contrast, the commitment of the DC plan is created for the current period - is the provision that the sponsor will contribute on behalf of the workers. Basic contribution commitment can be a fixed rate payment included in the plan by the employer. Or, is committed to contribute to reach a fixed rate that participants want to contribute to the plan.

DC plans include the following components (1) retirement plan in which contributions are committed and does not include commitment to the benefits, and (2) profit sharing plan in which the contributions or at least part of the contribution is based on the profit contribution of the donor. We can classify the DC plan as personal objects including small, small business, and the tax savings benefit plans of government in which the benefits are not committed and participants often contribute to the plan (e.g., IRAs - Individual Retirement Account). The basic elements of the plan include (1) contributions to account for the individuals involved, (2) the capital investment in a period of time, (3) investments from tax-deferred plan, and (4) to the time of withdrawal from the plan or reach retirement age, the participants who received the money from the account can be a sum or a series of payments mathematics.

The important difference between DC and DB plans are as follows:

• For DC plans, because the benefits are not committed, plan sponsors do not bear the financial burden, in contrast to DB plans.

• DB plan is terminated by the plan sponsor. The participants in DC plans bear the investment risk (e.g. the ability to investment results is not high). In contrast, in the DB implementation plan sponsors must take this risk (at least partly) because donors have a responsibility to pay a sum of future retirement benefits determined.

• Because the DC plan contributions are made based on personal interest, the payment of contributions and investment earnings generated belong to the DC plan participants. Empowerment plan, and the ability of the tax or penalty payments, a member can transfer the assets in your plan to a new plan.

On investment stance, DC plans are divided into two categories:

• Directed by donors, of which almost like a DB plan, donors choose investments. For example, a profit sharing plan (retirement plan where contributions are made only by the employer) as directed by the donor.

• Directed by participants, in which donors provide a list of diversified investment options and the participants decide their own investment mechanism. Most DC plans as directed by the participants.

For a DC plan is directed by participants, donors have very little influence on the creation of investment allocation policy. Even for DC plan directed by donors, investment policies much less complex than in the DB plan.

2.1. The defined benefit plan: Overview and Investment Environment

Defined benefit plan has existed for a long time, form first appeared in 1928 in the U.S. and is set by the American Express Company. Currently, DB plans have different spheres of influence all over the world, but in recent years, the use of DC plans has increased. In the U.S., the assets of the DB plan at nearly $ 2.5 trillion by the end of 2000. However, in the U.S., evaluated by both the number of participants and total assets, the DC plan than outstanding. The growing advantages of DC plans in the U.S. have largely been created by the rise of 401 (k) plans in the business sector. In the UK, the traditional models DB prominence, accounting for about 4/5 of the total plan of the private sector in 2001; however, the percentage of companies using DB plans including the new members dropped 38% in 2004 from 56% in 2002. In Europe, DB plans continue to be made based on the model of the basic pension; however DC plan is slowly becoming more accepted. Japanese private pension funds have overwhelming advantages in favor of the benefits identified, but the Japanese company now also offers cash balance plan and the DC plan.

Asset retirement resources to pay for retirement benefits. Therefore, the investment performance of a pension plan should be evaluated relative to the assets of the plan and shall provide pensions; even when it is evaluated based on a total basis . Clear understanding of the pension liability is very important for the establishment of effective investment policy.

Expert of the plan sponsor is a mathematician responsible for the estimated pension liability. Along with the specific benefits identified, estimated pension liability also involves forecasting changes in human resources, determine the growth of salaries and wages, estimated capacity of the early retirement option, the applicable mortality table and other factors.

First, the specialist will determine the liability payments and the present value of it compared to the current value of assets of the list. The relationship between the value of the assets of a plan and its current debt value is called the capital of the state plan. In a fully funded plan, the ratio between the assets and liabilities of about 100% or more (the state capital is 100% or more). Pension surplus is calculated as the market value of pension plan assets minus the market value of pension plan liabilities. In a plan is not enough capital, the ratio of plan assets and liabilities is less than 100%.

There are three basic concepts debt exists in the pension plan:

• Responsibilities of accumulated benefits (ABO - Accumulated Benefit Obligation). ABO is the present value of pension benefits in the event the plan is terminated immediately and therefore responsible to fund retirement income payments to all beneficiaries during operations to fund the time of termination of (Accumulated services)

ABO excludes the impact of the increase in salaries and wages in the future

• Responsibilities of expected benefits (PBO). PBO stop the service accumulation similar to the case of ABO but compensation is expected in the future will increase if benefits are determined to be associated with a certain amount of the final payment. Therefore PBO including the impact of the compensation expected to rise and is a reasonable measure of pension liabilities for an enterprise to continue operations and has no plans to terminate their DB plans.

• General liability to pay future. This is a measure of the easiest to understand but most certainly not responsible for the pension plan. Total future liability of card defined as the present value of the accumulated value and forecasts of future service benefits, including the impact of the value of future compensation increases. Financial means can be done internally as the basic elements to create investment policies.

Insurance professional mission is to determine the division ratio of debt plan members and retired employees. This distinction indicates two important factors:

• Because the people who are receiving retirement benefits, if the number of people who retire more and more in larger monthly cash flow, therefore, the liquidity requirements of the higher retirement. The rate of debt retirement related to employee retirement period is retired; related to people who are in the stage of labor is the labor time is.

• Do the same mortality table used for plan beneficiaries are retired workers and a greater rate plans who retire with a shorter average duration calculated future pension liabilities.

We move on to the construction of the factors in the investment policy for a DB plan.

2.1.1. The objective of risk in the process of building target risks, plan sponsors must consider the status of the plans, financial position and profit of the donor, the overall risk of the donor and retirement experience,