Appropriate action R31 - EOC 2-B

CFA Level III Portfolio Management
#1

Duane Rogers, as chief investment officer for the Summit PLC defined benefit pension scheme, has developed an economic forecast for presentation to the plan’s board of trustees. Rogers projects that UK inflation will be substantially higher over the next three years than the board’s current forecast.

Rogers recommends that the board immediately take the following actions based on his forecast:

  1. Revise the pension scheme’s investment policy statement to account for a change in the UK inflation forecast.
  2. Reallocate pension assets from domestic (UK) to international equities because he also expects inflation in the United Kingdom to be higher than in other countries.
  3. Initiate a program to protect the pension scheme’s financial strength from the effects of UK inflation by indexing benefits paid by the scheme.

My answer to part B was that the action is not appropriate because international equities reallocation may not be suitable according to policy. But the answer in the book says its appropriate action.

Is it tactical asset allocation? When such a question appears in exam, how should we know what to answer?

The answer from book is below.

The second action (“Reallocate pension assets from domestic [UK] to international equities because he also expects inflation in the United Kingdom to be higher than in other countries”) is correct. A change in economic forecast might necessitate a change in asset allocation and investment strategy. An expectation of increased inflation in the United Kingdom might lead to expectations that UK equity performance will slow and would likely result in both weaker UK equity returns and stronger returns from overseas markets. This would justify an increased allocation to international equities.

#2

The term “RE-allocate” evokes a situation where the CIO is starting from an existing allocation to UK and international equity and then shifts the weights around (RE-allocates) in an attempt to hedge the plan from rising domestic inflation.

In other words, international equities were already in the asset mix hence the question as to whether they are out of policy does not seem a valid argument.

Good luck, Carlo

#3

Still not as clear as it should be… Specially when asking questions to us CFAI wants to focus on keywords like “all clients”, “within risk tolerance” etc (typical ethics questions). But in this question no such keywords are mentioned.

Would it be ok to reallocate “all” UK equity to international equity? After all, its all based on expectation. What if the expectations are not correct, you lose the benefit of diversification.

While I do understand the logic of reallocating, I still dont know what level of detail should I expect.

#4

Rogers is a CIO; working on a presentation for the plan’s trustees; he provides a recommendation to…

The answer is reasonable and safe