T-bills are appropriate assets to include in an optimized surplus portfolio for a DB plan. Do you agree or disagree? Justify your stand with one reason.
Disagree Bcz growth shall be the the target of surplus portfolio.
Disagree, duration issues.
depends on what the investor wants to do with the surplus. if he/she wants to protect the value then yes but if they are looking for growth then no
Just to be different: Agree. Liquidity issues.
Agree Emergency Liquidty reserve
Agree There should be an allocation to liquid assets in order to meet unexpected payments due (early exercise) and to fund distributions.
Agree along the same lines as team_alex. If you have a mature DB plan, you could be facing serious liquidity issues.
This is asset allocation, where the liquidity reserve is already taken out for surplus maximization. T-Bills DO NOT appears in surplus maximization in an ALM framework as they can’t plot on the efficient frontier when taken against the pension liability. On a side note, not to toot my own horn but in theory it is possible I will pass this exam. First time I have felt this way so far.
Paraguay Wrote: ------------------------------------------------------- > This is asset allocation, where the liquidity > reserve is already taken out. > > T-Bills DO NOT appears in surplus maximization in > an ALM framework. You might be right, but I’m wondering why you wouldn’t consider the liquidity reserve in your asset allocation?
It depends…P285, example 14. Cash drag is a disadvantage of T-bill. Coupon payment from the bonds may meet the liquidity needs.
abushey31 Wrote: ------------------------------------------------------- > Paraguay Wrote: > -------------------------------------------------- > ----- > > This is asset allocation, where the liquidity > > reserve is already taken out. > > > > T-Bills DO NOT appears in surplus maximization > in > > an ALM framework. > > > You might be right, but I’m wondering why you > wouldn’t consider the liquidity reserve in your > asset allocation? Per the texts you take out the present value of the liquidity need and then allocate the remainder of the portfolio for surplus maximization. Generally you would do the same on the individual level before creating the efficient frontier.
> Per the texts you take out the present value of > the liquidity need and then allocate the remainder > of the portfolio for surplus maximization. > Generally you would do the same on the individual > level before creating the efficient frontier. Please advise which page
“As Exhibit 32 shows, US T-Bills do not enter into any efficient portfolio; including T-Bills in the policy mix accounts at least in the part for the 60/40 portfolio not appearing on the surplus efficient frontier.” They aren’t including for asset allocation optimization but the PV of the liability would be included in the final allocation.
alta168 Wrote: ------------------------------------------------------- > > Per the texts you take out the present value of > > the liquidity need and then allocate the > remainder > > of the portfolio for surplus maximization. > > Generally you would do the same on the > individual > > level before creating the efficient frontier. > > Please advise which page Example 9 on the individual level. Exhibit 32 on the institutional level.
I agree that T-bills are appropriate assets. One can argue both ways but from the level of minimizing surplus volatility, T-bills will go a long way to help in achieving this. If interest rates are high, bonds, equity investments and real estate are all going to be negatively affected but t-bills will provide a huge boost for surplus portfolio return. A well diversified portfolio should include t-bills in order to improve the risk adjusted return and this is the reason we have a surplus efficient frontier.
me.tega Wrote: ------------------------------------------------------- > I agree that T-bills are appropriate assets. > > One can argue both ways but from the level of > minimizing surplus volatility, T-bills will go a > long way to help in achieving this. If interest > rates are high, bonds, equity investments and real > estate are all going to be negatively affected but > t-bills will provide a huge boost for surplus > portfolio return. A well diversified portfolio > should include t-bills in order to improve the > risk adjusted return and this is the reason we > have a surplus efficient frontier. OK well I am just going to tell you now. This is wrong and against what the book says. You will get this wrong. There is no argument. Interest rate effects are irrelevant due to the fact the surplus efficient frontier is matched against a liability with a duration > than a T-Bill. By purchasing the T-Bill you are adding risk in not meeting the liability not subtracting it. This is the basis of ALM. The thought process you are using is AO. Duration using ALM = “Asset Duration = Liability Duration” Duration using me-tega = “Asset Duration < Liability Duration” You are making an asset bet that rates will rise. Rising rates will be offset in the ALM approach however lowering rates will not be offset in the me-tega portfolio. Market value improvement will not make up decreasing reinvestment risk, thus lowering surplus.
Paraguay Wrote: ------------------------------------------------------- > me.tega Wrote: > -------------------------------------------------- > ----- > > I agree that T-bills are appropriate assets. > > > > One can argue both ways but from the level of > > minimizing surplus volatility, T-bills will go > a > > long way to help in achieving this. If interest > > rates are high, bonds, equity investments and > real > > estate are all going to be negatively affected > but > > t-bills will provide a huge boost for surplus > > portfolio return. A well diversified portfolio > > should include t-bills in order to improve the > > risk adjusted return and this is the reason we > > have a surplus efficient frontier. > > OK well I am just going to tell you now. This is > wrong and against what the book says. > > You will get this wrong. There is no argument. > Interest rate effects are irrelevant due to the > fact the surplus efficient frontier is matched > against a liability with a duration > than a > T-Bill. By purchasing the T-Bill you are adding > risk in not meeting the liability not subtracting > it. > > This is the basis of ALM. The thought process you > are using is AO. Are you sure about your argument? Here is what the book says: Surplus = Asset - Liability The question CFASniper asked was if t-bills are appropriate for an optimized surplus portfolio. A surplus portfolio has no liability to match anymore and the only way to look at it is through the lenses of AO. It is when the surplus gets to zero that it will become advantageous to remove the t-bills. We are talking about a surplus portfolio here.
me.tega Wrote: ------------------------------------------------------- > Paraguay Wrote: > -------------------------------------------------- > ----- > > me.tega Wrote: > > > -------------------------------------------------- > > > ----- > > > I agree that T-bills are appropriate assets. > > > > > > One can argue both ways but from the level of > > > minimizing surplus volatility, T-bills will > go > > a > > > long way to help in achieving this. If > interest > > > rates are high, bonds, equity investments and > > real > > > estate are all going to be negatively > affected > > but > > > t-bills will provide a huge boost for surplus > > > portfolio return. A well diversified > portfolio > > > should include t-bills in order to improve > the > > > risk adjusted return and this is the reason > we > > > have a surplus efficient frontier. > > > > OK well I am just going to tell you now. This > is > > wrong and against what the book says. > > > > You will get this wrong. There is no argument. > > > Interest rate effects are irrelevant due to the > > fact the surplus efficient frontier is matched > > against a liability with a duration > than a > > T-Bill. By purchasing the T-Bill you are > adding > > risk in not meeting the liability not > subtracting > > it. > > > > This is the basis of ALM. The thought process > you > > are using is AO. > > Are you sure about your argument? Here is what the > book says: > > Surplus = Asset - Liability > > The question CFASniper asked was if t-bills are > appropriate for an optimized surplus portfolio. A > surplus portfolio has no liability to match > anymore and the only way to look at it is through > the lenses of AO. Absolutely. To quote Example 32 “The proposed 60/40 allocation includes a 10 percent weighting in T-Bills. As Exhibit 32 shows, US T-bills do not enter into ANY SURPLUS EFFICIENT PORTFOLIO; including T-bills in the policy mix accounts at least in part for the 60/40 portfolio not appearing on the surplus efficient frontier.” “By itself, holding long-term bonds is riskier than holding T-bills, but relative to the pension liability, T-bills are riskier. The MSV portfolio is 100 percent long-term bonds. If we want to move from the MSV portfolio to a high-expected surplus portfolios, we logically require equities with a 10% expected return NOT T-BILLS.” I would say that is definitive. Take position in long-term bonds. Invest surplus in equities/real estate or higher yielding assets to generate great surplus. Definitely don’t invest them in T-bills which have the lowest return. This is a question I could definitely see on the exam looking at it. There is a lot of information regarding this.
Thanks for this debate…helpful