# Institutional Q

Reid Williams is responsible for training new analysts and portfolio managers for Grames Investment Advisors. Since Grames specializes in institutional clients, Williams wants to make sure that his new trainees know the needs of various institutional investors. Reid gives an assignment to all of his trainees to identify general differences in asset allocations for different types of institutional investors. One of Williams’ trainees, Phil Nagy, turns in his assignment with the following statements.

Statement 1: A bank is likely to hold more bonds than an insurance company’s surplus portfolio. Statement 2: An endowment is likely to hold more equities than the portfolio that funds an insurance company’s fixed annuities. Statement 3: An endowment is more likely to hold more emerging market equities than an insurance company’s surplus portfolio. Statement 4: A private foundation is likely to have higher cash needs than a pension fund with a low ratio of retired to active lives.

When grading the papers, Williams gives his trainees 25 points for each correct statement. Given the grading criteria, Nagy’s grade on the paper is most likely:

A) 50%. B) 100%. C) 75%.

SPOILER: Are you as good as Nagy?

I guess C but I realize it could be B.

C

Doesn’t seem to me that an endowmen is any more likely to hold EM eq than surplus port. I would think equally likely.

Ans is C with the reasoning correctly explained by ftwcfa

Wait, why is this not A?

1st statement - correct

2nd statement - correct

3rd statement - probably equal probability so incorrect (however you should consider position limits that may be imposed on the insurance company so this isn’t 100%)

4th statement - Incorrect… the pension fund still has higher cash needs, it has to pay benefits every year.

Don’t foundations have to pay out each year according to regulation? So they pay out every year just like the pension fund.

It depends on the type of foundation, but typically yes, there is a 5% rule required to maintain their tax status. I would still argue that those cash flows are more predictable than a pension fund, which could be volatile and therefore would still require more cash.

Let me guess, this is a “made up” question that was not in any books.

what is wrong with this one?

Statement 3: An endowment is more likely to hold more emerging market equities than an insurance company’s surplus portfolio.

Endowment being long term, can definitely take bigger risk and include emerging market equities - more than a insurance company’s surplus portfolio. They do not have the payout needs.

it will definitely NOT be equal probability.

this is what i thought, but i thought maybe some retarded CFA logic might make it true. nice to know my first instincts were right.

I would say it is equal probability because we are talking about the surplus portion, not the policy credited rate portion. The surplus has a capital appreciation focus and invests in equities to acheive this growth.

The ONLY reason i would hesitate is that there may be position limits

@ prophets, cpk

Both endowments and a surplus portfolio have the same return obj and risk profile (high return req. / above avg risk tolerance).

EM equities are not illiquid, just volatile, so not sure that time horizon plays into it the same way time horizon would play into venture capital or private equity.

Again, why is A incorrect? And is this an actual question or another “made up” one ?

I guess it all gets very confusing at the end of the day… at least to me.

Statement 1: A bank is likely to hold more bonds than an insurance company’s surplus portfolio. – True

Statement 2: An endowment is likely to hold more equities than the portfolio that funds an insurance company’s fixed annuities. - True

Statement 3: An endowment is more likely to hold more emerging market equities than an insurance company’s surplus portfolio. - False? [Equally likely]

Statement 4: A private foundation is likely to have higher cash needs than a pension fund with a low ratio of retired to active lives. - is this true or false?

I am lost … hence asking.

I think statement 4 is not 100% cut and dry, but in the absensce of a stated constraint in the form of holding limitations required by some sort of regulation on the insurance company, they should have equal likeliehood of holding foreign stock.

Remember, the portion of the portfolio that funds the policyholder reserves is focused on ALM management and invests primarily in fixed income, as it’s goal is to meet the reserve rate sufficient to meet future payouts. The surplus portion is managed as if it is a separate portfolio, and it’s goal is to increase the surplus through capital appreciation so the insurance company can expand it’s business and offer more competitive rates.

#4 - not true because active participants are contributing cash, while inactive retirees are fewer in #s to withdraw cash (against the new inflows).

Oops i was referring to #3. I wrote the response correctly just said 4 by accident.

for #3 I summary obj and constrains

Return ! risk tol ! Liq ! horizon

Endow : principle protection ! moderate high ! belong 2 spending rate (5%) ! long term

Surplus: Cap gain ! aggressive ! nil ! geting shorter ?

so i think #3 wrong

#4 low rate of retired/active - how low it is? If it is low enough the liquidity requirment may be lower and the #4 may be true

Regulations on insurance companies are much higher than on endowments. For this reason, insurance cos might have a cap on the amount of EM equities they can own. So Statement 3 could be correct. Endowments typically can invest as much as they want in hedge funds etc, which are not accessible to insurance cos - even in the surplus portfolio.