Investment Portfolio of a Private DB Plan

Pension Funds

Asset allocations for pension funds show very large differences by country. In the same vein, asset allocations of pension funds within a country are often characterized by large differences. There are many factors that contribute to these inter- and intra-national differences, including the differences in:

1. Legal.
2. Regulatory.
3. Accounting.
4. Tax constraints.

Also playing a key role in the asset allocation are the beneficiaries:

• Investment objectives.
• Risk appetites.
• Investment beliefs
• The liabilities to and demographics of the ultimate beneficiaries.
• The availability of investment opportunities.
• The expected cost of living in retirement.

Sovereign Wealth Funds

Each of the five types of sovereign wealth funds has different objectives and purposes. Not surprisingly, then, these funds have vastly different asset allocations.

The portfolios of budget stabilization funds are dominated by fixed-income investments because of their defensive nature, relatively stable investment returns, and diversification against cyclically-sensitive factors that drive government budget revenues in some countries. The conservative asset allocation may be partly explained by the fact that several major stabilization funds are managed by their countries' central bank or Ministry of Finance; these entities tend to be relatively risk-averse.

The portfolios of savings funds are shown to be tilted toward growth assets, equities, and alternatives. These funds can take on more equity-related risks due to their long investment horizons, and they, therefore, have relatively high allocations to alternatives such as real assets, debt (loans), and hedge funds.

Reserve investment funds have a similar allocation to savings funds, but they tend to allocate less to alternatives. Public equities are typically the most liquid growth asset available and help counter the negative carry generated by foreign exchange reserves, while bonds and other fixed-income investments help to reduce reserve funds' portfolio volatility.

Pension reserve funds generally have long-term investment horizons (but not necessarily inter-generational as with savings funds) and low liquidity needs during their accumulation phases, which can explain their high allocation to alternatives compared with other SWFs.

Endowments Private Foundations

Most large endowments follow the endowment investment model and rely heavily on alternative investments to achieve their long-term investment objectives. This approach is not without risks. During the global financial crisis, several large endowments faced significant liquidity challenges and were forced to either sell portions of their private investment portfolios in the secondary markets, reduce payouts to their universities, or issue bonds to bridge their liquidity needs.

The investment approach of foundations is similar to that of endowments despite important differences in their liability structures. Two differences between foundations and endowments that should have a bearing on asset allocation are that:

1. A foundation supports the entire budget of their organization, whereas universities have access to significant other sources of funding besides the endowment.
2. Foundations (in the US) are required to pay out at least 5% of their assets to maintain tax-exempt status and typically receive no additional inflows in the form of gifts and donations, whereas university endowments typically have a net payout of under 5%.

In addition to private equity and venture capital, hedge funds, and other alternatives, as well as private real estate, energy and natural resources, and distressed debt, other alternative investments include real estate and hedge funds.

Banks and insurers

Financial and portfolio management of banks and insurance companies is an attempt to create positive net present value for capital holders by solving simultaneously several different conditions with several different variables. Specific analysts and investment managers are typically assigned only to specialized subsets of the institution's varied assets and liabilities. In such dynamically changing economic and regulatory environments, it is difficult to specify particular portfolio investment rules and policies.

Reading 10: Portfolio Management for Institutional Investors

Los 10 (h) Evaluate the investment portfolio of a private DB plan, sovereign wealth fund, university endowment, and private foundation