The Investment Environment

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Chapter 4
Asset-Liability Management for Actuaries

• The Investment Environment
• tie-in with Actuarial Investment Course

Shane Whelan, L527
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Actuarial Investment Course

• Treated investment markets
• History of the capital markets
• long-term returns from different asset classes
• Characteristics of the return volatility,
  inflation-linked, etc.
• Description of modern markets
• Market indices/calculating returns
• Factors influencing prices of securities
• Regulation of markets
• Pointers on constructing an investment strategy
  to meet liabilities.
• The investment environment forms a background to
  this course
• it is assumed knowledge that will not be directly
  examined but should be used where relevant.
• Recall the Extended Actuarial Control Cycle, with
  its investment process which, in itself is an
  Actuarial Control Cycle

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Extended Actuarial Control Cycle
Context of Business/Economic/Commercial
Environment
Specifying the Problem
Professional Considerations
Developing a Solution
Monitoring the Experience
Investment Process
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Investment Process Cycle within a Cycle
Investmentobjectives
Strategicassetallocation
Monitoring Evaluation
Fund managerstructure
Fundmanager selection
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A Single Extra Topic Collective Investments

• Many institutions advised by actuaries offer
  attractive ways for smaller investors to
  participate in the capital markets.
• Many saving products offer a choice of
  investments or asset-links.
• We shall take a brief look at the structure of
  these investment vehicles, in particular at their
  pricing.
• Such collective investments meet a need
• They are convenient
• A cost-effective way of obtaining a diversified
  portfolio for a small investor
• thereby lowering investment risk
• A cost effective way of getting expert or
  specialist investment management
• which would otherwise by available only to large
  institutional investors (e.g., pension funds,
  life office, charities and endowments).
• Maybe taxation advantages
• Maybe improvement to marketability
• The costs include the extra management costs and
  the lack of control.

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Collective Investments

• Collective investments (known as mutual funds in
  the US) are structures for the management of
  investments on a group basis
• Such collective vehicles come in two generic
  types closed-ended and open-ended.
• In a closed-ended vehicle, once the initial
  tranche of money has been invested, the fund is
  closed to new money. So, after launch, the only
  way of investing in the fund is to buy from a
  willing seller.
• In an opened-ended vehicle, investment or
  disinvestment can be made at regular intervals by
  expanding or contracting the size of the fund
  (through making or cancelling units).

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Investment Trusts

• Investment trusts are a form of closed-ended
  fund. They are public companies whose function is
  to manage shares and/or other investments.
• Investment trusts have a board of directors who
  are responsible for the direction of the company,
  but day-to-day investment decisions are made by
  appointed investment managers.
• Investment trusts have stated investment
  objectives, outlined in the prospectus or offer
  for sale documents. It may also be stated in the
  articles of association.
• They have a capital structure like any other
  public company, and can raise both loan and
  equity capital.
• Many investment trusts are quoted on a stock
  exchange and their shares are bought and sold in
  the same way as other quoted shares.
• Fees generally levied as a of market value at
  nay time.
• Key in valuing such shares is the Net Asset Value
  (NAV) and the discount to NAV (see Actuarial
  Investment Course)

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Unit Trusts

• Unit trusts are an example of an open-ended fund.
  They are trusts in the legal sense, and, as such,
  are subject to trust law (as opposed to company
  law).
• The role of the trustees, as in any legal trust,
  is to ensure that the trust is managed according
  to the Trust Deed, and to hold the assets in
  trust for the unit holders.
• Unit trusts cannot borrow against their portfolio
  they can only invest the funds entrusted to
  them.
• Investors buy units in the trust, which will have
  a stated investment objective.
• Units can be created or redeemed with investors
  buying or selling the units from or to the
  managers.
• The managers can create more units for sale to
  investors or cancel them if supply exceeds
  demand.

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Pricing Unit Trusts

• Equity (in sense of fairness) considerations
  require that the unit price is set so that all
  the other unit-holders are financially
  indifferent to the marginal unit transaction.
• The underlying price of the unit is determined by
  the market price of the assets, divided by the
  number of units.
• But how such market price be determined?
• Offer price price of unit to buyer
• Bid price price of unit to seller
• Offer-pricing basis is the price of a unit when
  the marginal transaction in the fund is to create
  units (i.e., expanding fund).
• Give example
• Give example of pricing a unit trust on a
  bid-pricing basis.
• Fees are levied as an initial charge (often
  called a bid-offer spread) and an on-going charge
  as a of the market value.

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Other Types of Collective Investment Vehicle

• Open-ended investment companies are an example of
  a vehicle that is a cross between an investment
  trust and unit trust.
• They are open-ended and units are priced at NAV.
• They are governed by company law
• There is no bid-offer spread. Entry and exit
  charges are explicit.
• Internal unit funds offered by life companies
• Not companies in themselves but not subject to
  trust law.

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Concludes Chapter 4
Asset-Liability Management for Actuaries

• The Investment Environment
• tie-in with Actuarial Investment Course

Shane Whelan, L527