LA TROBE UNIVERSITY

SCHOOL OF ECONOMICS AND FINANCE

FIN5PMT PORTFOLIO MANAGEMENT

ASSIGNMENT 1: PORTFOLIO MANAGEMENT PROCESS AND ASSET

ALLOCATION

SUGGESTED SOLUTION

A. Construct the risk and return objectives portion of an investment policy

statement for UniLife’s portfolio segments. (4 marks)

Answer Question A in the template provided. Please attach extra pages if there is
not enough space.

Template for Question A

Investment Policy Statement for UniLife Portfolio Segments

Short-term portfolio:
The quality of commercial paper instruments should not be sacrificed.
The minimum acceptable quality for this portfolio is that at 90-day high
grade commercial paper.

Long-term bond portfolio:

A1-rating is the lowest quality corporate instruments that can be held in
this portfolio. Although UniLife seeks higher return from extending
maturity, minimum acceptable credit quality instruments are required to
meet the liability structure.
Risk
Objectives Stock portfolio:
(Risk The stock portfolio can accept market to above market levels of risk.
Tolerance) Growing the surplus is the focus. Maintaining a well diversified portfolio
is required including the maximum 5% international allocation, because
adding international equities to a diversified holding of domestic equities
has been shown to shift the efficient frontier upward (i.e., increased return
for given risk).

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 Short-term portfolio:
Return should meet the return for 90-day high grade commercial paper.
Returns of the short-term portfolio should meet the returns for Moody’s or
Standard and Poor’s 90-day benchmark commercial paper. Investment
returns from U.S. Treasuries are acceptable, but somewhat higher returns
are desirable for competitive positioning.

Long-term bond portfolio:

Return should exceed the crediting rate + operating expenses = 7%.
Since the purpose of this portfolio is to cover crediting rates and operating
expenses, the required return of this segment is 7% plus the desired spread
(i.e., 5%+2%+spread). Attention to opportunities in 10-year or longer A-
Return rated corporate instruments should be directed to attaining the required
Objectives after-tax return.

Stock portfolio:
Returns should meet or exceed the total returns to the designated
benchmarks, the S&P MidCap and S&P 500. The focus should be on growing
the surplus and providing a competitive advantage.

B. Construct the constraints portion of an investment policy statement for UniLife.

Address the time horizon, liquidity, legal/regulatory, tax, and unique
circumstances constraints. Address the time horizon and liquidity constraints for
each of UniLife’s portfolio segments. (6 marks)

Answer Question B in the template provided. Please attach extra pages if there is
not enough space.

Template for Question B

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 Short-term portfolio:
Very liquid, low risk, low return assets. The targeted time horizon for the
short-term portfolio is as short as 30 days and no longer than one year.

Long-term bond portfolio:

The targeted time horizon for the long-term portfolio is 10 to 20 years.
To minimize sensitivity to interest rates, a laddered maturity portfolio is
Time
appropriate. This laddered maturity structure represents a pseudo-cash
Horizon
flow matching strategy, in that bonds sequentially mature to meet liquidity
needs. Maturing short term bonds are replaced with bonds of maximum
maturity within the IPS guidelines.

Stock portfolio:
The time horizon for the stock portfolio is perpetual. Insurance companies
are taxable entities, so attention to investments with potential for capital
gains is encouraged.

Short-term portfolio:
Liquidity requirements for this portfolio are high. Access to cash when
needed to cover liability payments is paramount.

Long-term bond portfolio:

Liquidity requirements (i.e., the credited rates and net interest margin) of
the long-term portfolio are expected to be met from the laddered maturity
Liquidity schedule inherent in the instruments selected. Periodic income payments
generated by instruments in the portfolio can be used to meet shorter term
liquidity needs.

Stock portfolio:
The liquidity requirements for the stock portfolio are low. Liquidity will be
provided by the short-term portfolio and to a lesser extent, the long-term
bon portfolio.

Numerous state regulations and general provisions of the NAIC govern the
Legal/ activities of insurance companies. Therefore, operating divisions should
Regulatory meet with appropriate counsel for advice on regulatory matters.

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 Operations are taxable are both the state and federal level. Within risk
Taxes objectives, investments in instruments that generate the highest after-tax
total return are encouraged.

Competition in the life insurance market requires the UniLife investment

Unique portfolio to be flexible to a changing market environment. Contribution to
Circumstances an overall positive interest margin is a competitive reality and should be
considered in all investment decisions.