Professional Documents
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OVERVIEW
There two broad classes of investors active in capital markets:
Individual and Institutional investors
Institutional investors are corporations or other legal entities that ultimately serve as financial intermediaries between individuals and investment markets. They represent large pools of money Institutional investors have attained great importance - in many cases dominance in financial markets worldwide. Institutional investors have also made important contributions to the advancement of investment knowledge and techniques, spurred by the challenges of effectively managing large amounts of money.
PENSION FUNDS
Pension funds contain assets that are set aside to support a promise of retirement income. Pension plans divide principally into one of two broad types, based on the nature of the promise that was made. They are either defined-benefit (DB) plans or defined-contribution (DC) plans. A define-benefit plan is a pension plan that specifies the plan sponsors obligations in terms of the benefit to plan participants.
Return Objectives
A DB pension plans broad return objective is to achieve returns that adequately fund its pension liabilities on an inflation-adjusted basis.
In setting return objectives, the pension sponsor may also specify numerical return objectives.
For a DB pension plan, the return requirement (in the sense of the return the plan needs to achieve on average) depends on a number of factors, including the current funded status of the plan and pension contributions in relation to the accrual of pension benefits. If pension assets equal the present value of pension liabilities and if the rate of return earned on the assets equals the discount rate used to calculate the present value of the liabilities, then pension assets should be exactly sufficient to pay for the liabilities as they mature.
Liquidity Requirement
A DB pension fund receives pension contributions from its sponsor and disburses benefits to retirees. The net cash outflow (benefit payments minus pension contributions) constitutes the pensions plan liquidity requirement.
Time Horizon
The investment time horizon for a DB plan depends on the following factors:
Whether the plan is a going concern or plan termination is expected. The age of the workforce and the proportion of active lives. When the workforce is young and active lives predominate, and when the DB plan is open to new entrants, the plans time horizon is longer. The overall time horizon for many going-concern DB plans is long.
FOUNDATIONS AND ENDOWMENTS Foundations and endowments provide vital support for much of todays philanthropic and charitable activities. Foundations are typically grant-making institutions funded by gifts and investment assets. Endowments, on the other hand, are long-term funds generally owned by operating nonprofit institutions such as universities and colleges, museums, hospital, and other organizations involved in charitable activities.
FOUNDATIONS
Private foundations typically are created and funded by a single donor to fund philanthropic goals.
The investment portfolio provides the dominant source of revenue, and the purchasing power of its corpus is either maintained or eventually given away.
Endowments, are often built up over time by many individual gifts to the endowed institution. Spending distributions are determined by the beneficiary institution, supplementing other revenue sources such as tuition, grants, fees or gifts for current use. Prominent endowments, such as those of Harvard, Yale and Princeton universities, have grown along with their institutions over centuries.
Another distinctive characteristic of the foundation sector, in contrast to endowments, is that most private and family foundations must generate their entire grantmaking and operating budget from their investment portfolio for the following reasons:
These institutions generally do not engage in fund-raising campaigns; They may not receive any new contributions from the donor; and they do not receive any public support.
These unique conditions held to guide the investment approach taken by foundations. Private and family foundations are subject to a payout requirement that mandates a minimum level of spending. Foundations can have a higher risk tolerance.
Return Objectives
Foundations differ in their purposes, and so vary in their return objectives. Some foundations are meant to be short lived; others are intended to operate in perpetuity. For those foundations with an indefinitely long horizon, the long-term return objective is to preserve the real (inflation-adjusted) value of the investment assets while allowing spending at an appropriate (either statutory or decided-upon) rate.
Liquidity Requirements
A foundations liquidity requirements are anticipated or unanticipated needs for cash in excess of contributions made to the foundation.
Time Horizon
The majority of foundation wealth resides in private and other foundations established or managed with the intent of lasting into perpetuity. Some institutions, however, are created to be spent down over a predefined period of time; therefore, they pursue a different strategy, exhibiting an increasing level of conservatism as time passes.
Endowments
Endowments play a critical role in the vitality and success of todays charitable activity. As the long-term investment portfolios of nonprofit operating institutions, endowments provide a significant amount of budgetary support for universities, colleges, private schools, hospitals, museums and religious organizations. The term endowment has taken on two related but distinct meanings.
As commonly understood, an endowment is simply the longterm investment portfolio of a charitable organization. Legally and formally, however, the term endowment refers to a permanent fund established by a donor with the condition that the fund principal be maintained over time.
Most endowed institutions determine spending through policies based on total return as reflected in market values. Spending is typically calculated as a percentage, usually between 4 percent and 6 percent of endowment market value.
Risk Objectives
An endowments investment risk should be considered in conjunction with its spending policy and in the context of its long-term objective of providing a significant, stable, and sustainable stream of spending distributions.
Return Objectives
Endowments have high return objectives, reflecting the goal of providing a significant, stable, and sustainable flow of income to operations. An endowments returns need to exceed the spending rate to protect against a long-term loss of purchasing power. Calculating the return objective as the sum of the spending rate, the expected inflation rate, and the cost of generating investment returns can serve as a starting point for determining an endowments appropriate return objective.
Liquidity Requirements
The perpetual nature and measured spending of true endowments limit their need for liquidity. They must, however, have cash to make spending distributions, to meet capital commitments, and to facilitate portfolio-rebalancing transactions. In general, endowments are well suited to invest in illiquid, nonmarketable securities given their limited need for liquidity.
Time Horizon
In principle, endowment time horizons are extremely long term because of the objective of maintaining purchasing power in perpetuity.
HEDGE FUNDS
Hedge funds
The term hedge fund is commonly used to describe a variety of different types of investment vehicles that share some similar characteristics.
Return Objective
Positive absolute returns under all market conditions, without regard to a particular benchmark. Usually managers also commit their own money; therefore, the preservation of capital is very important The performance of many hedge funds historically has not been highly correlated with overall market performance, thus accounting for their inclusion in the portfolios of wealthy individuals and institutional investors who seek a broad diversification of their investments.
Mark-to-market practices, the discipline of periodically valuing positions at current market prices may be imposed through external accounting or regulatory requirements, or through internal risk management practices. In addition, mark-to-market practices may be imposed through counterparties valuation of trading exposures and collateral. This discipline is useful for preventing the concealment of losses and for encouraging the timely resolution of problems. While they may not necessarily be required to do so, hedge funds generally practice this discipline. The use of mark-to-market valuation for managing collateral and variation margin to mitigate credit risk can impose cash flow and liquidity strains on a trading entity. Such liquidity and cash flow problems can be particularly severe for a highly leveraged trading vehicle, especially during episodes of extreme price volatility when mark-to-market driven collateral and margin calls can impose a very short time frame for resolving liquidity problems.
Leverage
Hedge funds obtain economic leverage in various ways:
short positions, and derivative contracts
hedge funds use of leverage, combined with any structured or illiquid positions whose full value cannot be realized in a quick sale, can potentially make them somewhat fragile institutions that are vulnerable to liquidity shocks
Active trading
Active trading, which is typical of hedge funds, is a practice in which investment positions are changed with high frequency. Such trading may be conducted to maintain a desired risk return profile as market prices fluctuate, or it may be conducted to attempt to profit from short term changes in prices. Active trading strategies rely on market liquidity and access to credit to meet funding needs. An entitys ability to trade actively can diminish either because creditworthiness concerns cause counterparties to cut trading and credit limits or because of a broader disappearance of market liquidity. The inability to execute active trading strategies can lead to unexpectedly large mark-to-market losses as positions that had been thought of as modifiable exposures become longer-term positions.
Incentive structure
Typically 1-2% management fee and 15-25% performance fee. Quite often high watermarks apply (i.e. performance fees are paid only if cumulative performance recovers any past shortfalls) and/or a certain hurdle rate must be exceeded before managers may receive any incentive allocation.
Subscription/Withdrawal
Predefined schedule with quarterly or monthly subscription and redemption. Lock-up periods for up to one year until first redemption. Some hedge funds retain the right to suspend redemptions under exceptional circumstances.
Managers
May or may not be registered or regulated by financial supervisors. Managers serve as general partners in private partnership agreements.
Investor base
High net worth individuals and institutional investors. High minimum investment levels. Not widely available to the public. Securities issued take the form of private placements.
Regulation
Generally minimal or no regulatory oversight due to their offshore residence or light touch approach by onshore regulators; exempt from many investor protection and disclosure requirements.
Disclosure
Voluntary or very limited disclosure requirements in comparison with registered investment funds.
Global Macro
Global macro managers carry long and short positions in any of the worlds major capital or derivative markets. These positions reflect their views on overall market direction as influenced by major economic trends and/or events. The portfolios of these funds can include stocks, bonds, currencies and commodities in the form of cash or derivatives instruments. Most funds invest globally in both developed and emerging markets.
Event Driven
These strategies are defined as special situations investing, designed to capture price movements generated by a significant pending corporate event such as a merger, corporate restructuring, liquidation, bankruptcy or reorganisation.
Convertible Arbitrage
This strategy is identified by hedged investing in the convertible securities of a company. A typical investment is long in the convertible bond and short in the common stock of the same company. Positions are designed to generate profits from the fixed income security as well as the short sale of stock, while protecting principal from market moves.
Fund of Funds
A fund will employ the services of two or more trading advisors or hedge funds who/which will be allocated cash to trade on behalf of the fund.
SWF
the new power broker in financial market..
Edwin M. Trumanbefore the U.S. House Committee on Banking, Housing, and Urban Affairs, November 2007 Separate pools of international assets owned and managed by governments to achieve a variety of economic and financial objectives. They sometimes hold domestic assets as well.
Deutsche Bank, September 2007 Sovereign wealth fundsor state investment fundsare financial vehicles owned by states which hold, manage, or administer public funds and invest them in a wider range of assets of various kinds. Their funds are mainly derived from excess liquidity in the public sector stemming from government fiscal surpluses or from official reserves at central banks.
SWFInstitute
A Sovereign Wealth Fund (SWF) is a state-owned investment fund or entity that is commonly established from balance of payments surpluses, official foreign currency operations, the proceeds of privatizations, governmental transfer payments, fiscal surpluses, and/or receipts resulting from resource exports. The definition of sovereign wealth fund exclude, among other things, foreign currency reserve assets held by monetary authorities for the traditional balance of payments or monetary policy purposes, state-owned enterprises (SOEs) in the traditional sense, governmentemployee pension funds (funded by employee/employer contributions), or assets managed for the benefit of individuals.
U.S. Treasury, June 2007 There is no single universally accepted definition of an SWF. the term SWF means a government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from the official reserves of the monetary authorities.
Sovereign Wealth Funds (SWFs) are becoming important in the global financial system
High oil prices, financial globalization, and sustained, large global imbalances have resulted in the rapid accumulation of foreign assets particularly by oil exporters and several Asian countries. SWFs have diverse legal, institutional, and governance structures.
Investment Strategies
Long term investment horizon No explicit Liability Preference for returns over liquidity
In 1992, the U.S. had passed a specific act to review any state-controlled investment that would raise a national security concern.
Santiago Principles
The International Working Group of Sovereign Wealth Funds, with the assistance of the IMF, has developed the voluntary generally accepted principles and practices for SWFs (also known as the Santiago Principles).
1.
Fund provides history including reason for creation, origins of wealth, and government ownership structure 2. Fund provides up-to-date independently audited annual reports 3. Fund provides ownership percentage of company holdings, and geographic locations of holdings 4. Fund provides total portfolio market value, returns, and management compensation 5. Fund provides guidelines in reference to ethical standards, investment policies, and enforcer of guidelines 6. Fund provides clear strategies and objectives 7. If applicable, the fund clearly identifies subsidiaries and contact information 8. If applicable, the fund identifies external managers 9. Fund manages its own web site 10. Fund provides main office location address and contact information such as telephone and fax.
Determinants of Investments
Physical Closeness Trade Closeness Industrial Closeness Ethnic Closeness Language Closeness Religious Closeness Stock Market Development Judicial Efficiency Risk of Expropriation Accounting Standards
SEGMENTWISE REPRESENTATIONS
Basic materials Consumer goods Consumer services Financials Healthcare Industrials Oil & Gas Technology Telecom Utilities
Holding Pattern
SEGMENTS BASIC MATERIALS CONSUMER GOODS ABU DHABI 17.60 0.40 NORWAY 3.60 8.10 SINGAPORE KUWAIT CHINA
CONSUMER SERVICES
FINANCIALS HEALTHCARE INDUSTRIES OIL & GAS TELECOM TECHNOLOGY
0.10
15.00 0.20 3.60 60.30 0.90 1.90
12.80
25.50 6.60 9.70 6.70 6.80 3.80
6.30
91.10 0.20 1.70 0.10 0.60 6.60 5.30 93.40 94.70
UTILITIES
16.40