Pension Finance

Pension Finance......Page 4
Contents......Page 10
Preface......Page 18
1.1 Money-Market Securities......Page 22
1.2 Bonds and Loans......Page 26
1.3 Shares......Page 31
1.4.1 Unit Trusts and Open-Ended Investment Vehicles......Page 34
1.4.2 Investment Trusts......Page 36
1.4.3 Insurance Products......Page 37
1.4.4 Exchange-Traded Funds and Guaranteed Growth Funds......Page 38
1.5.1 Property......Page 39
1.5.3 Collectibles......Page 42
1.6.1 Forwards and Futures......Page 43
1.6.2 Options, Warrants and Convertibles......Page 47
1.6.3 Swaps......Page 53
1.6.4 Forward-Rate Agreements......Page 57
1.7 Alternative Investments......Page 58
1.7.1 Public Market Strategies......Page 59
1.7.2 Private Market or Private Equity Strategies......Page 65
1.7.3 Natural Resources......Page 68
1.8 Socially Responsible Investment......Page 69
1.9 Global Custody......Page 70
1.10.1 Asset Characteristics......Page 72
1.10.2 Asset Uses......Page 73
Questions......Page 82
Appendix: Standard Deviation, Value-At-Risk and Correlation......Page 83
References......Page 85
2.1 Introduction......Page 88
2.2 Modelling the Allocation of Personal Wealth to Different Asset Classes......Page 91
2.3 Conclusions......Page 95
Questions......Page 96
References......Page 97
3.1 The Valuation of Pension Liabilities: Differences Between the Actuarial and Economic Approaches......Page 98
3.2 Pensions and the Company Balance Sheet: Differences Between the Accounting and Economic Approaches......Page 100
3.3 The Asset Allocation of the Pension Fund......Page 104
3.3.1 A Fully Funded Pension Fund......Page 105
3.3.3 A Pension Fund with Liabilities Linked to Earnings Growth......Page 108
3.3.4 An Insured Pension Fund......Page 109
3.4.1 Profitability......Page 112
3.4.2 Credit Rating......Page 113
3.4.3 Share Price......Page 114
3.5 Conclusions......Page 117
Questions......Page 119
References......Page 120
4.1 The Optimal Design of DC Schemes During the Accumulation Phase......Page 122
4.1.1 Stochastic Pension Scheme Design......Page 123
4.1.2 Risk Factors......Page 125
4.1.3 Control Variables......Page 132
4.1.4 Simulation Output......Page 135
4.1.5 Choosing the Optimal Asset-Allocation Strategy......Page 143
4.1.6 The Trade-Off between Risk and Contribution Rates......Page 144
4.2.1 Types of Charges......Page 145
4.2.2 Reduction in Yield......Page 146
4.2.3 Reduction in Contributions......Page 148
4.2.4 Changing Charging Structures and the Impact of Hidden Charges......Page 151
4.3.1 Persistency Rates......Page 153
4.3.2 Adjusting Reported Charges for Policy Lapses......Page 154
4.4 Conclusions......Page 155
Questions......Page 156
Appendix: Charges......Page 158
A.1 Reduction in Yield......Page 159
A.2 Reduction in Contributions......Page 160
A.3 Adjusting for Lapse Rates......Page 161
References......Page 163
5.1 Annuities......Page 166
5.1.2 Coverage......Page 167
5.1.4 Other Features......Page 168
5.1.5 Payment Terms......Page 169
5.1.6 Decomposition of Annuity Charges......Page 173
5.1.7 Mortality Drag......Page 180
5.2 The Optimal Design of DC Schemes During the Distribution Phase......Page 182
5.2.1 Alternative Distribution Programmes......Page 183
5.2.2 Stochastic Pension Scheme Design......Page 187
5.2.3 Simulation Output......Page 195
5.2.5 The Annuitisation Decision......Page 204
5.3 Conclusions......Page 208
Questions......Page 209
References......Page 210
6.1 Types of Defined Benefit Scheme......Page 212
6.2 Defined Benefit Liabilities......Page 215
6.3 The Option Composition of Pension Schemes......Page 217
6.4 Valuing the Options......Page 220
6.5 The Pension Scheme Preferences of Members, Sponsors and Fund Managers......Page 227
6.6 Conclusions......Page 229
References......Page 230
7.1 The Role of a Pension Fund......Page 232
7.2 The Functions of a Pension Fund Manager......Page 238
7.3 Fund Management Styles......Page 239
7.4 Different Fund Management Strategies for Defined Benefit and Defined Contribution Schemes......Page 241
7.5.1 Determining the Trustees’ Objectives and Constraints......Page 245
7.5.2 Determining the Trustees’ Benchmark Portfolio......Page 246
7.5.3 Investment-Risk Budgeting......Page 252
7.6 Passive Fund Management......Page 254
7.7 Active Fund Management......Page 258
7.7.1 Active Share-Fund Management......Page 259
7.7.2 Active Bond-Fund Management......Page 264
7.7.3 Mixed Active–Passive Fund Management......Page 269
7.8 Asset–Liability Management......Page 271
7.8.1 Managing Surplus Risk......Page 274
7.8.2 Managing Contribution Risk......Page 280
7.8.3 Key ALM Strategies......Page 281
7.9 The Myners Review of Institutional Investment......Page 296
Questions......Page 302
Appendix 7A: Investment-Objectives Questionnaire......Page 304
Appendix 7B: Derivation of the Optimal Contribution Rate and Asset Allocation in a Defined Benefit Pension Fund......Page 308
References......Page 312
8.1 Ex Post Returns......Page 314
8.2 Benchmarks of Comparison for Actively Managed Funds......Page 317
8.3 Risk-Adjusted Measures of Portfolio Performance for Actively Managed Funds......Page 320
8.3.1 Performance Measures Based on Risk-Adjusted Excess Returns......Page 321
8.3.2 Performance Measures Based on Alpha......Page 323
8.4 Performance Attribution for Actively Managed Funds......Page 326
8.5 Liability-Driven Performance Attribution......Page 331
8.6.1 Investment Performance of DC Funds......Page 335
8.6.2 The Investment Performance of DB Funds......Page 338
8.7 Performance-Related Fund Management Fees......Page 345
8.8 How Frequently Should Fund Managers be Assessed?......Page 347
8.9 Conclusions......Page 349
Questions......Page 350
Appendix: Deriving the Power Function......Page 351
References......Page 353
9.1 The Objective of Hedging......Page 356
9.2 Hedging with Futures......Page 357
9.2.1 Hedging with Stock-Index Futures......Page 359
9.2.2 Hedging with Bond Futures......Page 361
9.2.3 Hedging with Currency Futures......Page 364
9.3.1 Hedging with Individual Stock Options......Page 365
9.3.2 Hedging with Stock-Index Options......Page 371
9.3.4 Hedging with Currency Options......Page 372
9.4 Hedging with Swaps......Page 373
9.5.1 Longevity Risk......Page 375
9.5.3 The Implications of Longevity Bonds......Page 379
9.5.4 Mortality-Linked Derivatives......Page 383
Questions......Page 384
References......Page 385
10.1 The Pension Protection Fund (PPF)......Page 388
10.2 What the Pension Protection Fund can Learn from Other Financial Institutions and Compensation Schemes......Page 389
10.2.1 The Financial Regulation of Banks......Page 390
10.2.2 The Financial Regulation of Life Assurers......Page 395
10.2.3 Financial Services Compensation Scheme......Page 403
10.2.4 The Financial Regulation of Pension Funds......Page 404
10.2.5 Pension Benefit Guaranty Corporation (PBGC)......Page 409
10.3 The Risks Facing the PPF......Page 411
10.3.1 Moral Hazard......Page 412
10.3.3 Systemic Risk......Page 413
10.4 Dealing with These Risks......Page 415
10.4.3 Risk-Based Premiums Linked to the Level of Underfunding......Page 416
10.4.4 A Funding Standard for Schemes......Page 417
10.4.5 Close Supervision and the Public Exposure of Companies that Underfund their Schemes......Page 418
10.5 Conclusions......Page 419
Questions......Page 420
Appendix: The Marcus (1987) and Vanderhei (1990) Models......Page 421
References......Page 429
A.1.1 Simple Interest......Page 432
A.1.3 Compound Interest: more Frequent Compounding......Page 433
A.2 Present Values: Single Payments......Page 435
A.2.2 Present Values: More Frequent Discounting......Page 436
A.3.1 Irregular Payments......Page 437
A.3.2 Regular Payments......Page 438
A.4.1 Irregular Payments......Page 439
A.4.3 Perpetuities......Page 440
A.5.1 Single-Period Rate of Return......Page 441
A.5.2 Internal Rate of Return or Money-Weighted Rate of Return......Page 442
A.5.3 Time-Weighted Rate of Return or Geometric Mean Rate of Return......Page 444
B.1.2 Yield to Maturity......Page 446
B.2.1 The Yield to Maturity Yield Curve......Page 448
B.2.2 The Coupon Yield Curve......Page 449
B.2.3 The Par (or Swap) Yield Curve......Page 450
B.2.4 The Spot (or Zero-Coupon) Yield Curve......Page 451
B.2.5 The Forward Yield Curve......Page 454
B.2.6 The Annuity Yield Curve......Page 457
B.2.7 Rolling Yield Curve......Page 458
C.1 Duration......Page 460
C.2 Convexity......Page 467
Index......Page 472