Retirement Plan Investing

Investment Policy

Communicates risk policy & degree of risk sponsor will assume

Investment Objective

desired result of investment process

Investment Objective

desired resulit of

Modern Portfolio Theory

Defines risk in terms of volatility of investment in relation to market

Purchasing Power Risk

Relationship between nominal rate of return on investment & increase in rate of inflation

Business RIsk

Company issuing investable stock experiences decline in earing power

Interest Rate Risk

Inverse relationship between interest rates & long term bond prices (interest up, bonds down). Value of long term bonds is affected by this.

Market Risk

Individual stock’s reaction to a change in the market (quantified by beta)

Specific Risks

Factors that are intrinsic to firm

Internal Rate of Return / “Dollar weighted rate of return”

rate that accumulates all cash flows of portfolio to exactly the market value of the ending balance. Effective for evaluating investment managers. 

Time Weighted Rate of Return

Computed by dividing interval under study into subintervals, who’s dates of cash flows into and out of fund, and by computing internal rate of return for each subinterval. 

CAPM Capital Asset Pricing Model

Uses standard statistical techniques (simple linear regression) to analyze relationship between returns of portfolio and market. 

Alpha Value

Portfolio’s amount of return, indepenent of the market.

Beta Value

Slope of line measured as change in vertical movement per unit of change in horizontal movement. Represents average return on portfolio per 1% return on market.

Dedication Program

Model expected schedule of liabilities under specific subset of plan. Computer search for acceptable bonds to produce cash flow needed.

Immunization Program

Create portfolio of bonds with market value equal to present value of liabilities. Will always be at least as great (value) as liabilities. 

Contingent Immunization

Sponsor accepts minimum rate of return on bond portfolio a % point or two below current market rate. 

Horizon Matching

splits liabilities into two portions: all liabilities that occur up to certain horizon (3-5 years) & liabilities beyond horizon and treated through immunization.