RSM336 lecture 4

Base Canadian Pension Plan

• Covers 25% of income

• Partially funded (40% from account, rest from govt)

• Lower risk tolerance

Additional CPP

• Provide additional pension

• 33% of income

• Fully funded (account assets must cover 100%)

Separation property

For very risk averse investors combine:

1. Optimal risky portfolio

2. Risk free asset

Issues with mean variance optimization

1. Optimization is sensitive to inputs

2. Optimization generates concentrated portfolios

3. Risk = standard dev, but may not be investors risk objective

Strategic → policy portfolio

• Focus on long term expected asset returns

• Designed to meet investors long term objective (5 to 10+ years)

Tactical → active management

• Focus on short term expected asset returns

• (12 to 24 months)

• Change asset allocation of portfolio relative to policy portfolio

Active management use 2 techniques to outperform policy portfolio

1. Tactical asset allocation - outperform policy portfolio next year

2. Security selection - outperform market index

Total portfolio approach

• Consider fund as a whole

• Look for best opportunities → not asset class

Portfolio management process step 1

• KYC (know your client)

• Statement of investment policies and procedures

• Legal requirement

Taxation of portfolio returns

• Pension funds are tax exempt

• Investment returns earned by insurance companies are fully taxable

• Must pay tax on interest income, dividends and capital gains

Defined benefit plan

• Liabilities must be funded

• Plan sponsor is financially responsible for covering any deficit in traditional pension plan

• Calculated using actuarial valuation